PAGE 1
Combined Prospectus, dated May 1, 1997, should be inserted here.
<PAGE>
PROSPECTUS
May 1, 1997
T. Rowe Price Funds
Prime Reserve New Income Equity Income International Stock
A selection of stock, bond, and money market funds to help investors meet their
financial objectives.
<PAGE>
FACTS AT A GLANCE
Investment Goal
Each of the four funds seeks the highest total return over time consistent with
its particular investment strategy and level of potential risk. There is no
assurance the funds will achieve their goal.
Strategies and Risk/Reward
Prime Reserve Fund A money market fund seeking preservation of capital,
liquidity, and, consistent with these goals, the highest possible income
through investments in high-quality money market securities. Risk/Reward Lowest
potential risk and reward.Your investment in the fund is neither insured nor
guaranteed by the U.S. government, and there is no assurance the fund will be
able to maintain a stable net asset value of $1.00 per share.
New Income Fund A bond fund seeking the highest level of income consistent with
the preservation of capital over time through investments primarily in
marketable debt securities. Risk/Reward Potential for moderate to high income
with commensurate share price fluctuation.
Equity Income Fund A conservative stock fund with the potential for dividend
income and some capital appreciation by investing primarily in dividend-paying
common stocks of established companies. Risk/Reward Lower risk than a fund
focusing on growth stocks, but greater risk than a bond fund.
International Stock Fund/(R)/ Invests worldwide primarily in well-established,
non-U.S. companies. Risk/Reward The fund's share price will fluctuate with
changes in market, economic, and foreign currency exchange conditions. High
potential risk and reward.
Investor Profile
Investors should select funds that closely match their goals (e.g.,
preservation of principal or capital appreciation) and investment time horizons
(e.g., short or long term). The funds are appropriate for both regular and
tax-deferred accounts, such as IRAs.
Fees and Charges
100% no load. No sales charges; free telephone exchange; no 12b-1 marketing
fees.
Investment Manager
The Prime Reserve, New Income, and Equity Income Funds are managed by T. Rowe
Price Associates, Inc. ("T. Rowe Price"), which was founded in 1937 and managed
over $99 billion as of December 31, 1996. The International Stock Fund is
managed by Rowe Price-Fleming International, Inc. ("Price-Fleming"), a joint
venture established in 1979 between T. Rowe Price and Robert Fleming Holdings,
Ltd. which managed over $29 billion as of December 31, 1996.
<PAGE>
T. Rowe Price
Prime Reserve Fund, Inc. New Income Fund, Inc. Equity Income Fund International
Funds, Inc.
Prospectus
May 1, 1997
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<PAGE>
T. ROWE PRICE 2
CONTENTS
1
ABOUT THE FUNDS
Transaction and Fund Expenses 2
Financial Highlights 4
Fund, Market, and Risk Characteristics 8
2
ABOUT YOUR ACCOUNT
Pricing Shares and Receiving Sale Proceeds 26
Distributions and Taxes 27
Transaction Procedures and Special Requirements 30
3
MORE ABOUT THE FUNDS
Organization and Management 34
Understanding Performance Information 38
Investment Policies and Practices 40
4
INVESTING WITH T. ROWE PRICE
Account Requirements and Transaction Information 60
Opening a New Account 60
Purchasing Additional Shares 62
Exchanging and Redeeming 62
Shareholder Services 64
Discount Brokerage 66
Investment Information 67
This prospectus contains information you should know before investing. Please
keep it for future reference. A Statement of Additional Information about the
funds, dated May 1, 1997, has been filed with the Securities and Exchange
Commission and is incorporated by reference in this prospectus. To obtain a free
copy, call 1-800-638-5660.
<PAGE>
ABOUT THE FUNDS
1
TRANSACTION AND FUND EXPENSES
----------------------------------------------------------
o Like all T. Rowe Price funds, these funds are 100% no load.
These tables should help you understand the kinds of expenses you will bear
directly or indirectly as a fund shareholder.
Shareholder Transaction Expenses in Table 1 shows that you pay no sales
charges. All the money you invest in a fund goes to work for you, subject to
the fees explained below. Annual Fund Expenses provides an estimate of how
much it will cost to operate each fund for a year, based on fiscal year
expenses. These are costs you pay indirectly, because they are deducted from
the funds' total assets before the daily share price is calculated and before
dividends and other distributions are made. In other words, you will not see
these expenses on your account statement.
<TABLE>
Table 1
<CAPTION>
<S> <C> <C> <C> <C> <C>
Shareholder
Transaction Expenses
Prime New Equity International
Reserve Income Income Stock
Sales charge "load" on
purchases None None None None
Sales charge "load" on
reinvested
distributions None None None None
Redemption fees None None None None
Exchange fees None None None None
Annual Fund Expenses Percentage of Fiscal Year Average Net Assets/a/
Prime New Equity International
Reserve Income Income Stock
Management fee 0.38% 0.48% 0.58% 0.68%
Marketing fees (12b-1) None None None None
Total other
(shareholder
servicing, custodial,
auditing, etc.) 0.28% 0.27% 0.23% 0.20%
Total fund expenses 0.66% 0.75% 0.81% 0.88%
- -------------------------------------------------------------------------------
</TABLE>
/a/ Expenses are expressed as a percent of fiscal year 1996.
Note: A $5 fee is charged for wire redemptions under $5,000, subject to change
with notice, and a $10 fee is charged for small accounts, when applicable (see
Small Account Fee under Transaction Procedures and Special Requirements).
<PAGE>
T. ROWE PRICE 4
The main types of expenses, which all mutual funds may charge against fund
assets, are:
o A management fee The percent of fund assets paid to the fund's investment
manager. Each fund's fee comprises both a group fee, 0.33% as of December 31,
1996, and an individual fund fee, as follows: 0.05% for the Prime Reserve
Fund, 0.15% for the New Income Fund, 0.25% for the Equity Income Fund, and
0.35% for the International Stock Fund.
o "Other" administrative expenses Primarily the servicing of shareholder
accounts, such as providing statements and reports, disbursing dividends, and
providing custodial services. For the years ended May 31, 1996 (Prime Reserve
and New Income Funds), December 31, 1996 (Equity Income Fund) and October 31,
1996 (International Stock Fund), the funds paid the fees shown in Table 5 to
T. Rowe Price Services, Inc. for transfer and dividend disbursing functions
and shareholders services; T. Rowe Price Retirement Plan Services, Inc. for
recordkeeping services for certain retirement plans; and T. Rowe Price for
accounting services.
o Marketing or distribution fees An annual charge ("12b-1") to existing
shareholders to defray the cost of selling shares to new shareholders. T.
Rowe Price funds do not levy 12b-1 fees.
For further details on fund expenses, please see Organization and Management.
o Hypothetical example Assume you invest $1,000, the fund returns 5% annually,
expense ratios remain as listed previously, and you close your account at the
end of the time periods shown. Your expenses would be:
<TABLE>
Table 2
<CAPTION>
<S> <C> <C> <C> <C> <C>
Hypothetical Fund Expenses
Fund 1 year 3 years 5 years 10 years
Prime Reserve $7 $21 $37 $82
New Income 8 24 42 93
Equity Income 8 26 45 100
International Stock 9 28 49 108
- ---------------------------------------------------------------------------------
</TABLE>
o Table 2 is just an example; actual expenses can be higher or lower than
those shown.
<PAGE>
ABOUT THE FUNDS 5
FINANCIAL HIGHLIGHTS
----------------------------------------------------------
Table 3, which provides information about each fund's financial history, is
based on a single share outstanding throughout each fiscal year. Each fund's
table is part of the financial statements which are included in its annual
report, and are incorporated by reference into the Statement of Additional
Information (available upon request). The financial statements in each fund's
annual report were audited by the funds' independent accountants.
<TABLE>
Table 3 Financial Highlights
<CAPTION>
<S> <C> <C> <C>
Income From Investment Activities
PeriodEnded Net AssetValue,Beginningof Period NetInvestmentIncome
Prime Reserve
1987 $1.000 $0.059
1988/a/ 1.000 0.063
1989 1.000 0.072
1990 1.000 0.085
1991 1.000 0.073
1992/a/ 1.000 0.051
1993 1.000 0.030
1994 1.000 0.026
1994/b/ 1.000 0.008
1995 1.000 0.047
1996 1.000 0.051
- ---------------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C> <C>
Less Distributions
Net Realized& UnrealizedGain (Loss) onInvestments Total FromInvestmentActivities Net
-- $0.059 $(0.059)
--
-- 0.063 (0.063)
--
-- 0.072 (0.072)
--
-- 0.085 (0.085)
--
-- 0.073 (0.073)
--
-- 0.051 (0.051)
--
-- 0.030 (0.030)
--
-- 0.026 (0.026)
--
-- 0.008 (0.008)
--
-- 0.047 (0.047)
--
-- 0.051 (0.051)
- --------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C> <C>
Net Realized
Gain
-- $(0.059) $1.000
--
-- (0.063) 1.000
--
-- (0.072) 1.000
--
-- (0.085) 1.000
--
-- (0.073) 1.000
--
-- (0.051) 1.000
--
-- (0.030) 1.000
--
-- (0.026) 1.000
--
-- (0.008) 1.000
--
-- (0.047) 1.000
--
-- (0.051) 1.000
- -------------------------------------------------
</TABLE>
Footnotes appear on page 5. (continued on next page)
<PAGE>
T. ROWE PRICE 6
<TABLE>
Table 3 Financial Highlights (continued)
<CAPTION>
<S> <C> <C> <C>
Returns, Ratios, and Supplemental Data
Total Return(IncludesReinvestedCistributions) Net Assets($thousands)
Prime Reserve
1987 6.0 % $2,633,001
1988/a/ 6.5 % 3,424,753
1989 7.5 % 4,063,417
1990 8.8 % 4,841,954
1991 7.6 % 4,753,267
1992/a/ 5.3 % 4,115,224
1993 3.1 % 3,596,590
1994 2.6 % 3,378,976
1994/b/ 0.8 % 3,627,255
1995 0.7 % 3,840,778
1996 5.3 % 4,011,000
- ---------------------------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C>
Ratio ofExpenses toAverage NetAssets Ratio of NetInvestmentIncome toAverage NetAssets
0.76 % 5.89 %
0.79 % 6.37 %
0.79 % 7.29 %
0.75 % 8.45 %
0.75 % 7.33 %
0.78 % 5.14 %
0.75 % 3.04 %
0.74 % 2.56 %
0.73 %/b/ 3.02 %/b/
0.67 % 4.76 %
0.66 % 5.07 %
- -------------------------------------------------------------------------------------------------
</TABLE>
/a/ Year ended February 29.
/b/For the three months ended May 31, 1994. Fiscal year-end changed from
February 28 to May 31. All ratios are annualized.
<TABLE>
Table 3 Financial Highlights
<CAPTION>
<S> <C> <C> <C>
Income From Investment Activities
Net AssetValue,Beginningof Period NetInvestmentIncome
New Income
1987 $8.95 $0.75
1988/c/ 9.17 0.76
1989 8.76 0.81
1990 8.26 0.75
1991 8.37 0.70
1992/c/ 8.60 0.67
1993 8.94 0.57
1994 9.24 0.54
1994/d/ 9.12 0.14
1995 8.65 0.58
1996 8.97 0.60
- ----------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C> <C>
Less Distributions
Net Realized& UnrealizedGain (Loss)onInvestments Total FromInvestmentActivities NetInvestmentIncome (Loss)
$0.22 $0.97 $(0.75 )
(0.41 ) 0.35 (0.76 )
(0.50 ) 0.31 (0.81 )
0.12 0.87 (0.75 )
0.24 0.94 (0.70 )
0.36 1.03 (0.67 )
0.30 0.87 (0.57 )
(0.05 ) 0.49 (0.54 )
(0.40 ) (0.26 ) (0.14 )
0.34 0.92 (0.58 )
(0.27 ) 0.33 (0.60 )
- ----------------------------------------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C> <C>
Net AssetValue
Net RealizedGain (Loss) TotalDistributions Net AssetValue,End of Period
-- $(0.75 ) $9.17
--
-- (0.76 ) 8.76
--
-- (0.81 ) 8.26
$(0.01 ) (0.76 ) 8.37
(0.01 ) (0.71 ) 8.60
(0.02 ) (0.69 ) 8.94
-- (0.57 ) 9.24
(0.07 ) (0.61 ) 9.12
(0.07 ) (0.21 ) 8.65
(0.02 ) (0.60 ) 8.97
-- (0.60 ) 8.70
- ----------------------------------------------------------------------------------
</TABLE>
Footnotes appear on page 6. (continued on next page)
<PAGE>
ABOUT THE FUNDS 7
<TABLE>
Table 3 Financial Highlights (continued)
<CAPTION>
<S> <C> <C> <C>
Returns, Ratios, and Supplemental Data
Total Return(IncludesReinvestedDistributions) Net Assets($ thousands)
New Income
1987 11.2 % $939,078
1988/c/ 4.3 % 834,487
1989 3.7 % 860,231
1990 10.7 % 992,566
1991 11.8 % 1,130,857
1992/c/ 12.4 % 1,306,674
1993 10.1 % 1,527,299
1994 5.4 % 1,457,959
1994/d/ (2.8 )% 1,375,056
1995 11.1 % 1,566,903
1996 3.70 % 1,634,000
- -----------------------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C> <C>
Ratio ofExpenses toAverage NetAssets Ratio of NetInvestmentIncome toAverage NetAssets PortfolioTurnover Rate/b/
0.65 % 8.22 % 125.4 %
0.80 % 8.77 % 157.9 %
0.91 % 9.50 % 91.8 %
0.86 % 8.85 % 51.1 %
0.88 % 8.33 % 20.7 %
0.87 % 7.64 % 49.7 %
0.84 % 6.36 % 85.8 %
0.82 % 5.77 % 58.3 %
0.80 %/d/6.43 %/d/ 91.5 %/d/
0.78 % 6.95 % 54.1 %
0.75 % 6.66 % 35.5 %
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
/a/Total return reflects the following capital gain distributions: long-term
gains of $0.01, $0.07 on 1/4/78 and 12/31/93, respectively, short-term gains
of $0.01 and $0.02 on 12/31/90 and 12/31/91, respectively.
/b/Portfolio turnover rate prior to February 28, 1986 excludes long-term U.S.
government securities.
/c/ Year ended February 29.
/d/For the three months ended May 31, 1994. Fiscal year-end changed from
February 28 to May 31. All ratios are annualized.
<TABLE>
Table 3 Financial Highlights
<CAPTION>
<S> <C> <C> <C>
Income From Investment Activities
PeriodEnded Net AssetValue,Beginningof Period NetInvestmentIncome (Loss)
Equity Income
1987 12.96 0.64
1988 11.29 0.63
1989 13.38 0.77
1990 14.06 0.67
1991 12.27 0.62
1992 14.62 0.62
1993 15.63 0.54
1994 16.65 0.60
1995 15.98 0.66
20.01 0.64
- ---------------------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C>
Net Realized& UnrealizedGain (Loss) onInvestments Total FromInvestmentActivities
(0.14 ) 0.50
2.46 3.09
1.06 1.83
(1.62 ) (0.95 )
2.44 3.06
1.41 2.03
1.74 2.28
0.13 0.73
4.56 5.22
3.38 4.02
- --------------------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C> <C> <C>
Less Distributions Net AssetValue
NetInvestmentIncome (Loss) Net RealizedGain (Loss) TotalDistributions Net AssetValue,End of Period
(0.82 ) (1.35 ) (2.17 ) 11.29
(0.62 ) (0.38 ) (1.00 ) 13.38
(0.76 ) (0.39 ) (1.15 ) 14.06
(0.65 ) (0.19 ) (0.84 ) 12.27
(0.61 ) (0.10 ) (0.71 ) 14.62
(0.63 ) (0.39 ) (1.02 ) 15.63
(0.54 ) (0.72 ) (1.26 ) 16.65
(0.59 ) (0.81 ) (1.40 ) 15.98
(0.65 ) (0.54 ) (1.19 ) 20.01
(0.65 ) (0.84 ) (1.47 ) 22.54
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
T. ROWE PRICE 8
Footnotes appear on page 7. (continued on next page)
<TABLE>
Table 3 Financial Highlights (continued)
<CAPTION>
<S> <C> <C> <C>
Returns, Ratios, and Supplemental Data
Total Return(IncludesReinvestedDistributions)
Equity Income
1987 3.5 %/a/ 185,096
1988 27.6 500,922
1989 13.74 968,441
1990 (6.79 ) 862,059
1991 25.30 1,335,400
1992 14.13 2,091,535
1993 14.84 2,851,347
1994 4.53 3,203,851
1995 33.35 5,214,778
20.40 7,818,134
- ---------------------------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C> <C>
Ratio ofExpenses toAverage NetAssets Ratio of NetInvestmentIncome toAverage NetAssets PortfolioTurnoverRate
1.10 %/a/4.58 %/a/79.8 %
1.30 4.83 36.4
1.11 5.31 34.4
1.13 5.09 24.4
1.05 4.44 33.5
0.97 3.95 30.0
0.91 3.23 31.2
0.88 3.63 36.3
0.85 3.69 21.4
0.81 3.08 25.0
- -------------------------------------------------------------------------------------------------------------------------
<CAPTION>
<S> <C>
Average
Commission
Rate Paid
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
$ 0.0644
- --------------------
</TABLE>
a Excludes expenses in excess of a state expense limitation.
<TABLE>
Table 3 Financial Highlights
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Income From Investment Activities Less Distributions Net Asset Value
Net Asset Net Net Realized Total From Net Net Asset
Period Value, Investment & Unrealized Investment Investment Net Realized Total Value,
Ended Beginning Income (Loss) Gain (Loss) on Activities Income Gain Distributions End of Period
of Period Investments
International Stock
1987 $12.89 $0.12 $0.74 $0.86 $(0.23) $(4.98) $(5.21) $8.54
1988 8.54 0.16 1.36 1.52 (0.16) (0.93) (1.09) 8.97
1989 8.97 0.16 1.94 2.10 (0.16) (0.67) (0.83) 10.24
1990 10.24 0.22 (1.13) (0.91) (0.16) (0.36) (0.52) 8.81
1991 8.81 0.15 1.22 1.37 (0.15) (0.49) (0.64) 9.54
1992 9.54 0.14 (0.47) (0.33) (0.16) (0.16) (0.32) 8.89
1993/ 8.89 0.10 2.75 2.85 -- -- -- 11.74
b/
1994 11.74 0.09 1.30 1.39 (0.09) (0.20) (0.29) 12.84
1995 12.84 0.18 (0.19) (0.01) (0.12) (0.62) (0.74) 12.09
1996 12.09 0.19 1.57 1.76 (0.18) (0.20) (0.38) 13.47
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Footnotes appear on page 8. (continued on next page)
<PAGE>
ABOUT THE FUNDS 9
<TABLE>
Table 3 Financial Highlights (continued)
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
Returns, Ratios, and Supplemental Data
Total Return Ratio of Ratio of Net
Period (Includes Expenses to Investment Portfolio Average
Ended Reinvested Average Net Income to Turnover Commission
Distributions) Net Assets Assets Average Net Rate Rate Paid
($ thousands) Assets
International Stock
1987 8.0% $642,463 1.14% 0.93% 76.5% --
--
1988 17.9% 630,114 1.16% 1.78% 42.4% --
--
1989 23.7% 970,214 1.10% 1.63% 47.8% --
--
1990 (8.9 ) % 1,030,848 1.09% 2.16% 47.1% --
--
1991 15.87% 1,476,309 1.10% 1.51% 45.0% --
--
1992 (3.47)% 1,949,631 1.05% 1.49% 37.8% --
--
1993/ 32.06% 3,746,055 1.01%/c/ 1.52%/c/ 29.8%/c/ --
b/
--
1994 12.03% 6,205,713 0.96% 1.11% 22.9% --
--
1995 0.38% 6,385,905 0.91% 1.56% 17.8% --
1996 14.87% 8,776,736 0.88% 1.58% 11.6% $ 0.0020
- -----------------------------------------------------------------------------------------------
</TABLE>
/a/ All per-share figures reflect the 2-for-1 stock split effective August
31, 1987.
/b/ For the 10 months ended October 31, 1993. Fiscal year-end changed from
December 31 to October 31.
/c/ Annualized.
FUND, MARKET, AND RISK CHARACTERISTICS: WHAT TO EXPECT
----------------------------------------------------------
Prime Reserve Fund
To help you decide whether this fund is appropriate for you, this section
takes a closer look at its investment objective and approach.
What is the fund's objective?
The fund's objective is preservation of capital, liquidity, and, consistent
with these, the highest possible current income through investments primarily
in high-quality, money market securities.
o There is no assurance the fund will be able to maintain a stable net asset
value of $1.00 per share.
What is the fund's investment program?
The fund invests at least 95% of its total assets in prime money market
instruments, that is, securities receiving the highest credit rating assigned
by at least two established rating agencies, by one rating agency if the
security is rated
<PAGE>
T. ROWE PRICE 10
by only one, or, if unrated, the equivalent rating as established by T. Rowe
Price. The fund's dollar-weighted average maturity will not exceed 90 days.
It will not purchase any security with a maturity of more than 13 months. Its
yield will fluctuate in response to changes in interest rates, but the share
price is managed to remain stable at $1.00. Unlike most bank accounts or
certficates of deposit, the fund is not insured or guaranteed by the U.S.
government.
What is a money market fund?
A money market fund is a pool of assets invested in U.S. dollar-denominated,
short-term debt obligations with fixed or floating rates of interest and
maturities generally less than 13 months. Issuers can include the U.S.
government and its agencies, domestic and foreign banks and other
corporations, and municipalities. Money funds can be taxable or tax-exempt,
depending on their investment program. Because of the high degree of safety
they provide, money market funds typically offer the lowest return potential
of any type of mutual fund.
What are the main types of money market securities the fund can invest in?
o Commercial paper Unsecured promissory notes that corporations typically
issue to finance current operations and other expenditures.
o Treasury bills Debt obligations sold at discount and repaid at face value by
the U.S. Treasury. Bills mature in one year or less and are backed by the
full faith and credit of the U.S. government.
o Certificates of deposit Receipts for funds deposited at banks that guarantee
a fixed interest rate over a specified time period.
o Repurchase agreements Contracts, usually involving U.S. government
securities, that require one party to repurchase securities at a fixed price
on a designated date.
o Banker's acceptances Bank-issued commitments to pay for merchandise sold in
the import/export market.
o Agency notes Debt obligations of agencies sponsored by the U.S. government
that are not backed by the full faith and credit of the United States.
o Medium-term notes Unsecured corporate debt obligations that are continuously
offered in a broad range of maturities and structures.
o Bank notes Unsecured obligations of a bank that rank on an equal basis with
other kinds of deposits but do not carry FDIC insurance.
o For further details on the fund's investment program and practices, please
see the section entitled Investment Policies and Practices.
<PAGE>
ABOUT THE FUNDS 11
What are the main risks of investing in money market funds?
Since they are managed to maintain a $1.00 share price, money market funds
should have little risk of principal loss. However, the potential for
realizing a loss of principal in a bond or money market fund could derive
from:
o Credit risk The chance that any of the fund's holdings will have its credit
rating downgraded or will default (fail to make scheduled interest or
principal payments), potentially reducing the fund's income level and share
price. Regulations require that 95% of the holdings in money market funds be
rated in the highest credit category, and that the remaining 5% be rated no
lower than the second highest credit category.
o Interest rate or market risk The decline in the prices of fixed income
securities and funds that may accompany a rise in the overall level of
interest rates. A sharp and unexpected rise in interest rates could cause a
money fund's price to drop below a dollar. However, the extremely short
maturity of securities held in money market portfolios- a means of achieving
an overall fund objective of principal safety-reduces their potential for
price fluctuation.
How does the portfolio manager try to reduce risk?
Consistent with the fund's objective, the portfolio manager actively seeks to
reduce risk and increase total return. Risk management tools include:
o Diversification of assets to reduce the impact of a single holding on the
fund's net asset value.
o Thorough credit research by our own analysts.
o Maturity adjustments to reflect the fund manager's interest rate outlook.
What are derivatives and can the fund invest in them?
The term derivative is used to describe financial instruments whose value is
derived from an underlying security (e.g., a stock or bond) or a market
benchmark (e.g., an interest rate index). Many types of investments
representing a wide range of potential risks and rewards fall under the
"derivatives" umbrella-from conventional instruments such as callable bonds,
futures, and options, to more exotic investments such as stripped mortgage
securities and structured notes. While the term "derivative" has only
recently become widely known among the investing public, derivatives have in
fact been employed by investment managers for many years.
<PAGE>
T. ROWE PRICE 12
The fund does not invest in high-risk, highly leveraged derivatives, and it
will invest in derivatives only if the expected risks and rewards are
consistent with the fund's objective, policies, and overall risk profile as
described in this prospectus.
o You may want to review some fundamentals of money market securities.
Is the fund's yield fixed or will it vary?
It will vary. Yield is calculated every day by dividing the fund's net income
per share, expressed at annual rates, by the share price. Since income in the
fund will fluctuate as the short-term securities in its portfolio mature and
the proceeds are reinvested, its yield will vary.
Is the fund's "yield" the same thing as its "total return"?
Yes. The total return reported for the fund is the result of reinvested
distributions (income and capital gains) and the change in share price for a
given time period. Since money funds are managed to maintain a stable share
price, their yield and total return should be the same. Of course, there is
no guarantee a money fund will maintain a $1.00 share price.
What is "credit quality" and how does it affect a money market fund's yield?
Credit quality refers to a borrower's expected ability to make all required
interest and principal payments in a timely manner. Because highly rated
issuers represent less risk, they can borrow at lower interest rates than
less creditworthy issuers. Securities backed by the full faith and credit of
the U.S. government are regarded as free of credit risk. Among money market
securities, Treasury bills generally carry lower yields than other
instruments of comparable maturity.
What is meant by a money market fund's "maturity"?
Every money market instrument has a stated maturity date when the issuer must
repay the entire principal to the investor. The fund has no maturity in the
strict sense of the word, but does have a dollar-weighted average maturity,
expressed in days. This number is an average of the maturities of the
underlying instruments, with each maturity "weighted" by the percentage of
fund assets it represents.
Do money market securities react to changes in interest rates?
Yes. As interest rates change, the prices of money market securities
fluctuate, but changes are usually small because of their very short
maturities. Investments are typically held until maturity in a money fund to
help it maintain a $1.00 share price.
<PAGE>
ABOUT THE FUNDS 13
How can I decide if the fund is appropriate for me?
Review your own financial objectives, time horizon, and risk tolerance. For
example, a money fund is designed to provide principal stability, which makes
it a good choice for money you may need for occasional or unexpected expenses
and for money awaiting investment in longer-term bond or stock funds.
o An investment in the fund should help you meet your individual investment
goals for principal stability, liquidity, and income, but should not
represent your complete investment program.
Is there other information I need to review before making a decision?
Be sure to review Investment Policies and Practices in Section 3, which
discusses the following: Types of Portfolio Securities (money market
securities, asset-backed securities, foreign securities, and private
placements); and Types of Management Practices (borrowing money and
transferring assets, and lending of portfolio securities).
New Income Fund
To help you decide whether this fund is appropriate for you, this section
takes a closer look at its investment objective and approach.
What is the fund's objective?
The fund's objective is to provide the highest level of income consistent
with the preservation of capital over time through investment primarily in
marketable debt securities.
o The fund should not represent your complete investment program nor be used
for short-term trading purposes.
What is the fund's investment program?
At least 80% of the fund's total assets will be invested in income-producing,
investment-grade instruments, including (but not limited to) U.S. government
and agency obligations, mortgage-backed securities, corporate debt
securities, asset-backed securities, bank obligations, collateralized
mortgage obligations (CMOs), commercial paper, foreign securities, and
others. There are no maturity restrictions on securities purchased by the
fund, but the fund's dollar-weighted average maturity is generally expected
to be between 4 and 15 years.
o For further details on the fund's investment program and practices, please
see the section entitled Investment Policies and Practices.
<PAGE>
T. ROWE PRICE 14
What is the credit quality of the fund's investments?
Securities purchased by the fund must be rated within the four highest credit
categories by at least one established public rating agency (or, if unrated,
must have a T. Rowe Price equivalent) and the fund will not purchase any
security rated below investment grade by Standard & Poor's, Moody's, or Fitch
Investor Services. An investment-grade security can range from the highest
rating (AAA) to medium quality (BBB). Securities in the BBB category may be
more susceptible to adverse economic conditions or changing circumstances,
and the securities at the lower end of the BBB category have certain
speculative characteristics. The fund may retain a security that is
downgraded to a noninvestment-grade level after purchase.
Is the fund a substitute for a money market fund?
No. Money market funds, which have an average maturity substantially under
one year, ordinarily generate lower income in return for stability of net
asset value. The fund is designed to provide higher income than these funds
with commensurately greater price fluctuation. As such, it should be viewed
as a longer-term investment.
What are the most important influences on fund performance?
Performance (total return) is determined by the change in the fund's share
price and income level over a given period. Both components are affected by
changes in interest rates.
The fund's share price will generally move in the opposite direction of
interest rates. For example, as interest rates rise, share price will likely
decline. Rising rates provide the opportunity for the fund's income to
increase, but it is unlikely that the higher income by itself will entirely
offset the fall in price.
The maturity and type of securities in the fund's portfolio determine just
how much the share price rises or falls when rates change. Generally, when
rates fall, long-term securities rise more in price than short-term
securities, and vice versa. Mortgage-backed securities usually follow this
pattern but, because of prepayments, would not be expected to rise as much in
price as Treasury or corporate bonds.
You will find more information about the types of securities the fund may own
and how they may perform further on in this section and in Section 3.
What are the main risks of investing in the fund?
o Interest rate or market risk The decline in the prices of fixed income
securities and funds that may accompany a rise in the overall level of
interest rates (please see Table 4).
<PAGE>
ABOUT THE FUNDS 15
o Credit risk The chance that any of a fund's holdings will have its credit
rating downgraded or will default (fail to make scheduled interest or
principal payments), potentially reducing the fund's income level and share
price.
o Currency risk The possibility that the fund's foreign holdings will be
adversely affected by fluctuations in currency markets.
o The fund's share price will fluctuate; when you sell your shares, you may
lose money.
How does the portfolio manager try to reduce risk?
Consistent with the fund's objective, the portfolio manager actively seeks to
reduce risk and increase total return. Risk management tools include:
o Diversification of assets to reduce the impact of a single holding on the
fund's net asset value.
o Thorough credit research by our own analysts.
o Adjustment of fund duration to try to reduce the negative impact of rising
interest rates or take advantage of the benefits of falling rates.
What are derivatives and can the fund invest in them?
The term derivative is used to describe financial instruments whose value is
derived from an underlying security (e.g., a stock or bond) or a market
benchmark (e.g., an interest rate index). Many types of investments
representing a wide range of potential risks and rewards fall under the
"derivatives" umbrella-from conventional instruments such as callable bonds,
futures, and options, to more exotic investments such as stripped mortgage
securities and structured notes. While the term "derivative" has only
recently become widely known among the investing public, derivatives have in
fact been employed by investment managers for many years.
The fund will invest in derivatives only if the expected risks and rewards
are consistent with its objective, policies, and overall risk profile as
described in this prospectus. The fund limits its use of derivatives to
situations in which they may enable the fund to accomplish the following:
increase yield; hedge against a decline in principal value; invest in
eligible asset classes with greater efficiency and lower cost than is
possible through direct investment; or adjust the fund's duration.
The fund will not invest in any high-risk, highly leveraged derivative
instrument that is expected to cause the price volatility of the portfolio to
be meaningfully different than that of a long-term investment-grade bond.
<PAGE>
T. ROWE PRICE 16
o You may want to review some fundamentals that apply to all fixed income
investments.
Is the fund's yield fixed or will it vary?
It will vary. The yield is calculated every day by dividing the fund's net
income per share, expressed at annual rates, by the share price. Since both
income and share price will fluctuate, a fund's yield will also vary.
Is a fund's "yield" the same as "total return"?
Not for bond funds. The total return reported for a fund is the result of
reinvested distributions (income and capital gains) and the change in share
price for a given time period. Income is always a positive contributor to
total return and can enhance a rise in share price or serve as an offset to a
drop in share price.
What is "credit quality" and how does it affect the fund's yield?
Credit quality refers to a bond issuer's expected ability to make all
required interest and principal payments in a timely manner. Because highly
rated issuers represent less risk, they can borrow at lower interest rates
than less creditworthy issuers. Therefore, a fund investing in high-quality
securities should have a lower yield than an otherwise comparable fund
investing in lower credit-quality securities.
What is meant by a bond fund's "maturity"?
Every bond has a stated maturity date when the issuer must repay the bond's
entire principal value to the investor. However, many corporate and municipal
bonds are "callable," meaning their principal can be repaid before their
stated maturity dates on (or after) specified call dates. Bonds are most
likely to be called when interest rates are falling, because the issuer wants
to refinance at a lower rate. In such an environment, a bond's "effective
maturity" is usually its nearest call date. For example, the effective
maturity of mortgage-backed bonds is determined by the rate at which
homeowners pay down the principal on the underlying mortgages.
A bond mutual fund has no maturity in the strict sense of the word, but it
does have an average maturity and an average effective maturity. This number
is an average of the stated or effective maturities of the underlying bonds,
with each bond's maturity "weighted" by the percentage of fund assets it
represents. Funds that target effective maturities would use the effective
(rather than stated) maturities of the underlying instruments when computing
the average. Targeting
<PAGE>
ABOUT THE FUNDS 17
effective maturity provides additional flexibility in portfolio management
but, all else being equal, could result in higher volatility than a fund
targeting a stated maturity or maturity range.
What is meant by a bond fund's "duration"?
Duration is a calculation that seeks to measure the price sensitivity of a
bond or a bond fund to changes in interest rates. It measures bond price
sensitivity to interest rate changes more accurately than maturity because it
takes into account the time value of cash flows generated over the bond's
life. Future interest and principal payments are discounted to reflect their
present value and then are multiplied by the number of years they will be
received to produce a value that is expressed in years, i.e., the duration.
Effective duration takes into account call features and sinking fund payments
that may shorten a bond's life.
Since duration can also be computed for bond funds, you can estimate the
effect of interest rates on a fund's share price. Simply multiply the fund's
duration (available for T. Rowe Price bond funds in our shareholder reports)
by an expected change in interest rates. For example, the price of a bond
fund with a duration of five years would be expected to fall approximately 5%
if rates rose by one percentage point.
How is a bond's price affected by changes in interest rates?
When interest rates rise, a bond's price usually falls, and vice versa. In
general, the longer a bond's maturity, the greater the price increase or
decrease in response to a given change in interest rates, as shown in Table
4.
<TABLE>
Table 4
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
How Interest Rates Affect Bond Prices Price per $1,000 of Bond Face Value if Interest Rates:
Bond Maturity Coupon Increase1 Point 2 Points Decrease1 Point 2 Points
1 year 3.65% $ 990 $981 $ 1,010 $1,020
5 years 4.55 957 916 1,045 1,093
10 years 5.05 926 858 1,082 1,171
30 years 5.80 873 769 1,158 1,356
- ------------------------------------------------------------------------------------------------------
</TABLE>
Coupons reflect yields on Treasury securities as of December 31, 1996. This is
an illustration and does not represent expected yields or share price changes
of any T. Rowe Price fund.
How can I decide if the fund is appropriate for me?
Review your own financial objectives, time horizon, and risk tolerance to
choose a fund (or funds) suitable for your particular needs. The fund may be
appropriate for a variety of objectives. For instance, steadily reinvesting
the fund's income is a conservative strategy for building capital over time.
The
<PAGE>
T. ROWE PRICE 18
fund may also be appropriate if you are looking for a higher level of income
than provided by a shorter-term bond fund and can accept greater fluctuations
in share price. Keep in mind that the share price of any bond fund will
fluctuate. If you are investing for principal safety and liquidity, you
should consider a money market fund.
Is there other information I need to review before making a decision?
Be sure to review Investment Policies and Practices in Section 3, which
discusses the following: Types of Portfolio Securities (bonds, common and
preferred stocks, convertible securities and warrants, foreign securities,
asset-backed securities, mortgage-backed securities, hybrid instruments,
private placements, and utility industry concentration); and Types of
Management Practices (cash position, borrowing money and transferring assets,
futures and options, managing foreign exchange risk, lending of portfolio
securities, when-issued securities and forward commitment contracts, and
portfolio turnover).
Equity Income Fund
To help you decide whether this fund is appropriate for you, this section
takes a closer look at its investment objective and approach.
o The fund should not represent your complete investment program nor be used
for short-term trading purposes.
What is the fund's objective?
The fund's objective is to provide substantial dividend income as well as
long-term capital appreciation through investments in common stocks of
established companies.
What is the fund's investment program?
Under normal circumstances, the fund will invest at least 65% of total assets
in the common stocks of established companies paying above-average dividends.
These companies are expected to have favorable prospects for dividend growth
and capital appreciation, as determined by T. Rowe Price.
The fund may also purchase other types of securities, for example, foreign
securities, convertible stocks and bonds, and warrants, when considered
consistent with the fund's investment objective and program. The portfolio
manager may also engage in a variety of investment management practices, such
as buying and selling futures and options.
<PAGE>
ABOUT THE FUNDS 19
What are the fund's major characteristics?
T. Rowe Price believes that income can be a significant contributor to total
return over time and expects the fund's yield to be above that of the
Standard & Poor's 500 Stock Index. The fund will tend to take a "value"
approach and invest in stocks and other securities that appear to be
temporarily undervalued by various measures, such as price/earnings ratios.
How does the fund select stocks for the portfolio?
The fund will generally consider companies with the following
characteristics:
o Established operating histories.
o Above-average current dividend yield relative to the average yield of the
S&P 500.
o Low price/earnings ratios relative to the S&P 500.
o Sound balance sheets and other financial characteristics.
o Low stock price relative to a company's underlying value as measured by
assets, earnings, cash flow, or business franchises.
What is meant by a "value" investment approach?
Value investors seek to invest in companies whose stock prices are low in
relation to their real worth or future prospects. By identifying companies
whose stocks are currently out of favor or misunderstood, value investors
hope to realize significant appreciation as other investors recognize the
stock's intrinsic value and the price rises accordingly.
Finding undervalued stocks requires considerable research to identify the
particular company, analyze its underlying financial condition and prospects,
and assess the likelihood that the stock's underlying value will be
recognized by the market and reflected in its price.
o Value investors look for undervalued assets.
Some of the principal measures used to identify such stocks are:
o Price/earnings ratio Dividing a stock's price by its earnings per share
generates a price/earnings or P/E ratio. A stock with a P/E that is
significantly below that of its peers, the market as a whole, or its own
historical norm may represent an attractive opportunity.
o Price/book value ratio This ratio, calculated by dividing a stock's price by
its book value per share, indicates how a stock is priced relative to the
accounting
<PAGE>
T. ROWE PRICE 20
(i.e., book) value of the company's assets. A ratio below the market, that of
its competitors, or its own historic norm could indicate an undervalued
situation.
o Dividend yield A stock's dividend yield is found by dividing its annual
dividend by its share price. A yield significantly above a stock's own
historic norm or that of its peers may suggest an investment opportunity.
o A stock selling at $10 with a dividend of $0.50 has a 5% yield.
o Price/cash flow Dividing a stock's price by the company's cash flow per
share, rather than its earnings or book value, provides a more useful measure
of value in some cases. A ratio below that of the market or of its peers
suggests the market may be incorrectly valuing the company's cash flow for
reasons that may be temporary.
o Undervalued assets This analysis compares a company's stock price with its
underlying asset values, its projected value in the private (as opposed to
public) market, or its expected value if the company or parts of it were sold
or liquidated.
o Restructuring opportunities The market can react favorably to the
announcement or the successful implementation of a corporate restructuring,
financial reengineering, or asset redeployment. Such events can result in an
increase in a company's stock price. A value investor may try to anticipate
these actions and invest before the market places an appropriate value on any
actual or expected changes.
What are some of the fund's potential risks?
The fund's emphasis on stocks of established, high dividend-paying companies,
as well as its possible exposure to fixed income securities, could limit its
potential for capital appreciation. Sharply rising interest rates could also
decrease the appeal of stocks purchased by the fund, further restraining
total return.
o The fund's share price will fluctuate; when you sell your shares, you may
lose money.
What are some of the fund's potential rewards?
Dividends are normally a more stable and predictable component of total
return than capital appreciation. While the price of a company's stock can go
up or down in response to earnings or to fluctuations in the general market,
dividends are usually more reliable. Stocks paying a high level of dividend
income tend to be less volatile than those with below-average dividends.
<PAGE>
ABOUT THE FUNDS 21
What are some potential risks and rewards of investing in the stock market
through this fund?
Common stocks in general offer a way to invest for long-term growth of
capital. As the U.S. economy has expanded, corporate profits have grown and
share prices have risen. Nevertheless, economic growth has been punctuated by
periods of stagnation and recession. Share prices of all companies, even the
best managed and most profitable, can fall for any number of reasons, ranging
from lower-than-expected earnings to changes in investor psychology.
Significant trading by large institutional investors also can lead to price
declines. In addition, if our assessment of company prospects proves
incorrect, companies that our managers and analysts expect to do well may
perform poorly. Since 1950, the U.S. stock market has experienced 10 negative
years as well as steep drops of shorter duration. Its worst calendar quarter
return in recent years was -22.5% in 1987's fourth quarter.
o Equity investors should have a long-term investment horizon and be willing
to wait out bear markets.
How can I decide if the fund is appropriate for me?
Consider your investment goals, your time horizon for achieving them, and
your tolerance for risk. If you can accept the price fluctuations inherent in
stock investing in an effort to achieve income and capital appreciation, the
fund could be an appropriate part of your overall investment strategy.
Is there other information I need to review before making a decision?
Be sure to read Investment Policies and Practices in Section 3, which
discusses the principal types of portfolio securities that the fund may
purchase as well as the types of management practices that the fund may use.
International Stock Fund
To help you decide whether this fund is appropriate for you, this section
takes a closer look at its investment objective and approach.
What is the fund's objective and investment program?
The fund's objective is long-term growth of capital through investments
primarily in common stocks of established, non-U.S. companies. The fund
expects to invest substantially all of its assets outside the U.S. and to
diversify broadly among countries throughout the world-developed, newly
industrialized, and emerging.
<PAGE>
T. ROWE PRICE 22
What securities can the fund invest in other than common stocks?
The fund expects to invest substantially all of its assets in common stocks.
However, the fund may also invest in a variety of other equity-related
securities, such as preferred stocks, warrants and convertible securities, as
well as corporate and governmental debt securities, when considered
consistent with the fund's investment objective and program. The fund may
also engage in a variety of investment management practices, such as buying
and selling futures and options. Under normal market conditions, the fund's
investment in securities other than common stocks is limited to no more than
35% of total assets. However, for temporary defensive purposes, the fund may
invest all or a significant portion of its assets in U.S. government and
corporate debt obligations. The fund will not purchase any debt security
which at the time of purchase is rated below investment grade. This would not
prevent the fund from retaining a security downgraded to below investment
grade after purchase.
How does the portfolio manager select stocks?
Price-Fleming blends a bottom-up approach to individual stock selection based
on fundamental research with an awareness of the economic overview of the
countries in our opportunity set. Country weightings and stock selection are
developed through the interplay of general economic analysis and an
examination of the relative attractiveness of opportunities within each
market. Stock selection is the focal point of decision-making, however. Fund
managers weigh a company's prospects for achieving and sustaining
above-average, long-term earnings growth and also look at valuation factors
such as price/earnings, price/cash flow, and price/book value ratios.
What are the major risks associated with international investing and this fund?
Stock prices of foreign and U.S. companies are subject to many of the same
influences, such as general economic conditions, company and industry
earnings prospects, and investor psychology. However, investing in foreign
securities also involves additional risks which can increase the potential
for losses in the fund. These risks are normally significantly magnified for
investments in emerging markets.
o Currency fluctuations Transactions in foreign securities are conducted in
local currencies, so dollars must often be exchanged for another currency
when a stock is bought or sold or a dividend is paid. Likewise, share price
quotations and total return information reflect conversion into dollars.
Fluctuations in foreign exchange rates can significantly increase or decrease
the dollar value of a foreign investment, boosting or offsetting its local
market return. For example, if a French stock rose 10% in price during a
year, but the U.S. dollar gained 5% against the French franc during that
time, the U.S. investor's return would be
<PAGE>
ABOUT THE FUNDS 23
reduced to 5%. This is because the franc would "buy" fewer dollars at the end
of the year than at the beginning, or, conversely, a dollar would buy more
francs.
o Exchange rate movements can be large and can last for extended periods.
o Increased costs It is more expensive for U.S. investors to trade in foreign
markets than in the U.S. Mutual funds offer an efficient way for individuals
to invest abroad, but the overall expense ratios of international funds are
usually higher than those of typical domestic funds.
o Political and economic factors The economies, markets, and political
structures of a number of the countries in which each fund can invest do not
compare favorably with the U.S. and other mature economies in terms of wealth
and stability. Therefore, investments in these countries will be riskier and
more subject to erratic and abrupt price movements. This is especially true
for emerging markets such as those found in Latin America, Asia, Eastern
Europe, and Africa. However, even investments in countries with highly
developed economies are subject to risk. For example, the Japanese stock
market historically has experienced wide swings in value.
o While certain countries have made progress in economic growth,
liberalization, fiscal discipline, and political and social stability, there
is no assurance these trends will continue.
Some economies are less well developed (for example, various countries in
Latin America, Eastern Europe, Africa, and Asia), overly reliant on
particular industries, and more vulnerable to the ebb and flow of
international trade, trade barriers, and other protectionist or retaliatory
measures (for example, Japan, Southeast Asia, Latin America, Eastern Europe,
and Africa). This makes investment in such markets significantly riskier than
in other countries. Some countries, particularly in Latin America and other
emerging markets, have legacies of hyperinflation and currency devaluations
versus the dollar (which adversely affects returns to U.S. investors).
Investments in countries that have recently begun moving away from central
planning and state-owned industries toward free markets, such as Eastern
Europe, China, and Africa, should be regarded as speculative.
Certain countries have histories of instability and upheaval (for example,
various countries in Latin America and Africa) with respect to their internal
politics that could cause their governments to act in a detrimental or
hostile manner toward private enterprise or foreign investment. Actions such
as nationalizing a company or industry, expropriating assets, or imposing
punitive taxes could have a severe effect on security prices and impair a
fund's ability to
<PAGE>
T. ROWE PRICE 24
repatriate capital or income. Significant external risks, including war,
currently affect some countries. Governments in many emerging market
countries participate to a significant degree in their economies and
securities markets.
o Legal, regulatory, and operational Certain countries lack uniform
accounting, auditing, and financial reporting standards, have less
governmental supervision of financial markets than in the U.S., do not honor
legal rights enjoyed in the U.S., and have settlement practices, such as
delays, which could subject a fund to risks not customary in the U.S. In
addition, securities markets in these countries have substantially lower
trading volumes than U.S. markets, resulting in less liquidity and more
volatility than in the U.S.
o Pricing Portfolio securities may be listed on foreign exchanges that are
open days (such as Saturdays) when the funds do not compute their prices. As
a result, a fund's net asset value may change significantly on days when
shareholders cannot make transactions.
o For more details on potential risks of foreign investments, please see
Investment Policies and Practices.
What can I expect in terms of price volatility?
Like U.S. stock investments, common stocks of foreign companies offer
investors a way to build capital over time. Nevertheless, the long-term rise
of foreign stock prices as a group has been punctuated by declines. Share
prices of all companies, even the best managed, most profitable, whether U.S.
or foreign, are subject to market risk, which means they can fluctuate
widely.
In less well-developed stock markets, such as those found in Latin America,
Eastern Europe, Africa, and Asia, volatility may be heightened by actions of
a few major investors. For example, substantial increases or decreases in
cash flows of mutual funds investing in these markets could significantly
affect local stock prices and, therefore, fund share prices.
o The fund's share price will fluctuate; when you sell your shares, you may
lose money.
How does the portfolio manager try to reduce risk?
The principal tools are intensive research and diversification; currency
hedging techniques are used from time to time.
o In addition to conducting on-site research in portfolio countries and
companies, Price-Fleming has close ties with investment analysts based
throughout the world.
<PAGE>
ABOUT THE FUNDS 25
o Diversification significantly reduces but does not eliminate risk. The
impact on a fund's share price from a drop in the price of a particular stock
is reduced substantially by investing in a portfolio with dozens of different
companies. Likewise, the impact of unfavorable developments in a particular
country is reduced when investments are spread among many countries.
Portfolio managers keep close watch on individual investments as well as on
political and economic trends in each country and region. Holdings are
adjusted according to the manager's analysis and outlook.
o Under normal conditions, the funds do not engage in extensive currency
hedging programs. However, when foreign exchange rates are expected to be
unfavorable for U.S. investors, fund managers can hedge the risk through the
use of currency forwards and options. In a general sense, these tools allow a
manager to exchange currencies in the future at a rate specified in the
present. (For more details, please see Foreign Currency Transactions under
Investment Policies and Practices.) If the manager's forecast is wrong, the
hedge may cause a loss. Also, it may be difficult or not practical to hedge
currency risk in many emerging countries.
How can I decide if the fund may be appropriate for me?
First, be sure that your investment objective is the same as the fund's:
capital appreciation over time. If you will need the money you plan to invest
in the near future, the fund is not suitable.
Second, your decision should take into account whether you have any other
foreign stock investments.
Third, consider your risk tolerance and the risk profile of the fund.
o The fund should not represent your complete investment program, nor be used
for short-term trading purposes.
Is there other information I need to review before making a decision?
Be sure to review Investment Policies and Practices in Section 3, which
discusses the following: Types of Portfolio Securities (common and preferred
stocks, convertible securities and warrants, fixed income securities, hybrid
instruments, passive foreign investment companies, and private placements);
and Types of Management Practices (cash position, borrowing money and
transferring assets, foreign currency transactions, futures and options, tax
consequences of hedging, and portfolio turnover).
<PAGE>
ABOUT YOUR ACCOUNT
2
PRICING SHARES AND RECEIVING SALE PROCEEDS
----------------------------------------------------------
Here are some procedures you should know when investing in a T. Rowe Price
fund.
How and when shares are priced
The share price (also called "net asset value" or NAV per share) for each
fund is calculated at 4 p.m. ET each day the New York Stock Exchange is open
for business. To calculate the NAV, a fund's assets are valued and totaled,
liabilities are subtracted, and the balance, called net assets, is divided by
the number of shares outstanding. Amortized cost is used to value money fund
securities.
The calculation of the International Stock Fund's net asset value normally
will not take place contemporaneously with the determination of the value of
the fund's portfolio securities. Events affecting the values of portfolio
securities that occur between the time their prices are determined and the
time the fund's net asset value is calculated will not be reflected in the
fund's net asset value unless Price-Fleming, under the supervision of the
fund's Board of Directors, determines that the particular event should be
taken into account in computing the fund's net asset value.
o The various ways you can buy, sell, and exchange shares are explained at the
end of this prospectus and on the New Account Form. These procedures may
differ for institutional and employer-sponsored retirement accounts.
How your purchase, sale, or exchange price is determined
If we receive your request in correct form by 4 p.m. ET, your transaction
will be priced at that day's NAV. If we receive it after 4 p.m., it will be
priced at the next business day's NAV.
We cannot accept orders that request a particular day or price for your
transaction or any other special conditions.
Note: The time at which transactions and shares are priced and the time until
which orders are accepted may be changed in case of an emergency or if the
New York Stock Exchange closes at a time other than 4 p.m. ET.
How you can receive the proceeds from a sale
If your request is received by 4 p.m. ET in correct form, proceeds are
usually sent on the next business day. Proceeds can be sent to you by mail or
to your bank account by ACH transfer or bank wire. Proceeds sent by ACH
transfer should be credited the second day after the sale. ACH (Automated
Clearing
<PAGE>
ABOUT YOUR ACCOUNT 27
House) is an automated method of initiating payments from and receiving
payments in your financial institution account. ACH is a payment system
supported by over 20,000 banks, savings banks, and credit unions, which
electronically exchanges the transactions primarily through the Federal
Reserve Banks. Proceeds sent by bank wire should be credited to your account
the next business day.
o When filling out the New Account Form, you may wish to give yourself the
widest range of options for receiving proceeds from a sale.
o Exception: Under certain circumstances and when deemed to be in the fund's
best interests, your proceeds may not be sent for up to five business days
after receiving your sale or exchange request. If you were exchanging into a
bond or money fund, your new investment would not begin to earn dividends
until the sixth business day.
o If for some reason we cannot accept your request to sell shares, we will
contact you.
USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES
----------------------------------------------------------
o All net investment income and realized capital gains are distributed to
shareholders.
Dividends and Other Distributions
Dividend and capital gain distributions are reinvested in additional fund
shares in your account unless you select another option on your New Account
Form. The advantage of reinvesting distributions arises from compounding;
that is, you receive income dividends and capital gain distributions on a
rising number of shares.
Distributions not reinvested are paid by check or transmitted to your bank
account via ACH. If the Post Office cannot deliver your check, or if your
check remains uncashed for six months, the fund reserves the right to
reinvest your distribution check in your account at the NAV on the business
day of the reinvestment and to reinvest all subsequent distributions in
shares of the fund.
Income dividends
o The Prime Reserve Fund declares income dividends daily to shareholders of
record as of 12:00 noon ET on that day. Wire purchase orders received before
12:00 noon ET receive the dividend for that day. Other purchase orders
receive the dividend for the next business day after payment has been
received.
<PAGE>
T. ROWE PRICE 28
o The New Income Fund declares income dividends daily at 4 p.m. ET to
shareholders of record at that time provided payment has been received on the
previous business day.
o Bond and money funds pay dividends on the first business day of each month.
o Bond and money fund shares will earn dividends through the date of
redemption; also, shares redeemed on a Friday or prior to a holiday will
continue to earn dividends until the next business day. Generally, if you
redeem all of your shares at any time during the month, you will also receive
all dividends earned through the date of redemption in the same check. When
you redeem only a portion of your shares, all dividends accrued on those
shares will be reinvested, or paid in cash, on the next dividend payment
date.
o The Equity Income Fund declares and pays a dividend quarterly. All or part
of the fund's dividends will be eligible for the 70% deduction for dividends
received by corporations.
o The International Stock Fund declares and pays dividends (if any) annually.
The dividends of the fund will not be eligible for the 70% deduction for
dividends received by corporations, if, as expected, none of the fund's
income consists of dividends paid by U.S. corporations.
Capital gains
o A capital gain or loss is the difference between the purchase and sale price
of a security.
o If the fund has net capital gains for the year (after subtracting any
capital losses), they are usually declared and paid in December to
shareholders of record on a specified date that month. If a second
distribution is necessary, it is usually declared and paid during the first
quarter of the following year.
o Since money funds are managed to maintain a constant share price, the Prime
Reserve Fund is not expected to make capital gain distributions.
Tax Information
You need to be aware of the possible tax consequences when:
o You sell fund shares, including an exchange from one fund to another.
o The fund makes a distribution to your account.
o You will be sent timely information for your tax filing needs.
Taxes on fund redemptions
When you sell shares in any fund, you may realize a gain or loss. An exchange
from one fund to another is still a sale for tax purposes.
<PAGE>
ABOUT YOUR ACCOUNT 29
In January, you will be sent Form 1099-B, indicating the date and amount of
each sale you made in the fund during the prior year. This information will
also be reported to the IRS. For accounts opened new or by exchange in 1983
or later, we will provide you with the gain or loss of the shares you sold
during the year, based on the "average cost" method. This information is not
reported to the IRS, and you do not have to use it. You may calculate the
cost basis using other methods acceptable to the IRS, such as "specific
identification."
To help you maintain accurate records, we send you a confirmation immediately
following each transaction you make (except for systematic purchases and
redemptions) and a year-end statement detailing all your transactions in each
fund account during the year.
Taxes on fund distributions
The following summary does not apply to retirement accounts, such as IRAs,
which are tax-deferred until you withdraw money from them.
In January, you will be sent Form 1099-DIV indicating the tax status of any
dividend and capital gain distribution made to you. This information will
also be reported to the IRS. All distributions made by the funds are taxable
to you for the year in which they were paid. The only exception is that
distributions declared during the last three months of the year and paid in
January are taxed as though they were paid by December 31. You will be sent
any additional information you need to determine your taxes on fund
distributions, such as the portion of your dividend, if any, that may be
exempt from state income taxes.
Short-term capital gain distributions are taxable as ordinary income and
long-term gain distributions are taxable at the applicable long-term gain
rate. The gain is long- or short-term depending on how long the fund held the
securities, not how long you held shares in the fund. If you realize a loss
on the sale or exchange of fund shares held six months or less and you
received a long-term capital gain on such shares, your short-term loss
recognized is reclassified to long-term to the extent of such capital gain
distribution received.
Gains and losses from the sale of foreign currencies and the foreign currency
gain or loss resulting from the sale of a foreign debt security can increase
or decrease a fund's ordinary income dividend. Net foreign currency losses
may result in a fund's dividend being classified as a return of capital.
If a fund pays nonrefundable taxes to foreign governments during the year,
the taxes will reduce a fund's dividends, but will still be included in your
taxable income. However, you may be able to claim an offsetting credit or
deduction on your tax return for your portion of foreign taxes paid by a
fund.
<PAGE>
T. ROWE PRICE 30
Foreign investments (not applicable to Prime Reserve Fund)
Distributions resulting from the sale of certain foreign currencies and debt
securities, to the extent of foreign exchange gains, are taxed as ordinary
income or loss. If any of the funds pays nonrefundable taxes to foreign
governments during the year, the taxes will reduce the fund's dividends, and
with respect to the International Stock Fund, will also be included in your
taxable income. However, you may be able to claim an offsetting credit or
deduction on your tax return for your portion of foreign taxes paid by the
International Stock Fund.
o Distributions are taxable whether reinvested in additional shares or
received in cash.
Tax effect of buying shares before a capital gain distribution (excluding
Prime Reserve Fund)
If you buy shares shortly before or on the "record date"- the date that
establishes you as the person to receive the upcoming distribution-you will
receive, in the form of a taxable distribution, a portion of the money you
just invested. Therefore, you may wish to find out a fund's record date
before investing. Of course, a fund's share price may, at any time, reflect
undistributed capital gains or unrealized appreciation. When these amounts
are eventually distributed, they are taxable.
TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS
----------------------------------------------------------
o Following these procedures helps assure timely and accurate transactions.
Purchase Conditions
Nonpayment
If your payment is not received or you pay with a check or ACH transfer that
does not clear, your purchase will be canceled. You will be responsible for
any losses or expenses incurred by the fund or transfer agent, and the fund
can redeem shares you own in this or another identically registered T. Rowe
Price fund as reimbursement. The funds and their agents have the right to
reject or cancel any purchase, exchange, or redemption due to nonpayment.
U.S. dollars
All purchases must be paid for in U.S. dollars; checks must be drawn on U.S.
banks.
<PAGE>
ABOUT YOUR ACCOUNT 31
Sale (Redemption) Conditions
10-day hold
If you sell shares that you just purchased and paid for by check or ACH
transfer, the fund will process your redemption, but will generally delay
sending you the proceeds for up to 10 calendar days to allow the check or
transfer to clear. If your redemption request was sent by mail or mailgram,
proceeds will be mailed no later than the seventh calendar day following
receipt unless the check or ACH transfer has not cleared. If, during the
clearing period, we receive a check drawn against your bond or money market
account, it will be returned marked "uncollected." (The 10-day hold does not
apply to the following: purchases paid for by bank wire; cashier's,
certified, or treasurer's checks; or automatic purchases through your
paycheck.)
Telephone, Tele*Access/(R)/, and personal computer transactions
These exchange and redemption services are established automatically when you
sign the New Account Form unless you check the box which states that you do
not want these services. The fund uses reasonable procedures (including
shareholder identity verification) to confirm that instructions given by
telephone are genuine and is not liable for acting on these instructions. If
these procedures are not followed, it is the opinion of certain regulatory
agencies that the fund may be liable for any losses that may result from
acting on the instructions given. A confirmation is sent promptly after the
telephone transaction. All conversations are recorded.
Redemptions over $250,000
Large sales can adversely affect a portfolio manager's ability to implement a
fund's investment strategy by causing the premature sale of securities that
would otherwise be held. If, in any 90-day period, you redeem (sell) more
than $250,000, or your sale amounts to more than 1% of the fund's net assets,
the fund has the right to delay sending your proceeds for up to five business
days after receiving your request, or to pay the difference between the
redemption amount and the lesser of the two previously mentioned figures with
securities from the fund.
o T. Rowe Price may bar excessive traders from purchasing shares.
Excessive Trading
Frequent trades, involving either substantial fund assets or a substantial
portion of your account or accounts controlled by you, can disrupt management
of the fund and raise its expenses. We define "excessive trading" as
exceeding one purchase and sale involving the same fund within any 120-day
period.
<PAGE>
T. ROWE PRICE 32
For example, you are in fund A. You can move substantial assets from fund A
to fund B and, within the next 120 days, sell your shares in fund B to return
to fund A or move to fund C.
If you exceed the number of trades described above, you may be barred
indefinitely from further purchases of T. Rowe Price funds.
Three types of transactions are exempt from excessive trading guidelines: 1)
trades solely between money market funds; 2) redemptions that are not part of
exchanges; and 3) systematic purchases or redemptions (see Shareholder
Services).
Keeping Your Account Open
Due to the relatively high cost to the funds of maintaining small accounts,
we ask you to maintain an account balance of at least $1,000. If your balance
is below $1,000 for three months or longer, we have the right to close your
account after giving you 60 days in which to increase your balance.
Small Account Fee
Because of the disproportionately high costs of servicing accounts with low
balances, a $10 fee, paid to T. Rowe Price Services, the funds' transfer
agent, will automatically be deducted from nonretirement accounts with
balances falling below a minimum level. The valuation of accounts and the
deduction are expected to take place during the last five business days of
September. The fee will be deducted from accounts with balances below $2,000,
except for UGMA/ UTMA accounts, for which the limit is $500. The fee will be
waived for any investor whose aggregate T. Rowe Price mutual fund investments
total $25,000 or more. Accounts employing automatic investing (e.g., payroll
deduction, automatic purchase from a bank account, etc.) are also exempt from
the charge. The fee will not apply to IRAs and other retirement plan
accounts. (A separate custodial fee may apply to IRAs and other retirement
plan accounts.)
<PAGE>
ABOUT YOUR ACCOUNT 33
Signature Guarantees
o A signature guarantee is designed to protect you and the T. Rowe Price funds
from fraud by verifying your signature.
You may need to have your signature guaranteed in certain situations, such
as:
o Written requests 1) to redeem over $100,000, or 2) to wire redemption
proceeds.
o Remitting redemption proceeds to any person, address, or bank account not on
record.
o Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration (name or ownership) from yours.
o Establishing certain services after the account is opened.
You can obtain a signature guarantee from most banks, savings institutions,
broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot
accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
<PAGE>
MORE ABOUT THE FUNDS
3
ORGANIZATION AND MANAGEMENT
----------------------------------------------------------
How are the funds organized?
The Prime Reserve and New Income Funds are Maryland corporations organized in
1975 and 1973, respectively, and the Equity Income Fund, for tax and business
reasons, was organized as a Massachusetts business trust in 1985. The
International Stock Fund is a series of the T. Rowe Price International
Funds, Inc. (the Corporation) which was organized in 1979 as a Maryland
corporation. The Prime Reserve, New Income, and Equity Income Funds, as well
as the Corporation, are registered with the Securities and Exchange
Commission under the Investment Company Act of 1940 as diversified, open-end
As with all mutual funds, investors purchase shares when they put money in a
fund. These shares are part of a fund's authorized capital stock, but share
o Cast one vote per share on certain fund matters, including the election of
fund directors/trustees, changes in fundamental policies, or approval of
The funds are not required to hold annual meetings and, in order to avoid
unnecessary costs to fund shareholders, do not intend to do so except when
certain matters, such as a change in a fund's fundamental policies, are to be
decided. In addition, shareholders representing at least 10% of all eligible
votes may call a special meeting if they wish for the purpose of voting on
the removal of any fund director or trustee. If a meeting is held and you
cannot attend, you can vote by proxy. Before the meeting, the fund will send
you proxy materials that explain the issues to be decided and include a
o All decisions regarding the purchase and sale of fund investments are made
by T. Rowe Pricesss-specifically by the funds' portfolio managers.
<PAGE>
ABOUT YOUR ACCOUNT 35
Who runs the funds?
General Oversight
The funds are governed by a Board of Directors or Trustees that meets
regularly to review the funds' investments, performance, expenses, and other
business affairs. The Board elects the funds' officers. The policy of each
fund is that a majority of Board members will be independent of T. Rowe Price
and Price-Fleming.
Investment Manager
For the Prime Reserve, New Income, and Equity Income Funds, all decisions
regarding the purchase and sale of fund investments are made by T. Rowe
Price-specifically by the funds' portfolio managers. T. Rowe Price's office
is located at 100 East Pratt Street, Baltimore, Maryland 21202. For the
International Stock Fund, Price-Fleming is responsible for selection and
management of portfolio investments. Price-Fleming was incorporated in
Maryland in 1979 as a joint venture between T. Rowe Price and Robert Fleming
Holdings Limited (Flemings). Price-Fleming's U.S. office is located at 100
East Pratt Street, Baltimore, Maryland 21202. Price-Fleming also has offices
in London, Tokyo, Singapore, and Hong Kong.
o Flemings is a diversified investment organization which participates in a
global network of regional investment offices in New York, London, Zurich,
Geneva, Tokyo, Hong Kong, Manila, Kuala Lumpur, Seoul, Taipei, Bombay,
Jakarta, Singapore, Bangkok, and Johannesburg.
The common stock of Price-Fleming is 50% owned by a wholly owned subsidiary
of T. Rowe Price, 25% by a subsidiary of Flemings, and 25% by a subsidiary of
Jardine Fleming Group Limited (Jardine Fleming). (Half of Jardine Fleming is
owned by Flemings and half by Jardine Matheson Holdings Limited.) T. Rowe
Price has the right to elect a majority of the Board of Directors of
Price-Fleming, and Flemings has the right to elect the remaining directors,
one of whom will be nominated by Jardine Fleming.
Portfolio Management
The Prime Reserve Fund has an Investment Advisory Committee composed of the
following members: Edward A. Wiese, Chairman, Patrice L. Berchtenbreiter,
Paul W. Boltz, Brian E. Burns, Robert P. Campbell, Donna M. Davis-Ennis,
James M. McDonald, Joan R. Potee, Robert M. Rubino, and Gwendolyn G. Wagner.
The committee chairman has day-to-day responsibility for managing the fund
and works with the committee in developing and executing the fund's
investment program. Mr. Weise has been chairman of the fund's committee since
1990. He joined T. Rowe Price in 1984 and has been managing investments since
1985.
<PAGE>
T. ROWE PRICE 36
The New Income Fund has an Investment Advisory Committee composed of the
following members: Charles P. Smith, Chairman, Paul W. Boltz, Heather R.
Landon, Edmund M. Notzon, Robert M. Rubino, Peter Van Dyke, and Gwendolyn G.
Wagner. The committee chairman has day-to-day responsibility for managing the
fund and works with the committee in developing and executing the fund's
investment program. Mr. Smith has been chairman of the fund's committee since
1988. He joined T. Rowe Price in 1972 and has been managing investments since
1975.
The Equity Income Fund has an Investment Advisory Committee composed of the
following members: Brian C. Rogers, Chairman, Thomas H. Broadus Jr., Richard
P. Howard, William J. Stromberg, and Daniel M. Theriault. The committee
chairman has day-to-day responsibility for managing the fund and works with
the committee in developing and executing the fund's investment program. Mr.
Rogers has been chairman of the fund's committee since 1993. He joined T.
Rowe Price in 1982 and has been managing investments since 1983.
The International Stock Fund has an Investment Advisory Group that has
day-to-day responsibility for managing the portfolio and developing and
executing the fund's investment program. The members of the advisory group
are: Martin G. Wade, Christopher D. Alderson, Peter B. Askew, Mark J.T.
Edwards, John R. Ford, James B.M. Seddon, Benedict R.F. Thomas, and David
J.L. Warren.
Martin Wade joined Price-Fleming in 1979 and has 27 years of experience with
the Fleming Group in research, client service, and investment management.
(Fleming Group includes Robert Fleming and/or Jardine Fleming.) Christopher
Alderson joined Price-Fleming in 1988, and has 10 years of experience with
the Fleming Group in research and portfolio management. Peter Askew joined
Price-Fleming in 1988 and has 21 years of experience managing multi-currency
fixed income portfolios. Mark Edwards joined Price-Fleming in 1986 and has 15
years of experience in financial analysis. John Ford joined Price-Fleming in
1982 and has 16 years of experience with the Fleming Group in research and
portfolio management. James Seddon joined Price-Fleming in 1987 and has 11
years of portfolio management experience. Benedict Thomas joined
Price-Fleming in 1988 and has seven years of portfolio management experience.
David Warren joined Price-Fleming in 1984 and has 16 years of experience in
equity research, fixed income research, and portfolio management.
<PAGE>
ABOUT YOUR ACCOUNT 37
Portfolio Transactions
The International Stock Fund's Board of Directors has authorized
Price-Fleming to utilize affiliates of Flemings and Jardine Fleming in the
capacity of broker in connection with the execution of a fund's portfolio
transactions if Price-Fleming believes that doing so would result in an
economic advantage (in the form of lower execution costs or otherwise) being
obtained by the fund.
Marketing
T. Rowe Price Investment Services, Inc., a wholly owned subsidiary of T. Rowe
Price, distributes (sells) shares of this and all other T. Rowe Price funds.
Shareholder Services
T. Rowe Price Services, Inc., another wholly owned subsidiary, acts as the
fund's transfer and dividend disbursing agent and provides shareholder and
administrative services. Services for certain types of retirement plans are
provided by T. Rowe Price Retirement Plan Services, Inc., also a wholly owned
subsidiary. The address for each is 100 East Pratt St., Baltimore, MD 21202.
How are fund expenses determined?
The management agreement spells out the expenses to be paid by each fund. In
addition to the management fee, the funds pay for the following: shareholder
service expenses; custodial, accounting, legal, and audit fees; costs of
preparing and printing prospectuses and reports sent to shareholders;
registration fees and expenses; proxy and annual meeting expenses (if any);
and director/trustee fees and expenses.
<TABLE>
Table 5 Service Fees Paid
<CAPTION>
<S> <S> <C> <C> <C>
Fund Transfer Agent Sub-accountingServices Accounting
$ 5,089,000 $3,176,000 $ 85,000
1,664,000 1,683,000 129,000
4,963,000 6,407,000 85,000
5,147,000 2,340,000 130,000
- -----------------------------------------------------------------------------------------
</TABLE>
Fees paid for each fund are for the 1996 fiscal year.
The Management Fee
This fee has two parts-an "individual fund fee" (discussed under Transaction
and Fund Expenses), which reflects a fund's particular investment management
costs, and a "group fee." The group fee, which is designed to reflect the
benefits of the shared resources of the T. Rowe Price investment management
complex, is calculated daily based on the combined net assets of all T. Rowe
Price funds (except Equity Index and the Spectrum Funds and any institutional
or private
<PAGE>
T. ROWE PRICE 38
label mutual funds). The group fee schedule (shown below) is graduated,
declining as the asset total rises, so shareholders benefit from the overall
growth in mutual fund assets.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
0.480% First $1 billion 0.360% Next $2 billion 0.310% Next $16 billion
--------------------------
0.450% Next $1 billion 0.350% Next $2 billion 0.305% Next $30 billion
----------------------------------------------------
0.420% Next $1 billion 0.340% Next $5 billion 0.300% Thereafter
----------------------------------------------------
0.390% Next $1 billion 0.330% Next $10 billion
------------------------------------------------------------------------------
0.370% Next $1 billion 0.320% Next $10 billion
</TABLE>
The fund's portion of the group fee is determined by the ratio of its daily
net assets to the daily net assets of all the Price funds described
previously. Based on combined T. Rowe Price funds' assets of approximately
$61 billion at December 31, 1996, the group fee was 0.33%.
International Stock Fund
Research and Administration
Certain administrative support is provided by T. Rowe Price, which receives
from Price-Fleming a fee of .15% of the market value of all assets in equity
accounts, .15% of the market value of all assets in active fixed income
accounts, and .035% of the market value of all assets in passive fixed income
accounts under Price-Fleming's management. Additional investment research and
administrative support for equity investments is provided to Price-Fleming by
Fleming Investment Management Limited (FIM) and Jardine Fleming International
Holdings Limited (JFIH), for which each receives from Price-Fleming a fee of
.075% of the market value of all assets in equity accounts under
Price-Fleming's management. Fleming International Asset Management Limited
(FIAM) and JFIH provide research and administration support for fixed income
accounts for which each receive a fee of .075% of the market value of all
assets in active fixed income accounts and .0175% of such market value in
passive fixed income accounts under Price-Fleming's management. FIM and JFIH
are wholly owned subsidiaries of Flemings and Jardine Fleming, respectively,
and FIAM is an indirect subsidiary of Flemings.
UNDERSTANDING PERFORMANCE INFORMATION
----------------------------------------------------------
This section should help you understand the terms used to describe fund
performance. You will come across them in shareholder reports you receive
from us, in our newsletter, The Price Report, in Insights articles, in T.
Rowe Price advertisements, and in the media.
<PAGE>
MORE ABOUT THE FUNDS 39
Total Return
This tells you how much an investment in a fund has changed in value over a
given time period. It reflects any net increase or decrease in the share
price and assumes that all dividends and capital gains (if any) paid during
the period were reinvested in additional shares. Including reinvested
distributions means that total return numbers include the effect of
compounding, i.e., you receive income and capital gain distributions on a
rising number of shares.
Advertisements for a fund may include cumulative or compound average annual
total return figures, which may be compared with various indices, other
performance measures, or other mutual funds.
o Total return is the most widely used performance measure. Detailed
performance information is included in fund annual and semiannual shareholder
reports, and in the quarterly Performance Update, which are all available
without charge.
Cumulative Total Return
This is the actual rate of return on an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated between the beginning and the end of the period specified.
Average Annual Total Return
This is always hypothetical. Working backward from the actual cumulative
return, it tells you what constant year-by-year return would have produced
the actual cumulative return. By smoothing out all the variations in annual
performance, it gives you an idea of the investment's annual contribution to
your portfolio provided you held it for the entire period in question.
Yield
The current or "dividend" yield on a fund or any investment tells you the
relationship between the investment's current level of annual income and its
price on a particular day. The dividend yield reflects the actual income paid
to shareholders for a given period, annualized, and divided by the net asset
value. For example, a fund providing $5 of annual income per share and a
price of $50 has a current yield of 10%. Yields can be calculated for any
time period.
Prime Reserve Fund The fund may advertise a "current" yield, reflecting the
latest seven-day income annualized, or an "effective" yield, which assumes
the income has been reinvested in the fund.
<PAGE>
T. ROWE PRICE 40
New Income Fund The advertised or "SEC" yield is found by determining the net
income per share (as defined by the SEC) earned by the fund during a 30-day
base period and dividing this amount by the per share price on the last day
of the base period. The SEC yield may differ from the dividend yield.
o You will see frequent references to a fund's yield in our reports, in
advertisements, in media stories, and so on.
INVESTMENT POLICIES AND PRACTICES
----------------------------------------------------------
This section takes a detailed look at some of the types of securities the
funds may hold in their portfolios and the various kinds of investment
practices that may be used in day-to-day portfolio management. The funds'
investment programs are subject to further restrictions and risks described
in the Statement of Additional Information.
Shareholder approval is required to substantively change a fund's objectives
and certain investment restrictions noted in the following section as
"fundamental policies." The managers also follow certain "operating
policies," which can be changed without shareholder approval. However,
significant changes are discussed with shareholders in fund reports. Each
fund adheres to applicable investment restrictions and policies at the time
it makes an investment. A later change in circumstances will not require the
sale of an investment if it was proper at the time it was made.
A fund's holdings of certain kinds of investments cannot exceed maximum
percentages of total assets, which are set forth herein. For instance, the
New Income Fund is not permitted to invest more than 10% of total assets in
hybrid instruments. While these restrictions provide a useful level of detail
about a fund's investment program, investors should not view them as an
accurate gauge of the potential risk of such investments. For example, in a
given period, a 5% investment in hybrid securities could have significantly
more of an impact on a fund's share price than its weighting in the
portfolio. The net effect of a particular investment depends on its
volatility and the size of its overall return in relation to the performance
of all the fund's other investments.
Changes in a fund's holdings, a fund's performance, and the contribution of
various investments are discussed in the shareholder reports sent to you.
o Fund managers have considerable leeway in choosing investment strategies and
selecting securities they believe will help the funds achieve their
objectives.
<PAGE>
MORE ABOUT THE FUNDS 41
Prime Reserve Fund
Types of Portfolio Securities
In seeking to meet its investment objective, the fund may invest in any type
of short-term security or instrument whose investment characteristics are
consistent with the fund's investment program. The following pages describe
the principal types of portfolio securities and investment management
practices of the fund.
Money Market Securities
Money market securities are IOUs issued by companies or governmental units.
Money market securities may be interest-bearing or discounted to reflect the
rate of interest paid. In the case of interest-bearing securities, the issuer
has a contractual obligation to pay coupon interest at a stated rate on
specific dates and to repay the face value on a specified date. In the case
of a discount security, no coupon interest is paid, but the security's price
is discounted so that the interest is realized when the security matures at
face value. In either case, an issuer may have the right to redeem or "call"
the security before maturity, and the investor may have to reinvest the
proceeds at lower market rates.
Except for adjustable rate instruments, a money market security's interest
rate, as reflected in the coupon rate or discount, is usually fixed for the
life of the security. Its current yield (coupon or discount as a percent of
current price) will fluctuate to reflect changes in interest rate levels. A
money market security's price usually rises when interest rates fall, and
vice versa.
Money market securities may be unsecured (backed by the issuer's general
creditworthiness only) or secured (also backed by specified collateral).
Certain money market securities have interest rates that are adjusted
periodically which tend to minimize fluctuations in their principal value.
When calculating its weighted average maturity, the fund may shorten the
maturity of these securities in accordance with Rule 2a-7.
Operating policy Except as may be permitted by Rule 2a-7, the fund will not
purchase any security (other than a U.S. government security) if it would
cause the fund to have more than: (1) 5% of its total assets in securities of
that issuer, where the securities are prime securities (other than for
certain temporary, limited purposes); or (2) where the securites are not
prime securities, 5% of its total assets in such securities and 1% of its
total assets in the securities of that issuer.
<PAGE>
T. ROWE PRICE 42
Asset-Backed Securities
An underlying pool of assets, such as credit card or automobile trade
receivables or corporate loans or bonds, backs these bonds and provides the
interest and principal payments to investors. On occasion, the pool of assets
may also include a swap obligation, which is used to change the cash flows on
the underlying assets. As an example, a swap may be used to allow floating
rate assets to back a fixed rate obligation. Credit quality depends primarily
on the quality of the underlying assets, the level of credit support, if any,
provided by the issuer, and the credit quality of the swap counterparty, if
any. The underlying assets (i.e., loans) are subject to prepayments which can
shorten the securities' weighted average life and may lower their return. The
value of these securities also may change because of actual or perceived
changes in the creditworthiness of the originator, the servicing agent, the
financial institution providing the credit support, or of the swap
counterparty. There is no limit on the fund's investment in these securities.
Foreign Securities
The fund may invest in certain foreign securities-dollar-denominated money
market securities of foreign issuers, foreign branches of U.S. banks, and
U.S. branches of foreign banks. Such investments increase a portfolio's
diversification and may enhance return, but they also involve some special
risks, such as exposure to potentially adverse local political and economic
developments; nationalization and exchange controls; potentially lower
liquidity and higher volatility; possible problems arising from accounting,
disclosure, settlement, and regulatory practices that differ from U.S.
standards.
o Foreign securities increase the fund's diversification and may enhance
return, but involve special risks, especially for developing countries.
Operating policy The fund may invest without limit in U.S. dollar-denominated
foreign securities.
Private Placements
These securities are sold directly to a small number of investors, usually
institutions. Unlike public offerings, such securities are not registered
with the SEC. Although certain of these securities may be readily sold, for
example, under Rule 144A, others may be illiquid, and their sale may involve
substantial delays and additional costs.
Operating policy The fund will not invest more than 10% of its net assets in
illiquid securities.
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MORE ABOUT THE FUNDS 43
Types of Management Practices
Borrowing Money and Transferring Assets
The fund can borrow money from banks as a temporary measure for emergency
purposes, to facilitate redemption requests, or for other purposes consistent
with the fund's investment objective and program. Such borrowings may be
collateralized with fund assets, subject to restrictions.
Fundamental policy Borrowings may not exceed 33/1//\\/3/\\% of total fund
assets.
Operating policies The fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33/1//\\/3/\\% of the
fund's total assets. The fund may not purchase additional securities when
borrowings exceed 5% of total assets.
Lending of Portfolio Securities
Like other mutual funds, the fund may lend securities to broker-dealers,
other institutions, or other persons to earn additional income. The principal
risk is the potential insolvency of the broker-dealer or other borrower. In
this event, the fund could experience delays in recovering its securities and
possibly capital losses.
Fundamental policy The value of loaned securities may not exceed
33/1//\\/3/\\% of total fund assets.
New Income Fund
Types of Portfolio Securities
In seeking to meet its investment objective, the fund may invest in any type
of security or instrument (including certain potentially high-risk
derivatives described in this section) whose investment characteristics are
consistent with the fund's investment program. The following pages describe
the principal types of portfolio securities and investment management
practices of the fund.
Fundamental policy The fund will not purchase a security if, as a result,
with respect to 75% of its total assets, more than 5% of its total assets
would be invested in securities of a single issuer or more than 10% of the
outstanding voting securities of the issuer would be held by the fund,
provided that these limitations do not apply to the fund's purchase of
securities issued or guaranteed by the U.S. government, its agencies, or
instrumentalities.
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T. ROWE PRICE 44
Bonds
A bond is an interest-bearing security-an IOU-issued by companies or
governmental units. The issuer has a contractual obligation to pay interest
at a stated rate on specific dates and to repay principal (the bond's face
value) on a specified date. An issuer may have the right to redeem or "call"
a bond before maturity, and the investor may have to reinvest the proceeds at
lower market rates.
A bond's annual interest income, set by its coupon rate, is usually fixed for
the life of the bond. Its yield (income as a percent of current price) will
fluctuate to reflect changes in interest rate levels. A bond's price usually
rises when interest rates fall, and vice versa, so its yield stays current.
Bonds may be unsecured (backed by the issuer's general creditworthiness only)
or secured (also backed by specified collateral).
Certain bonds have interest rates that are adjusted periodically, which tend
to minimize fluctuations in their principal value. The maturity of those
securities may be shortened under certain specified conditions.
Bonds may be designated as senior or subordinated obligations. Senior
obligations generally have the first claim on a corporation's earnings and
assets and, in the event of liquidation, are paid before subordinated debt.
Common and Preferred Stocks
Stocks represent shares of ownership in a company. Generally, preferred stock
has a specified dividend and ranks after bonds and before common stocks in
its claim on income for dividend payments and on assets should the company be
liquidated. After other claims are satisfied, common stockholders participate
in company profits on a pro rata basis; profits may be paid out in dividends
or reinvested in the company to help it grow. Increases and decreases in
earnings are usually reflected in a company's stock price, so common stocks
generally have the greatest appreciation and depreciation potential of all
corporate securities. While most preferred stocks pay a dividend, the fund
may purchase preferred stock where the issuer has omitted, or is in danger of
omitting, payment of its dividend. Such investments would be made primarily
for their capital appreciation potential.
o Without regard to quality, the fund may invest up to 25% of its total assets
(not including cash) in preferred and common stocks and convertible
securities, convertible into or which carry warrants for common stocks or
other equity securities.
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MORE ABOUT THE FUNDS 45
Convertible Securities and Warrants
The fund may invest in debt or preferred equity securities convertible into
or exchangeable for equity securities. Traditionally, convertible securities
have paid dividends or interest at rates higher than common stocks but lower
than nonconvertible securities. They generally participate in the
appreciation or depreciation of the underlying stock into which they are
convertible, but to a lesser degree. In recent years, convertibles have been
developed which combine higher or lower current income with options and other
features. Warrants are options to buy a stated number of shares of common
stock at a specified price anytime during the life of the warrants
(generally, two or more years).
Foreign Securities
The fund may invest in foreign securities, including nondollar-denominated
securities traded outside of the U.S. and dollar-denominated securities of
foreign issuers. Such investments increase a portfolio's diversification and
may enhance return, but they also involve some special risks such as exposure
to potentially adverse local political and economic developments;
nationalization and exchange controls; potentially lower liquidity and higher
volatility; possible problems arising from accounting, disclosure,
settlement, and regulatory practices that differ from U.S. standards; and the
chance that fluctuations in foreign exchange rates will decrease the
investment's value (favorable changes can increase its value). To the extent
the fund invests in developing countries, these risks are increased.
Operating policy The fund may invest without limitation in U.S.
dollar-denominated debt securities issued by foreign issuers, foreign
branches of U.S. banks, and U.S. branches of foreign banks. The fund may also
invest up to 20% of its total assets (excluding reserves) in non-U.S.
dollar-denominated fixed income securities principally traded in financial
markets outside the United States.
Asset-Backed Securities
An underlying pool of assets, such as credit card or automobile trade
receivables or corporate loans or bonds, backs these bonds and provides the
interest and principal payments to investors. Credit quality depends
primarily on the quality of the underlying assets and the level of credit
support, if any, provided by the issuer. The underlying assets (i.e., loans)
are subject to prepayments which can shorten the securities' weighted average
life and may lower their return. The value of these securities also may
change because of actual or perceived changes in the creditworthiness of the
originator, servicing agent, or of the financial institution providing the
credit support. There is no limit on the fund's investment in these
securities.
<PAGE>
T. ROWE PRICE 46
Mortgage-Backed Securities
The fund may invest in a variety of mortgage-backed securities. Mortgage
lenders pool individual home mortgages with similar characteristics to back a
certificate or bond, which is sold to investors such as the fund. Interest
and principal payments generated by the underlying mortgages are passed
through to the investors. The "big three" issuers are the Government National
Mortgage Association (GNMA), the Federal National Mortgage Association
(Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac).
GNMA certificates are backed by the full faith and credit of the U.S.
government, while others, such as Fannie Mae and Freddie Mac certificates,
are only supported by the ability to borrow from the U.S. Treasury or
supported only by the credit of the agency. Private mortgage bankers and
other institutions also issue mortgage-backed securities.
Mortgage-backed securities are subject to scheduled and unscheduled principal
payments as homeowners pay down or prepay their mortgages. As these payments
are received, they must be reinvested when interest rates may be higher or
lower than on the original mortgage security. Therefore, these securities are
not an effective means of locking in long-term interest rates. In addition,
when interest rates fall, the pace of mortgage prepayments picks up. These
refinanced mortgages are paid off at face value (par), causing a loss for any
investor who may have purchased the security at a price above par. In such an
environment, this risk limits the potential price appreciation of these
securities and can negatively affect the fund's net asset value. When rates
rise, the prices of mortgage-backed securities can be expected to decline,
although historically these securities have experienced smaller price
declines than comparable quality bonds. In addition, when rates rise and
prepayments slow, the effective duration of mortgage-backed securities
extends, resulting in increased volatility.
o There is no limit on the fund's investment in mortgage-backed securities.
o Collateralized Mortgage Obligations (CMOs) CMOs are debt securities that are
fully collateralized by a portfolio of mortgages or mortgage-backed
securities. All interest and principal payments from the underlying mortgages
are passed through to the CMOs in such a way as to create, in most cases,
more definite maturities than is the case with the underlying mortgages. CMOs
may pay fixed or variable rates of interest, and certain CMOs have priority
over others with respect to the receipt of prepayments.
o Stripped Mortgage Securities Stripped mortgage securities (a type of
potentially high-risk derivative) are created by separating the interest and
principal payments generated by a pool of mortgage-backed securities or a CMO
to create
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MORE ABOUT THE FUNDS 47
additional classes of securities. Generally, one class receives only interest
payments (IOs) and one principal payments (POs). Unlike other mortgage-backed
securities and POs, the value of IOs tends to move in the same direction as
interest rates. The fund could use IOs as a hedge against falling prepayment
rates (interest rates are rising) and/or a bear market environment. POs can
be used as a hedge against rising prepayment rates (interest rates are
falling) and/or a bull market environment. IOs and POs are acutely sensitive
to interest rate changes and to the rate of principal prepayments.
A rapid or unexpected increase in prepayments can severely depress the price
of IOs, while a rapid or unexpected decrease in prepayments could have the
same effect on POs. These securities are very volatile in price and may have
lower liquidity than most other mortgage-backed securities. Certain
non-stripped CMOs may also exhibit these qualities, especially those that pay
variable rates of interest that adjust inversely with and more rapidly than
short-term interest rates. In addition, if interest rates rise rapidly and
prepayment rates slow more than expected, certain CMOs, in addition to losing
value, can exhibit characteristics of longer securities and become more
volatile. There is no guarantee the fund's investment in CMOs, IOs, or POs
will be successful, and the fund's total return could be adversely affected
as a result.
Operating policy The fund may invest up to 10% of its total assets in
stripped mortgage securities.
Hybrid Instruments
These instruments (a type of potentially high-risk derivative) can combine
the characteristics of securities, futures, and options. For example, the
principal amount or interest rate of a hybrid could be tied (positively or
negatively) to the price of some commodity, currency, or securities index or
another interest rate (each a "benchmark"). Hybrids can be used as an
efficient means of pursuing a variety of investment goals, including currency
hedging, duration management, and increased total return. Hybrids may not
bear interest or pay dividends. The value of a hybrid or its interest rate
may be a multiple of a benchmark and, as a result, may be leveraged and move
(up or down) more steeply and rapidly than the benchmark. These benchmarks
may be sensitive to economic and political events, such as commodity
shortages and currency devaluations, which cannot be readily foreseen by the
purchaser of a hybrid. Under certain conditions, the redemption value of a
hybrid could be zero. Thus, an investment in a hybrid may entail significant
market risks that are not associated with a similar investment in a
traditional, U.S. dollar-denominated bond that has a fixed principal amount
and pays a fixed rate or floating rate of interest. The purchase of hybrids
also exposes the fund to the credit risk of the issuer of the hybrid. These
risks may cause significant fluctuations in the net asset value of the fund.
<PAGE>
T. ROWE PRICE 48
o Hybrids can have volatile prices and limited liquidity and their use by the
fund may not be successful.
Operating policy The fund may invest up to 10% of its total assets in hybrid
instruments.
Private Placements
These securities are sold directly to a small number of investors, usually
institutions. Unlike public offerings, such securities are not registered
with the SEC. Although certain of these securities may be readily sold, for
example, under Rule 144A, others may be illiquid, and their sale may involve
substantial delays and additional costs.
Operating policy The fund will not invest more than 15% of its net assets in
illiquid securities.
Utility Industry Concentration
The fund may, under certain circumstances, invest a substantial amount of its
assets in the utility industry. Investments in this industry may be affected
by environmental conditions, energy conservation programs, fuel shortages,
availability of capital to finance operations and construction programs, and
federal and state legislative and regulatory actions. T. Rowe Price believes
that any risk to the fund which might result from concentrating in any such
industry will be minimized by diversification of the fund's investments.
Fundamental policy As a matter of fundamental policy, the fund will, under
certain conditions, invest up to 50% of its assets in any one of the
following industries: gas utility, gas transmission utility, electric
utility, telephone utility, and petroleum.
Types of Management Practices
Cash Position
The fund will hold a certain portion of its assets in U.S. and foreign
dollar-denominated money market securities, including repurchase agreements,
in the two highest rating categories, maturing in one year or less. For
temporary, defensive purposes, the fund may invest without limitation in such
securities. This reserve position provides flexibility in meeting
redemptions, expenses, and the timing of new investments and serves as a
short-term defense during periods of unusual market volatility.
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MORE ABOUT THE FUNDS 49
Borrowing Money and Transferring Assets
The fund can borrow money from banks as a temporary measure for emergency
purposes, to facilitate redemption requests, or for other purposes consistent
with the fund's investment objective and program. Such borrowings may be
collateralized with fund assets, subject to restrictions.
Fundamental policy Borrowings may not exceed 33/1//\\/3/\\% of total fund
assets.
Operating policies The fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33/1//\\/3/\\% of the
fund's total assets. The fund may not purchase additional securities when
borrowings exceed 5% of total assets.
Futures and Options
Futures (a type of potentially high-risk derivative) are often used to manage
or hedge risk because they enable the investor to buy or sell an asset in the
future at an agreed upon price. Options (another type of potentially
high-risk derivative) give the investor the right, but not the obligation, to
buy or sell an asset at a predetermined price in the future. The fund may buy
and sell futures and options contracts for any number of reasons, including:
to manage its exposure to changes in interest rates, bond prices, and foreign
currencies; as an efficient means of adjusting its overall exposure to
certain markets; in an effort to enhance income; to protect the value of
portfolio securities; and to adjust the portfolio's duration. The fund may
purchase, sell, or write call and put options on securities, financial
indices, and foreign currencies.
Futures contracts and options may not always be successful hedges; their
prices can be highly volatile. Using them could lower the fund's total
return, and the potential loss from the use of futures can exceed the fund's
initial investment in such contracts.
Operating policies Futures: Initial margin deposits and premiums on options
used for non-hedging purposes will not equal more than 5% of the fund's net
asset value. Options on securities: The total market value of securities
against which the fund has written call or put options may not exceed 25% of
its total assets. The fund will not commit more than 5% of its total assets
to premiums when purchasing call or put options.
Managing Foreign Exchange Risk
Investors in foreign securities may "hedge" their exposure to potentially
unfavorable currency changes by purchasing a contract to exchange one
currency for another on some future date at a specified exchange rate. In
certain circumstances, a "proxy currency" may be substituted for the currency
in which
<PAGE>
T. ROWE PRICE 50
the investment is denominated, a strategy known as "proxy hedging." The fund
may also use these contracts to create a synthetic bond-issued by a U.S.
company, for example, but with the dollar component transformed into a
foreign currency. Although foreign currency transactions will be used
primarily to protect the fund's foreign securities from adverse currency
movements relative to the dollar, they involve the risk that anticipated
currency movements will not occur and the fund's total return could be
reduced.
Operating policy The fund will not commit more than 20% of its total assets
to forward currency contracts.
Lending of Portfolio Securities
Like other mutual funds, the fund may lend securities to broker-dealers,
other institutions, or other persons to earn additional income. The principal
risk is the potential insolvency of the broker-dealer or other borrower. In
this event, the fund could experience delays in recovering its securities and
possibly capital losses.
Fundamental policy The value of loaned securities may not exceed
33/1//\\/3/\\% of total fund assets.
When-Issued Securities and Forward Commitment Contracts
The fund may purchase securities on a when-issued or delayed delivery basis
or may purchase or sell securities on a forward commitment basis. There is no
limit on the fund's investment in these securities. The price of these
securities is fixed at the time of the commitment to buy, but delivery and
payment can take place a month or more later. During the interim period, the
market value of the securities can fluctuate, and no interest accrues to the
purchaser. At the time of delivery, the value of the securities may be more
or less than the purchase or sale price. To the extent the fund remains fully
or almost fully invested (in securities with a remaining maturity of more
than one year) at the same time it purchases these securities, there will be
greater fluctuations in the fund's net asset values than if the fund did not
purchase them.
Portfolio Turnover
Although the fund will not generally trade for short-term profits,
circumstances may warrant a sale without regard to the length of time a
security was held. A high turnover rate may increase transaction costs and
result in additional taxable gains. The fund's portfolio turnover rates for
the fiscal years ended May 31, 1996 and May 31, 1995, were 35.5%, and 54.1%;
respectively. The fund's annualized portfolio turnover rate for the
three-month fiscal year ended May 31, 1994, was 91.5%. The fund's portfolio
turnover rates for the fiscal years ended February 28, 1994, and February 28,
1993, were 58.3%, and 85.8%, respectively.
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MORE ABOUT THE FUNDS 51
Equity Income Fund
Types of Portfolio Securities
In seeking to meet its investment objective, the fund may invest in any type
of security or instrument (including certain potentially high-risk
derivatives described in this section) whose investment characteristics are
consistent with the fund's investment program. The following pages describe
the principal types of portfolio securities and investment management
practices of the fund.
Fundamental policy The fund will not purchase a security if, as a result,
with respect to 75% of its total assets, more than 5% of its total assets
would be invested in securities of a single issuer or more than 10% of the
voting securities of the issuer would be held by the fund.
Common and Preferred Stocks
Stocks represent shares of ownership in a company. Generally, preferred stock
has a specified dividend and ranks after bonds and before common stocks in
its claim on income for dividend payments and on assets should the company be
liquidated. After other claims are satisfied, common stockholders participate
in company profits on a pro rata basis; profits may be paid out in dividends
or reinvested in the company to help it grow. Increases and decreases in
earnings are usually reflected in a company's stock price, so common stocks
generally have the greatest appreciation and depreciation potential of all
corporate securities. While most preferred stocks pay a dividend, the fund
may purchase preferred stock where the issuer has omitted, or is in danger of
omitting, payment of its dividend. Such investments would be made primarily
for their capital appreciation potential.
Convertible Securities and Warrants
The fund may invest in debt or preferred equity securities convertible into
or exchangeable for equity securities. Traditionally, convertible securities
have paid dividends or interest at rates higher than common stocks but lower
than nonconvertible securities. They generally participate in the
appreciation or depreciation of the underlying stock into which they are
convertible, but to a lesser degree. In recent years, convertibles have been
developed which combine higher or lower current income with options and other
features. Warrants are options to buy a stated number of shares of common
stock at a specified price anytime during the life of the warrants
(generally, two or more years).
Foreign Securities
The fund may invest in foreign securities. These include
nondollar-denominated securities traded outside of the U.S. and
dollar-denominated securities of foreign issuers traded in the U.S. (such as
ADRs). Such investments increase a portfolio's
<PAGE>
T. ROWE PRICE 52
diversification and may enhance return, but they also involve some special
risks such as exposure to potentially adverse local political and economic
developments; nationalization and exchange controls; potentially lower
liquidity and higher volatility; possible problems arising from accounting,
disclosure, settlement, and regulatory practices that differ from U.S.
standards; and the chance that fluctuations in foreign exchange rates will
decrease the investment's value (favorable changes can increase its value).
These risks are heightened for investments in developing countries and there
is no limit on the amount of the fund's foreign investments which may be made
in such countries.
Operating policy The fund may invest up to 25% of its total assets (excluding
reserves) in foreign securities.
Fixed Income Securities
The fund may invest in debt securities of any type, including municipal
securities, without regard to quality or rating. Such securities would be
purchased in companies, municipalities, or entities which meet the investment
criteria for the fund. The price of a bond fluctuates with changes in
interest rates, rising when interest rates fall and falling when interest
rates rise.
High-Yield/High-Risk Investing
The total return and yield of lower-quality (high-yield/high-risk) bonds,
commonly referred to as "junk" bonds, can be expected to fluctuate more than
the total return and yield of higher-quality, shorter-term bonds, but not as
much as common stocks. Junk bonds (those rated below BBB or in default) are
regarded as predominantly speculative with respect to the issuer's continuing
ability to meet principal and interest payments.
Operating policy The fund will not purchase a noninvestment-grade debt
security (or junk bond) if immediately after such purchase the fund would
have more than 10% of its total assets invested in such securities.
Hybrid Instruments
These instruments (a type of potentially high-risk derivative) can combine
the characteristics of securities, futures, and options. For example, the
principal amount, redemption, or conversion terms of a security could be
related to the market price of some commodity, currency, or securities index.
Such securities may bear interest or pay dividends at below market (or even
relatively nominal) rates. Under certain conditions, the redemption value of
such an investment could be zero.
o Hybrids can have volatile prices and limited liquidity and their use by the
fund may not be successful.
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MORE ABOUT THE FUNDS 53
Operating policy The fund may invest up to 10% of its total assets in hybrid
instruments.
Private Placements
These securities are sold directly to a small number of investors, usually
institutions. Unlike public offerings, such securities are not registered
with the SEC. Although certain of these securities may be readily sold, for
example, under Rule 144A, others may be illiquid, and their sale may involve
substantial delays and additional costs.
Operating policy The fund will not invest more than 15% of its net assets in
illiquid securities.
Types of Management Practices
Cash Position
The fund will hold a certain portion of its assets in U.S. and foreign
dollar-denominated money market securities, including repurchase agreements,
in the two highest rating categories, maturing in one year or less. For
temporary, defensive purposes, the fund may invest without limitation in such
securities. This reserve position provides flexibility in meeting
redemptions, expenses, and the timing of new investments and serves as a
short-term defense during periods of unusual market volatility.
Borrowing Money and Transferring Assets
The fund can borrow money from banks as a temporary measure for emergency
purposes, to facilitate redemption requests, or for other purposes consistent
with the fund's investment objective and program. Such borrowings may be
collateralized with fund assets, subject to restrictions.
Fundamental policy Borrowings may not exceed 33/1//\\/3/\\% of total fund
assets.
Operating policies The fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33/1//\\/3/\\% of the
fund's total assets. The fund may not purchase additional securities when
borrowings exceed 5% of total assets.
Futures and Options
Futures (a type of potentially high-risk derivative) are often used to manage
or hedge risk, because they enable the investor to buy or sell an asset in
the future at an agreed upon price. Options (another type of potentially
high-risk derivative) give the investor the right, but not the obligation, to
buy or sell an asset at a predetermined price in the future. The fund may buy
and sell futures and options contracts for any number of reasons, including:
to manage its
<PAGE>
T. ROWE PRICE 54
exposure to changes in securities prices and foreign currencies; as an
efficient means of adjusting its overall exposure to certain markets; in an
effort to enhance income; and to protect the value of portfolio securities.
The fund may purchase, sell, or write call and put options on securities,
financial indices, and foreign currencies.
Futures contracts and options may not always be successful hedges; their
prices can be highly volatile. Using them could lower the fund's total
return, and the potential loss from the use of futures can exceed the fund's
initial exposure to such contracts.
Operating policies Futures: Initial margin deposits and premiums on options
used for non-hedging purposes will not equal more than 5% of the fund's net
asset value. Options on securities: The total market value of securities
against which the fund has written call or put options may not exceed 25% of
its total assets. The fund will not commit more than 5% of its total assets
to premiums when purchasing call or put options.
Managing Foreign Currency Risk
Investors in foreign securities may "hedge" their exposure to potentially
unfavorable currency changes by purchasing a contract to exchange one
currency for another on some future date at a specified exchange rate. In
certain circumstances, a "proxy currency" may be substituted for the currency
in which the investment is denominated, a strategy known as "proxy hedging."
Although foreign currency transactions will be used primarily to protect the
fund's foreign securities from adverse currency movements relative to the
dollar, they involve the risk that anticipated currency movements will not
occur and the fund's total return could be reduced.
Lending of Portfolio Securities
Like other mutual funds, the fund may lend securities to broker-dealers,
other institutions, or other persons to earn additional income. The principal
risk is the potential insolvency of the broker-dealer or other borrower. In
this event, the fund could experience delays in recovering its securities and
possibly capital losses.
Fundamental policy The value of loaned securities may not exceed
33/1//\\/3/\\% of total fund assets.
Portfolio Turnover
The fund will not generally trade in securities for short-term profits, but,
when circumstances warrant, securities may be purchased and sold without
regard to the length of time held. A high turnover rate may increase
transaction costs and
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MORE ABOUT THE FUNDS 55
result in additional taxable gains. The fund's portfolio turnover rates for
the fiscal years ending December 31, 1996, 1995, and 1994, were 25.0%, 21.4%,
and 36.3%, respectively.
International Stock Fund
Types of Portfolio Securities
In seeking to meet its investment objective, the fund may invest in any type
of security whose investment characteristics are consistent with the fund's
investment program. The following pages describe the principal types of
portfolio securities and investment management practices of the fund.
Fundamental policy The fund will not purchase a security if, as a result,
with respect to 75% of its total assets, more than 5% of its total assets
would be invested in securities of a single issuer or more than 10% of the
voting securities of the issuer would be held by the fund.
Common and Preferred Stocks
Stocks represent shares of ownership in a company. Generally, preferred stock
has a specified dividend and ranks after bonds and before common stocks in
its claim on income for dividend payments and on assets should the company be
liquidated. After other claims are satisfied, common stockholders participate
in company profits on a pro rata basis; profits may be paid out in dividends
or reinvested in the company to help it grow. Increases and decreases in
earnings are usually reflected in a company's stock price, so common stocks
generally have the greatest appreciation and depreciation potential of all
corporate securities. While most preferred stocks pay a dividend, the fund
may purchase preferred stock where the issuer has omitted, or is in danger of
omitting, payment of its dividend. Such investments would be made primarily
for their capital appreciation potential.
Convertible Securities and Warrants
The fund may invest in debt or preferred equity securities convertible into
or exchangeable for equity securities. Traditionally, convertible securities
have paid dividends or interest at rates higher than common stocks but lower
than nonconvertible securities. They generally participate in the
appreciation or depreciation of the underlying stock into which they are
convertible, but to a lesser degree. In recent years, convertibles have been
developed which combine higher or lower current income with options and other
features. Warrants are options to buy a stated number of shares of common
stock at a specified price anytime during the life of the warrants
(generally, two or more years).
<PAGE>
T. ROWE PRICE 56
Fixed Income Securities
The fund may invest in any type of investment-grade security. Such securities
would be purchased in companies which meet the investment criteria for the
fund. The price of a bond fluctuates with changes in interest rates, rising
when interest rates fall and falling when interest rates rise.
Hybrid Instruments
These instruments (a type of potentially high-risk derivative) can combine
the characteristics of securities, futures, and options. For example, the
principal amount, redemption, or conversion terms of a security could be
related to the market price of some commodity, currency, or securities index.
Such securities may bear interest or pay dividends at below market (or even
relatively nominal) rates. Under certain conditions, the redemption value of
such an investment could be zero.
o Hybrids can have volatile prices and limited liquidity and their use by the
fund may not be successful.
Operating policy The fund may invest up to 10% of its total assets in hybrid
instruments.
Passive Foreign Investment Companies
The fund may purchase the securities of certain foreign investment funds or
trusts called passive foreign investment companies. Such trusts have been the
only or primary way to invest in certain countries. In addition to bearing
their proportionate share of the trust's expenses (management fees and
operating expenses), shareholders will also indirectly bear similar expenses
of such trusts. Capital gains on the sale of such holdings are considered
ordinary income regardless of how long the fund held its investment. In
addition, the fund may be subject to corporate income tax and an interest
charge on certain dividends and capital gains earned from these investments,
regardless of whether such income and gains are distributed to shareholders.
To avoid such tax and interest, the fund intends to treat these securities as
sold on the last day of its fiscal year and recognize any gains for tax
purposes at that time; losses will not be recognized. Such gains will be
considered ordinary income, which the fund will be required to distribute
even though it has not sold the security.
<PAGE>
MORE ABOUT THE FUNDS 57
Private Placements
These securities are sold directly to a small number of investors, usually
institutions. Unlike public offerings, such securities are not registered
with the SEC. Although certain of these securities may be readily sold, for
example, under Rule 144A, others may be illiquid, and their sale may involve
substantial delays and additional costs.
Operating policy The fund will not invest more than 15% of its net assets in
illiquid securities.
Types of Management Practices
Cash Position
The fund will hold a certain portion of its assets in U.S. and foreign
dollar-denominated money market securities, including repurchase agreements,
in the two highest rating categories, maturing in one year or less. For
temporary, defensive purposes, the fund may invest without limitation in such
securities. This reserve position provides flexibility in meeting
redemptions, expenses, and the timing of new investments and serves as a
short-term defense during periods of unusual market volatility.
Borrowing Money and Transferring Assets
The fund can borrow money from banks as a temporary measure for emergency
purposes, to facilitate redemption requests, or for other purposes consistent
with the fund's investment objective and program. Such borrowings may be
collateralized with fund assets, subject to restrictions.
Fundamental policy Borrowings may not exceed 33/1//\\/3/\\% of total fund
assets.
Operating policies The fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33/1//\\/3/\\% of the
fund's total assets. The fund may not purchase additional securities when
borrowings exceed 5% of total assets.
Foreign Currency Transactions
The fund will normally conduct its foreign currency exchange transactions
either on a spot (i.e., cash) basis at the spot rate prevailing in the
foreign currency exchange market, or through entering into forward contracts
to purchase or sell foreign currencies. The fund will generally not enter
into a forward contract with a term greater than one year.
The fund will generally enter into forward foreign currency exchange
contracts only under two circumstances. First, when a fund enters into a
contract for the purchase or sale of a security denominated in a foreign
currency, it may desire
<PAGE>
T. ROWE PRICE 58
to "lock in" the U.S. dollar price of the security. Second, when
Price-Fleming believes that the currency of a particular foreign country may
suffer or enjoy a substantial movement against another currency, it may enter
into a forward contract to sell or buy the former foreign currency (or
another currency which acts as a proxy for that currency), approximating the
value of some or all of the fund's portfolio securities denominated in such
foreign currency. Under certain circumstances, the fund may commit a
substantial portion or the entire value of its portfolio to the consummation
of these contracts. Price-Fleming will consider the effect such a commitment
of its portfolio to forward contracts would have on the investment program of
the fund and the flexibility of the fund to purchase additional securities.
Although forward contracts will be used primarily to protect the fund from
adverse currency movements, they also involve the risk that anticipated
currency movements will not be accurately predicted and the fund's total
return could be adversely affected as a result.
There are certain markets where it is not possible to engage in effective
foreign currency hedging. This may be true, for example, for the currencies
of various Latin American countries and other emerging markets where the
foreign exchange markets are not sufficiently developed to permit hedging
activity to take place.
Futures and Options
Futures (a type of potentially high-risk derivative) are often used to manage
or hedge risk, because they enable the investor to buy or sell an asset in
the future at an agreed upon price. Options (another type of potentially
high-risk derivative) give the investor the right, but not the obligation, to
buy or sell an asset at a predetermined price in the future. The fund may buy
and sell futures and options contracts for any number of reasons, including:
to manage its exposure to changes in securities prices and foreign
currencies; as an efficient means of adjusting its overall exposure to
certain markets; in an effort to enhance income; and to protect the value of
portfolio securities. The fund may purchase, sell, or write call and put
options on securities, financial indices, and foreign currencies.
Futures contracts and options may not always be successful hedges; their
prices can be highly volatile. Using them could lower the fund's total
return, and the potential loss from the use of futures can exceed the fund's
initial exposure to such contracts. In many foreign countries, futures and
options markets do not exist or are not sufficiently developed to be
effectively used by the fund.
Operating policies Futures: Initial margin deposits and premiums on options
used for non-hedging purposes will not equal more than 5% of the fund's net
asset value. Options on securities: The total market value of securities
against
<PAGE>
MORE ABOUT THE FUNDS 59
which the fund has written call or put options may not exceed 25% of its
total assets. The fund will not commit more than 5% of its total assets to
premiums when purchasing call or put options.
Tax Consequences of Hedging
Under applicable tax law, the fund may be required to limit its gains from
hedging in foreign currency forwards, futures, and options. Although the fund
is expected to comply with such limits, the extent to which these limits
apply is subject to tax regulations as yet unissued. Hedging may also result
in the application of the mark-to-market and straddle provisions of the
Internal Revenue Code. These provisions could result in an increase (or
decrease) in the amount of taxable dividends paid by the fund and could
affect whether dividends paid by the fund are classified as capital gains or
ordinary income.
Lending of Portfolio Securities
Like other mutual funds, the fund may lend securities to broker-dealers,
other institutions, or other persons to earn additional income. The principal
risk is the potential insolvency of the broker-dealer or other borrower. In
this event, the fund could experience delays in recovering its securities and
possibly capital losses.
Fundamental policy The value of loaned securities may not exceed
33/1//\\/3/\\% of total fund assets.
Portfolio Turnover
Turnover is an indication of frequency. The fund will not generally trade in
securities for short-term profits, but when circumstances warrant, securities
may be purchased and sold without regard to the length of time held. The
fund's portfolio turnover rates for the fiscal years ended October 31, 1994,
October 31, 1995, and October 31, 1996 were 22.9%, 17.8%, and 11.6%,
respectively.
<PAGE>
INVESTING WITH T. ROWE PRICE
4
ACCOUNT REQUIREMENTS AND TRANSACTION INFORMATION
----------------------------------------------------------
Tax Identification Number
We must have your correct Social Security or corporate tax identification number
on a signed New Account Form or W-9 Form. Otherwise, federal law requires the
funds to withhold a percentage (currently 31%) of your dividends, capital gain
distributions, and redemptions, and may subject you to an IRS fine. If this
information is not received within 60 days after your account is established,
your account may be redeemed, priced at the NAV on the date of redemption.
Always verify your transactions by carefully reviewing the confirmation we send
you. Please report any discrepancies to Shareholder Services promptly.
Employer-Sponsored Retirement Plans and Institutional Accounts T. Rowe Price
Trust Company 1-800-492-7670 1-410-625-6585
Transaction procedures in the following sections may not apply to
employer-sponsored retirement plans and institutional accounts. For procedures
regarding employer-sponsored retirement plans, please call T. Rowe Price Trust
Company or consult your plan administrator. For institutional account
procedures, please call your designated account manager or service
representative.
OPENING A NEW ACCOUNT
----------------------------------------------------------
$2,500 minimum initial investment; $1,000 for retirement plans or gifts or
transfers to minors (UGMA/UTMA) accounts
Account Registration
If you own other T. Rowe Price funds, be sure to register any new account just
like your existing accounts so you can exchange among them easily. (The name and
account type would have to be identical.)
By Mail
Please make your check payable to T. Rowe Price Funds (otherwise it will be
returned) and send your check together with the New Account Form to the address
on the following page. We do not accept third party checks to open new accounts,
except for IRA Rollover checks that are properly endorsed.
<PAGE>
INVESTING WITH T. ROWE PRICE 61
Regular Mail
T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21298-9353
Mailgram, Express, Registered, or Certified Mail
T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117
By Wire
Call Investor Services for an account number and give the following wire
information to your bank:
PNC Bank, N.A. (Pittsburgh) ABA# 043000096 T. Rowe Price [fund name] Account#
1004397951 account name and account number
Complete a New Account Form and mail it to one of the appropriate addresses
listed above.
Note: No services will be established and IRS penalty withholding may occur
until a signed New Account Form is received. Also, retirement plans cannot be
opened by wire.
By Exchange
Call Shareholder Services or use Tele*Access or your personal computer (see
Automated Services under Shareholder Services). The new account will have the
same registration as the account from which you are exchanging. Services for the
new account may be carried over by telephone request if preauthorized on the
existing account. For limitations on exchanging, see explanation of Excessive
Trading under Transaction Procedures and Special Requirements.
In Person
Drop off your New Account Form at any location listed on the cover and obtain a
receipt.
<PAGE>
T. ROWE PRICE 62
PURCHASING ADDITIONAL SHARES
----------------------------------------------------------
$100 minimum purchase; $50 minimum for retirement plans, Automatic Asset
Builder, and gifts or transfers to minors (UGMA/UTMA) accounts
By ACH Transfer
Use Tele*Access or your personal computer or call Investor Services if you have
established electronic transfers using the ACH network.
By Wire
Call Shareholder Services or use the wire address in Opening a New Account.
By Mail
1. Make your check payable to T. Rowe Price Funds (otherwise it may be
returned).
2. Mail the check to us at the address shown below with either a fund
reinvestment slip or a note indicating the fund you want to buy and your fund
account number.
3. Remember to provide your account number and the fund name on the memo line
of your check.
Regular Mail
T. Rowe Price Funds Account Services P.O. Box 89000 Baltimore, MD 21289-1500
/(For mailgrams, express, registered, or certified mail, see previous /
/section.)/
By Automatic Asset Builder
Fill out the Automatic Asset Builder section on the New Account or Shareholder
Services Form.
EXCHANGING AND REDEEMING SHARES
----------------------------------------------------------
By Phone
Call Shareholder Services
If you find our phones busy during unusually volatile markets, please consider
placing your order by your personal computer, Tele*Access (if you have
previously authorized telephone services), mailgram,
<PAGE>
INVESTING WITH T. ROWE PRICE 63
or express mail. For exchange policies, please see Transaction Procedures and
Special Requirements -Excessive Trading.
Redemption proceeds can be mailed to your account address, sent by ACH transfer,
or wired to your bank (provided your bank information is already on file). For
charges, see Electronic Transfers -By Wire under Shareholder Services.
By Mail
For each account involved, provide the account name, number, fund name, and
exchange or redemption amount. For exchanges, be sure to indicate any fund you
are exchanging out of and the fund or funds you are exchanging into. Please mail
to the appropriate address below. T. Rowe Price requires the signatures of all
owners exactly as registered, and possibly a signature guarantee (see
Transaction Procedures and Special Requirements-Signature Guarantees).
Regular Mail
For nonretirement and IRA accounts
T. Rowe Price Account Services P.O. Box 89000 Baltimore, MD 21289-0220
For employer-sponsored retirement accounts
T. Rowe Price Trust Company P.O. Box 89000 Baltimore, MD 21289-0300
Redemptions from employer-sponsored retirement accounts must be in writing;
please call T. Rowe Price Trust Company or your plan administrator for
instructions. IRA distributions may be requested in writing or by telephone;
please call Shareholder Services to obtain an IRA Distribution Form or an IRA
Shareholder Services Form to authorize the telephone redemption service.
Rights Reserved by the Fund
The fund and its agents reserve the right to waive or lower investment minimums;
to accept initial purchases by telephone or mailgram; to refuse any purchase
order; to cancel or rescind any purchase or exchange (for example, if an account
has been
<PAGE>
T. ROWE PRICE 64
restricted due to excessive trading or fraud) upon notice to the shareholder
within five business days of the trade or if the written confirmation has not
been received by the shareholder, whichever is sooner; to freeze any account and
suspend account services when notice has been received of a dispute between the
registered or beneficial account owners or there is reason to believe a
fraudulent transaction may occur; to otherwise modify the conditions of purchase
and any services at any time; or to act on instructions believed to be genuine.
SHAREHOLDER SERVICES
----------------------------------------------------------
Shareholder Services 1-800-225-5132 1-410-625-6500 Investor Services
1-800-638-5660 1-410-547-2308
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically and others you must authorize on the New Account Form. By
signing up for services on the New Account Form rather than later on, you avoid
having to complete a separate form and obtain a signature guarantee. This
section reviews some of the principal services currently offered. Our Services
Guide contains detailed descriptions of these and other services.
If you are a new T. Rowe Price investor, you will receive a Services Guide with
our Welcome Kit.
Note: Corporate and other institutional accounts require an original or
certified resolution to establish services and to redeem by mail. For more
information, call Investor Services.
Retirement Plans
We offer a wide range of plans for individuals, institutions, and large and
small businesses: IRAs, SIMPLE IRAs, SEP-IRAs, Keoghs (profit sharing, money
purchase pension), 401(k), and 403(b). For information on IRAs, call Investor
Services. For information on all other retirement plans, including our no-load
variable annuity, please call our Trust Company at 1-800-492-7670.
<PAGE>
INVESTING WITH T. ROWE PRICE 65
Exchange Service
You can move money from one account to an existing identically registered
account or open a new identically registered account. Remember, exchanges are
purchases and sales for tax purposes. (Exchanges into a state tax-free fund are
limited to investors living in states where the funds are registered.) Some of
the T. Rowe Price funds may impose a redemption fee of 0.5% to 2% on shares held
for less than six months or one year, as specified in the prospectus. The fee is
paid to the fund.
Automated Services Tele*Access 1-800-638-2587
Tele*Access
24-hour service via a toll-free number enables you to (1) access information on
fund yields, prices, distributions, account balances, and your latest
transaction; (2) request checks, prospectuses, services forms, duplicate
statements and tax forms; and (3) initiate purchase, redemption, and exchange
transactions in your accounts (see Electronic Transfers below).
T. Rowe Price OnLine
24-hour service via dial-up modem provides the same services as Tele*Access but
on a personal computer. Please call Investor Services for an information guide.
Plan Account Line 1-800-401-3279
Plan Account Line
This 24-hour service is similar to Tele*Access but is designed specifically to
meet the needs of retirement plan investors.
Telephone and Walk-In Services
Buy, sell, or exchange shares by calling one of our service representatives or
by visiting one of our investor center locations whose addresses are listed on
the cover.
Electronic Transfers
By ACH
With no charges to pay, you can initiate a purchase or redemption for as little
as $100 or as much as $100,000 between your bank account and fund account using
the ACH network. Enter instructions via Tele*Access or your personal computer,
or call Shareholder Services.
<PAGE>
T. ROWE PRICE 66
By Wire
Electronic transfers can be conducted via bank wire. There is currently a $5 fee
for wire redemptions under $5,000, and your bank may charge for incoming or
outgoing wire transfers regardless of size.
Checkwriting
(Not available for equity funds or the High Yield or Emerging Markets Bond
Funds) You may write an unlimited number of free checks on any money market
fund, and most bond funds, with a minimum of $500 per check. Keep in mind,
however, that a check results in a redemption; a check written on a bond fund
will create a taxable event which you and we must report to the IRS.
Automatic Investing
($50 minimum) You can invest automatically in several different ways, including:
Automatic Asset Builder
You instruct us to move $50 or more from your bank account, or you can instruct
your employer to send all or a portion of your paycheck to the fund or funds you
designate.
Automatic Exchange
You can set up systematic investments from one fund account into another, such
as from a money fund into a stock fund.
DISCOUNT BROKERAGE
----------------------------------------------------------
This additional service gives you the opportunity to easily consolidate all of
your investments with one company. Through our discount brokerage, you can buy
and sell individual securities -stocks, bonds, options, and others - at
considerable commission savings over full-service brokers. We also provide a
wide range of services, including:
<PAGE>
INVESTING WITH T. ROWE PRICE 67
To open an account 1-800-638-5660 For existing discount brokerage investors
1-800-225-7720
Automated telephone and on-line services
You can enter trades, access quotes, and review account information 24 hours a
day, seven days a week. Any trades executed through these programs save you an
additional 10% on commissions.
Note: Discount applies to our current commission schedule, subject to our $35
minimum commission.
Investor information
A variety of informative reports, such as our Brokerage Insights series, S&P
Market Month newsletter, and select stock reports, can help you better evaluate
economic trends and investment opportunities.
Dividend Reinvestment Service
Virtually all stocks held in customer accounts are eligible for this
service-free of charge.
/Discount Brokerage is a division of //T. Rowe Price// Investment / /Services,
Inc., Member NASD/SIPC./
INVESTMENT INFORMATION
----------------------------------------------------------
To help shareholders monitor their current investments and make decisions that
accurately reflect their financial goals, T. Rowe Price offers a wide variety of
information in addition to account statements.
Shareholder Reports
Fund managers' reviews of their strategies and results. If several members of a
household own the same fund, only one fund report is mailed to that address. To
receive additional copies, please call Shareholder Services or write to us at
100 East Pratt Street, Baltimore, Maryland 21202.
The T. Rowe Price Report
A quarterly investment newsletter discussing markets and financial strategies.
Performance Update
Quarterly review of all T. Rowe Price fund results.
<PAGE>
T. ROWE PRICE 68
Insights
Educational reports on investment strategies and financial markets.
Investment Guides
Asset Mix Worksheet, College Planning Kit, Personal Strategy Planner, Retirees
Financial Guide, Retirement Planning Kit, Tax Considerations for Investors and
Diversifying Overseas: A T. Rowe Price Guide to International Investing.
<PAGE>
To help you achieve your financial goals, T. Rowe Price offers a wide range of
stock, bond, and money market investments, as well as convenient services and
timely, informative reports.
To Open a Mutual Fund Account
Investor Services
1-800-638-5660 1-410-547-2308
For Existing Accounts
Shareholder Services 1-800-225-5132
1-410-625-6500
For Yields, Prices, Account Information, or to Conduct Transactions
Tele*Access/(R)/
1-800-638-2587 24 hours, 7 days
To Open a Discount Brokerage Account
1-800-638-5660
Plan Account Line
1-800-401-3279
For retirement plan
investors
Investor Centers
101 East Lombard St. Baltimore, MD 21202
T. Rowe Price
Financial Center
10090 Red Run Blvd.
Owings Mills, MD 21117
Farragut Square
900 17th Street, N.W.
Washington, D.C. 20006
ARCO Tower
31st Floor
515 South Flower St.
Los Angeles, CA 90071
4200 West Cypress St.
10th Floor
Tampa, FL 33607
Internet Address
www.troweprice.com
C00-040 5/1/97
PAGE 2
STATEMENT OF ADDITIONAL INFORMATION
T. Rowe Price Prime Reserve Fund, Inc.
T. Rowe Price New Income Fund, Inc.
T. Rowe Price Equity Income Fund
T. Rowe Price International Stock FundR
(the "Funds")
This Statement of Additional Information is not a prospectus
but should be read in conjunction with each Fund's prospectus
dated May 1, 1997, which may be obtained from T. Rowe Price
Investment Services, Inc., 100 East Pratt Street, Baltimore,
Maryland 21202.
If you would like a prospectus for a Fund of which you are
not a shareholder, please call 1-800-638-5660. A prospectus with
more complete information, including management fees and expenses
will be sent to you. Please read it carefully.
The date of this Statement of Additional Information is May
1, 1997.
SAI-GEN 5/1/97
PAGE 3
TABLE OF CONTENTS
Page Page
Adjustable Rate Mortgages 13 Investment Restrictions . 37
Adjustable Rate Securities 13 Legal Counsel . . . . . . 74
Asset-Backed Securities . . 15 Lending of Portfolio
Code of Ethics . . . . . . 53 Securities . . . . . . . 22
Covered Call and Put Management of Funds . . . 41
Options . . . . . . . . . 23 Mortgage-Related Securities 9
Custodian . . . . . . . . . 53 Net Asset Value Per Share 65
Dealer Options . . . . . . 27 Organization of the Funds 71
Distributor for Funds . . . 52 Portfolio Management
Dividends . . . . . . . . . 65 Practices . . . . . . . 22
Federal Registration Portfolio Transactions . 54
of Shares . . . . . . . . 74 Pricing of Securities . . 63
Foreign Currency Principal Holders of
Transactions . . . . . . . 34 Securities . . . . . . . 49
Futures Contracts . . . . . 28 Ratings of Commercial
Hybrid Instruments . . . . 18 Paper . . . . . . . . . 76
Illiquid or Restricted Ratings of Corporate Debt
Securities . . . . . . . . 20 Securities . . . . . . . 77
Independent Accountants . . 74 Repurchase Agreements . . 22
Industry Concentration . . 17 Risk Factors . . . . . . . 3
Investment Management Shareholder Services . . 53
Services . . . . . . . . . 49 Tax Status . . . . . . . 66
Investment Objectives and Warrants . . . . . . . . 18
Policies . . . . . . . . . . 2 When-Issued Securities and
Investment Performance . . 69 Forward Commitment
Investment Program . . . . . 8 Contracts . . . . . . . 20
Yield Information . . . . 68
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of each
Fund's investment objectives and policies discussed in the
prospectus. The International Stock Fund's investment objective
is a fundamental policy. The Prime Reserve, New Income, and
Equity Income Funds will not make a material change in their
investment objectives without obtaining shareholder approval.
Unless otherwise specified, the investment program and
restrictions of each Fund are not fundamental policies. The
operating policies of each Fund are subject to change by its
Board of Directors/Trustees without shareholder approval.
However, shareholders will be notified of a material change in an
operating policy. The fundamental policies of each Fund may not
be changed without the approval of at least a majority of the
outstanding shares of the Fund or, if it is less, 67% of the
PAGE 4
shares represented at a meeting of shareholders at which the
holders of 50% or more of the shares are represented.
RISK FACTORS
General
New Income, Equity Income and International Stock Funds
Because of its investment policy, the Fund may or may not be
suitable or appropriate for all investors. The Funds are not
money market funds and are not an appropriate investment for
those whose primary objective is principal stability. The Equity
Income and International Stock Funds will normally have
substantially all of their assets in equity securities (e.g.,
common stocks). This portion of the Funds' assets will be
subject to all of the risks of investing in the stock market.
There is risk in all investment. The value of the portfolio
securities of the Funds will fluctuate based upon market
conditions. Although the Funds seek to reduce risk by investing
in a diversified portfolio, such diversification does not
eliminate all risk. There can, of course, be no assurance that
the Funds will achieve their investment objectives. Reference is
also made to the sections entitled "Types of Securities" and
"Portfolio Management Practices" for discussions of the risks
associated with the investments and practices described therein
as they apply to the Fund.
Prime Reserve Fund
There can be no assurance that the Fund will achieve its
investment objectives or be able to maintain its net asset value
per share at $1.00. The price of the Fund is not guaranteed or
insured by the U.S. Government, and its yield is not fixed. An
increase in interest rates could reduce the value of the Fund's
portfolio investments, and a decline in interest rates could
increase the value.
New Income and Equity Income Funds
Debt Obligations
Although substantially all of the Equity Income Fund's
assets are invested in common stocks, the Fund may invest in
convertible securities, corporate debt securities and preferred
stocks which hold the prospect of contributing to the achievement
of the Fund's objectives. Yields on short, intermediate, and
long-term securities are dependent on a variety of factors,
including the general conditions of the money and bond markets,
PAGE 5
the size of a particular offering, the maturity of the
obligation, and the credit quality and rating of the issue. Debt
securities with longer maturities tend to have higher yields and
are generally subject to potentially greater capital appreciation
and depreciation than obligations with shorter maturities and
lower yields. The market prices of debt securities usually vary,
depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio investments, and a
decline in interest rates will generally increase the value of
portfolio investments. The ability of each Fund to achieve its
investment objective is also dependent on the continuing ability
of the issuers of the debt securities in which the Fund invests
to meet their obligations for the payment of interest and
principal when due. The Equity Income Fund's investment program
permits it to purchase below investment grade securities. Since
investors generally perceive that there are greater risks
associated with investment in lower quality securities, the
yields from such securities normally exceed those obtainable from
higher quality securities. However, the principal value of
lower-rated securities generally will fluctuate more widely than
higher quality securities. Lower quality investments entail a
higher risk of default--that is, the nonpayment of interest and
principal by the issuer than higher quality investments. Such
securities are also subject to special risks, discussed below.
Although each Fund seeks to reduce risk by portfolio
diversification, credit analysis, and attention to trends in the
economy, industries and financial markets, such efforts will not
eliminate all risk. There can, of course, be no assurance that
the Fund will achieve their investment objectives.
Prime Reserve, New Income and Equity Income Funds
After purchase by each Fund, a debt security may cease to be
rated or its rating may be reduced below the minimum required for
purchase by the Fund. For the Prime Reserve Fund, the procedures
set forth in Rule 2a-7, under the Investment Company Act of 1940,
may require the prompt sale of any such security. For the other
Funds, neither event will require a sale of such security by the
Fund. However, T. Rowe Price will consider such event in its
determination of whether the Fund should continue to hold the
security. To the extent that the ratings given by Moody's or S&P
may change as a result of changes in such organizations or their
rating systems, the Fund will attempt to use comparable ratings
as standards for investments in accordance with the investment
policies contained in the prospectus. When purchasing unrated
securities, T. Rowe Price, under the supervision of each Fund's
Board of Directors/Trustees, determines whether the unrated
security is of a quality comparable to that which the Fund is
allowed to purchase.
PAGE 6
Equity Income Fund
Special Risks of High Yield Investing
The Fund may invest in low quality bonds commonly referred
to as "junk" bonds. Junk bonds are regarded as predominantly
speculative with respect to the issuer's continuing ability to
meet principal and interest payments. Because investment in low
and lower-medium quality bonds involves greater investment risk,
to the extent the Fund invests in such bonds, achievement of its
investment objective will be more dependent on T. Rowe Price's
credit analysis than would be the case if the Fund was investing
in higher quality bonds. High yield bonds may be more
susceptible to real or perceived adverse economic conditions than
investment grade bonds. A projection of an economic downturn, or
higher interest rates, for example, could cause a decline in high
yield bond prices because the advent of such events could lessen
the ability of highly leverage issuers to make principal and
interest payments on their debt securities. In addition, the
secondary trading market for high yield bonds may be less liquid
than the market for higher grade bonds, which can adversely
affect the ability of a Fund to dispose of its portfolio
securities. Bonds for which there is only a "thin" market can be
more difficult to value inasmuch as objective pricing data may be
less available and judgment may play a greater role in the
valuation process.
New Income Fund
Mortgage securities differ from conventional bonds in that
principal is paid back over the life of the security rather than
at maturity. As a result, the holder of a mortgage security
(i.e., the Fund) receives monthly scheduled payments of principal
and interest, and may receive unscheduled principal payments
representing prepayments on the underlying mortgages. The
incidence of unscheduled principal payments is also likely to
increase in mortgage pools owned by the Fund when prevailing
mortgage loan rates fall below the mortgage rates of the
securities underlying the individual pool. The effect of such
prepayments in a falling rate environment is to (1) cause the
Fund to reinvest principal payments at the then lower prevailing
interest rate, and (2) reduce the potential for capital
appreciation beyond the face amount of the security. Conversely,
the Fund may realize a gain on prepayments of mortgage pools
trading at a discount. Such prepayments will provide an early
return of principal which may then be reinvested at the then
higher prevailing interest rate.
PAGE 7
The market value of adjustable rate mortgage securities
("ARMs"), like other U.S. government securities, will generally
vary inversely with changes in market interest rates, declining
when interest rates rise and rising when interest rates decline.
Because of their periodic adjustment feature, ARMs should be more
sensitive to short-term interest rates than long-term rates.
They should also display less volatility than long-term mortgage
securities. Thus, while having less risk of a decline during
periods of rapidly rising rates, ARMs may also have less
potential for capital appreciation than other investments of
comparable maturities. Interest rate caps on mortgages
underlying ARM securities may prevent income on the ARM from
increasing to prevailing interest rate levels and cause the
securities to decline in value. In addition, to the extent ARMS
are purchased at a premium, mortgage foreclosures and unscheduled
principal prepayments may result in some loss of the holders'
principal investment to the extent of the premium paid. On the
other hand, if ARMs are purchased at a discount, both a scheduled
payment of principal and an unscheduled prepayment of principal
will increase current and total returns and will accelerate the
recognition of income which when distributed to shareholders will
be taxable as ordinary income.
All Funds, except Prime Reserve Fund
Foreign Securities
The Equity Income Fund may invest in U.S. dollar-denominated
and non U.S. dollar-denominated securities of foreign issuers.
Risk Factors of Foreign Investing
There are special risks in foreign investing. Certain
of these risks are inherent in any mutual fund investing in
foreign securities while others relate more to the countries in
which the Funds will invest. Many of the risks are more
pronounced for investments in developing or emerging countries,
such as many of the countries of Southeast Asia, China, Latin
America, Eastern Europe, the countries of the former Soviet
Union, Africa and the Middle East. Although there is no
universally accepted definition, a developing country is
generally considered to be a country which is in the initial
stages of its industrialization cycle with a per capita gross
national product of less than $8,000.
General (International Stock Fund). Investors should
understand that all investments have a risk factor. There can be
no guarantee against loss resulting from an investment in the
Fund, and there can be no assurance that the Fund's investment
PAGE 8
policies will be successful, or that its investment objective
will be attained. The Fund is designed for individual and
institutional investors seeking to diversify beyond the United
States in actively researched and managed portfolios, and is
intended for long-term investors who can accept the risks
entailed in investment in foreign securities.
Political and Economic Factors. Individual foreign
economies of certain countries may differ favorably or
unfavorably from the United States' economy in such respects as
growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments
position. The internal politics of certain foreign countries are
not as stable as in the United States. For example, in 1991, the
existing government in Thailand was overthrown in a military
coup. In 1992, there were two military coup attempts in
Venezuela and in 1992 the President of Brazil was impeached. In
addition, significant external political risks currently affect
some foreign countries. Both Taiwan and China still claim
sovereignty of one another and there is a demilitarized border
between North and South Korea.
Governments in certain foreign countries continue to
participate to a significant degree, through ownership interest
or regulation, in their respective economies. Action by these
governments could have a significant effect on market prices of
securities and payment of dividends. The economies of many
foreign countries are heavily dependent upon international trade
and are accordingly affected by protective trade barriers and
economic conditions of their trading partners. The enactment by
these trading partners of protectionist trade legislation could
have a significant adverse effect upon the securities markets of
such countries.
Currency Fluctuations. The Funds will invest in securities
denominated in various currencies. Accordingly, a change in the
value of any such currency against the U.S. dollar will result in
a corresponding change in the U.S. dollar value of the Funds'
assets denominated in that currency. Such changes will also
affect the Funds' income. Generally, when a given currency
appreciates against the dollar (the dollar weakens) the value of
the Fund's securities denominated in that currency will rise.
When a given currency depreciates against the dollar (the dollar
strengthens) the value of the Funds' securities denominated in
that currency would be expected to decline.
Investment and Repatriation Restrictions. Foreign
investment in the securities markets of certain foreign countries
is restricted or controlled in varying degrees. These
restrictions may limit at times and preclude investment in
PAGE 9
certain of such countries and may increase the cost and expenses
of the Funds. Investments by foreign investors are subject to a
variety of restrictions in many developing countries. These
restrictions may take the form of prior governmental approval,
limits on the amount or type of securities held by foreigners,
and limits on the types of companies in which foreigners may
invest. Additional or different restrictions may be imposed at
any time by these or other countries in which the Funds invest.
In addition, the repatriation of both investment income and
capital from several foreign countries is restricted and
controlled under certain regulations, including in some cases the
need for certain government consents. For example, capital
invested in Chile normally cannot be repatriated for one year.
Market Characteristics. It is contemplated that most
foreign securities will be purchased in over-the-counter markets
or on stock exchanges located in the countries in which the
respective principal offices of the issuers of the various
securities are located, if that is the best available market.
Investments in certain markets may be made through ADRs traded in
the United States. Foreign stock markets are generally not as
developed or efficient as, and may be more volatile than, those
in the United States. While growing in volume, they usually have
substantially less volume than U.S. markets and the Funds'
portfolio securities may be less liquid and subject to more rapid
and erratic price movements than securities of comparable U.S.
companies. Equity securities may trade at price/earnings
multiples higher than comparable United States securities and
such levels may not be sustainable. Fixed commissions on foreign
stock exchanges are generally higher than negotiated commissions
on United States exchanges, although the Funds will endeavor to
achieve the most favorable net results on their portfolio
transactions. There is generally less government supervision and
regulation of foreign stock exchanges, brokers and listed
companies than in the United States. Moreover, settlement
practices for transactions in foreign markets may differ from
those in United States markets. Such differences may include
delays beyond periods customary in the United States and
practices, such as delivery of securities prior to receipt of
payment, which increase the likelihood of a "failed settlement."
Failed settlements can result in losses to a Fund.
Investment Funds. The Funds may invest in investment funds
which have been authorized by the governments of certain
countries specifically to permit foreign investment in securities
of companies listed and traded on the stock exchanges in these
respective countries. If the Funds invest in such investment
funds, the Funds' shareholders will bear not only their
proportionate share of the expenses of the Funds (including
operating expenses and the fees of the investment manager), but
PAGE 10
also will bear indirectly similar expenses of the underlying
investment funds. In addition, the securities of these
investment funds may trade at a premium over their net asset
value.
Information and Supervision. There is generally less
publicly available information about foreign companies comparable
to reports and ratings that are published about companies in the
United States. Foreign companies are also generally not subject
to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those
applicable to United States companies. It also may be more
difficult to keep currently informed of corporate actions which
affect the prices of portfolio securities.
Taxes. The dividends and interest payable on certain of the
Funds' foreign portfolio securities may be subject to foreign
withholding taxes, thus reducing the net amount of income
available for distribution to the Funds' shareholders. A
shareholder otherwise subject to United States federal income
taxes may, subject to certain limitations, be entitled to claim a
credit or deduction for U.S. federal income tax purposes for his
or her proportionate share of such foreign taxes paid by the
Funds. (See "Tax Status.")
Other. With respect to certain foreign countries,
especially developing and emerging ones, there is the possibility
of adverse changes in investment or exchange control regulations,
expropriation or confiscatory taxation, limitations on the
removal of funds or other assets of the Funds, political or
social instability, or diplomatic developments which could affect
investments by U.S. persons in those countries.
Eastern Europe and Russia. Changes occurring in Eastern
Europe and Russia today could have long-term potential
consequences. As restrictions fall, this could result in rising
standards of living, lower manufacturing costs, growing consumer
spending, and substantial economic growth. However, investment
in the countries of Eastern Europe and Russia is highly
speculative at this time. Political and economic reforms are too
recent to establish a definite trend away from centrally-planned
economies and state owned industries. In many of the countries
of Eastern Europe and Russia, there is no stock exchange or
formal market for securities. Such countries may also have
government exchange controls, currencies with no recognizable
market value relative to the established currencies of western
market economies, little or no experience in trading in
securities, no financial reporting standards, a lack of a banking
and securities infrastructure to handle such trading, and a legal
tradition which does not recognize rights in private property.
PAGE 11
In addition, these countries may have national policies which
restrict investments in companies deemed sensitive to the
country's national interest. Further, the governments in such
countries may require governmental or quasi-governmental
authorities to act as custodian of a Fund's assets invested in
such countries and these authorities may not qualify as a foreign
custodian under the Investment Company Act of 1940 and exemptive
relief from such Act may be required. All of these
considerations are among the factors which could cause
significant risks and uncertainties to investment in Eastern
Europe and Russia. Each Fund will only invest in a company
located in, or a government of, Eastern Europe and Russia, if it
believes the potential return justifies the risk. To the extent
any securities issued by companies in Eastern Europe and Russia
are considered illiquid, each Fund will be required to include
such securities within its 15% restriction on investing in
illiquid securities.
INVESTMENT PROGRAM
Types of Securities
Set forth below is additional information about certain of
the investments described in the Funds' prospectus.
Debt Securities
Prime Reserve, New Income and Equity Income Funds
Fixed income securities in which the Funds may invest
include, but are not limited to, those described below.
U.S. Government Obligations. Bills, notes, bonds, and other
debt securities issued by the U.S. Treasury. These are direct
obligations of the U.S. Government and differ mainly in the
length of their maturities.
U.S. Government Agency Securities. Issued or guaranteed by
U.S. Government sponsored enterprises and federal agencies.
These include securities issued by the Federal National Mortgage
Association, Government National Mortgage Association, Federal
Home Loan Bank, Federal Land Banks, Farmers Home Administration,
Banks for Cooperatives, Federal Intermediate Credit Banks,
Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these
securities are supported by the full faith and credit of the U.S.
Treasury; and the remainder are supported only by the credit of
the instrumentality, which may or may not include the right of
the issuer to borrow from the Treasury.
PAGE 12
Bank Obligations. Certificates of deposit, bankers'
acceptances, and other short-term debt obligations. Certificates
of deposit are short-term obligations of commercial banks. A
bankers' acceptance is a time draft drawn on a commercial bank by
a borrower, usually in connection with international commercial
transactions. Certificates of deposit may have fixed or variable
rates. The Funds may invest in U.S. banks, foreign branches of
U.S. banks, U.S. branches of foreign banks, and foreign branches
of foreign banks.
Corporate Debt Securities. Outstanding nonconvertible
corporate debt securities (e.g., bonds and debentures).
Corporate notes may have fixed, variable, or floating rates.
Commercial Paper. Short-term promissory notes issued by
corporations primarily to finance short-term credit needs.
Certain notes may have floating or variable rates.
Foreign Government Securities. Issued or guaranteed by a
foreign government, a province, instrumentality or political
subdivision, or similar unit thereof.
Savings and Loan Obligations. Negotiable certificates of
deposit and other short-term debt obligations of savings and loan
associations.
Supranational Agencies. Securities of certain supranational
entities, such as the International Development Bank.
New Income Fund
Mortgage-Related Securities
Mortgage-related securities in which the Fund may invest
include, but are not limited to, those described below.
Mortgage-Backed Securities. Mortgage-backed securities are
securities representing an interest in a pool of mortgages. The
mortgages may be of a variety of types, including adjustable
rate, conventional 30-year fixed rate, graduated payment, and 15-
year. Principal and interest payments made on the mortgages in
the underlying mortgage pool are passed through to the Fund. This
is in contrast to traditional bonds where principal is normally
paid back at maturity in a lump sum. Unscheduled prepayments of
principal shorten the securities' weighted average life and may
lower their total return. (When a mortgage in the underlying
mortgage pool is prepaid, an unscheduled principal prepayment is
passed through to the Fund. This principal is returned to the
PAGE 13
Fund at par. As a result, if a mortgage security were trading at
a premium, its total return would be lowered by prepayments, and
if a mortgage security were trading at a discount, its total
return would be increased by prepayments.) The value of these
securities also may change because of changes in the market's
perception of the creditworthiness of the federal agency that
issued them. In addition, the mortgage securities market in
general may be adversely affected by changes in governmental
regulation or tax policies.
U.S. Government Agency Mortgage-Backed Securities. These
are obligations issued or guaranteed by the United States
Government or one of its agencies or instrumentalities, such as
the Government National Mortgage Association ("Ginnie Mae" or
"GNMA"), the Federal National Mortgage Association ("Fannie Mae"
or "FNMA") the Federal Home Loan Mortgage Corporation ("Freddie
Mac" or "FHLMC"), and the Federal Agricultural Mortgage
Corporation ("Farmer Mac" or "FAMC"). FNMA, FHLMC, and FAMC
obligations are not backed by the full faith and credit of the
U.S. Government as GNMA certificates are, but they are supported
by the instrumentality's right to borrow from the United States
Treasury. U.S. Government Agency Mortgage-Backed Certificates
provide for the pass-through to investors of their pro-rata share
of monthly payments (including any prepayments) made by the
individual borrowers on the pooled mortgage loans, net of any
fees paid to the guarantor of such securities and the servicer of
the underlying mortgage loans. Each of GNMA, FNMA, FHLMC, and
FAMC guarantees timely distributions of interest to certificate
holders. GNMA and FNMA guarantee timely distributions of
scheduled principal. FHLMC has in the past guaranteed only the
ultimate collection of principal of the underlying
mortgage loan; however, FHLMC now issues Mortgage-Backed
Securities (FHLMC Gold PCs) which also guarantee timely payment
of monthly principal reductions.
Ginnie Mae Certificates. Ginnie Mae is a wholly-owned
corporate instrumentality of the United States within the
Department of Housing and Urban Development. The National
Housing Act of 1934, as amended (the "Housing Act"), authorizes
Ginnie Mae to guarantee the timely payment of the principal of
and interest on certificates that are based on and backed by a
pool of mortgage loans insured by the Federal Housing
Administration under the Housing Act, or Title V of the Housing
Act of 1949 ("FHA Loans"), or guaranteed by the Department of
Veterans Affairs under the Servicemen's Readjustment Act of 1944,
as amended ("VA Loans"), or by pools of other eligible mortgage
loans. The Housing Act provides that the full faith and credit
of the United States government is pledged to the payment of all
amounts that may be required to be paid under any guaranty. In
order to meet its obligations under such guaranty, Ginnie Mae is
PAGE 14
authorized to borrow from the United States Treasury with no
limitations as to amount.
Fannie Mae Certificates. Fannie Mae is a federally
chartered and privately owned corporation organized and existing
under the Federal National Mortgage Association Charter Act of
1938. FNMA Certificates represent a pro-rata interest in a group
of mortgage loans purchased by Fannie Mae. FNMA guarantees the
timely payment of principal and interest on the securities it
issues. The obligations of FNMA are not backed by the full faith
and credit of the U.S. Government.
Freddie Mac Certificates. Freddie Mac is a corporate
instrumentality of the United States created pursuant to the
Emergency Home Finance Act of 1970, as amended (the "FHLMC Act").
Freddie Mac Certificates represent a pro-rata interest in a group
of mortgage loans (a "Freddie Mac Certificate group") purchased
by Freddie Mac. Freddie Mac guarantees timely payment of
interest and principal on certain securities it issues and timely
payment of interest and eventual payment of principal on other
securities is issues. The obligations of Freddie Mac are
obligations solely of Freddie Mac and are not backed by the full
faith and credit of the U.S. Government.
Farmer Mac Certificates. The Federal Agricultural Mortgage
Corporation ("Farmer Mac") is a federally chartered
instrumentality of the United States established by Title VIII of
the Farm Credit Act of 1971, as amended ("Charter Act"). Farmer
Mac was chartered primarily to attract new capital for financing
of agricultural real estate by making a secondary market in
certain qualified agricultural real estate loans. Farmer Mac
provides guarantees of timely payment of principal and interest
on securities representing interests in, or obligations backed
by, pools of mortgages secured by first liens on agricultural
real estate ("Farmer Mac Certificates"). Similar to Fannie Mae
and Freddie Mac, Farmer Mac's Certificates are not supported by
the full faith and credit of the U.S. Government; rather, Farmer
Mac may borrow up from the U.S. Treasury to meet its guaranty
obligations.
As discussed above, prepayments on the underlying mortgages
and their effect upon the rate of return of a Mortgage-Backed
Security, is the principal investment risk for a purchaser of
such securities, like the Fund. Over time, any pool of mortgages
will experience prepayments due to a variety of factors,
including (1) sales of the underlying homes (including
foreclosures), (2) refinancings of the underlying mortgages, and
(3) increased amortization by the mortgagee. These factors, in
turn, depend upon general economic factors, such as level of
interest rates and economic growth. Thus, investors normally
PAGE 15
expect prepayment rates to increase during periods of strong
economic growth or declining interest rates, and to decrease in
recessions and rising interest rate environments. Accordingly,
the life of the Mortgage-Backed Security is likely to be
substantially shorter than the stated maturity of the mortgages
in the underlying pool. Because of such variation in prepayment
rates, it is not possible to predict the life of a particular
Mortgage-Backed Security, but FHA statistics indicate that 25- to
30-year single family dwelling mortgages have an average life of
approximately 12 years. The majority of Ginnie Mae Certificates
are backed by mortgages of this type, and, accordingly, the
generally accepted practice treats Ginnie Mae Certificates as 30-
year securities which prepay full in the 12th year. FNMA and
Freddie Mac Certificates may have differing prepayment
characteristics.
Fixed Rate Mortgage-Backed Securities bear a stated "coupon
rate" which represents the effective mortgage rate at the time of
issuance, less certain fees to GNMA, FNMA and FHLMC for providing
the guarantee, and the issuer for assembling the pool and for
passing through monthly payments of interest and principal.
Payments to holders of Mortgage-Backed Securities consist of
the monthly distributions of interest and principal less the
applicable fees. The actual yield to be earned by a holder of
Mortgage-Backed Securities is calculated by dividing interest
payments by the purchase price paid for the Mortgage-Backed
Securities (which may be at a premium or a discount from the face
value of the certificate).
Monthly distributions of interest, as contrasted to semi-
annual distributions which are common for other fixed interest
investments, have the effect of compounding and thereby raising
the effective annual yield earned on Mortgage-Backed Securities.
Because of the variation in the life of the pools of mortgages
which back various Mortgage-Backed Securities, and because it is
impossible to anticipate the rate of interest at which future
principal payments may be reinvested, the actual yield earned
from a portfolio of Mortgage-Backed Securities will differ
significantly from the yield estimated by using an assumption of
a certain life for each Mortgage-Backed Security included in such
a portfolio as described above.
U.S. Government Agency Multiclass Pass-Through Securities.
Unlike CMOs, U.S. Government Agency Multiclass Pass-Through
Securities, which include FNMA Guaranteed REMIC Pass-Through
Certificates and FHLMC Multi-Class Mortgage Participation
Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references
herein to CMOs include multiclass pass-through securities.
PAGE 16
Multi-Class Residential Mortgage Securities. Such
securities represent interests in pools of mortgage loans to
residential home buyers made by commercial banks, savings and
loan associations or other financial institutions. Unlike GNMA,
FNMA and FHLMC securities, the payment of principal and interest
on Multi-Class Residential Mortgage Securities is not guaranteed
by the U.S. Government or any of its agencies. Accordingly,
yields on Multi-Class Residential Mortgage Securities have been
historically higher than the yields on U.S. government mortgage
securities. However, the risk of loss due to default on such
instruments is higher since they are not guaranteed by the U.S.
Government or its agencies. Additionally, pools of such
securities may be divided into senior or subordinated segments.
Although subordinated mortgage securities may have a higher yield
than senior mortgage securities, the risk of loss of principal is
greater because losses on the underlying mortgage loans must be
borne by persons holding subordinated securities before those
holding senior mortgage securities.
Privately-Issued Mortgage-Backed Certificates. These are
pass-through certificates issued by non-governmental issuers.
Pools of conventional residential mortgage loans created by such
issuers generally offer a higher rate of interest than government
and government-related pools because there are no direct or
indirect government guarantees of payment. Timely payment of
interest and principal of these pools is, however, generally
supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance. The insurance
and guarantees are issued by government entities, private
insurance or the mortgage poolers. Such insurance and guarantees
and the creditworthiness of the issuers thereof will be
considered in determining whether a mortgage-related security
meets the Fund's quality standards. The Fund may buy mortgage-
related securities without insurance or guarantees if through an
examination of the loan experience and practices of the poolers,
the investment manager determines that the securities meet the
Fund's quality standards.
Collateralized Mortgage Obligations (CMOs). CMOs are bonds
that are collateralized by whole loan mortgages or mortgage pass-
through securities. The bonds issued in a CMO deal are divided
into groups, and each group of bonds is referred to as a
"tranche." Under the traditional CMO structure, the cash flows
generated by the mortgages or mortgage pass-through securities in
the collateral pool are used to first pay interest and then pay
principal to the CMO bondholders. The bonds issued under a CMO
structure are retired sequentially as opposed to the pro rata
return of principal found in traditional pass-through
PAGE 17
obligations. Subject to the various provisions of individual CMO
issues, the cash flow generated by the underlying collateral (to
the extent it exceeds the amount required to pay the stated
interest) is used to retire the bonds. Under the CMO structure,
the repayment of principal among the different tranches is
prioritized in accordance with the terms of the particular CMO
issuance. The "fastest-pay" tranche of bonds, as specified in
the prospectus for the issuance, would initially receive all
principal payments. When that tranche of bonds is retired, the
next tranche, or tranches, in the sequence, as specified in the
prospectus, receive all of the principal payments until they are
retired. The sequential retirement of bond groups continues
until the last tranche, or group of bonds, is retired.
Accordingly, the CMO structure allows the issuer to use cash
flows of long maturity, monthly-pay collateral to formulate
securities with short, intermediate and long final maturities and
expected average lives.
CMO structures may also include floating rate CMOs, planned
amortization classes, accrual bonds and CMO residuals. These
structures affect the amount and timing of principal and interest
received by each tranche from the underlying collateral. Under
certain of these structures, given classes of CMOs have priority
over others with respect to the receipt of prepayments on the
mortgages. Therefore, depending on the type of CMOs in which the
Fund invests, the investment may be subject to a greater or
lesser risk of prepayment than other types of mortgage-related
securities.
The primary risk of any mortgage security is the uncertainty
of the timing of cash flows. For CMOs, the primary risk results
from the rate of prepayments on the underlying mortgages serving
as collateral. An increase or decrease in prepayment rates
(resulting from a decrease or increase in mortgage interest
rates) will affect the yield, average life and price of CMOs.
The prices of certain CMOs, depending on their structure and the
rate of prepayments, can be volatile. Some CMOs may also not be
as liquid as other securities.
Stripped Mortgage-Backed Securities. Stripped Mortgage-
Backed securities represent interests in a pool of mortgages, the
cash flow of which has been separated into its interest and
principal components. "IOs" (interest only securities) receive
the interest portion of the cash flow while "POs" (principal only
securities) receive the principal portion. IOs and POs are
usually structured as tranches of a CMO. Stripped
Mortgage-Backed Securities may be issued by U.S. Government
Agencies or by private issuers similar to those described above
with respect to CMOs and privately-issued mortgage-backed
certificates. As interest rates rise and fall, the value of IOs
PAGE 18
tends to move in the same direction as interest rates. The value
of the other mortgage-backed securities described herein, like
other debt instruments, will tend to move in the opposite
direction compared to interest rates. Under the Internal Revenue
Code of 1986, as amended (the "Code"), POs may generate taxable
income from the current accrual of original issue discount,
without a corresponding distribution of cash to the Fund.
The cash flows and yields on IO and PO classes are extremely
sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets. In the
case of IOs, prepayments affect the amount, but not the timing,
of cash flows provided to the investor. In contrast, prepayments
on the mortgage pool affect the timing, but not the amount, of
cash flows received by investors in POs. A rapid or slow rate of
principal payments may have a material adverse effect on the
prices of IOs or POs, respectively. If the underlying mortgage
assets experience greater than anticipated prepayments of
principal, an investor may fail to recoup fully its initial
investment in an IO class of a stripped mortgage-backed security,
even if the IO class is rated AAA or Aaa or is derived from a
full faith and credit obligation. Conversely, if the underlying
mortgage assets experience slower than anticipated prepayments of
principal, the price on a PO class will be affected more severely
than would be the case with a traditional mortgage-backed
security.
The staff of the Securities and Exchange Commission has
advised the Fund that it believes the Fund should treat IOs and
POs, other than government-issued IOs or POs backed by fixed rate
mortgages, as illiquid securities and, accordingly, limit its
investments in such securities, together with all other illiquid
securities, to 15% of the Fund's net assets. Under the Staff's
position, the determination of whether a particular
government-issued IO and PO backed by fixed rate mortgages may be
made on a case by case basis under guidelines and standards
established by the Fund's Board of Directors/Trustees. The
Fund's Board of Directors/Trustees has delegated to T. Rowe Price
the authority to determine the liquidity of these investments
based on the following guidelines: the type of issuer; type of
collateral, including age and prepayment characteristics; rate of
interest on coupon relative to current market rates and the
effect of the rate on the potential for prepayments; complexity
of the issue's structure, including the number of tranches; size
of the issue and the number of dealers who make a market in the
IO or PO. The Fund will treat non-government-issued IOs and POs
not backed by fixed or adjustable rate mortgages as illiquid
unless and until the Securities and Exchange Commission modifies
its position.
PAGE 19
Adjustable Rate Mortgages. Adjustable rate mortgage (ARM)
securities are collateralized by adjustable rate, rather than
fixed rate, mortgages.
ARMs, like fixed rate mortgages, have a specified maturity
date, and the principal amount of the mortgage is repaid over the
life of the mortgage. Unlike fixed rate mortgages, the interest
rate on ARMs is adjusted at regular intervals based on a
specified, published interest rate "index" such as a Treasury
rate index. The new rate is determined by adding a specific
interest amount, the "margin," to the interest rate of the index.
Investment in ARM securities allows the Fund to participate in
changing interest rate levels through regular adjustments in the
coupons of the underlying mortgages, resulting in more variable
current income and lower price volatility than longer term fixed
rate mortgage securities. The ARM securities in which the Fund
expects to invest will generally adjust their interest rates at
regular intervals of one year or less. ARM securities are a less
effective means of locking in long-term rates than fixed rate
mortgages since the income from adjustable rate mortgages will
increase during periods of rising interest rates and decline
during periods of falling rates.
Characteristics of Adjustable Rate Mortgage Securities -
Interest Rate Indices. The interest rates paid on adjustable
rate securities are readjusted periodically to an increment over
some predetermined interest rate index. Such readjustments occur
at intervals ranging from one to 60 months. There are three main
categories of indexes: (1) those based on U.S. Treasury
securities (2) those derived from a calculated measure such as a
cost of funds index ("COFI") or a moving average of mortgage
rates and (3) those based on actively traded or prominently
posted short-term, interest rates. Commonly utilized indexes
include the one-year, three-year and five-year constant maturity
Treasury rates, the three-month Treasury bill rate, the 180-day
Treasury bill rate, rates on longer-term Treasury securities, the
11th District Federal Home Loan Bank Cost of Funds, the National
Median Cost of Funds, the one-month, three-month, six-month or
one-year London Interbank Offered Rate (LIBOR), the prime rate of
a specific bank, or commercial paper rates. Some indexes, such
as the one-year constant maturity Treasury rate, closely mirror
changes in market interest rate levels. Others, such as the 11th
District Home Loan Bank Cost of Funds index, tend to lag behind
changes in market rate levels. The market value of the Fund's
assets and of the net asset value of the Fund's shares will be
affected by the length of the adjustment period, the degree of
volatility in the applicable indexes and the maximum increase or
decrease of the interest rate adjustment on any one adjustment
date, in any one year and over the life of the securities. These
PAGE 20
maximum increases and decreases are typically referred to as
"caps" and "floors", respectively.
A number of factors affect the performance of the Cost of
Funds Index and may cause the Cost of Funds Index to move in a
manner different from indices based upon specific interest rates,
such as the One Year Treasury Index. Additionally, there can be
no assurance that the Cost of Funds Index will necessarily move
in the same direction or at the same rate as prevailing interest
rates. Furthermore, any movement in the Cost of Funds Index as
compared to other indices based upon specific interest rates may
be affected by changes instituted by the FHLB of San Francisco in
the method used to calculate the Cost of Funds Index. To the
extent that the Cost of Funds Index may reflect interest changes
on a more delayed basis than other indices, in a period of rising
interest rates, any increase may produce a higher yield later
than would be produced by such other indices, and in a period of
declining interest rates, the Cost of Funds Index may remain
higher than other market interest rates which may result in a
higher level of principal prepayments on mortgage loans which
adjust in accordance with the Cost of Funds Index than mortgage
loans which adjust in accordance with other indices.
LIBOR, the London interbank offered rate, is the interest
rate that the most creditworthy international banks dealing in
U.S. dollar-denominated deposits and loans charge each other for
large dollar-denominated loans. LIBOR is also usually the base
rate for large dollar-denominated loans in the international
market. LIBOR is generally quoted for loans having rate
adjustments at one, three, six or 12 month intervals.
Caps and Floors. ARMs will frequently have caps and floors
which limit the maximum amount by which the interest rate to the
residential borrower may move up or down, respectively, each
adjustment period and over the life of the loan. Interest rate
caps on ARM securities may cause them to decrease in value in an
increasing interest rate environment. Such caps may also prevent
their income from increasing to levels commensurate with
prevailing interest rates. Conversely, interest rate floors on
ARM securities may cause their income to remain higher than
prevailing interest rate levels and result in an increase in the
value of such securities. However, this increase may be tempered
by the acceleration of prepayments.
Mortgage securities generally have a maximum maturity of up
to 30 years. However, due to the adjustable rate feature of ARM
securities, their prices are considered to have volatility
characteristics which approximate the average period of time
PAGE 21
until the next adjustment of the interest rate. As a result, the
principal volatility of ARM securities may be more comparable to
short- and intermediate-term securities than to longer term fixed
rate mortgage securities. Prepayments, however, will increase
their principal volatility. See also the discussion of Mortgage-
Backed Securities on page 9. Several characteristics of ARMs may
make them more susceptible to prepayments than other Mortgage-
Backed Securities. An adjustable rate mortgage has greater
incentives to refinance with a fixed rate mortgage during
favorable interest rate environments, in order to avoid interest
rate risk. Also, homes financed with adjustable rate mortgages
may be sold more frequently because of the prevalence of first-
time home buyers in the adjustable rate mortgage market. Also,
delinquency and foreclosure rates are higher in this market since
many buyers use adjustable rate mortgages to purchase homes that
they could not otherwise finance on a fixed rate basis.
Significant increases in the index rates for the adjustable rate
mortgages may also result in increased delinquency and default
rates, which in turn, may affect prepayment rates on the ARMs.
Other Mortgage Related Securities. The Fund expects that
governmental, government-related or private entities may create
mortgage loan pools offering pass-through investments in addition
to those described above. The mortgages underlying these
securities may be alternative mortgage instruments, that is,
mortgage instruments whose principal or interest payments may
vary or whose terms to maturity may differ from customary long-
term fixed rate mortgages. As new types of mortgage-related
securities are developed and offered to investors, the investment
manager will, consistent with the Fund's objective, policies and
quality standards, consider making investments in such new types
of securities.
Asset-Backed Securities
Prime Reserve, New Income and Equity Income Funds
The credit quality of most asset-backed securities depends
primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated
from the credit risk of the originator or any other affiliated
entities and the amount and quality of any credit support
provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of
principal payments received on the underlying assets which in
turn may be affected by a variety of economic and other factors.
As a result, the yield on any asset-backed security is difficult
to predict with precision and actual yield to maturity may be
more or less than the anticipated yield to maturity. Asset-
PAGE 22
backed securities may be classified either as pass-through
certificates or collateralized obligations.
Pass-through certificates are asset-backed securities which
represent an undivided fractional ownership interest in an
underlying pool of assets. Pass-through certificates usually
provide for payments of principal and interest received to be
passed through to their holders, usually after deduction for
certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest
in the underlying assets, the holders thereof bear directly the
risk of any defaults by the obligors on the underlying assets not
covered by any credit support. See "Types of Credit Support".
Asset-backed securities issued in the form of debt
instruments, also known as collateralized obligations, are
generally issued as the debt of a special purpose entity
organized solely for the purpose of owning such assets and
issuing such debt. Such assets are most often trade, credit card
or automobile receivables. The assets collateralizing such
asset-backed securities are pledged to a trustee or custodian for
the benefit of the holders thereof. Such issuers generally hold
no assets other than those underlying the asset-backed securities
and any credit support provided. As a result, although payments
on such asset-backed securities are obligations of the issuers,
in the event of defaults on the underlying assets not covered by
any credit support (see "Types of Credit Support"), the issuing
entities are unlikely to have sufficient assets to satisfy their
obligations on the related asset-backed securities.
Methods of Allocating Cash Flows. While many asset-backed
securities are issued with only one class of security, many
asset-backed securities are issued in more than one class, each
with different payment terms. Multiple class asset-backed
securities are issued for two main reasons. First, multiple
classes may be used as a method of providing credit support.
This is accomplished typically through creation of one or more
classes whose right to payments on the asset-backed security is
made subordinate to the right to such payments of the remaining
class or classes. See "Types of Credit Support". Second,
multiple classes may permit the issuance of securities with
payment terms, interest rates or other characteristics differing
both from those of each other and from those of the underlying
assets. Examples include so-called "strips" (asset-backed
securities entitling the holder to disproportionate interests
with respect to the allocation of interest and principal of the
assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of
non-asset-backed securities, such as floating interest rates
PAGE 23
(i.e., interest rates which adjust as a specified benchmark
changes) or scheduled amortization of principal.
Asset-backed securities in which the payment streams on the
underlying assets are allocated in a manner different than those
described above may be issued in the future. The Fund may invest
in such asset-backed securities if such investment is otherwise
consistent with its investment objectives and policies and with
the investment restrictions of the Fund.
Types of Credit Support. Asset-backed securities are often
backed by a pool of assets representing the obligations of a
number of different parties. To lessen the effect of failures by
obligors on underlying assets to make payments, such securities
may contain elements of credit support. Such credit support
falls into two classes: liquidity protection and protection
against ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to
ensure that scheduled payments on the underlying pool are made in
a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through
guarantees, insurance policies or letters of credit obtained from
third parties, through various means of structuring the
transaction or through a combination of such approaches.
Examples of asset-backed securities with credit support arising
out of the structure of the transaction include "senior-
subordinated securities" (multiple class asset-backed securities
with certain classes subordinate to other classes as to the
payment of principal thereon, with the result that defaults on
the underlying assets are borne first by the holders of the
subordinated class) and asset-backed securities that have
"reserve funds" (where cash or investments, sometimes funded from
a portion of the initial payments on the underlying assets, are
held in reserve against future losses) or that have been
"overcollateralized" (where the scheduled payments on, or the
principal amount of, the underlying assets substantially exceeds
that required to make payment of the asset-backed securities and
pay any servicing or other fees). The degree of credit support
provided on each issue is based generally on historical
information respecting the level of credit risk associated with
such payments. Delinquency or loss in excess of that anticipated
could adversely affect the return on an investment in an asset-
backed security.
Automobile Receivable Securities. The Fund may invest in
Asset-Backed Securities which are backed by receivables from
motor vehicle installment sales contracts or installment loans
secured by motor vehicles ("Automobile Receivable Securities").
PAGE 24
Since installment sales contracts for motor vehicles or
installment loans related thereto ("Automobile Contracts")
typically have shorter durations and lower incidences of
prepayment, Automobile Receivable Securities generally will
exhibit a shorter average life and are less susceptible to
prepayment risk.
Most entities that issue Automobile Receivable Securities
create an enforceable interest in their respective Automobile
Contracts only by filing a financing statement and by having the
servicer of the Automobile Contracts, which is usually the
originator of the Automobile Contracts, take custody thereof. In
such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in
violation of its obligation not to do so, there is a risk that
such party could acquire an interest in the Automobile Contracts
superior to that of the holders of Automobile Receivable
Securities. Also although most Automobile Contracts grant a
security interest in the motor vehicle being financed, in most
states the security interest in a motor vehicle must be noted on
the certificate of title to create an enforceable security
interest against competing claims of other parties. Due to the
large number of vehicles involved, however, the certificate of
title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually
is not amended to reflect the assignment of the seller's security
interest for the benefit of the holders of the Automobile
Receivable Securities. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be
available to support payments on the securities. In addition,
various state and federal securities laws give the motor vehicle
owner the right to assert against the holder of the owner's
Automobile Contract certain defenses such owner would have
against the seller of the motor vehicle. The assertion of such
defenses could reduce payments on the Automobile Receivable
Securities.
Credit Card Receivable Securities. The Fund may invest in
Asset Backed Securities backed by receivables from revolving
credit card agreements ("Credit Card Receivable Securities").
Credit balances on revolving credit card agreements ("Accounts")
are generally paid down more rapidly than are Automobile
Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order
to lengthen the maturity of Credit Card Receivable Securities,
most such securities provide for a fixed period during which only
interest payments on the underlying Accounts are passed through
to the security holder and principal payments received on such
Accounts are used to fund the transfer to the pool of assets
supporting the related Credit Card Receivable Securities of
PAGE 25
additional credit card charges made on an Account. The initial
fixed period usually may be shortened upon the occurrence of
specified events which signal a potential deterioration in the
quality of the assets backing the security, such as the
imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable
Securities thus depends upon the continued generation of
additional principal amounts in the underlying accounts during
the initial period and the non-occurrence of specified events.
An acceleration in cardholders' payment rates or any other event
which shortens the period during which additional credit card
charges on an Account may be transferred to the pool of assets
supporting the related Credit Card Receivable Security could
shorten the weighted average life and yield of the Credit Card
Receivable Security.
Credit cardholders are entitled to the protection of a
number of state and federal consumer credit laws, many of which
give such holder the right to set off certain amounts against
balances owed on the credit card, thereby reducing amounts paid
on Accounts. In addition, unlike most other Asset Backed
Securities, Accounts are unsecured obligations of the cardholder.
Other Assets. T. Rowe Price anticipates that Asset Backed
Securities backed by assets other than those described above will
be issued in the future. The Fund may invest in such securities
in the future if such investment is otherwise consistent with its
investment objective and policies.
There are, of course, other types of securities that are, or
may become available, which are similar to the foregoing, and the
Fund reserves the right to invest in these securities.
Industry Concentration
When the market for corporate debt securities is dominated
by issues in the gas utility, gas transmission utility, electric
utility, telephone utility, or petroleum industry, the Fund will
as a matter of fundamental policy concentrate 25% or more, but
not more than 50% of its assets, in any one such industry, if the
Fund has cash for such investment (i.e., the Fund will not sell
portfolio securities to raise cash) and, if in T. Rowe Price's
judgment, the return available and the marketability, quality,
and availability of the debt securities of such industry
justifies such concentration in light of the Fund's investment
objectives. Domination would exist with respect to any one such
industry, when, in the preceding 30-day period, more than 25% of
all new-issue corporate debt offerings (within the four highest
grades of Moody's or Standard & Poor's and with maturities of 10
PAGE 26
years or less) of $25,000,000 or more consisted of issues in such
industry. Although the Fund will normally purchase corporate
debt securities in the secondary market as opposed to new
offerings, T. Rowe Price believes that the new issue-based
dominance standard, as defined above, is appropriate because it
is easily determined and represents an accurate correlation to
the secondary market. Investors should understand that
concentration in any industry may result in increased risk.
Investments in any of these industries may be affected by
environmental conditions, energy conservation programs, fuel
shortages, difficulty in obtaining adequate return on capital in
financing operations and large construction programs, and the
ability of the capital markets to absorb debt issues. In
addition, it is possible that the public service commissions
which have jurisdiction over these industries may not grant
future increases in rates sufficient to offset increases in
operating expenses. These industries also face numerous
legislative and regulatory uncertainties at both federal and
state government levels. Management believes that any risk to
the Fund which might result from concentration in any industry
will be minimized by the Fund's practice of diversifying its
investments in other respects. The Fund's policy with respect to
industry concentration is a fundamental policy. (For investment
restriction on industry concentration, see Investment Restriction
(3) on page 38.)
New Income, Equity Income and International Stock Funds
Warrants
The Fund may invest in warrants. Warrants are pure
speculation in that they have no voting rights, pay no dividends
and have no rights with respect to the assets of the corporation
issuing them. Warrants basically are options to purchase equity
securities at a specific price valid for a specific period of
time. They do not represent ownership of the securities, but
only the right to buy them. Warrants differ from call options in
that warrants are issued by the issuer of the security which may
be purchased on their exercise, whereas call options may be
written or issued by anyone. The prices of warrants do not
necessarily move parallel to the prices of the underlying
securities.
Hybrid Instruments (All Funds, except Prime Reserve)
Hybrid Instruments (a type of potentially high-risk
derivative) have been developed and combine the elements of
futures contracts or options with those of debt, preferred equity
or a depository instrument (hereinafter "Hybrid Instruments").
PAGE 27
Generally, a Hybrid Instrument will be a debt security, preferred
stock, depository share, trust certificate, certificate of
deposit or other evidence of indebtedness on which a portion of
or all interest payments, and/or the principal or stated amount
payable at maturity, redemption or retirement, is determined by
reference to prices, changes in prices, or differences between
prices, of securities, currencies, intangibles, goods, articles
or commodities (collectively "Underlying Assets") or by another
objective index, economic factor or other measure, such as
interest rates, currency exchange rates, commodity indices, and
securities indices (collectively "Benchmarks"). Thus, Hybrid
Instruments may take a variety of forms, including, but not
limited to, debt instruments with interest or principal payments
or redemption terms determined by reference to the value of a
currency or commodity or securities index at a future point in
time, preferred stock with dividend rates determined by reference
to the value of a currency, or convertible securities with the
conversion terms related to a particular commodity.
Hybrid Instruments can be an efficient means of creating
exposure to a particular market, or segment of a market, with the
objective of enhancing total return. For example, a Fund may
wish to take advantage of expected declines in interest rates in
several European countries, but avoid the transactions costs
associated with buying and currency-hedging the foreign bond
positions. One solution would be to purchase a U.S. dollar-
denominated Hybrid Instrument whose redemption price is linked to
the average three year interest rate in a designated group of
countries. The redemption price formula would provide for
payoffs of greater than par if the average interest rate was
lower than a specified level, and payoffs of less than par if
rates were above the specified level. Furthermore, the Fund
could limit the downside risk of the security by establishing a
minimum redemption price so that the principal paid at maturity
could not be below a predetermined minimum level if interest
rates were to rise significantly. The purpose of this
arrangement, known as a structured security with an embedded put
option, would be to give the Fund the desired European bond
exposure while avoiding currency risk, limiting downside market
risk, and lowering transactions costs. Of course, there is no
guarantee that the strategy will be successful and the Fund could
lose money if, for example, interest rates do not move as
anticipated or credit problems develop with the issuer of the
Hybrid.
The risks of investing in Hybrid Instruments reflect a
combination of the risks of investing in securities, options,
futures and currencies. Thus, an investment in a Hybrid
Instrument may entail significant risks that are not associated
with a similar investment in a traditional debt instrument that
PAGE 28
has a fixed principal amount, is denominated in U.S. dollars or
bears interest either at a fixed rate or a floating rate
determined by reference to a common, nationally published
Benchmark. The risks of a particular Hybrid Instrument will, of
course, depend upon the terms of the instrument, but may include,
without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the
instrument is linked. Such risks generally depend upon factors
which are unrelated to the operations or credit quality of the
issuer of the Hybrid Instrument and which may not be readily
foreseen by the purchaser, such as economic and political events,
the supply and demand for the Underlying Assets and interest rate
movements. In recent years, various Benchmarks and prices for
Underlying Assets have been highly volatile, and such volatility
may be expected in the future. Reference is also made to the
discussion of futures, options, and forward contracts herein for
a discussion of the risks associated with such investments.
Hybrid Instruments are potentially more volatile and carry
greater market risks than traditional debt instruments.
Depending on the structure of the particular Hybrid Instrument,
changes in a Benchmark may be magnified by the terms of the
Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices
of the Hybrid Instrument and the Benchmark or Underlying Asset
may not move in the same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred
dividends at below market (or even relatively nominal) rates.
Alternatively, Hybrid Instruments may bear interest at above
market rates but bear an increased risk of principal loss (or
gain). The latter scenario may result if "leverage" is used to
structure the Hybrid Instrument. Leverage risk occurs when the
Hybrid Instrument is structured so that a given change in a
Benchmark or Underlying Asset is multiplied to produce a greater
value change in the Hybrid Instrument, thereby magnifying the
risk of loss as well as the potential for gain.
Hybrid Instruments may also carry liquidity risk since the
instruments are often "customized" to meet the portfolio needs of
a particular investor, and therefore, the number of investors
that are willing and able to buy such instruments in the
secondary market may be smaller than that for more traditional
debt securities. In addition, because the purchase and sale of
Hybrid Instruments could take place in an over-the-counter market
without the guarantee of a central clearing organization or in a
transaction between the Fund and the issuer of the Hybrid
Instrument, the creditworthiness of the counter party or issuer
of the Hybrid Instrument would be an additional risk factor which
the Fund would have to consider and monitor. Hybrid Instruments
PAGE 29
also may not be subject to regulation of the Commodities Futures
Trading Commission ("CFTC"), which generally regulates the
trading of commodity futures by U.S. persons, the SEC, which
regulates the offer and sale of securities by and to U.S.
persons, or any other governmental regulatory authority.
The various risks discussed above, particularly the market
risk of such instruments, may in turn cause significant
fluctuations in the net asset value of the Fund. Accordingly,
the Fund will limit its investments in Hybrid Instruments to 10%
of net assets. However, because of their volatility, it is
possible that the Fund's investment in Hybrid Instruments will
account for more than 10% of the Fund's return (positive or
negative).
Prime Reserve, New Income and Equity Income Funds
When-Issued Securities and Forward Commitment Contracts
The Fund may purchase securities on a "when-issued" or
delayed delivery basis ("When-Issueds") and may purchase
securities on a forward commitment basis ("Forwards"). Any or
all of the Fund's investments in debt securities may be in the
form of When-Issueds and Forwards. The price of such securities,
which may be expressed in yield terms, is fixed at the time the
commitment to purchase is made, but delivery and payment take
place at a later date. Normally, the settlement date occurs
within 90 days of the purchase for the When-Issueds, but may be
substantially longer for Forwards. During the period between
purchase and settlement, no payment is made by a Fund to the
issuer and no interest accrues to the Fund. The purchase of
these securities will result in a loss if their value declines
prior to the settlement date. This could occur, for example, if
interest rates increase prior to settlement. The longer the
period between purchase and settlement, the greater the risks
are. At the time the Fund makes the commitment to purchase these
securities, it will record the transaction and reflect the value
of the security in determining its net asset value. The Fund
will cover these securities by maintaining cash and/or liquid,
high-grade debt securities with its custodian bank equal in value
to commitments for them during the time between the purchase and
the settlement. Therefore, the longer this period, the longer
the period during which alternative investment options are not
available to the Fund (to the extent of the securities used for
cover). Such securities either will mature or, if necessary, be
sold on or before the settlement date.
To the extent the Fund remains fully or almost fully
invested (in securities with a remaining maturity of more than
one year) at the same time it purchases these securities, there
PAGE 30
will be greater fluctuations in the Fund's net asset value than
if the Fund did not purchase them.
All Funds
Illiquid or Restricted Securities
Restricted securities may be sold only in privately
negotiated transactions or in a public offering with respect to
which a registration statement is in effect under the Securities
Act of 1933 (the "1933 Act"). Where registration is required, a
Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to
sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop,
a Fund might obtain a less favorable price than prevailed when it
decided to sell. Restricted securities will be priced at fair
value as determined in accordance with procedures prescribed by
the Funds' Boards of Directors/Trustees. If through the
appreciation of illiquid securities or the depreciation of liquid
securities, a Fund should be in a position where more than 15%
(10% for Prime Reserve Fund) of the value of its net assets are
invested in illiquid assets, including restricted securities, the
Fund will take appropriate steps to protect liquidity.
Notwithstanding the above, the Funds may purchase securities
which, while privately placed, are eligible for purchase and sale
under Rule 144A under the 1933 Act. This rule permits certain
qualified institutional buyers, such as the Funds, to trade in
privately placed securities even though such securities are not
registered under the 1933 Act. T. Rowe Price or Price-Fleming,
under the supervision of the Funds' Boards of Directors/Trustees,
will consider whether securities purchased under Rule 144A are
illiquid and thus subject to each Fund's restriction of investing
no more than 15% (10% for Prime Reserve Fund) of its assets in
illiquid securities. A determination of whether a Rule 144A
security is liquid or not is a question of fact. In making this
determination, T. Rowe Price or Price-Fleming will consider the
trading markets for the specific security taking into account the
unregistered nature of a Rule 144A security. In addition,
T. Rowe Price or Price-Fleming could consider the (1) frequency
of trades and quotes, (2) number of dealers and potential
purchases, (3) dealer undertakings to make a market, and (4) the
nature of the security and of marketplace trades (e.g., the time
needed to dispose of the security, the method of soliciting
offers and the mechanics of transfer). The liquidity of Rule
144A securities would be monitored, and if as a result of changed
conditions it is determined that a Rule 144A security is no
longer liquid, a Fund's holdings of illiquid securities would be
PAGE 31
reviewed to determine what, if any, steps are required to assure
that the Fund does not invest more than 15% (10% for Prime
Reserve Fund) of its assets in illiquid securities. Investing in
Rule 144A securities could have the effect of increasing the
amount of a Fund's assets invested in illiquid securities if
qualified institutional buyers are unwilling to purchase such
securities.
Prime Reserve and New Income Funds
Additional Adjustable Rate Securities
Certain securities may be issued with adjustable interest
rates that are reset periodically by pre-determined formulas or
indexes in order to minimize movements in the principal value of
the investment. Such securities may have long-term maturities,
but may be treated as a short-term investment under certain
conditions. Generally, as interest rates decrease or increase,
the potential for capital appreciation or depreciation on these
securities is less than for fixed-rate obligations. These
securities may take the following forms:
Variable Rate Securities. Variable rate instruments are
those whose terms provide for the adjustment of their
interest rate on set dates and which, upon adjustment, can
reasonably be expected to have a market value which
approximates its par value. A variable rate instrument, the
principal amount of which is scheduled to be paid in 397
calendar days or less, is deemed to have a maturity equal to
the period remaining until the next readjustment of the
interest rate. A variable rate instrument which is subject
to a demand feature entitles the purchaser to receive the
principal amount of the underlying security or securities,
either (i) upon notice of no more than 30 days, or (ii) at
specified intervals not exceeding 397 calendar days and upon
no more than 30 days' notice, is deemed to have a maturity
equal to the longer of the period remaining until the next
readjustment of the interest rate or the period remaining
until the principal amount can be recovered through demand.
Floating Rate Securities. Floating rate instruments are
those whose terms provide for the adjustment of their
interest rates whenever a specified interest rate changes
and which, at any time, can reasonably be expected to have a
market value that approximates its par value. The maturity
of a floating rate instrument is deemed to be the period
remaining until the date (noted on the face of the
instrument) on which the principal amount must be paid, or
in the case of an instrument called for redemption, the date
PAGE 32
on which the redemption payment must be made. Floating rate
instruments with demand features are deemed to have a
maturity equal to the period remaining until the principal
amount can be recovered through demand.
Put Option Bonds. Long-term obligations with maturities
longer than one year may provide purchasers an optional or
mandatory tender of the security at par value at
predetermined intervals, often ranging from one month to
several years (e.g., a 30-year bond with a five-year tender
period). These instruments are deemed to have a maturity
equal to the period remaining to the put date.
There are, of course, other types of securities that are, or
may become, available, which are similar to the foregoing.
PORTFOLIO MANAGEMENT PRACTICES
All Funds
Lending of Portfolio Securities
Securities loans are made to broker-dealers, institutional
investors or other persons, pursuant to agreements requiring that
the loans be continuously secured by collateral at least equal at
all times to the value of the securities lent marked to market on
a daily basis. The collateral received will consist of cash,
U.S. government securities, letters of credit or such other
collateral as may be permitted under its investment program.
While the securities are being lent, each Fund will continue to
receive the equivalent of the interest or dividends paid by the
issuer on the securities, as well as interest on the investment
of the collateral or a fee from the borrower. Each Fund has a
right to call each loan and obtain the securities within the
lesser of five business days' notice or, in connection with
securities trading the normal settlement period for such
securities. The Funds will not have the right to vote securities
while they are being lent, but it will call a loan in
anticipation of any important vote. The risks in lending
portfolio securities, as with other extensions of secured credit,
consist of possible delay in receiving additional collateral or
in the recovery of the securities or possible loss of rights in
the collateral should the borrower fail financially. Loans will
only be made to firms deemed by T. Rowe Price or Price-Fleming to
be of good standing and will not be made unless, in the judgment
of T. Rowe Price or Price-Fleming, the consideration to be earned
from such loans would justify the risk.
PAGE 33
Other Lending/Borrowing
Subject to approval by the Securities and Exchange
Commission, each Fund may make loans to, or borrow funds from,
other mutual funds sponsored or advised by T. Rowe Price or
Price-Fleming (collectively, "Price Funds"). The Funds have no
current intention of engaging in these practices at this time.
Repurchase Agreements
Each Fund may enter into a repurchase agreement through
which an investor (such as the Fund) purchases a security (known
as the "underlying security") from a well-established securities
dealer or a bank that is a member of the Federal Reserve System.
Any such dealer or bank will be on T. Rowe Price's approved list.
At that time, the bank or securities dealer agrees to repurchase
the underlying security at the same price, plus specified
interest. Repurchase agreements are generally for a short period
of time, often less than a week. Repurchase agreements which do
not provide for payment within seven days will be treated as
illiquid securities. Each Fund will only enter into repurchase
agreements where (i) Prime Reserve Fund -- the underlying
securities are either U.S. government securities or securities
that, at the time the repurchase agreement is entered into, are
rated in the highest rating category by the requisite number of
NRSROs (as required by Rule 2a-7 under the 1940 Act) and
otherwise are of the type (excluding maturity limitations) which
the Fund's investment guidelines would allow it to purchase
directly, New Income, Equity Income, and International Stock
Funds -- the underlying securities are of the type (excluding
maturity limitations) which each Fund's investment guidelines
would allow it to purchase directly, (ii) the market value of the
underlying security, including interest accrued, will be at all
times equal to or exceed the value of the repurchase agreement,
and (iii) payment for the underlying security is made only upon
physical delivery or evidence of book-entry transfer to the
account of the custodian or a bank acting as agent. In the event
of a bankruptcy or other default of a seller of a repurchase
agreement, a Fund could experience both delays in liquidating the
underlying security and losses, including: (a) possible decline
in the value of the underlying security during the period while
the Fund seeks to enforce its rights thereto; (b) possible
subnormal levels of income and lack of access to income during
this period; and (c) expenses of enforcing its rights.
Reverse Repurchase Agreements
Although the Fund has no current intention, in the
foreseeable future, of engaging in reverse repurchase agreements,
the Fund reserves the right to do so. Reverse repurchase
PAGE 34
agreements are ordinary repurchase agreements in which a Fund is
the seller of, rather than the investor in, securities, and
agrees to repurchase them at an agreed upon time and price. Use
of a reverse repurchase agreement may be preferable to a regular
sale and later repurchase of the securities because it avoids
certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the Fund,
subject to Investment Restriction (1). (See "Investment
Restrictions," page 37.)
New Income, Equity Income and International Stock Funds
Options
Options are a type of potentially high-risk derivative.
Writing Covered Call Options
Each Fund may write (sell) "covered" call options and
purchase options to close out options previously written by a
Fund. In writing covered call options, a Fund expects to
generate additional premium income which should serve to enhance
the Fund's total return and reduce the effect of any price
decline of the security or currency involved in the option.
Covered call options will generally be written on securities or
currencies which, in T. Rowe Price's or Price-Fleming's opinion,
are not expected to have any major price increases or moves in
the near future but which, over the long term, are deemed to be
attractive investments for a Fund.
A call option gives the holder (buyer) the "right to
purchase" a security or currency at a specified price (the
exercise price) at expiration of the option (European style) or
at any time until a certain date (the expiration date) (American
style). So long as the obligation of the writer of a call option
continues, he may be assigned an exercise notice by the broker-
dealer through whom such option was sold, requiring him to
deliver the underlying security or currency against payment of
the exercise price. This obligation terminates upon the
expiration of the call option, or such earlier time at which the
writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his
obligation to deliver the underlying security or currency in the
case of a call option, a writer is required to deposit in escrow
the underlying security or currency or other assets in accordance
with the rules of a clearing corporation.
The Funds will write only covered call options. This means
that a Fund will own the security or currency subject to the
option or an option to purchase the same underlying security or
PAGE 35
currency, having an exercise price equal to or less than the
exercise price of the "covered" option, or will establish and
maintain with its custodian for the term of the option, an
account consisting of cash, U.S. government securities or other
liquid high-grade debt obligations having a value equal to the
fluctuating market value of the optioned securities or
currencies.
Portfolio securities or currencies on which call options may
be written will be purchased solely on the basis of investment
considerations consistent with each Fund's investment objective.
The writing of covered call options is a conservative investment
technique believed to involve relatively little risk (in contrast
to the writing of naked or uncovered options, which the Funds
will not do), but capable of enhancing a Fund's total return.
When writing a covered call option, a Fund, in return for the
premium, gives up the opportunity for profit from a price
increase in the underlying security or currency above the
exercise price, but conversely retains the risk of loss should
the price of the security or currency decline. Unlike one who
owns securities or currencies not subject to an option, a Fund
has no control over when it may be required to sell the
underlying securities or currencies, since it may be assigned an
exercise notice at any time prior to the expiration of its
obligation as a writer. If a call option which a Fund has
written expires, the Fund will realize a gain in the amount of
the premium; however, such gain may be offset by a decline in the
market value of the underlying security or currency during the
option period. If the call option is exercised, the Fund will
realize a gain or loss from the sale of the underlying security
or currency. The Funds do not consider a security or currency
covered by a call to be "pledged" as that term is used in the
Funds' policy which limits the pledging or mortgaging of its
assets.
The premium received is the market value of an option. The
premium a Fund will receive from writing a call option will
reflect, among other things, the current market price of the
underlying security or currency, the relationship of the exercise
price to such market price, the historical price volatility of
the underlying security or currency, and the length of the option
period. Once the decision to write a call option has been made,
T. Rowe Price or Price-Fleming, in determining whether a
particular call option should be written on a particular security
or currency, will consider the reasonableness of the anticipated
premium and the likelihood that a liquid secondary market will
exist for those options. The premium received by a Fund for
writing covered call options will be recorded as a liability of
the Fund. This liability will be adjusted daily to the option's
current market value, which will be the latest sale price at the
PAGE 36
time at which the net asset value per share of a Fund is computed
(close of the New York Stock Exchange), or, in the absence of
such sale, the latest asked price. The option will be terminated
upon expiration of the option, the purchase of an identical
option in a closing transaction, or delivery of the underlying
security or currency upon the exercise of the option.
Closing transactions will be effected in order to realize a
profit on an outstanding call option, to prevent an underlying
security or currency from being called, or, to permit the sale of
the underlying security or currency. Furthermore, effecting a
closing transaction will permit a Fund to write another call
option on the underlying security or currency with either a
different exercise price or expiration date or both. If a Fund
desires to sell a particular security or currency from its
portfolio on which it has written a call option, or purchased a
put option, it will seek to effect a closing transaction prior
to, or concurrently with, the sale of the security or currency.
There is, of course, no assurance that a Fund will be able to
effect such closing transactions at favorable prices. If a Fund
cannot enter into such a transaction, it may be required to hold
a security or currency that it might otherwise have sold. When a
Fund writes a covered call option, it runs the risk of not being
able to participate in the appreciation of the underlying
securities or currencies above the exercise price, as well as the
risk of being required to hold on to securities or currencies
that are depreciating in value. This could result in higher
transaction costs. Each Fund will pay transaction costs in
connection with the writing of options to close out previously
written options. Such transaction costs are normally higher than
those applicable to purchases and sales of portfolio securities.
Call options written by a Fund will normally have expiration
dates of less than nine months from the date written. The
exercise price of the options may be below, equal to, or above
the current market values of the underlying securities or
currencies at the time the options are written. From time to
time, a Fund may purchase an underlying security or currency for
delivery in accordance with an exercise notice of a call option
assigned to it, rather than delivering such security or currency
from its portfolio. In such cases, additional costs may be
incurred.
A Fund will realize a profit or loss from a closing purchase
transaction if the cost of the transaction is less or more than
the premium received from the writing of the option. Because
increases in the market price of a call option will generally
reflect increases in the market price of the underlying security
or currency, any loss resulting from the repurchase of a call
PAGE 37
option is likely to be offset in whole or in part by appreciation
of the underlying security or currency owned by the Fund.
Each Fund will not write a covered call option if, as a
result, the aggregate market value of all portfolio securities or
currencies covering written call or put options exceeds 25% of
the market value of the Fund's net assets. In calculating the
25% limit, each Fund will offset, against the value of assets
covering written calls and puts, the aggregate market value of
all assets underlying purchased calls and puts on identical
securities or currencies with identical maturity dates.
Writing Covered Put Options
The Funds may write American or European style covered put
options and purchase options to close out options previously
written by the Fund. A put option gives the purchaser of the
option the right to sell, and the writer (seller) has the
obligation to buy, the underlying security or currency at the
exercise price during the option period (American style) or at
the expiration of the option (European style). So long as the
obligation of the writer continues, he may be assigned an
exercise notice by the broker-dealer through whom such option was
sold, requiring him to make payment of the exercise price against
delivery of the underlying security or currency. The operation
of put options in other respects, including their related risks
and rewards, is substantially identical to that of call options.
Each Fund would write put options only on a covered basis,
which means that the Fund would maintain in a segregated account
cash, U.S. government securities or other liquid high-grade debt
obligations in an amount not less than the exercise price or each
Fund will own an option to sell the underlying security or
currency subject to the option having an exercise price equal to
or greater than the exercise price of the "covered" option at all
times while the put option is outstanding. (The rules of a
clearing corporation currently require that such assets be
deposited in escrow to secure payment of the exercise price.)
A Fund would generally write covered put options in
circumstances where T. Rowe Price or Price-Fleming wishes to
purchase the underlying security or currency for the Fund's
portfolio at a price lower than the current market price of the
security or currency. In such event a Fund would write a put
option at an exercise price which, reduced by the premium
received on the option, reflects the lower price it is willing to
pay. Since a Fund would also receive interest on debt securities
or currencies maintained to cover the exercise price of the
option, this technique could be used to enhance current return
during periods of market uncertainty. The risk in such a
PAGE 38
transaction would be that the market price of the underlying
security or currency would decline below the exercise price less
the premiums received. Such a decline could be substantial and
result in a significant loss to the Fund. In addition, a Fund,
because it does not own the specific securities or currencies
which it may be required to purchase in exercise of the put,
cannot benefit from appreciation, if any, with respect to such
specific securities or currencies.
The Funds will not write a covered put option if, as a
result, the aggregate market value of all portfolio securities or
currencies covering written put or call options exceeds 25% of
the market value of each Fund's net assets. In calculating the
25% limit, each Fund will offset, against the aggregate market
value of assets covering written puts and calls, the value of all
assets underlying purchased puts and calls on identical
securities or currencies with identical maturity dates.
Purchasing Put Options
Each Fund may purchase American or European style put
options. As the holder of a put option, each Fund has the right
to sell the underlying security or currency at the exercise price
at any time during the option period (American style) or at the
expiration of the option (European style). Each Fund may enter
into closing sale transactions with respect to such options,
exercise them or permit them to expire. Each Fund may purchase
put options for defensive purposes in order to protect against an
anticipated decline in the value of its securities or currencies.
An example of such use of put options is provided below.
A Fund may purchase a put option on an underlying security
or currency (a "protective put") owned by the Fund as a defensive
technique in order to protect against an anticipated decline in
the value of the security or currency. Such hedge protection is
provided only during the life of the put option when a Fund, as
the holder of the put option, is able to sell the underlying
security or currency at the put exercise price regardless of any
decline in the underlying security's market price or currency's
exchange value. For example, a put option may be purchased in
order to protect unrealized appreciation of a security or
currency where T. Rowe Price or Price-Fleming deems it desirable
to continue to hold the security or currency because of tax
considerations. The premium paid for the put option and any
transaction costs would reduce any capital gain otherwise
available for distribution when the security or currency is
eventually sold.
Each Fund may also purchase put options at a time when the
Fund does not own the underlying security or currency. Although
PAGE 39
the Equity Income Fund has no current intention, in the
foreseeable future, of purchasing put options at a time when the
Fund does not own the underlying security, it reserves the right
to do so. By purchasing put options on a security or currency it
does not own, a Fund seeks to benefit from a decline in the
market price of the underlying security or currency. If the put
option is not sold when it has remaining value, and if the market
price of the underlying security or currency remains equal to or
greater than the exercise price during the life of the put
option, a Fund will lose its entire investment in the put option.
In order for the purchase of a put option to be profitable, the
market price of the underlying security or currency must decline
sufficiently below the exercise price to cover the premium and
transaction costs, unless the put option is sold in a closing
sale transaction.
Each Fund will not commit more than 5% of its assets to
premiums when purchasing put and call options. The premium paid
by a Fund when purchasing a put option will be recorded as an
asset of the Fund. This asset will be adjusted daily to the
option's current market value, which will be the latest sale
price at the time at which the net asset value per share of each
Fund is computed (close of New York Stock Exchange), or, in the
absence of such sale, the latest bid price. This asset will be
terminated upon expiration of the option, the selling (writing)
of an identical option in a closing transaction, or the delivery
of the underlying security or currency upon the exercise of the
option.
Purchasing Call Options
The Funds may purchase American or European style call
options. As the holder of a call option, each Fund has the right
to purchase the underlying security or currency at the exercise
price at any time during the option period (American style) or at
the expiration of the option (European style). Each Fund may
enter into closing sale transactions with respect to such
options, exercise them or permit them to expire. Each Fund may
purchase call options for the purpose of increasing its current
return or avoiding tax consequences which could reduce its
current return. Each Fund may also purchase call options in
order to acquire the underlying securities or currencies.
Examples of such uses of call options are provided below.
Call options may be purchased by a Fund for the purpose of
acquiring the underlying securities or currencies for its
portfolio. Utilized in this fashion, the purchase of call
options enables a Fund to acquire the securities or currencies at
PAGE 40
the exercise price of the call option plus the premium paid. At
times the net cost of acquiring securities or currencies in this
manner may be less than the cost of acquiring the securities or
currencies directly. This technique may also be useful to a Fund
in purchasing a large block of securities or currencies that
would be more difficult to acquire by direct market purchases.
So long as it holds such a call option rather than the underlying
security or currency itself, a Fund is partially protected from
any unexpected decline in the market price of the underlying
security or currency and in such event could allow the call
option to expire, incurring a loss only to the extent of the
premium paid for the option.
The Fund will not commit more than 5% of its assets to
premiums when purchasing call and put options. The Fund may also
purchase call options on underlying securities or currencies it
owns in order to protect unrealized gains on call options
previously written by it. A call option would be purchased for
this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call
options may also be purchased at times to avoid realizing
losses.
Dealer (Over-the-Counter) Options
The New Income, Equity Income, and International Stock Funds
may engage in transactions involving dealer options. Certain
risks are specific to dealer options. While a Fund would look to
a clearing corporation to exercise exchange-traded options, if
the Fund were to purchase a dealer option, it would rely on the
dealer from whom it purchased the option to perform if the option
were exercised. Failure by the dealer to do so would result in
the loss of the premium paid by a Fund as well as loss of the
expected benefit of the transaction.
Exchange-traded options generally have a continuous liquid
market while dealer options have none. Consequently, a Fund will
generally be able to realize the value of a dealer option it has
purchased only by exercising it or reselling it to the dealer who
issued it. Similarly, when a Fund writes a dealer option, it
generally will be able to close out the option prior to its
expiration only by entering into a closing purchase transaction
with the dealer to which the Fund originally wrote the option.
While each Fund will seek to enter into dealer options only with
dealers who will agree to and which are expected to be capable of
entering into closing transactions with the Fund, there can be no
assurance that the Fund will be able to liquidate a dealer option
at a favorable price at any time prior to expiration. Until a
Fund, as a covered dealer call option writer, is able to effect a
PAGE 41
closing purchase transaction, it will not be able to liquidate
securities (or other assets) or currencies used as cover until
the option expires or is exercised. In the event of insolvency
of the contra party, a Fund may be unable to liquidate a dealer
option. With respect to options written by a Fund, the inability
to enter into a closing transaction may result in material losses
to the Fund. For example, since a Fund must maintain a secured
position with respect to any call option on a security it writes,
the Fund may not sell the assets which it has segregated to
secure the position while it is obligated under the option. This
requirement may impair a Fund's ability to sell portfolio
securities or currencies at a time when such sale might be
advantageous.
New Income, Equity Income and International Stock Funds
Futures Contracts
Futures are a type of potentially high-risk derivative.
Transactions in Futures
The Funds may enter into futures contracts, including stock
index interest rate and currency futures ("futures or futures
contracts").
Stock index futures contracts may be used to provide a hedge
for a portion of the Equity Income and International Stock Funds'
portfolios, as a cash management tool, or as an efficient way for
Price-Fleming to implement either an increase or decrease in
portfolio market exposure in response to changing market
conditions. Stock index futures contracts are currently traded
with respect to the S&P 500 Index and other broad stock market
indices, such as the New York Stock Exchange Composite Stock
Index and the Value Line Composite Stock Index. The Fund may,
however, purchase or sell futures contracts with respect to any
stock index whose movements will, in its judgment, have a
significant correlation with movements in the prices of all or
portions of the Fund's portfolio securities.
Interest rate or currency futures contracts may be used as a
hedge against changes in prevailing levels of interest rates or
currency exchange rates in order to establish more definitely the
effective return on securities or currencies held or intended to
be acquired by a Fund. In this regard, a Fund could sell
interest rate or currency futures as an offset against the effect
of expected increases in interest rates or currency exchange
rates and purchase such futures as an offset against the effect
of expected declines in interest rates or currency exchange
PAGE 42
rates. Futures can also be used as an efficient means of
regulating the Fund's exposure to the market.
The Funds will enter into futures contracts which are traded
on national or foreign futures exchange and are standardized as
to maturity date and underlying financial instrument. Futures
exchanges and trading in the United States are regulated under
the Commodity Exchange Act by the CFTC. Futures are traded in
London at the London International Financial Futures Exchange, in
Paris at the MATIF and in Tokyo at the Tokyo Stock Exchange.
Although techniques other than the sale and purchase of futures
contracts could be used for the above-referenced purposes,
futures contracts offer an effective and relatively low cost
means of implementing each Fund's objectives in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each case in accordance with rules and
regulations of the CFTC.
The Funds may not purchase or sell futures contracts or
related options if, with respect to positions which do not
qualify as bona fide hedging under applicable CFTC rules, the sum
of the amounts of initial margin deposits and premiums paid on
these positions would exceed 5% of the net asset value of the
Fund after taking into account unrealized profits and unrealized
losses on any such contracts it has entered into; provided,
however, that in the case of an option that is in-the-money at
the time of purchase, the in-the-money amount may be excluded in
calculating the 5% limitation. For purposes of this policy,
options on futures contracts and foreign currency options traded
on a commodities exchange will be considered "related options."
This policy may be modified by the Board of Directors/Trustees
without a shareholder vote and does not limit the percentage of
the Fund's assets at risk to 5%.
The Fund's use of futures contracts will not result in
leverage. Therefore, to the extent necessary, in instances
involving the purchase of futures contracts or the writing of
call or put options thereon by each Fund, an amount of cash, U.S.
government securities or other liquid, high-grade debt
obligations, equal to the market value of the futures contracts
and options thereon (less any related margin deposits), will be
identified in an account with the Fund's custodian to cover the
position, or alternative cover (such as owning an offsetting
position) will be employed. Assets used as cover or held in an
identified account cannot be sold while the position in the
corresponding option or future is open, unless they are replaced
PAGE 43
with similar assets. As a result, the commitment of a large
portion of a Fund's assets to cover or identified accounts could
impede portfolio management or the Fund's ability to meet
redemption requests or other current obligations.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund
would comply with such new restrictions.
Trading in Futures
A futures contract provides for the future sale by one party
and purchase by another party of a specified amount of a specific
financial instrument (e.g., units of a stock index with respect
to the Equity Income and International Stock Funds, and a debt
security with respect to the New Income Fund) for a specified
price, date, time and place designated at the time the contract
is made. Brokerage fees are incurred when a futures contract is
bought or sold and margin deposits must be maintained. Entering
into a contract to buy is commonly referred to as buying or
purchasing a contract or holding a long position. Entering into
a contract to sell is commonly referred to as selling a contract
or holding a short position.
Unlike when a Fund purchases or sells a security, no price
would be paid or received by the Fund upon the purchase or sale
of a futures contract. Upon entering into a futures contract,
and to maintain the Fund's open positions in futures contracts,
the Fund would be required to deposit with its custodian in a
segregated account in the name of the futures broker an amount of
cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as
"initial margin." The margin required for a particular futures
contract is set by the exchange on which the contract is traded,
and may be significantly modified from time to time by the
exchange during the term of the contract. Futures contracts are
customarily purchased and sold on margins that may range upward
from less than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
PAGE 44
These subsequent payments, called "variation margin," to and
from the futures broker, are made on a daily basis as the price
of the underlying assets fluctuate making the long and short
positions in the futures contract more or less valuable, a
process known as "marking to the market." Each Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require
actual future delivery of and payment for the underlying
instruments, in practice most futures contracts are usually
closed out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract purchase or sale, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able
to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the futures
contract.
For the New Income Fund, as an example of an offsetting
transaction in which the underlying instrument is not delivered,
the contractual obligations arising from the sale of one contract
of September Treasury Bills on an exchange may be fulfilled at
any time before delivery of the contract is required (i.e., on a
specified date in September, the "delivery month") by the
purchase of one contract of September Treasury Bills on the same
exchange. In such instance, the difference between the price at
which the futures contract was sold and the price paid for the
offsetting purchase, after allowance for transaction costs,
represents the profit or loss to the Fund.
With respect to the Equity Income Fund, for example, the
Standard & Poor's 500 Stock Index is composed of 500 selected
common stocks, most of which are listed on the New York Stock
Exchange. The S&P 500 Index assigns relative weightings to the
common stocks included in the Index, and the Index fluctuates
with changes in the market values of those common stocks. In the
case of the S&P 500 Index, contracts are to buy or sell 500
units. Thus, if the value of the S&P 500 Index were $150, one
contract would be worth $75,000 (500 units x $150). The stock
index futures contract specifies that no delivery of the actual
stock making up the index will take place. Instead, settlement
PAGE 45
in cash occurs. Over the life of the contract, the gain or loss
realized by the Fund will equal the difference between the
purchase (or sale) price of the contract and the price at which
the contract is terminated. For example, if the Fund enters into
a futures contract to buy 500 units of the S&P 500 Index at a
specified future date at a contract price of $150 and the S&P 500
Index is at $154 on that future date, the Fund will gain $2,000
(500 units x gain of $4). If the Fund enters into a futures
contract to sell 500 units of the stock index at a specified
future date at a contract price of $150 and the S&P 500 Index is
at $152 on that future date, the Fund will lose $1,000 (500 units
x loss of $2).
With respect to the International Stock Fund, for example,
one contract in the Financial Times Stock Exchange 100 Index
future is a contract to buy 25 pounds sterling multiplied by the
level of the UK Financial Times 100 Share Index on a given future
date. Settlement of a stock index futures contract may or may
not be in the underlying security. If not in the underlying
security, then settlement will be made in cash, equivalent over
time to the difference between the contract price and the actual
price of the underlying asset at the time the stock index futures
contract expires.
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts
are volatile and are influenced, among other things, by actual
and anticipated changes in the market and interest rates, which
in turn are affected by fiscal and monetary policies and national
and international policies and economic events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular
type of futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price
movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting
some futures traders to substantial losses.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a
PAGE 46
relatively small price movement in a futures contract may result
in immediate and substantial loss, as well as gain, to the
investor. For example, if at the time of purchase, 10% of the
value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract.
However, a Fund would presumably have sustained comparable losses
if, instead of the futures contract, it had invested in the
underlying instrument and sold it after the decline.
Furthermore, in the case of a futures contract purchase, in order
to be certain that a Fund has sufficient assets to satisfy its
obligations under a futures contract, the Fund earmarks to the
futures contract cash, liquid high-grade debt or other
appropriate cover, equal in value to the current value of the
underlying instrument less the margin deposit.
Liquidity. Each Fund may elect to close some or all of its
futures positions at any time prior to their expiration. A Fund
would do so to reduce exposure represented by long futures
positions or increase exposure represented by short futures
positions. Each Fund may close its positions by taking opposite
positions which would operate to terminate the Fund's position in
the futures contracts. Final determinations of variation margin
would then be made, additional cash would be required to be paid
by or released to the Fund, and the Fund would realize a loss or
a gain.
Futures contracts may be closed out only on the exchange or
board of trade where the contracts were initially traded.
Although the Funds intend to purchase or sell futures contracts
only on exchanges or boards of trade where there appears to be an
active market, there is no assurance that a liquid market on an
exchange or board of trade will exist for any particular contract
at any particular time. In such event, it might not be possible
to close a futures contract, and in the event of adverse price
movements, a Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures
contracts have been used to hedge the underlying instruments, a
Fund would continue to hold the underlying instruments subject to
the hedge until the futures contracts could be terminated. In
such circumstances, an increase in the price of the underlying
instruments, if any, might partially or completely offset losses
on the futures contract. However, as described below, there is
no guarantee that the price of the underlying instruments will,
in fact, correlate with the price movements in the futures
PAGE 47
contract and thus provide an offset to losses on a futures
contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of unexpected market
behavior, market or interest rate trends. There are several
risks in connection with the use by the Fund of futures contracts
as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures
contracts and movements in the prices of the underlying
instruments which are the subject of the hedge. T. Rowe Price
and Price-Fleming will, however, attempt to reduce this risk by
entering into futures contracts whose movements, in its judgment,
will have a significant correlation with movements in the prices
of the Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Funds for hedging
purposes is also subject to T. Rowe Price's and Price-Fleming's
ability to correctly predict movements in the direction of the
market. It is possible that, when a Fund has sold futures to
hedge its portfolio against a decline in the market, the index,
indices, or underlying instruments on which the futures are
written might advance and the value of the underlying instruments
held in the Fund's portfolio might decline. If this were to
occur, the Fund would lose money on the futures and also would
experience a decline in value in its underlying instruments.
However, while this might occur to a certain degree, T. Rowe
Price and Price-Fleming believe that over time the value of a
Fund's portfolio will tend to move in the same direction as the
market indices which are intended to correlate to the price
movements of the underlying instruments sought to be hedged. It
is also possible that if a Fund were to hedge against the
possibility of a decline in the market (adversely affecting the
underlying instruments held in its portfolio) and prices instead
increased, the Fund would lose part or all of the benefit of
increased value of those underlying instruments that it has
hedged, because it would have offsetting losses in its futures
positions. In addition, in such situations, if a Fund had
insufficient cash, it might have to sell underlying instruments
to meet daily variation margin requirements. Such sales of
underlying instruments might be, but would not necessarily be, at
increased prices (which would reflect the rising market). A Fund
might have to sell underlying instruments at a time when it would
be disadvantageous to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
portfolio being hedged, the price movements of futures contracts
PAGE 48
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by
T. Rowe Price or Price-Fleming might not result in a successful
hedging transaction over a very short time period.
Options on Futures Contracts
The Funds may purchase and sell options on the same types of
futures in which they may invest.
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the
right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase
or sell the futures contract, at a specified exercise price at
any time during the period of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the
option to the holder of the option will be accompanied by the
delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market
price of the futures contract, at exercise, exceeds (in the case
of a call) or is less than (in the case of a put) the exercise
price of the option on the futures contract. Purchasers of
options who fail to exercise their options prior to the exercise
date suffer a loss of the premium paid.
As an alternative to writing or purchasing call and put
options on stock index futures, the Fund may write or purchase
call and put options on stock indices with respect to the Equity
Income and International Stock Funds, or financial indices with
respect to the New Income Funds. Such options would be used in a
manner similar to the use of options on futures contracts. From
time to time, a single order to purchase or sell futures
PAGE 49
contracts (or options thereon) may be made on behalf of the Funds
and other T. Rowe Price Funds. Such aggregated orders would be
allocated among the Funds and the other T. Rowe Price Funds in a
fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks of Transactions on
Futures Contracts" are substantially the same as the risks of
using options on futures. In addition, where the Funds seek to
close out an option position by writing or buying an offsetting
option covering the same index, underlying instruments, or
contract and having the same exercise price and expiration date.
The ability to establish and close out positions on such options
will be subject to the maintenance of a liquid secondary market.
Reasons for the absence of a liquid secondary market on an
exchange include the following: (i) there may be insufficient
trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or
series of options, or underlying instruments; (iv) unusual or
unforeseen circumstances may interrupt normal operations on an
exchange; (v) the facilities of an exchange or a clearing
corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic
or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or
series of options), in which event the secondary market on that
exchange (or in the class or series of options) would cease to
exist, although outstanding options on the exchange that had been
issued by a clearing corporation as a result of trades on that
exchange would continue to be exercisable in accordance with
their terms. There is no assurance that higher than anticipated
trading activity or other unforeseen events might not, at times,
render certain of the facilities of any of the clearing
corporations inadequate, and thereby result in the institution by
an exchange of special procedures which may interfere with the
timely execution of customers' orders.
Additional Futures and Options Contracts
Although each Fund has no current intention of engaging in
financial futures or options transactions other than those
described above, it reserves the right to do so. Such futures
and options trading might involve risks which differ from those
involved in the futures and options described above.
PAGE 50
Foreign Futures and Options--New Income, Equity Income and
International Stock Funds
Participation in foreign futures and foreign options
transactions involves the execution and clearing of trades on or
subject to the rules of a foreign board of trade. Neither the
National Futures Association nor any domestic exchange regulates
activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the
power to compel enforcement of the rules of a foreign board of
trade or any applicable foreign law. This is true even if the
exchange is formally linked to a domestic market so that a
position taken on the market may be liquidated by a transaction
on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or
foreign options transaction occurs. For these reasons, customers
who trade foreign futures or foreign options contracts may not be
afforded certain of the protective measures provided by the
Commodity Exchange Act, the CFTC's regulations and the rules of
the National Futures Association and any domestic exchange,
including the right to use reparations proceedings before the
Commission and arbitration proceedings provided by the National
Futures Association or any domestic futures exchange. In
particular, funds received from customers for foreign futures or
foreign options transactions may not be provided the same
protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any
foreign futures or foreign options contract and, therefore, the
potential profit and loss thereon may be affected by any variance
in the foreign exchange rate between the time your order is
placed and the time it is liquidated, offset or exercised.
New Income, Equity Income and International Stock Funds
Foreign Currency Transactions
A forward foreign currency exchange contract involves an
obligation to purchase or sell a specific currency at a future
date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are principally traded in the
interbank market conducted directly between currency traders
(usually large, commercial banks) and their customers. A forward
contract generally has no deposit requirement, and no commissions
are charged at any stage for trades.
The Funds may enter into forward contracts for a variety of
purposes in connection with the management of the foreign
securities portion of its portfolio. The Fund's use of such
contracts would include, but not be limited to, the following:
PAGE 51
First, when a Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, it may
desire to "lock in" the U.S. dollar price of the security. By
entering into a forward contract for the purchase or sale, for a
fixed amount of dollars, of the amount of foreign currency
involved in the underlying security transactions, a Fund will be
able to protect itself against a possible loss resulting from an
adverse change in the relationship between the U.S. dollar and
the subject foreign currency during the period between the date
the security is purchased or sold and the date on which payment
is made or received.
Second, when T. Rowe Price or Price-Fleming believe that the
currency of a particular foreign country may experience a
substantial movement against another currency, including the U.S.
dollar, it may enter into a forward contract to sell or buy the
amount of the former foreign currency, approximating the value of
some or all of a Fund's portfolio securities denominated in such
foreign currency. Alternatively, where appropriate, each Fund
may hedge all or part of its foreign currency exposure through
the use of a basket of currencies or a proxy currency where such
currency or currencies act as an effective proxy for other
currencies. In such a case, the Fund may enter into a forward
contract where the amount of the foreign currency to be sold
exceeds the value of the securities denominated in such currency.
The use of this basket hedging technique may be more efficient
and economical than entering into separate forward contracts for
each currency held in the Fund. The precise matching of the
forward contract amounts and the value of the securities involved
will not generally be possible since the future value of such
securities in foreign currencies will change as a consequence of
market movements in the value of those securities between the
date the forward contract is entered into and the date it
matures. The projection of short-term currency market movement
is extremely difficult, and the successful execution of a short-
term hedging strategy is highly uncertain. Under normal
circumstances, consideration of the prospect for currency
parities will be incorporated into the longer term investment
decisions made with regard to overall diversification strategies.
However, T. Rowe Price and Price-Fleming believe that it is
important to have the flexibility to enter into such forward
contracts when either determines that the best interests of the
Fund will be served.
Third, the New Income Fund may use forward contracts when
the Fund wishes to hedge out of the dollar into a foreign
currency in order to create a synthetic bond or money market
instrument -- the security would be issued by a U.S. issuer but
the dollar component would be transformed into a foreign currency
through a forward contract.
PAGE 52
The Fund may enter into forward contacts for any other
purpose consistent with the Fund's investment objective and
program. However, a Fund will not enter into a forward contract,
or maintain exposure to any such contract(s), if the amount of
foreign currency required to be delivered thereunder would exceed
the Fund's holdings of liquid, high-grade debt securities,
currency available for cover of the forward contract(s) or other
suitable cover. In determining the amount to be delivered under
a contract, a Fund may net offsetting positions.
At the maturity of a forward contract, a Fund may either
sell the portfolio security and make delivery of the foreign
currency, or it may retain the security and either extend the
maturity of the forward contract (by "rolling" that contract
forward) or may initiate a new forward contract.
If a Fund retains the portfolio security and engages in an
offsetting transaction, the Fund will incur a gain or a loss (as
described below) to the extent that there has been movement in
forward contract prices. If a Fund engages in an offsetting
transaction, it may subsequently enter into a new forward
contract to sell the foreign currency. Should forward prices
decline during the period between a Fund's entering into a
forward contract for the sale of a foreign currency and the date
it enters into an offsetting contract for the purchase of the
foreign currency, the Fund will realize a gain to the extent the
price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward prices
increase, a Fund will suffer a loss to the extent of the price of
the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell.
A Fund's dealing in forward foreign currency exchange
contracts will generally be limited to the transactions described
above. However, the Funds reserve the right to enter into
forward foreign currency contracts for different purposes and
under different circumstances. Of course, a Fund is not required
to enter into forward contracts with regard to its foreign
currency-denominated securities and will not do so unless deemed
appropriate by T. Rowe Price or Price-Fleming. It also should be
realized that this method of hedging against a decline in the
value of a currency does not eliminate fluctuations in the
underlying prices of the securities. It simply establishes a
rate of exchange at a future date. Additionally, although such
contracts tend to minimize the risk of loss due to a decline in
the value of the hedged currency, at the same time, they tend to
limit any potential gain which might result from an increase in
the value of that currency.
PAGE 53
Although each Fund values its assets daily in terms of U.S.
dollars, it does not intend to convert its holdings of foreign
currencies into U.S. dollars on a daily basis. It will do so
from time to time, and investors should be aware of the costs of
currency conversion. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on
the difference (the "spread") between the prices at which they
are buying and selling various currencies. Thus, a dealer may
offer to sell a foreign currency to a Fund at one rate, while
offering a lesser rate of exchange should the Fund desire to
resell that currency to the dealer.
Federal Tax Treatment of Options, Futures Contracts and Forward
Foreign Exchange Contracts
The discussion herein may refer to transactions in which the
Equity Income Fund does not engage. The Fund's prospectus sets
forth the types of transactions permissible for the Fund.
The Funds may enter into certain option, futures, and
forward foreign exchange contracts, including options and futures
on currencies, which will be treated as Section 1256 contracts or
straddles.
Transactions which are considered Section 1256 contracts
will be considered to have been closed at the end of a Fund's
fiscal year and any gains or losses will be recognized for tax
purposes at that time. Such gains or losses from the normal
closing or settlement of such transactions will be characterized
as 60% long-term capital gain or loss and 40% short-term capital
gain or loss regardless of the holding period of the instrument.
A Fund will be required to distribute net gains on such
transactions to shareholders even though it may not have closed
the transaction and received cash to pay such distributions.
Options, futures and forward foreign exchange contracts,
including options and futures on currencies, which offset a
foreign dollar denominated bond or currency position may be
considered straddles for tax purposes in which case a loss on any
position in a straddle will be subject to deferral to the extent
of unrealized gain in an offsetting position. The holding period
of the securities or currencies comprising the straddle will be
deemed not to begin until the straddle is terminated. For
securities offsetting a purchased put, this adjustment of the
holding period may increase the gain from sales of securities
held less than three months. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an
equity security will not include the period of time the option is
outstanding.
PAGE 54
Losses on written covered calls and purchased puts on
securities, excluding certain "qualified covered call" options on
equity securities, may be long-term capital loss, if the security
covering the option was held for more than twelve months prior to
the writing of the option.
In order for each Fund to continue to qualify for federal
income tax treatment as a regulated investment company, at least
90% of its gross income for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income derived from
loans of securities, and gains from the sale of securities or
currencies. Pending tax regulations could limit the extent that
net gain realized from option, futures or foreign forward
exchange contracts on currencies is qualifying income for
purposes of the 90% requirement. In addition, gains realized on
the sale or other disposition of securities, including option,
futures or foreign forward exchange contracts on securities or
securities indexes and, in some cases, currencies, held for less
than three months, must be limited to less than 30% of a Fund's
annual gross income. In order to avoid realizing excessive gains
on securities or currencies held less than three months, a Fund
may be required to defer the closing out of option, futures or
foreign forward exchange contracts beyond the time when it would
otherwise be advantageous to do so. It is anticipated that
unrealized gains on Section 1256 option, futures and foreign
forward exchange contracts, which have been open for less than
three months as of the end of a Fund's fiscal year and which are
recognized for tax purposes, will not be considered gains on
securities or currencies held less than three months for purposes
of the 30% test.
INVESTMENT RESTRICTIONS
Fundamental policies may not be changed without the approval
of the lesser of (1) 67% of a 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 or (2) more
than 50% of a Fund's outstanding shares. Other restrictions, in
the form of operating policies, are subject to change by each
Fund's Board of Directors/Trustees without shareholder approval.
Any investment restriction which involves a maximum percentage of
securities or assets shall not be considered to be violated
unless an excess over the percentage occurs immediately after,
and is caused by, an acquisition of securities or assets of, or
borrowings by, a Fund.
PAGE 55
All Funds
Fundamental Policies
As a matter of fundamental policy, each Fund may not:
(1) Borrowing. Borrow money except that each Fund may (i)
borrow for non-leveraging, temporary or emergency
purposes and (ii) engage in reverse repurchase
agreements and make other investments or engage in
other transactions, which may involve a borrowing, in
a manner consistent with a Fund's investment objective
and program, provided that the combination of (i) and
(ii) shall not exceed 33 1/3% of the value of a Fund's
total assets (including the amount borrowed) less
liabilities (other than borrowings) or such other
percentage permitted by law. Any borrowings which
come to exceed this amount will be reduced in
accordance with applicable law. Each Fund may borrow
from banks, other Price Funds or other persons to the
extent permitted by applicable law;
(2) Commodities. Purchase or sell physical commodities;
except that the Funds (other than the Prime Reserve
Fund) may enter into futures contracts and options
thereon;
(3) (a) Industry Concentration (Equity Income and
International Stock Funds). Purchase the securities
of any issuer if, as a result, more than 25% of the
value of each Fund's total assets would be invested in
the securities of issuers having their principal
business activities in the same industry;
(b) Industry Concentration (Prime Reserve Fund).
Purchase the securities of any issuer if, as a result,
more than 25% of the value of the Fund's total assets
would be invested in the securities of issuers having
their principal business activities in the same
industry; provided, however, that this limitation does
not apply to securities of the banking industry
including, but not limited to, certificates of deposit
and bankers' acceptances; and
(c) Industry Concentration (New Income Fund).
Purchase the securities of any issuer if, as a result,
more than 25% of the value of the Fund's total assets
would be invested in the securities of issuers having
their principal business activities in the same
PAGE 56
industry; provided, however, that the Fund will invest
more than 25% of its total assets, but not more than
50%, in any one of the gas utility, gas transmission
utility, electric utility, telephone utility, and
petroleum industries under certain circumstances, and
further provided that this limitation does not apply
to securities of the banking industry including, but
not limited to, certificates of deposit and bankers'
acceptances;
(4) Loans. Make loans, although each Fund may (i) lend
portfolio securities and participate in an interfund
lending program with other Price Funds provided that
no such loan may be made if, as a result, the
aggregate of such loans would exceed 33 1/3% of the
value of a Fund's total assets; (ii) purchase money
market securities and enter into repurchase
agreements; and (iii) acquire publicly-distributed or
privately-placed debt securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One Issuer.
Purchase a security if, as a result, with respect to
75% of the value of its total assets, more than 5% of
the value of each Fund's total assets would be
invested in the securities of a single issuer, except
securities issued or guaranteed by the U.S. Government
or any of its agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer.
Purchase a security if, as a result, with respect to
75% of the value of each Fund's total assets, more
than 10% of the outstanding voting securities of any
issuer would be held by a Fund (other than obligations
issued or guaranteed by the U.S. Government, its
agencies or instrumentalities);
(7) Real Estate. Purchase or sell real estate, including
limited partnership interests therein, unless acquired
as a result of ownership of securities or other
instruments (but this shall not prevent each Fund from
investing in securities or other instruments backed by
real estate or in securities of companies engaged in
the real estate business);
(8) Senior Securities. Issue senior securities except in
compliance with the Investment Company Act of 1940; or
PAGE 57
(9) Underwriting. Underwrite securities issued by other
persons, except to the extent that each Fund may be
deemed to be an underwriter within the meaning of the
Securities Act of 1933 in connection with the purchase
and sale of its portfolio securities in the ordinary
course of pursuing its investment program.
NOTES
The following notes should be read in connection with
the above-described fundamental policies. The notes
are not fundamental policies.
With respect to investment restrictions (1) and (4),
each Fund will not borrow from or lend to any other
Price Fund unless each Fund applies for and receives
an exemptive order from the SEC or the SEC issues
rules permitting such transactions. Each Fund has no
current intention of engaging in any such activity and
there is no assurance the SEC would grant any order
requested by a Fund or promulgate any rules allowing
the transactions.
With respect to investment restriction (1), the Prime
Reserve Fund has no current intention of engaging in
any borrowing transactions.
With respect to investment restriction (2), each Fund
does not consider currency contracts or hybrid
instruments to be commodities.
For purposes of investment restriction (3), U.S.,
state or local governments, or related agencies or
instrumentalities, are not considered an industry.
Industries are determined by reference to the
classifications of industries set forth in each Fund's
Semi-annual and Annual reports.
For purposes of investment restriction (4), each Fund
will consider the acquisition of a debt security to
include the execution of a note or other evidence of
an extension of credit with a term of more than nine
months.
For purposes of investment restriction (5), the Prime
Reserve and New Income Funds will consider a
repurchase agreement fully collateralized with U.S.
government securities to be U.S. government
securities.
PAGE 58
Operating Policies
As a matter of operating policy, each Fund may not:
(1) Borrowing. Each Fund will not purchase additional
securities when money borrowed exceeds 5% of its total
assets;
(2) Control of Portfolio Companies. Invest in companies
for the purpose of exercising management or control;
(3) (a) Equity Securities (Prime Reserve Fund). Purchase
any common stocks or other equity securities, or
securities convertible into equity securities except
as set forth in its operating policy on investment
companies; and
(b) Equity Securities (New Income Fund). Invest more
than 25% of its total assets in equity securities;
(4) Futures Contracts. Purchase a futures contract or an
option thereon if, with respect to positions in
futures or options on futures which do not represent
bona fide hedging, the aggregate initial margin and
premiums on such positions would exceed 5% of each
Fund's net asset value;
(5) (a) Illiquid Securities (Equity Income and
International Stock Funds). Purchase illiquid
securities and securities of unseasoned issuers if, as
a result, more than 15% of its net assets would be
invested in such securities;
(b) Illiquid Securities (Prime Reserve and New Income
Funds). Purchase illiquid securities if, as a result,
more than 15% (10% for the Prime Reserve Fund) of its
net assets would be invested in such securities;
(6) Investment Companies. Purchase securities of open-end
or closed-end investment companies except in
compliance with the Investment Company Act of 1940;
(7) Margin. Purchase securities on margin, except (i) for
use of short-term credit necessary for clearance of
purchases of portfolio securities and (ii) it may make
margin deposits in connection with futures contracts
or other permissible investments;
(8) Mortgaging. Mortgage, pledge, hypothecate or, in any
manner, transfer any security owned by each Fund as
PAGE 59
security for indebtedness except as may be necessary
in connection with permissible borrowings or
investments and then such mortgaging, pledging or
hypothecating may not exceed 33 1/3% of a Fund's total
assets at the time of borrowing or investment;
(9) Oil and Gas Programs. Purchase participations or
other direct interests, or enter into leases with
respect to, oil, gas, or other mineral exploration or
development programs if, as a result thereof, more
than 5% of the value of the total assets of the Fund
would be invested in such programs;
(10) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement of
Additional Information;
(11) Short Sales. Effect short sales of securities; or
(12) Warrants. Invest in warrants if, as a result thereof,
more than 10% of the value of the net assets of each
Fund would be invested in warrants.
International Stock Fund
In addition to the restrictions described above, some
foreign countries limit, or prohibit, all direct foreign
investment in the securities of their companies. However, the
governments of some countries have authorized the organization of
investment funds to permit indirect foreign investment in such
securities. For tax purposes these funds may be known as Passive
Foreign Investment Companies. The Fund is subject to certain
percentage limitations under the 1940 Act and certain states
relating to the purchase of securities of investment companies,
and may be subject to the limitation that no more than 10% of the
value of the Fund's total assets may be invested in such
securities.
MANAGEMENT OF FUNDS
The officers and directors/trustees of each Fund are listed
below. Unless otherwise noted, the address of each is 100 East
Pratt Street, Baltimore, Maryland 21202. Except as indicated,
each has been an employee of T. Rowe Price for more than five
years. In the list below, the Fund's directors/trustees who are
considered "interested persons" of T. Rowe Price or the Funds as
defined under Section 2(a)(19) of the Investment Company Act of
1940 are noted with an asterisk (*). The directors/trustees are
PAGE 60
referred to as inside directors/trustees by virtue of their
officership, directorship and/or employment with T. Rowe Price.
Prime Reserve Fund
ROBERT P. BLACK, Director--Retired; formerly President, Federal
Reserve Bank of Richmond; Address: 10 Dahlgren Road, Richmond,
Virginia 23233
CALVIN W. BURNETT, PH.D., Director--President, Coppin State
College; Director, Maryland Chamber of Commerce and Provident
Bank of Maryland; Former President, Baltimore Area Council Boy
Scouts of America; Vice President, Board of Directors, The
Walters Art Gallery; Address: 2500 West North Avenue, Baltimore,
Maryland 21216
ANTHONY W. DEERING, Director--Director, President and Chief
Executive Officer, The Rouse Company, real estate developers,
Columbia, Maryland; Advisory Director, Kleinwort, Benson (North
America) Corporation, a registered broker-dealer; Address: 10275
Little Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, Director--President, F. Pierce Linaweaver &
Associates, Inc., Consulting Environmental & Civil Engineer(s);
formerly (1987-1991) Executive Vice President, EA Engineering,
Science, and Technology, Inc., and (1987-1990) President, EA
Engineering, Inc., Baltimore, Maryland; Address: 224 Wendover
Road, Baltimore, Maryland 21218
*WILLIAM T. REYNOLDS, Chairman of the Board--Managing Director,
T. Rowe Price; Chartered Financial Analyst
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., T. Rowe Price Trust Company and T. Rowe Price Investment
Services, Inc.; Director, Rhone-Poulenc Rorer, Inc.
JOHN G. SCHREIBER, Director--President, Schreiber Investments,
Inc., a real estate investment company; Director and formerly
(1/80-12/90) Executive Vice President, JMB Realty Corporation, a
national real estate investment manager and developer; Address:
1115 East Illinois Road, Lake Forest, Illinois 60045
EDWARD A. WIESE, President--Vice President, T. Rowe Price, Price-
Fleming and T. Rowe Price Trust Company
ROBERT P. CAMPBELL, Executive Vice President--Vice President,
T. Rowe Price and Price-Fleming; formerly Vice President and
Director, Private Finance, New York Life Insurance Company, New
York, New York
JAMES M. MCDONALD, Executive Vice President--Vice President,
T. Rowe Price
PATRICE L. BERCHTENBREITER, Vice President--Vice President,
T. Rowe Price
PAUL W. BOLTZ, Vice President--Vice President and Financial
Economist of T. Rowe Price
PAGE 61
DONNA M. DAVIS-ENNIS, Vice President--Assistant Vice President,
T. Rowe Price
BRIAN E. BURNS, Vice President--Assistant Vice President, T. Rowe
Price
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Trust Company; Vice President, Price-Fleming and T. Rowe Price
Retirement Plan Services, Inc.
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
BRIAN E. BURNS, Vice President--Assistant Vice President, T. Rowe
Price
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price;
Vice President, Price-Fleming and T. Rowe Price Trust Company
GWENDOLYN G. WAGNER, Vice President--Vice President and
Economist, T. Rowe Price; Chartered Financial Analyst
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price,
and T. Rowe Price Trust Company
ROGER L. FIERY, III, Assistant Vice President--Vice President,
Price-Fleming and T. Rowe Price
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President,
T. Rowe Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee,
T. Rowe Price
New Income Fund
ROBERT P. BLACK, Director--Retired; formerly President, Federal
Reserve Bank of Richmond; Address: 10 Dahlgren Road, Richmond,
Virginia 23233
CALVIN W. BURNETT, PH.D., Director--President, Coppin State
College; Director, Maryland Chamber of Commerce and Provident
Bank of Maryland; Former President, Baltimore Area Council Boy
Scouts of America; Vice President, Board of Directors, The
Walters Art Gallery; Address: 2500 West North Avenue, Baltimore,
Maryland 21216
ANTHONY W. DEERING, Director--Director, President and Chief
Executive Officer, The Rouse Company, real estate developers,
Columbia, Maryland; Advisory Director, Kleinwort, Benson (North
America) Corporation, a registered broker-dealer; Address: 10275
Little Patuxent Parkway, Columbia, Maryland 21044
PAGE 62
F. PIERCE LINAWEAVER, Director--President, F. Pierce Linaweaver &
Associates, Inc., Consulting Environmental & Civil Engineer(s);
formerly (1987-1991) Executive Vice President, EA Engineering,
Science, and Technology, Inc., and (1987-1990) President, EA
Engineering, Inc., Baltimore, Maryland; Address: 224 Wendover
Road, Baltimore, Maryland 21218
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., T. Rowe Price Trust Company and T. Rowe Price Investment
Services, Inc; Director, Rhone-Poulenc Rorer, Inc.
JOHN G. SCHREIBER, Director--President, Schreiber Investments,
Inc., a real estate investment company; Director and formerly
(1/80-12/90) Executive Vice President, JMB Realty Corporation, a
national real estate investment manager and developer; Address:
1115 East Illinois Road, Lake Forest, Illinois 60045
*CHARLES P. SMITH, President and Director--Managing Director,
T. Rowe Price; Vice President, Price-Fleming
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Trust Company; Vice President, Price-Fleming and T. Rowe Price
Retirement Plan Services, Inc.
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company; formerly charter member of the
U.S. Senior Executive Service and Director, Analysis and
Evaluation Division in the Office of Water Regulations and
Standards of the U.S. Environmental Protection Agency
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President--Vice President, T. Rowe
Price; formerly senior bond trader, Scudder, Stevens & Clark,
Boston, Massachusetts
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price;
Vice President, Price-Fleming and T. Rowe Price Trust Company
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price,
and T. Rowe Price Trust Company
STEVEN G. BROOKS, Assistant Vice President--Vice President,
T. Rowe Price
PATRICK S. CASSIDY, Assistant Vice President--Vice President,
T. Rowe Price
PAGE 63
MICHAEL J. MCGONIGLE, Assistant Vice President--Assistant Vice
President, T. Rowe Price
ROGER L. FIERY, III, Assistant Vice President--Vice President,
Price-Fleming and T. Rowe Price
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President,
T. Rowe Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee,
T. Rowe Price
Equity Income Fund
*THOMAS H. BROADUS, JR., Vice President and Trustee--Managing
Director, T. Rowe Price; Chartered Financial Analyst and
Chartered Investment Counselor
DONALD W. DICK, JR., Trustee--Principal, Overseas Partners, Inc.,
a financial investment firm; formerly (6/65-3/89) Director and
Vice President-Consumer Products Division, McCormick & Company,
Inc., international food processors; Director, Waverly, Inc.,
Baltimore, Maryland; Address: 111 Pavonia Avenue, Suite 334,
Jersey City, New Jersey 07310
DAVID K. FAGIN, Trustee--Chairman, Chief Executive Officer and
Director, Golden Star Resources, Ltd.; formerly (1986-7/91)
President, Chief Operating Officer and Director, Homestake Mining
Company; Address: One Norwest Center, 1700 Lincoln Street, Suite
1950, Denver, Colorado 80203
HANNE M. MERRIMAN, Trustee--Retail business consultant;
formerly President and Chief Operating Officer (1991-92), Nan
Duskin, Inc., a women's specialty store, Director (1984-1990) and
Chairman (1989-90) Federal Reserve Bank of Richmond, and
President and Chief Executive Officer (1988-89), Honeybee, Inc.,
a division of Spiegel, Inc.; Director, Central Illinois Public
Service Company, CIPSCO Incorporated, The Rouse Company, State
Farm Mutual Automobile Insurance Company and USAir Group, Inc.;
Address: 3201 New Mexico Avenue, N.W., Suite 350, Washington,
D.C. 20016
*JAMES S. RIEPE, Vice President and Trustee--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., T. Rowe Price Retirement Plan Services, Inc., and T. Rowe
Price Investment Services, Inc; President and Trust Officer,
T. Rowe Price Trust Company, Director, Price-Fleming and Rhone-
Poulenc Rorer, Inc.
*M. DAVID TESTA, Trustee--Chairman of the Board, Price-Fleming;
Managing Director, T. Rowe Price; Vice President and Director,
T. Rowe Price Trust Company; Chartered Financial Analyst;
Chartered Investment Counselor
HUBERT D. VOS, Trustee--President, Stonington Capital
Corporation, a private investment company; Address: 1231 State
Street, Suite 210, Santa Barbara, California 93190-0409
PAGE 64
PAUL M. WYTHES, Trustee--Founding General Partner, Sutter Hill
Ventures, a venture capital limited partnership, providing equity
capital to young high technology companies throughout the United
States; Director, Teltone Corporation, Interventional
Technologies Inc. and Stuart Medical, Inc.; Address: 755 Page
Mill Road, Suite A200, Palo Alto, California 94304
BRIAN C. ROGERS, President--Managing Director, T. Rowe Price
ANDREW M. BROOKS, Vice President--Vice President, T. Rowe Price
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Trust Company; Vice President, Price-Fleming and T. Rowe Price
Retirement Plan Services, Inc.
RICHARD P. HOWARD, Vice President--Vice President, T. Rowe Price;
Chartered Financial Analyst
WILLIAM J. STROMBERG, Vice President--Vice President, T. Rowe
Price
DANIEL M. THERIAULT, Vice President--Vice President, T. Rowe
Price, Chartered Financial Analyst; formerly a Securities
Analyst, John A. Levin & Co.
MARK J. VASELKIV, Vice President-Vice President, T. Rowe Price
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc. and T. Rowe Price Trust Company
J. JEFFREY LANG, Assistant Vice President--Assistant Vice
President, T. Rowe Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee,
T. Rowe Price
International Stock Fund
LEO C. BAILEY, Retired (April 1996) Director--Address: 3396 South
Placita Fabula, Green Valley, Arizona 85614
ANTHONY W. DEERING, Director--Director, President and Chief
Executive Officer, The Rouse Company, real estate developers,
Columbia, Maryland; Advisory Director, Kleinwort, Benson (North
America) Corporation, a registered broker-dealer; Address: 10275
Little Patuxent Parkway, Columbia, Maryland 21044
DONALD W. DICK, JR., Director--Principal, Eurocapital Advisors,
LLC, an acquisition and management advisory Firm (from 7/95-to
present), Principal, Overseas Partners, Inc., a financial
investment firm (5/89-6/95); formerly (6/65-3/89) Director and
Vice President-Consumer Products Division, McCormick & Company,
Inc., international food processors; Director, Waverly, Inc.,
PAGE 65
Baltimore, Maryland; Address: P.O. Box 491, Chilmark, MA 02535-
0491
ADDISON LANIER, Retired (April 1996) Director--Financial
management; Manager, Thomas Emery's Sons, LLC, Alternative Asset
Holdings, LLC, President, Emery Group, Inc.; Director, Scinet
Development and Holdings, Inc.; Address: 441 Vine Street, #2300,
Cincinnati, Ohio 45202-2913
PAUL M. WYTHES, Director--Founding General Partner, Sutter Hill
Ventures, a venture capital limited partnership, providing equity
capital to young high technology companies throughout the United
States; Director, Teltone Corporation (Seattle, WA) and
Interventional Technologies Inc. (San Diego, CA); Address: 755
Page Mill Road, Suite A200, Palo Alto, California 94304
*M. DAVID TESTA, Chairman of the Board--Chairman of the Board,
Price-Fleming; Managing Director, T. Rowe Price; Vice President
and Director, T. Rowe Price Trust Company; Chartered Financial
Analyst; Chartered Investment Counselor
*MARTIN G. WADE, President and Director--President and Director,
Price-Fleming; Director, Robert Fleming Holdings Limited;
Director, Robert Fleming Asset Management; Address: 25 Copthall
Avenue, London, EC2R 7DR, England
PETER B. ASKEW, Executive Vice President--Executive Vice
President, Price-Fleming
EDWARD A. WIESE, Executive Vice President--Vice President,
T. Rowe Price, Price-Fleming and T. Rowe Price Trust Company
CHRISTOPHER D. ALDERSON, Vice President--Vice President, Price-
Fleming
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price
and Price-Fleming; formerly (4/80-5/90) Vice President and
Director, Private Finance, New York Life Insurance Company, New
York, New York
FRANCES DYDASCO, Vice President--Vice President and portfolio
manager of Price-Fleming (Singapore); formerly an Investment
Manager at LGT Asset Management Ltd. (Hong Kong)
MARK J. T. EDWARDS, Vice President--Vice President, Price-Fleming
JOHN R. FORD, Vice President--Vice President, Price-Fleming
HENRY H. HOPKINS, Vice President--Vice President, Price-Fleming
and T. Rowe Price Retirement Plan Services, Inc.; Managing
Director, T. Rowe Price; Vice President and Director, T. Rowe
Price Investment Services, Inc., T. Rowe Price Services, Inc. and
T. Rowe Price Trust Company
STEPHEN ILOTT, Vice President--Vice President, Price-Fleming;
formerly (1988-1991) portfolio management, Fixed Income
Portfolios Group, Robert Fleming Holdings Limited, London
GEORGE A. MURNAGHAN, Vice President--Vice President, Price-
Fleming, T. Rowe Price, T. Rowe Price Trust Company, and T. Rowe
Price Investment Services, Inc.
NICHOLA PEASE, Vice President--Vice President and portfolio
manager of Price-Fleming; formerly a Director of Smith New Court
PLC
PAGE 66
JAMES S. RIEPE, Vice President--Managing Director and Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., T. Rowe Price Retirement Plan Services, Inc. and T. Rowe
Price Trust Company; President and Director, T. Rowe Price
Investment Services, Inc.; Director, Rhone-Poulenc Rorer, Inc.
CHRISTOPHER ROTHERY, Vice President--Employee, Price-Fleming;
formerly (1987-1989) employee of Robert Fleming Holdings Limited,
London
JAMES B. M. SEDDON, Vice President--Vice President, Price-Fleming
MARK C. J. BICKFORD-SMITH, Vice President--Vice President and
portfolio manager of Price-Fleming; formerly a Director and
portfolio manager of Jardine Fleming Investment Management
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Price-Fleming
BENEDICT R. F. THOMAS, Vice President--Vice President, Price-
Fleming
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price;
Vice President, Price-Fleming
DAVID J. L. WARREN, Vice President--Vice President, Price-Fleming
WILLIAM F. WENDLER, II, Vice President--Vice President, Price-
Fleming, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
EDWARD A. WIESE, Vice President--Vice President, T. Rowe Price,
Price-Fleming and T. Rowe Price Trust Company
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc., and T. Rowe Price Trust Company
ANN B. CRANMER, Assistant Vice President--Vice President, Price-
Fleming
ROGER L. FIERY, III, Assistant Vice President--Vice President,
Price-Fleming and T. Rowe Price
LEAH P. HOLMES, Assistant Vice President--Vice President, Price-
Fleming and Assistant Vice President T. Rowe Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee,
T. Rowe Price
Each Fund's Executive Committee, consisting of the Fund's
interested directors/trustees, has been authorized by its
respective Board of Directors/Trustees to exercise all powers of
the Board to manage the Funds in the intervals between meetings
of the Board, except the powers prohibited by statute from being
delegated. The members of each Fund's Executive Committee are as
follows:
PAGE 67
Prime Reserve Fund--Messrs. Reynolds and Riepe
New Income Fund--Messrs. Riepe and Smith
Equity Income Fund--Messrs. Broadus, Riepe, and Testa
International Stock Fund--Messrs. Testa and Wade
COMPENSATION TABLE
The Funds do not pay pension or retirement benefits to their
officers or directors/trustees. Also, any director/trustee of a
Fund who is an officer or employee of T. Rowe Price does not
receive any remuneration from the Fund.
_________________________________________________________________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Complex
Person, from Paid to
Position Fund(a) Directors(b)
_________________________________________________________________
Prime Reserve Fund
Robert P. Black, $6,692 $56,000
Director
Calvin W. Burnett, 6,692 56,000
Ph.D, Director
Anthony W. Deering, 6,692 68,250
Director
F. Pierce Linaweaver, 6,692 56,000
Director
John G. Schreiber, 6,692 56,000
Director
_________________________________________________________________
New Income Fund
Robert P. Black, $3,381 $56,000
Director
Calvin W. Burnett, 3,381 56,000
Ph.D, Director
Anthony W. Deering, 3,381 68,250
Director
F. Pierce Linaweaver, 3,381 56,000
Director
PAGE 68
John G. Schreiber, 3,381 56,000
Director
_________________________________________________________________
Equity Income Fund
Leo C. Bailey, $1,876 $42,083
Trustee(e)
Donald W. Dick, Jr., 4,805 72,917
Trustee
David K. Fagin, 7,418 59,167
Trustee
Addison Lanier, 1,876 42,083
Trustee(e)
Hanne M. Merriman, 7,418 59,167
Trustee
John K. Major, 1,876 34,167
Trustee(e)
Hubert D. Vos, 7,418 59,167
Trustee
Paul M. Wythes, 4,805 69,667
Trustee
_________________________________________________________________
International Stock Fund
Leo C. Bailey, $5,027 $42,083
Director(c)
Anthony W. Deering, 6,347 70,667
Director
Donald W. Dick, Jr., 7,288 72,917
Director
Addison Lanier, 5,027 42,083
Director(c)
Paul M. Wythes, 4,054 69,667
Director(d)
PAGE 69
(a) Amounts in this Column are based on compensation accrued for
the following periods:
Equity Income Fund: January 1, 1996--December 31, 1996
Prime Reserve and New Income Funds: June 1, 1995--May 31,
1996
International Stock Fund: November 1, 1995--October 31, 1996
(b) Amounts in this column are for calendar year 1995.
(c) Messrs. Bailey and Lanier retired from their positions with
the Fund in April 1996.
(d) Mr. Wythes was appointed to the Board of Directors in
January 1996.
(e) Messrs. Bailey, Lanier, and Major retired from their
positions with the Fund in April 1996.
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and
directors/trustees of each Fund, as a group, owned less than 1%
of the outstanding shares of the Fund.
As of January 31, 1997, the following shareholder owned of
record more than 5% of the outstanding shares of the
International Stock Fund: Charles Schwab & Co. Inc., Reinvestment
Account, Attn.: Mutual Fund Dept., 101 West Montgomery Street,
San Francisco, California 94104-4122.
As of January 31, 1997, the following shareholders owned of
record more than 5% of the outstanding shares of the New Income
Fund: Yachtcrew & Co., FBO Spectrum Income Account, State Street
Bank and Trust Co., 1776 Heritage Drive-4W, North Quincy, MA
02171-2010.
INVESTMENT MANAGEMENT SERVICES
Services
Under the Management Agreement, T. Rowe Price or Price-
Fleming provides each Fund with discretionary investment
services. Specifically, T. Rowe Price or Price-Fleming is
responsible for supervising and directing the investments of each
Fund in accordance with the Fund's investment objective, program,
and restrictions as provided in its prospectus and this Statement
of Additional Information. T. Rowe Price or Price-Fleming is
also responsible for effecting all security transactions on
behalf of each Fund, including the negotiation of commissions and
the allocation of principal business and portfolio brokerage. In
addition to these services, T. Rowe Price or Price-Fleming
PAGE 70
provides each Fund with certain administrative services,
including: maintaining each Fund's existence, records, and
registering and qualifying a Fund's shares under federal and
state laws; monitoring the financial, accounting, and
administrative functions of each Fund; maintaining liaison with
the agents employed by each Fund such as the Fund's custodian and
transfer agent; assisting each Fund in the coordination of such
agents' activities; and permitting T. Rowe Price's or Price-
Fleming's employees to serve as officers, directors/trustees, and
committee members of each Fund without cost to the Fund.
The Management Agreement also provides that T. Rowe Price or
Price-Fleming, its directors, officers, employees, and certain
other persons performing specific functions for each Fund will
only be liable to a Fund for losses resulting from willful
misfeasance, bad faith, gross negligence, or reckless disregard
of duty.
Management Fee
Each Fund pays T. Rowe Price or Price-Fleming a fee ("Fee")
which consists of two components: a Group Management Fee ("Group
Fee") and an Individual Fund Fee ("Fund Fee"). The Fee is paid
monthly to the T. Rowe Price or Price-Fleming on the first
business day of the next succeeding calendar month and is
calculated as described below.
The monthly Group Fee ("Monthly Group Fee") is the sum of
the daily Group Fee accruals ("Daily Group Fee Accruals") for
each month. The Daily Group Fee Accrual for any particular day
is computed by multiplying the Price Funds' group fee accrual as
determined below ("Daily Price Funds' Group Fee Accrual") by the
ratio of the Fund's net assets for that day to the sum of the
aggregate net assets of the Price Funds for that day. The Daily
Price Funds' Group Fee Accrual for any particular day is
calculated by multiplying the fraction of one (1) over the number
of calendar days in the year by the annualized Daily Price Funds'
Group Fee Accrual for that day as determined in accordance with
the following schedule:
Price Funds'
Annual Group Base Fee
Rate for Each Level of Assets
0.480% First $1 billion
0.450% Next $1 billion
0.420% Next $1 billion
0.390% Next $1 billion
0.370% Next $1 billion
0.360% Next $2 billion
PAGE 71
0.350% Next $2 billion
0.340% Next $5 billion
0.330% Next $10 billion
0.320% Next $10 billion
0.310% Next $16 billion
0.305% Next $30 billion
0.300% Thereafter
For the purpose of calculating the Group Fee, the Price
Funds include all the mutual funds distributed by T. Rowe Price
Investment Services, Inc. (excluding T. Rowe Price Equity Index
Fund, T. Rowe Price Spectrum Fund, Inc. and any institutional or
private label mutual funds). For the purpose of calculating the
Daily Price Funds' Group Fee Accrual for any particular day, the
net assets of each Price Fund are determined in accordance with
the Fund's prospectus as of the close of business on the previous
business day on which the Fund was open for business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the
daily Fund Fee accruals ("Daily Fund Fee Accruals") for each
month. The Daily Fund Fee accrual for any particular day is
computed by multiplying the fraction of one (1) over the number
of calendar days in the year by the individual Fund Fee Rate for
the Prime Reserve, New Income, Equity Income and International
Stock Funds of .05%, .15%, .25% and 0.35%, respectively, and
multiplying this product by the net assets of the Fund for that
day, as determined in accordance with the Fund's prospectus as of
the close of business on the previous business day on which the
Fund was open for business.
Listed below are the total amounts paid to T. Rowe Price by
the Prime Reserve and New Income Funds (for the fiscal year ended
May 31, 1996, May 31, 1995, the three-month fiscal year ended May
31, 1994 and for the fiscal year ended February 28, 1994), and
Equity Income Fund (for the fiscal years ended December 31, 1996,
1995, and 1994), and amounts paid to Price-Fleming by the
International Stock Fund (for the fiscal years ended October 31,
1996, 1995, and 1994 under an investment management agreement, in
effect at that time, for each of the last three fiscal years or
year ends.
PAGE 72
Prime New Income Equity International
Reserve Fund Fund Income Fund Stock Fund
Fiscal Fiscal
Year Amount Year Amount Year Amount Year Amount
1996$15,320,000 1996$7,886,000 1996$37,762,000 1996 $52,565,000
1995 14,784,000 1995 6,972,000 1995 24,358,000 1995 41,829,000
1994**3,601,000 1994**1,748,000 1994 17,847,000 1994 35,176,000
1994*13,617,000 1994*7,750,000
* For the 10-month fiscal year ended October 31, 1993.
** For the three-month fiscal year ended May 31, 1994.
Limitation on Fund Expenses
The Management Agreement between each Fund and T. Rowe Price
or Price-Fleming provides that each Fund will bear all expenses
of its operations not specifically assumed by T. Rowe Price or
Price-Fleming. Set forth below are details of various expense
limitations agreed to by T. Rowe Price or Price-Fleming and the
Funds.
T. Rowe Price Spectrum Fund, Inc.
The Funds are parties to Special Servicing Agreements
("Agreement") between and among T. Rowe Price Spectrum Fund, Inc.
("Spectrum Fund"), T. Rowe Price, Price-Fleming, T. Rowe Price
Services, Inc. and various other T. Rowe Price funds which, along
with the Funds, are funds in which Spectrum Fund invests
(collectively all such funds "Underlying Price Funds").
The Agreements provide that, if the Board of
Directors/Trustees of any Underlying Price Fund determines that
such Underlying Fund's share of the aggregate expenses of
Spectrum Fund is less than the estimated savings to the
Underlying Price Fund from the operation of Spectrum Fund, the
Underlying Price Fund will bear those Spectrum Fund expenses in
proportion to the average daily value of its shares owned by
Spectrum Fund, provided further that no Underlying Price Fund
will bear such Spectrum Fund expenses in excess of the estimated
savings to it. Such savings are expected to result primarily
from the elimination of numerous separate shareholder accounts
which are or would have been invested directly in the Underlying
Price Funds and the resulting reduction in shareholder servicing
costs. Although such cost savings are not certain, the estimated
savings to the Underlying Price Funds generated by the operation
of Spectrum Fund are expected to be sufficient to offset most, if
not all, of the expenses incurred by Spectrum Fund.
PAGE 73
International Stock Fund
Under the Management Agreement, Price-Fleming is permitted
to utilize the services or facilities of others to provide it or
the Fund with statistical and other factual information, advice
regarding economic factors and trends, advice as to occasional
transactions in specific securities, and such other information,
advice or assistance as Price-Fleming may deem necessary,
appropriate, or convenient for the discharge of its obligations
under the Management Agreement or otherwise helpful to the Fund.
Certain administrative support is provided by T. Rowe Price
which receives from Price-Fleming a fee of .15% of the market
value of all assets in equity accounts, .15% of the market value
of all assets in active fixed income accounts and .035% of the
market value of all assets in passive fixed income accounts under
Price-Fleming's management.
Additional investment research and administrative support
for equity investments is provided to Price-Fleming by Fleming
Investment Management Limited (FIM) and Jardine Fleming
Investment Holdings Limited (JFIH) for which each receives from
Price-Fleming a fee of .075% of the market value of all assets in
equity accounts under Price-Fleming's management. Fleming
International Asset Management Limited (FIAM) and JFIH provide
research and administrative support for fixed income accounts for
which each receive a fee of .075% of the market value of all
assets in active fixed income accounts and 0.175% of such market
value in passive fixed income accounts under Price-Fleming's
management. FIM and JFIH are wholly owned subsidiaries of
Flemings and Jardine Fleming, respectively, and FIAM is an
indirect subsidiary of Flemings.
Robert Fleming personnel have extensive research resources
throughout the world. A strong emphasis is placed on direct
contact with companies in the research universe. Robert Fleming
personnel, who frequently speak the local language, have access
to the full range of research products available in the market
place and are encouraged to produce independent work dedicated
solely to portfolio investment management, which adds value to
that generally available.
DISTRIBUTOR FOR FUNDS
T. Rowe Price Investment Services, Inc. ("Investment
Services"), a Maryland corporation formed in 1980 as a wholly-
owned subsidiary of T. Rowe Price, serves as the Funds'
distributor. Investment Services is registered as a broker-
dealer under the Securities Exchange Act of 1934 and is a member
PAGE 74
of the National Association of Securities Dealers, Inc. The
offering of each Fund's shares is continuous.
Investment Services is located at the same address as the
Funds and T. Rowe Price -- 100 East Pratt Street, Baltimore,
Maryland 21202.
Investment Services serves as distributor to the Funds
pursuant to an Underwriting Agreement ("Underwriting Agreement"),
which provides that each Fund will pay all fees and expenses in
connection with: necessary state filings; preparing, setting in
type, printing, and mailing the Fund prospectuses and reports to
shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Underwriting Agreement provides that Investment Services
will pay all fees and expenses in connection with: printing and
distributing prospectuses and reports for use in offering and
selling Fund shares; preparing, setting in type, printing, and
mailing all sales literature and advertising; Investment
Services' federal and state registrations as a broker-dealer; and
offering and selling Fund shares, except for those fees and
expenses specifically assumed by each Fund. Investment Services'
expenses are paid by T. Rowe Price.
Investment Services acts as the agent of each Fund in
connection with the sale of its shares in the various states in
which Investment Services is qualified as a broker-dealer. Under
the Underwriting Agreement, Investment Services accepts orders
for Fund shares at net asset value. No sales charges are paid by
investors or the Funds.
SHAREHOLDER SERVICES
The Fund from time to time may enter into agreements with
outside parties through which shareholders hold Fund shares. The
shares would be held by such parties in omnibus accounts. The
agreements would provide for payments by the Fund to the outside
party for such shareholder services provided to shareholders in
the omnibus accounts.
CUSTODIAN
State Street Bank and Trust Company is the custodian for
each Fund's domestic securities and cash, but it does not
participate in the Fund's investment decisions. Portfolio
securities purchased in the U.S. are maintained in the custody of
PAGE 75
State Street Bank and may be entered into the Federal Reserve
Book Entry System, or the security depository system of the
Depository Trust Corporation. The New Income, Equity Income and
International Stock Funds have entered into a Custodian Agreement
with The Chase Manhattan Bank, N.A., London, pursuant to which
portfolio securities which are purchased outside the United
States are maintained in the custody of various foreign branches
of The Chase Manhattan Bank and such other custodians, including
foreign banks and foreign securities depositories as are approved
by each Fund's Board of Directors/Trustees in accordance with
regulations under the Investment Company Act of 1940. State
Street Bank's main office is at 225 Franklin Street, Boston,
Massachusetts 02110. The address for The Chase Manhattan Bank,
N.A., London is Woolgate House, Coleman Street, London, EC2P 2HD,
England.
CODE OF ETHICS
Prime Reserve, New Income and Equity Income Funds
The Fund's investment adviser (T. Rowe Price) has a written
Code of Ethics which requires all employees to obtain prior
clearance before engaging in personal securities transactions.
Transactions must be executed within three business days of their
clearance. In addition, all employees must report their personal
securities transactions within ten days of their execution.
Employees will not be permitted to effect transactions in a
security: If there are pending client orders in the security; the
security has been purchased or sold by a client within seven
calendar days; the security is being considered for purchase for
a client; a change has occurred in T. Rowe Price's rating of the
security within seven calendar days prior to the date of the
proposed transaction; or the security is subject to internal
trading restrictions. In addition, employees are prohibited from
profiting from short-term trading (e.g., purchases and sales
involving the same security within 60 days). Any material
violation of the Code of Ethics is reported to the Board of the
Fund. The Board also reviews the administration of the Code of
Ethics on an annual basis.
International Stock Fund
The Funds' investment adviser (Price-Fleming) has a written
Code of Ethics which requires all employees to obtain prior
clearance before engaging in any personal securities
transactions. In addition, all employees must report their
personal securities transactions within ten days of their
execution. Employees will not be permitted to effect
PAGE 76
transactions in a security: If there are pending client orders in
the security; the security has been purchased or sold by a client
within seven calendar days; the security is being considered for
purchase for a client; the security is subject to internal
trading restrictions. In addition, employees are prohibited from
engaging in short-term trading (e.g., purchases and sales
involving the same security within 60 days. Any material
violation of the Code of Ethics is reported to the Board of the
Fund. The Board also reviews the administration of the Code of
Ethics on an annual basis.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Funds are made by T. Rowe Price.
T. Rowe Price is also responsible for implementing these
decisions, including the negotiation of commissions and the
allocation of portfolio brokerage and principal business. Each
Fund's purchases and sales of fixed-income portfolio securities
are normally done on a principal basis and do not involve the
payment of a commission although they may involve the designation
of selling concessions. That part of the discussion below
relating solely to brokerage commissions would not normally apply
to the Prime Reserve Fund (and except to the extent it purchases
equity securities, New Income Fund). However, it is included
because T. Rowe Price does manage a significant number of common
stock portfolios which do engage in agency transactions and pay
commissions and because some research and services resulting from
the payment of such commissions may benefit the Funds.
How Brokers and Dealers are Selected
Equity Securities
In purchasing and selling the Fund's portfolio securities,
it is T. Rowe Price's policy to obtain quality execution at the
most favorable prices through responsible brokers and dealers
and, in the case of agency transactions, at competitive
commission rates. However, under certain conditions, the Fund may
pay higher brokerage commissions in return for brokerage and
research services. As a general practice, over-the-counter
orders are executed with market-makers. In selecting among
market-makers, T. Rowe Price generally seeks to select those it
believes to be actively and effectively trading the security
being purchased or sold. In selecting broker-dealers to execute
the Fund's portfolio transactions, consideration is given to such
PAGE 77
factors as the price of the security, the rate of the commission,
the size and difficulty of the order, the reliability, integrity,
financial condition, general execution and operational
capabilities of competing brokers and dealers, and brokerage and
research services provided by them. It is not the policy of
T. Rowe Price to seek the lowest available commission rate where
it is believed that a broker or dealer charging a higher
commission rate would offer greater reliability or provide better
price or execution.
Fixed Income Securities
Fixed income securities are generally purchased from the
issuer or a primary market-maker acting as principal for the
securities on a net basis, with no brokerage commission being
paid by the client although the price usually includes an
undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the
bid and asked prices. Securities may also be purchased from
underwriters at prices which include underwriting fees.
With respect to equity and fixed income securities, T. Rowe
Price may effect principal transactions on behalf of a Fund with
a broker or dealer who furnishes brokerage and/or research
services, designate any such broker or dealer to receive selling
concessions, discounts or other allowances, or otherwise deal
with any such broker or dealer in connection with the acquisition
of securities in underwritings. T. Rowe Price may receive
research services in connection with brokerage transactions,
including designations in fixed priced underwritings.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for
transactions executed on behalf of the Funds. In evaluating the
reasonableness of commission rates, T. Rowe Price considers: (a)
historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
PAGE 78
Description of Research Services Received from Brokers and
Dealers
T. Rowe Price receives a wide range of research services
from brokers and dealers. These services include information on
the economy, industries, groups of securities, individual
companies, statistical information, accounting and tax law
interpretations, political developments, legal developments
affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement
analysis, performance analysis and analysis of corporate
responsibility issues. These services provide both domestic and
international perspective. Research services are received
primarily in the form of written reports, computer generated
services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form
of meetings arranged with corporate and industry spokespersons,
economists, academicians and government representatives. In some
cases, research services are generated by third parties but are
provided to T. Rowe Price by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information
presently provided by brokers and dealers. T. Rowe Price pays
cash for certain research services received from external
sources. T. Rowe Price also allocates brokerage for research
services which are available for cash. While receipt of research
services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could
be materially increased if it attempted to generate such
additional information through its own staff. To the extent that
research services of value are provided by brokers or dealers,
T. Rowe Price may be relieved of expenses which it might
otherwise bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
PAGE 79
Commissions to Brokers who Furnish Research Services
Certain brokers and dealers who provide quality brokerage
and execution services also furnish research services to T. Rowe
Price. With regard to the payment of brokerage commissions,
T. Rowe Price has adopted a brokerage allocation policy embodying
the concepts of Section 28(e) of the Securities Exchange Act of
1934, which permits an investment adviser to cause an account to
pay commission rates in excess of those another broker or dealer
would have charged for effecting the same transaction, if the
adviser determines in good faith that the commission paid is
reasonable in relation to the value of the brokerage and research
services provided. The determination may be viewed in terms of
either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over
which it exercises investment discretion. Accordingly, while
T. Rowe Price cannot readily determine the extent to which
commission rates charged by broker-dealers reflect the value of
their research services, T. Rowe Price would expect to assess the
reasonableness of commissions in light of the total brokerage and
research services provided by each particular broker. T. Rowe
Price may receive research, as defined in Section 28(e), in
connection with selling concessions and designations in fixed
price offerings in which the Funds participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific
amount of business to any broker or dealer over any specific time
period. Historically, the majority of brokerage placement has
been determined by the needs of a specific transaction such as
market-making, availability of a buyer or seller of a particular
security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for
that portion of its discretionary client brokerage business where
special needs do not exist, or where the business may be
allocated among several brokers or dealers which are able to meet
the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers and dealers,
and attempts to allocate a portion of its brokerage business in
response to these assessments. Research analysts, counselors,
various investment committees, and the Trading Department each
seek to evaluate the brokerage and research services they receive
from brokers and dealers and make judgments as to the level of
business which would recognize such services. In addition,
brokers and dealers sometimes suggest a level of business they
would like to receive in return for the various brokerage and
research services they provide. Actual brokerage business
PAGE 80
received by any firm may be less than the suggested allocations
but can, and often does, exceed the suggestions, because the
total business is allocated on the basis of all the
considerations described above. In no case is a broker or dealer
excluded from receiving business from T. Rowe Price because it
has not been identified as providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent
a substantial majority of all assets under management. Research
services furnished by brokers or dealers through which T. Rowe
Price effects securities transactions may be used in servicing
all accounts (including non-Fund accounts) managed by T. Rowe
Price. Conversely, research services received from brokers or
dealers which execute transactions for the Fund are not
necessarily used by T. Rowe Price exclusively in connection with
the management of the Fund.
From time to time, orders for clients may be placed through
a computerized transaction network.
Each Fund does not allocate business to any broker-dealer on
the basis of its sales of the Fund's shares. However, this does
not mean that broker-dealers who purchase Fund shares for their
clients will not receive business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Funds. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Funds. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. T. Rowe
Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price Funds) if,
as a result of such purchases, 10% or more of the outstanding
common stock of such company would be held by its clients in the
aggregate.
PAGE 81
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through
T. Rowe Price Investment Services, Inc., the Fund's distributor.
At the present time, T. Rowe Price does not recapture commissions
or underwriting discounts or selling group concessions in
connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession
or underwriting discount when purchasing tax-exempt municipal
securities on behalf of its clients in underwritten offerings.
Transactions with Related Brokers and Dealers--New Income and
Equity Income Funds
As provided in the Investment Management Agreement between
the Fund and T. Rowe Price, T. Rowe Price is responsible not only
for making decisions with respect to the purchase and sale of the
Fund's portfolio securities, but also for implementing these
decisions, including the negotiation of commissions and the
allocation of portfolio brokerage and principal business. It is
expected that T. Rowe Price may place orders for the Fund's
portfolio transactions with broker-dealers through the same
trading desk T. Rowe Price uses for portfolio transactions in
domestic securities. The trading desk accesses brokers and
dealers in various markets in which the Fund's foreign securities
are located. These brokers and dealers may include of certain
affiliates of Robert Fleming Holdings Limited ("Robert Fleming
Holdings") and Jardine Fleming Group Limited ("JFG"), persons
indirectly related to T. Rowe Price. Robert Fleming Holdings,
through Copthall Overseas Limited, a wholly-owned subsidiary,
owns 25% of the common stock of Rowe Price-Fleming International,
Inc. ("RPFI"), an investment adviser registered under the
Investment Advisers Act of 1940. Fifty percent of the common
stock of RPFI is owned by TRP Finance, Inc., a wholly-owned
subsidiary of T. Rowe Price, and the remaining 25% is owned by
Jardine Fleming International Holdings Limited, a subsidiary of
JFG. JFG is 50% owned by Robert Fleming Holdings and 50% owned
by Jardine Matheson Holdings Limited. Orders for the Fund's
portfolio transactions placed with affiliates of Robert Fleming
Holdings and JFG will result in commissions being received by
such affiliates.
The Board of Directors/Trustees of the Funds has authorized
T. Rowe Price to utilize certain affiliates of Robert Fleming and
JFG in the capacity of broker in connection with the execution of
the Fund's portfolio transactions. These affiliates include, but
are not limited to, Jardine Fleming (Securities) Limited ("JFS"),
a wholly-owned subsidiary of JFG, Robert Fleming & Co. Limited
("RF&Co."), Jardine Fleming Australia Securities Limited, and
Robert Fleming, Inc. (a New York brokerage firm). Other
PAGE 82
affiliates of Robert Fleming Holdings and JFG also may be used.
Although it does not believe that the Funds' use of these brokers
would be subject to Section 17(e) of the Investment Company Act
of 1940, the Board of Directors/Trustees of the Funds has agreed
that the procedures set forth in Rule 17(e)(1) under that Act
will be followed when using such brokers.
Other
Prime Reserve Fund
For the fiscal years ended May 31, 1996, May 31, 1995, for
the three-month fiscal year ended May 31, 1994, and for the
fiscal year ended February 28, 1994, the Fund engaged in
portfolio transactions involving broker-dealers totaling
$52,505,379,000, $53,302,615,000, $5,945,733,000 and
$29,024,172,000, respectively. The entire amount for each of
these years represented principal transactions as to which the
Fund has no knowledge of the profits or losses realized by the
respective broker-dealers. Of all such portfolio transactions,
approximately 72%, 90%, 78% and 87%, respectively, were placed
with firms which provided research, statistical, or other
services to T. Rowe Price in connection with the management of
the Fund or, in some cases, to the Fund.
The Fund, in pursuing its objectives, may engage in short-
term trading to take advantage of market variations. The Fund
will seek to protect principal, improve liquidity of its
securities, or enhance yield by purchasing and selling securities
based upon existing or anticipated market discrepancies.
New Income Fund
For the fiscal years ended May 31, 1996, May 31, 1995, for
the three-month fiscal year ended May 31, 1994, and for the
fiscal year ended February 28, 1994, the Fund engaged in
portfolio transactions involving broker-dealers totaling
$5,290,374,000, $5,469,278,000, $1,649,029,000 and
$20,265,475,000, respectively. For the fiscal years ended May
31, 1996, May 31, 1995, and February 28, 1994 $5,273,923,000,
$5,469,278,000, and $20,206,382,000, consisted of principal
transactions as to which the Fund has no knowledge of the profits
or losses realized by the respective broker-dealers; and for the
years May 31, 1996, May 31, 1995, and February 28, 1994,
$16,451,000, $0, and $59,093,000, involved trades with brokers
acting as agents or underwriters, in which such brokers received
total commissions, including discounts received in connection
with underwritings, of $61,000, $0, and $169,000. For the three-
month fiscal year ended May 31, 1994, the entire amount
represented principal transactions as to which the Fund has no
PAGE 83
knowledge of the profits or losses realized by the respective
broker-dealers. Of all such portfolio transactions,
approximately 71%, 73%, 68%, and 61%, respectively, were placed
with firms which provided research, statistical, or other
services to T. Rowe Price in connection with the management of
the Fund or, in some cases, to the Fund.
The portfolio turnover rate of the Fund for the fiscal years
ended May 31, 1996, May 31, 1995, the three-month fiscal year
ended May 31, 1994, and for the fiscal year ended February 28,
1994, was 35.5%, 54.1%, 91.5%, and 58.3%, respectively.
Equity Income Fund
For the years 1996, 1995, and 1994, the total brokerage
commissions paid by the Fund, including the discounts received by
securities dealers in connection with underwritings, were
$6,912,071, $4,193,326, and $4,511,187, respectively. Of these
commissions, approximately 59.2%, 43.2%, and 48.4%, respectively,
were paid to firms which provided research, statistical, or other
services to T. Rowe Price in connection with the management of
the Fund, or, in some cases, to the Fund.
On December 31, 1996, the Equity Income Fund held common
stock of the following regular broker dealers of the Fund:
Bankers Trust, Chemical Bank, and J.P. Morgan, respectively, with
a value of $41,331,000, $0, and $82,981,000, respectively. The
Fund also held medium-term notes of GMAC and the Morgan Stanley
Group, with a value of $7,002,000 and $31,455,000, respectively.
In 1996, Bankers Trust, Chemical Bank, J.P. Morgan, GMAC, and
Morgan Stanley Group were among the Fund's regular brokers or
dealers as defined in Rule 10b-1 under the Investment Company Act
of 1940.
The portfolio turnover rate of the Fund for each of the last
three years has been as follows: 1996--25.0%, 1995--21.4%, and
1994--36.3%, respectively.
International Stock Fund
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund is made by Price-Fleming.
Price-Fleming is also responsible for implementing these
decisions, including the allocation of portfolio brokerage and
principal business and the negotiation of commissions.
PAGE 84
How Brokers and Dealers are Selected
Equity Securities
In purchasing and selling the Fund's portfolio securities,
it is Price-Fleming's policy to obtain quality execution at the
most favorable prices through responsible broker-dealers and, in
the case of agency transactions, at competitive commission rates
where such rates are negotiable. However, under certain
conditions, the Fund may pay higher brokerage commissions in
return for brokerage and research services. In selecting broker-
dealers to execute the Fund's portfolio transactions,
consideration is given to such factors as the price of the
security, the rate of the commission, the size and difficulty of
the order, the reliability, integrity, financial condition,
general execution and operational capabilities of competing
brokers and dealers, their expertise in particular markets and
the brokerage and research services they provide to Price-Fleming
or the Fund. It is not the policy of Price-Fleming to seek the
lowest available commission rate where it is believed that a
broker or dealer charging a higher commission rate would offer
greater reliability or provide better price or execution.
Transactions on stock exchanges involve the payment of
brokerage commissions. In transactions on stock exchanges in the
United States, these commissions are negotiated. Traditionally,
commission rates have generally not been negotiated on stock
markets outside the United States. In recent years, however, an
increasing number of overseas stock markets have adopted a system
of negotiated rates, although a number of markets continue to be
subject to an established schedule of minimum commission rates.
It is expected that equity securities will ordinarily be
purchased in the primary markets, whether over-the-counter or
listed, and that listed securities may be purchased in the
over-the-counter market if such market is deemed the primary
market. In the case of securities traded on the over-the-counter
markets, there is generally no stated commission, but the price
usually includes an undisclosed commission or markup. In
underwritten offerings, the price includes a disclosed, fixed
commission or discount.
Fixed Income Securities
For fixed income securities, it is expected that purchases
and sales will ordinarily be transacted with the issuer, or
issuer's underwriter, or with a primary market maker acting as
principal on a net basis, with no brokerage commission being paid
by the Fund. However, the price of the securities generally
includes compensation which is not disclosed separately.
Transactions placed though dealers who are serving as primary
PAGE 85
market makers reflect the spread between the bid and asked
prices.
With respect to equity and fixed income securities, Price-
Fleming may effect principal transactions on behalf of the Fund
with a broker or dealer who furnishes brokerage and/or research
services, designate any such broker or dealer to receive selling
concessions, discounts or other allowances or otherwise deal with
any such broker or dealer in connection with the acquisition of
securities in underwritings. The prices the Fund pays to
underwriters of newly-issued securities usually include a
concession paid by the issuer to the underwriter. Price-Fleming
may receive research services in connection with brokerage
transactions, including designations in fixed price offerings.
Price-Fleming may cause the Fund to pay a broker-dealer who
furnishes brokerage and/or research services a commission for
executing a transaction that is in excess of the commission
another broker-dealer would have received for executing the
transaction if it is determined that such commission is
reasonable in relation to the value of the brokerage and/or
research services which have been provided. In some cases,
research services are generated by third parties but are provided
to Price-Fleming by or through broker-dealers.
Descriptions of Research Services Received from Brokers and
Dealers
Price-Fleming receives a wide range of research services
from brokers and dealers covering investment opportunities
throughout the world, including information on the economies,
industries, groups of securities, individual companies,
statistics, political developments, technical market action,
pricing and appraisal services, and performance analyses of all
the countries in which the Fund's portfolio is likely to be
invested. Price-Fleming cannot readily determine the extent to
which commissions charged by brokers reflect the value of their
research services, but brokers occasionally suggest a level of
business they would like to receive in return for the brokerage
and research services they provide. To the extent that research
services of value are provided by brokers, Price-Fleming may be
relieved of expenses which it might otherwise bear. In some
cases, research services are generated by third parties but are
provided to Price-Fleming by or through brokers.
Commissions to Brokers who Furnish Research Services
Certain broker-dealers which provide quality execution
services also furnish research services to Price-Fleming. Price-
Fleming has adopted a brokerage allocation policy embodying the
PAGE 86
concepts of Section 28(e) of the Securities Exchange Act of 1934,
which permits an investment adviser to cause its clients to pay a
broker which furnishes brokerage or research services a higher
commission than that which might be charged by another broker
which does not furnish brokerage or research services, or which
furnishes brokerage or research services deemed to be of lesser
value, if such commission is deemed reasonable in relation to the
brokerage and research services provided by the broker, viewed in
terms of either that particular transaction or the overall
responsibilities of the adviser with respect to the accounts as
to which it exercises investment discretion. Accordingly, Price-
Fleming may assess the reasonableness of commissions in light of
the total brokerage and research services provided by each
particular broker.
Miscellaneous
Research services furnished by brokers through which Price-
Fleming effects securities transactions may be used in servicing
all accounts managed by Price-Fleming, Conversely, research
services received from brokers which execute transactions for the
Fund will not necessarily be used by Price-Fleming exclusively in
connection with the management of the Fund.
Some of Price-Fleming's other clients have investment
objectives and programs similar to those of the Fund. Price-
Fleming may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is Price-Fleming's policy not to favor
one client over another in making recommendations or in placing
orders. Price-Fleming frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. Price-
Fleming has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price Funds) if,
as a result of such purchases, 10% or more of the outstanding
common stock of such company would be held by its clients in the
aggregate.
The Fund does not allocate business to any broker-dealer on
the basis of its sales of the Fund's shares. However, this does
PAGE 87
not mean that broker-dealers who purchase Fund shares for their
clients will not receive business from the Fund.
Transactions with Related Brokers and Dealers
As provided in the Investment Management Agreement between
the Fund and Price-Fleming, Price-Fleming is responsible not only
for making decisions with respect to the purchase and sale of the
Fund's portfolio securities, but also for implementing these
decisions, including the negotiation of commissions and the
allocation of portfolio brokerage and principal business. It is
expected that Price-Fleming will often place orders for the
Fund's portfolio transactions with broker-dealers through the
trading desks of certain affiliates of Robert Fleming Holdings
Limited ("Robert Fleming"), an affiliate of Price-Fleming.
Robert Fleming, through Copthall Overseas Limited, a wholly-owned
subsidiary, owns 25% of the common stock of Price-Fleming. Fifty
percent of the common stock of Price-Fleming is owned by TRP
Finance, Inc., a wholly-owned subsidiary of T. Rowe Price, and
the remaining 25% is owned by Jardine Fleming Holdings Limited, a
subsidiary of Jardine Fleming Group Limited ("JFG"). JFG is 50%
owned by Robert Fleming and 50% owned by Jardine Matheson
Holdings Limited. The affiliates through whose trading desks
such orders may be placed include Fleming Investment Management
Limited ("FIM") and Robert Fleming & Co. Limited ("RF&Co."). FIM
and RF&Co. are wholly-owned subsidiaries of Robert Fleming.
These trading desks will operate under strict instructions from
the Fund's portfolio manager with respect to the terms of such
transactions. Neither Robert Fleming, JFG, nor their affiliates
will receive any commission, fee, or other remuneration for the
use of their trading desks, although orders for the Fund's
portfolio transactions may be placed with affiliates of Robert
Fleming and JFG who may receive a commission.
The Board of Directors of the Fund has authorized Price-
Fleming to utilize certain affiliates of Robert Fleming and JFG
in the capacity of broker in connection with the execution of
each Fund's portfolio transactions, provided that Price-Fleming
believes that doing so will result in an economic advantage (in
the form of lower execution costs or otherwise) being obtained
for each Fund. These affiliates include Jardine Fleming
Securities Limited ("JFS"), a wholly-owned subsidiary of JFG,
RF&Co., Jardine Fleming Australia Securities Limited, and Robert
Fleming, Inc. (a New York brokerage firm).
The above-referenced authorization was made in accordance
with Section 17(e) of the Investment Company Act of 1940 (the
"1940 Act") and Rule 17e-1 thereunder which require the Fund's
PAGE 88
independent directors to approve the procedures under which
brokerage allocation to affiliates is to be made and to monitor
such allocations on a continuing basis. Except with respect to
tender offers, it is not expected that any portion of the
commissions, fees, brokerage, or similar payments received by the
affiliates of Robert Fleming in such transactions will be
recaptured by the Fund. The directors have reviewed and from
time to time may continue to review whether other recapture
opportunities are legally permissible and available and, if they
appear to be, determine whether it would be advisable for the
Fund to seek to take advantage of them.
During the year 1995, the Fund paid JFS, RF&Co., and Ord
Minnett $6,029,012, $236,915, and $174,136, respectively, in
total brokerage commissions in connection with their portfolio
transactions. The brokerage commissions paid to JFS, RF&Co., and
Ord Minnett represented 9%, 4%, and 3%, respectively, of the
Fund's aggregate brokerage commissions paid during 1995. The
aggregate dollar amount of transactions effected through JFS,
RF&Co., and Ord Minnett, involving the payment of commissions,
represented 7%, 6%, and 2%, respectively, of the aggregate dollar
amount of all transactions involving the payment of commissions
during 1995. In accordance with the written procedures adopted
pursuant to Rule 17e-1, the independent directors of the Fund
reviewed the 1995 transactions with affiliated brokers and
determined that such transactions resulted in an economic
advantage to the Fund either in the form of lower execution costs
or otherwise.
Other
For the years 1996, 1995, and 1994, the total brokerage
commissions paid by International Stock Fund, including the
discounts received by securities dealers in connection with
underwritings, were $7,100,046, $6,029,012, and $9,684,485,
respectively. Of these commissions, approximately 89%, 85%, and
83%, respectively, were paid to firms which provided research,
statistical, or other services to Price-Fleming in connection
with the management of the Fund or, in some cases, to the Fund.
The portfolio turnover rate of the International Stock Fund
for each of the last three years has been as follows: 1996--
11.6%, 1995--17.8%, and 1994--22.9%.
PRICING OF SECURITIES
Prime Reserve Fund
Securities are valued at amortized cost.
PAGE 89
Maintenance of Net Asset Value Per Share
It is the policy of the Fund to attempt to maintain a net
asset value of $1.00 per share by using the amortized cost method
of valuation as permitted by Rule 2a-7 under the Investment
Company Act of 1940. Under this method, securities are valued by
reference to the funds acquisition cost as adjusted for
amortization of premium or accumulation of discount rather than
by reference to their market value. Under Rule 2a-7:
(a) The Board of Directors must establish written
procedures reasonably designed, taking into account current
market conditions and the fund's investment objectives, to
stabilize the fund's net asset value per share, as computed
for the purpose of distribution, redemption and repurchase,
at a single value;
(b) the Fund must (i) maintain a dollar-weighted average
portfolio maturity appropriate to its objective of
maintaining a stable price per share, (ii) not purchase any
instrument with a remaining maturity greater than 397 days,
and (iii) maintain a dollar-weighted average portfolio
maturity of 90 days or less;
(c) the Fund must limit its purchase of portfolio
instruments, including repurchase agreements, to those U.S.
dollar-denominated instruments which the Fund's Board of
Directors determines present minimal credit risks, and which
are eligible securities as defined by Rule 2a-7; and
(d) the Board of Directors must determine that (i) it is
in the best interest of the Fund and its shareholders to
maintain a stable net asset value per share under the
amortized cost method; and (ii) the Fund will continue to
use the amortized cost method only so long as the Board of
Directors believes that it fairly reflects the market based
net asset value per share.
Although the Fund believes that it will be able to maintain
its net asset value at $1.00 per share under most conditions,
there can be no absolute assurance that it will be able to do so
on a continuous basis. If the Fund's net asset value per share
declined, or was expected to decline, below $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
temporarily reduce or suspend dividend payments in an effort to
maintain the net asset value at $1.00 per share. As a result of
such reduction or suspension of dividends, an investor would
receive less income during a given period than if such a
reduction or suspension had not taken place. Such action could
PAGE 90
result in an investor receiving no dividend for the period during
which he holds his shares and in his receiving, upon redemption,
a price per share lower than that which he paid. On the other
hand, if the Fund's net asset value per share were to increase,
or were anticipated to increase above $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
supplement dividends in an effort to maintain the net asset value
at $1.00 per share.
Prime Money Market Securities Defined. Prime money market
securities are those which are described as First Tier Securities
under Rule 2a-7 of the Investment Company Act of 1940. These
include any security with a remaining maturity of 397 days or
less that is rated (or that has been issued by an issuer that is
rated with respect to a class of short-term debt obligations, or
any security within that class that is comparable in priority and
security with the security) by any two nationally recognized
statistical rating organizations (NRSROs) (or if only one NRSRO
has issued a rating, that NRSRO) in the highest rating category
for short-term debt obligations (within which there may be sub-
categories). First Tier Securities also include unrated
securities comparable in quality to rated securities, as
determined by T. Rowe Price under the supervision of the Fund's
Board of Directors.
New Income Fund
Fixed income securities are generally traded in the over-
the-counter market. Investments in domestic securities with
remaining maturities of one year or more and foreign securities
are stated at fair value using bid-side valuation as furnished by
dealers who make markets in such securities or by an independent
pricing service, which considers yield or price of bonds of
comparable quality, coupon, maturity, and type, as well as prices
quoted by dealers who make markets in such securities. Domestic
securities with remaining maturities less than one year are
stated at fair value which is determined by using a matrix system
that establishes a value for each security based on bid-side
money market yields.
There are a number of pricing services available, and the
Board of Directors, on the basis of an ongoing evaluation of
these services, may use or may discontinue the use of any pricing
service in whole or in part.
New Income, Equity Income and International Stock Funds
Equity securities are valued at the last quoted sales price
at the time the valuations are made. A security which is listed
PAGE 91
or traded on more than one exchange is valued at the quotation on
the exchange determined to be the primary market for such
security.
Debt securities are generally traded in the over-the-counter
market and are valued at a price deemed best to reflect fair
value as provided by dealers who make markets in these securities
or by an independent pricing service. Short-term debt securities
are valued at amortized cost in local currency which approximates
fair value.
For purposes of determining each Fund's net asset value per
share, the U.S. dollar value of all assets and liabilities
initially expressed in foreign currencies is determined by using
the mean of the bid and offer prices of such currencies against
U.S. dollars provided by a major bank.
All Funds
For purposes of determining the Fund's net asset value per
share, all assets and liabilities initially expressed in foreign
currencies are converted into U.S. dollars at the mean of the bid
and offer prices of such currencies against U.S. dollars quoted
by a major bank.
Assets and liabilities for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value are stated at fair value, as determined in good faith by or
under the supervision of officers of the Funds, as authorized by
the Board of Directors/Trustees.
International Stock Fund
Trading in the portfolio securities of the International
Stock Fund may take place in various foreign markets on certain
days (such as Saturday) when the Fund is not open for business
and does not calculate its net asset value. In addition, trading
in the Fund's portfolio securities may not occur on days when the
Fund is open. The calculation of the Fund's net asset value
normally will not take place contemporaneously with the
determination of the value of the Fund's portfolio securities.
Events affecting the values of portfolio securities that occur
between the time their prices are determined and the time the
Fund's net asset value is calculated will not be reflected in the
Fund's net asset value unless Price-Fleming, under the
supervision of the Fund's Board of Directors, determines that the
particular event should be taken into account in computing the
Fund's net asset value.
PAGE 92
All Funds
NET ASSET VALUE PER SHARE
The purchase and redemption price of each Fund's shares is
equal to the Fund's net asset value per share or share price.
Each Fund determines its net asset value per share by subtracting
the Fund's liabilities (including accrued expenses and dividends
payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
share of each Fund is calculated as of the close of trading on
the New York Stock Exchange ("NYSE") every day the NYSE is open
for trading. The net asset value of the Prime Reserve Fund is
also calculated as of 12:00 noon (Eastern time) every day the
NYSE is open for trading. The NYSE is closed on the following
days: New Year's Day, Washington's Birthday, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day.
Determination of the net asset value (and the offering, sale
redemption and repurchase of shares) for a Fund may be suspended
at times (a) during which the NYSE is closed, other than
customary weekend and holiday closings, (b) during which trading
on the NYSE is restricted (c) during which an emergency exists as
a result of which disposal by a Fund of securities owned by it is
not reasonably practicable or it is not reasonably practicable
for a Fund fairly to determine the value of its net assets, or
(d) during which a governmental body having jurisdiction over a
Fund may by order permit such a suspension for the protection of
a Fund's shareholders; provided that applicable rules and
regulations of the Securities and Exchange Commission (or any
succeeding governmental authority) shall govern as to whether the
conditions prescribed in (b), (c) or (d) exist.
DIVIDENDS
Unless you elect otherwise, the Funds' dividends and, with
respect to the Equity Income and International Stock Funds,
capital gain distributions, if any, and the Equity Income Fund's
final quarterly dividend, will be invested on the reinvestment
date using the NAV per share of that date. The reinvestment date
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
PAGE 93
TAX STATUS
Each Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
A portion of the dividends paid by the Prime Reserve, New
Income and Equity Income Funds may be eligible for the dividends-
received deduction for corporate shareholders. Dividends and
distributions paid by the Fund are not eligible for the
dividends-received deduction for corporate shareholders, if as
expected, none of the Fund's income consists of dividends paid by
United States corporations. Capital gain distributions paid from
the Fund are never eligible for this deduction.
For tax purposes, it does not make any difference whether
dividends and capital gain distributions are paid in cash or in
additional shares. Each Fund must declare dividends by December
31 of each year equal to at least 98% of ordinary income (as of
December 31) and capital gains (as of October 31) in order to
avoid a federal excise tax and distribute within 12 months 100%
of ordinary income and capital gains as of its tax year-end to
avoid federal income tax.
Foreign currency gains and losses, including the portion of
gain or loss on the sale of debt securities attributable to
foreign exchange rate fluctuations are taxable as ordinary
income. If the net effect of these transactions is a gain, the
ordinary income dividend paid by the International Stock Fund
will be increased; if the result is a loss, the income dividend
paid by the fund will be decreased, or to the extent such
dividend has already been paid a portion may be reclassified as a
return of capital. Adjustments, to reflect these gains and
losses will be made at the end of the Fund's taxable year.
At the time of your purchase, each Fund's net asset value
may reflect undistributed income, with respect to the Equity
Income and International Stock Funds, undistributed capital gains
or net unrealized appreciation of securities held by the Fund. A
subsequent distribution to you of such amounts, although
constituting a return of your investment, would be taxable either
as dividends or capital gain distributions. For federal income
tax purposes, each Fund is permitted to carry forward its net
realized capital losses, if any, for eight years and realize net
capital gains up to the amount of such losses without being
required to pay taxes on, or distribute such gains. On May 31,
1996, the books of the Prime Reserve Fund indicated that the
Fund's aggregate net assets included undistributed net income of
$814,000, net realized capital losses of $2,308,000 and
PAGE 94
unrealized appreciation of $0. On May 31, 1996, the books of the
New Income Fund indicated that the Fund's aggregate net assets
included undistributed net income of $2,679,000, net realized
capital losses of $11,496,000 and unrealized appreciation of
$363,000. On May 31, 1996, the books of the Equity Income Fund
indicated that the Fund's aggregate net assets included
undistributed net income of $37,316,812, net realized capital
gains of $212,460,674, and unrealized appreciation of
$1,184,882,324. On October 31, 1996, the books of the
International Stock Fund indicated that the Fund's aggregate net
assets included undistributed net income of $116,966,000, net
realized capital gains (losses) of $110,531,000 and unrealized
appreciation of $1,388,332,000.
If, in any taxable year, a Fund should not qualify as a
regulated investment company under the Code: (i) the Fund would
be taxed at normal corporate rates on the entire amount of its
taxable income without deduction for dividends or other
distributions to shareholders; (ii) the Fund's distributions to
the extent made out of the Fund's current or accumulated earnings
and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been
considered capital gain dividends), and with respect to the
International Stock Fund, may qualify for the 70% deduction for
dividends received by corporation; and (iii) foreign tax credits
would not "pass through" to International Stock Fund
shareholders.
To the extent the Fund invests in foreign securities, the
following would apply:
Passive Foreign Investment Companies
The Fund may purchase the securities of certain foreign
investment funds or trusts called passive foreign investment
companies. Capital gains on the sale of such holdings will be
deemed to be ordinary income regardless of how long the Fund
holds its investment. In addition to bearing their proportionate
share of the fund's expenses (management fees and operating
expenses) shareholders will also indirectly bear similar expenses
of such funds. In addition, the Fund may be subject to corporate
income tax and an interest charge on certain dividends and
capital gains earned from these investments, regardless of
whether such income and gains are distributed to shareholders.
To avoid such tax and interest, the Funds in accordance with
tax regulations, intend to treat these securities as sold on the
last day of the Fund's fiscal year and recognize any gains for
tax purposes at that time; losses will not be recognized. Such
gains will be considered ordinary income which the Fund will be
PAGE 95
required to distribute even though it has not sold the security
and received cash to pay such distributions.
Foreign Currency Gains and Losses
Foreign currency gains and losses, including the portion of
gain or loss on the sale of debt securities attributable to
foreign exchange rate fluctuations, are taxable as ordinary
income. If the net effect of these transactions is a gain, the
ordinary income dividend paid by the Fund will be increased. If
the result is a loss, the income dividend paid by the Fund will
be decreased, or to the extent such dividend has already been
paid, a portion may be reclassified as a return of capital.
Adjustments to reflect these gains and losses will be made at the
end of the Fund's taxable year.
Taxation of Foreign Shareholders--Equity Income and International
Stock Funds
The Code provides that dividends from net income (which are
deemed to include for this purpose each shareholder's pro rata
share of foreign taxes paid by the International Stock Fund--see
discussion of "pass through" of the foreign tax credit to U.S.
shareholders) will be subject to U.S. tax. For shareholders who
are not engaged in a business in the U.S., this tax would be
imposed at the rate of 30% upon the gross amount of the dividends
in the absence of a Tax Treaty providing for a reduced rate or
exemption from U.S. taxation. Distributions of net long-term
capital gains realized each Fund are not subject to tax unless
the foreign shareholder is a nonresident alien individual who was
physically present in the U.S. during the tax year for more than
182 days.
International Stock Fund
Income received by the Fund from sources within various
foreign countries will be subject to foreign income taxes
withheld at the source. Under the Code, if more than 50% of the
value of the Fund's total assets at the close of its taxable year
comprise securities issued by foreign corporations or
governments, the Fund may file an election with the Internal
Revenue Service to "pass through" to the Fund's shareholders the
amount of foreign income taxes paid by the Fund. Pursuant to
this election, shareholders will be required to: (i) include in
gross income, even though not actually received, their respective
pro rata share of foreign taxes paid by the Fund; (ii) treat
their pro rata share of foreign taxes as paid by them; and
(iii) either deduct their pro rata share of foreign taxes in
computing their taxable income, or use it as a foreign tax credit
against U.S. income taxes (but not both). No deduction for
PAGE 96
foreign taxes may be claimed by a shareholder who does not
itemize deductions.
The Fund intends to meet the requirements of the Code to
"pass through" to its shareholders foreign income taxes paid, but
there can be no assurance that the Fund will be able to do so.
Each shareholder will be notified within 60 days after the close
of each taxable year of the Fund, if the Fund will "pass through"
foreign taxes paid for that year, and, if so, the amount of each
shareholder's pro rata share (by country) of (i) the foreign
taxes paid, and (ii) the Fund's gross income from foreign
sources. Of course, shareholders who are not liable for federal
income taxes, such as retirement plans qualified under Section
401 of the Code, will not be affected by any such "pass through"
of foreign tax credits.
YIELD INFORMATION
Prime Reserve Fund
The Prime Reserve Fund's current and historical yield for a
period is calculated by dividing the net change in value of an
account (including all dividends accrued and dividends reinvested
in additional shares) by the account value at the beginning of
the period to obtain the base period return. This base period
return is divided by the number of days in the period then
multiplied by 365 to arrive at the annualized yield for that
period. The Fund's annualized compound yield for such period is
compounded by dividing the base period return by the number of
days in the period, and compounding that figure over 365 days.
The seven-day yield ending May 31, 1996 for the Fund was
4.68% and the Fund's compound yield for the same period was
4.79%.
New Income Fund
From time to time, the New income Fund may advertise a yield
figure calculated in the following manner:
An income factor is calculated for each security in the
portfolio based upon the security's market value at the beginning
of the period and yield as determined in conformity with
regulation of the Securities and Exchange Commission. The income
factors are then totalled for all securities in the portfolio.
Next, expenses of the Fund for the period net of expected
reimbursement are deducted from the income to arrive at net
income, which is then converted to a per-share amount by dividing
PAGE 97
net income by the average number of shares outstanding during the
period. The net income per share is divided by the net asset
value on the last day of the period to produce a monthly yield
which is then annualized. Quoted yield factors are for
comparison purposes only, and are not intended to indicate future
performance or forecast the dividend per share of the Fund.
The yield of the Fund calculated under the above described
method for the month ended May 31, 1996 was 6.37%.
INVESTMENT PERFORMANCE
Total Return Performance--New Income, Equity Income and
International Stock Funds
Each Fund's calculation of total return performance includes
the reinvestment of all capital gain distributions and income
dividends for the period or periods indicated, without regard to
tax consequences to a shareholder in the Fund. Total return is
calculated as the percentage change between the beginning value
of a static account in each Fund and the ending value of that
account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital
gains dividends. The results shown are historical and should not
be considered indicative of the future performance of a Fund.
Each average annual compound rate of return is derived from the
cumulative performance of each Fund over the time period
specified. The annual compound rate of return for each Fund over
any other period of time will vary from the average.
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
5/31/95 5/31/95 5/31/95 5/31/95
New Income Fund
T. Rowe Price New
Income Fund 3.70% 42.72% 111.98% 588.04%
(8/31/73)
PAGE 98
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
5/31/95 5/31/95 5/31/95 5/31/95
T. Rowe Price
New Income Fund 3.70% 7.37% 7.80% 8.85%
(8/31/73)
Equity Income Fund
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
12/31/96 12/31/96 12/31/96 12/31/96
________ _________ ________ ___________
T. Rowe Price
Equity Income Fund 20.40% 119.97% 286.01% 438.33%
(10/31/85)
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
12/31/96 12/31/96 12/31/96 12/31/96
________ ________ ________ __________
T. Rowe Price
Equity Income Fund 20.40% 17.08% 14.46% 16.27%
(10/31/85)
International Stock Fund
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
10/31/96 10/31/96 10/31/96 10/31/96
T. Rowe Price International
Stock Fund 14.87% 67.76% 204.20% 848.29%
(5/9/80)
PAGE 99
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
10/31/96 10/31/96 10/31/96 10/31/96
T. Rowe Price International
Stock Fund 14.87% 10.90% 11.77% 14.63%
(5/9/80)
Other Publications
From time to time, in newsletters and other publications
issued by T. Rowe Price Investment Services, Inc., T. Rowe Price
mutual fund portfolio managers may discuss economic, financial
and political developments in the U.S. and abroad and how these
conditions have affected or may affect securities prices or the
Fund; individual securities within the Fund's portfolio; and
their philosophy regarding the selection of individual stocks,
including why specific stocks have been added, removed or
excluded from the Fund's portfolio.
Other Features and Benefits--All Funds
The Fund is a member of the T. Rowe Price Family of Funds
and may help investors achieve various long-term investment
goals, such as investing money for retirement, saving for a down
payment on a home, or paying college costs. To explain how the
Fund could be used to assist investors in planning for these
goals and to illustrate basic principles of investing, various
worksheets and guides prepared by T. Rowe Price Associates, Inc.
and/or T. Rowe Price Investment Services, Inc. may be made
available.
Redemptions in Kind
In the unlikely event a shareholder of the Fund were to
receive an in kind redemption of portfolio securities of the
Fund, brokerage fees could be incurred by the shareholder in
subsequent sale of such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the Fund; (b) are acquired
for investment and not for resale except in accordance with
applicable law; (c) have a value that is readily ascertainable
PAGE 100
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
ORGANIZATION OF THE FUNDS
Prime Reserve, New Income and International Stock Funds
The T. Rowe Price International Funds, Inc. (the
"International Corporation") is a Maryland corporation. The
Institutional International Funds, Inc. (the "Institutional
Corporation") was organized in 1989, as a Maryland corporation.
Each Corporation is registered with the Securities and Exchange
Commission under the 1940 Act as a diversified, open-end
investment company, commonly known as a "mutual fund."
Currently, the Corporation consists of the following eleven
series, each of which represents a separate class of the
Corporation's shares and has different objectives and investment
policies. The International Bond, International Stock,
International Discovery, European Stock, New Asia, Global
Government Bond, Japan, Latin America, Emerging Markets Bond,
Emerging Markets Stock, and Global Stock Funds. The Global
Government Bond, International Bond, and Emerging Markets Bond
Funds are described in a separate Statement of Additional
Information. Currently, the Institutional Corporation consists
of one series, the Foreign Equity Fund. Each Charter also
provides that the Board of Directors may issue additional series
of shares.
Each Fund's Charter authorizes the Board of Directors to
classify and reclassify any and all shares which are then
unissued, including unissued shares of capital stock into any
number of classes, each class consisting of such number of shares
and having such designations, such powers, preferences, rights,
qualifications, limitations and restrictions, as shall be
determined by the Board subject to the Investment Company Act and
other applicable law, and provided that the authorized shares of
any class shall not be decreased below the number then
outstanding and the authorized shares of all classes shall not
exceed 15,000,000,000 for the Prime Reserve Fund and
1,000,000,000 for the New Income Fund. The shares of any such
additional classes might therefore differ from the shares of the
present class of capital stock and from each other as to
preferences, conversion or other rights, voting powers,
restrictions, limitations as to dividends, qualifications or
terms or conditions of redemption, subject to applicable law, and
might thus be superior or inferior to the capital stock or to
other classes in various characteristics. Each Fund's Board of
PAGE 101
Directors may increase or decrease the aggregate number of shares
of stock or the number of shares of stock of any class or series
authorized to be issued without shareholder approval.
Except to the extent that the Prime Reserve and New Income
Fund's Board of Directors might provide by resolution that
holders of shares of a particular class are entitled to vote as a
class on specified matters presented for a vote of the holders of
all shares entitled to vote on such matters, there would be no
right of class vote unless and to the extent that such a right
might be construed to exist under Maryland law. The Charter
contains no provision entitling the holders of the present class
of capital stock to a vote as a class on any matter.
Accordingly, the preferences, rights, and other characteristics
attaching to any class of shares, including the present class of
capital stock, might be altered or eliminated, or the class might
be combined with another class or classes, by action approved by
the vote of the holders of a majority of all the shares of all
classes entitled to be voted on the proposal, without any
additional right of vote as a class by the holders of the capital
stock or of another affected class or classes.
Each share of each series of the International Fund has
equal voting rights with every other share of every other series,
and all shares of all series vote as a single group except where
a separate vote of any class or series is required by the 1940
Act, the laws of the State of Maryland, the Corporation's
Articles of Incorporation, the By-Laws of the Corporation, or as
the Board of Directors may determine in its sole discretion.
Where a separate vote is required with respect to one or more
classes or series, then the shares of all other classes or series
vote as a single class or series, provided that, as to any matter
which does not affect the interest of a particular class or
series, only the holders of shares of the one or more affected
classes or series is entitled to vote. The preferences, rights,
and other characteristics attaching to any series of shares,
including the present series of capital stock, might be altered
or eliminated, or the series might be combined with another
series, by action approved by the vote of the holders of a
majority of all the shares of all series entitled to be voted on
the proposal, without any additional right to vote as a series by
the holders of the capital stock or of another affected series.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of directors (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding
PAGE 102
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
will be unable to elect any person as a director. As set forth
in the By-Laws of each Fund, a special meeting of shareholders of
a Fund shall be called by the Secretary of the Fund on the
written request of shareholders entitled to cast at least 10% of
all the votes of the Fund entitled to be cast at such meeting.
Shareholders requesting such a meeting must pay to the Fund the
reasonably estimated costs of preparing and mailing the notice of
the meeting. Each Fund, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating
to the other shareholders of the Fund to the extent required by
Section 16(c) of the Investment Company Act of 1940.
Equity Income Fund
For tax and business reasons, the Fund was organized in 1985
as a Massachusetts Business Trust and is registered with the
Securities and Exchange Commission under the Investment Company
Act of 1940 as diversified, open-end investment companies,
commonly known as a "mutual funds."
The Fund's Declaration of Trust permits its Board of
Trustees to issue an unlimited number of full and fractional
shares of a single class. The Declarations of Trust also
provides that the Fund's Board of Trustees may issue additional
series or classes of shares. Each share represents an equal
proportionate beneficial interest in the Fund. In the event of
the liquidation of the Fund, each share is entitled to a pro rata
share of the net assets of the Fund.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of trustees (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing trustees unless and
until such time as less than a majority of the trustees holding
office have been elected by shareholders, at which time the
trustees then in office will call a shareholders' meeting for the
election of trustees. Pursuant to Section 16(c) of the
Investment Company Act of 1940, holders of record of not less
than two-thirds of the outstanding shares of a Fund may remove a
PAGE 103
trustee by a vote cast in person or by proxy at a meeting called
for that purpose. Except as set forth above, the trustees shall
continue to hold office and may appoint successor trustees.
Voting rights are not cumulative, so that the holders of more
than 50% of the shares voting in the election of trustees can, if
they choose to do so, elect all the trustees of the Trust, in
which event the holders of the remaining shares will be unable to
elect any person as a trustee. No amendments may be made to the
Declarations of Trust without the affirmative vote of a majority
of the outstanding shares of the Trust.
Shares have no preemptive or conversion rights; the right of
redemption and the privilege of exchange are described in the
prospectus. Shares are fully paid and nonassessable, except as
set forth below. The Trust may be terminated (i) upon the sale
of its assets to another diversified, open-end management
investment company, if approved by the vote of the holders of
two-thirds of the outstanding shares of the Trust, or (ii) upon
liquidation and distribution of the assets of the Trust, if
approved by the vote of the holders of a majority of the
outstanding shares of the Trust. If not so terminated, the Trust
will continue indefinitely.
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of a
Fund. However, the Declarations of Trust disclaim shareholder
liability for acts or obligations of a Fund and requires that
notice of such disclaimer be given in each agreement, obligation
or instrument entered into or executed by the Fund or a Trustee.
The Declarations of Trust provide for indemnification from Fund
property for all losses and expenses of any shareholder held
personally liable for the obligations of the Fund. Thus, the
risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the
Fund itself would be unable to meet its obligations, a
possibility which T. Rowe Price believes is remote. Upon payment
of any liability incurred by the Fund, the shareholders of a Fund
paying such liability will be entitled to reimbursement from the
general assets of the Fund. The Trustees intend to conduct the
operations of each Fund in such a way so as to avoid, as far as
possible, ultimate liability of the shareholders for liabilities
of such Fund.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of directors (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
PAGE 104
until such time as less than a majority of the directors holding
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
will be unable to elect any person as a director. As set forth
in the By-Laws of the Corporation, a special meeting of
shareholders of the Corporation shall be called by the Secretary
of the Corporation on the written request of shareholders
entitled to cast at least 10% of all the votes of the
Corporation, entitled to be cast at such meeting. Shareholders
requesting such a meeting must pay to the Corporation the
reasonably estimated costs of preparing and mailing the notice of
the meeting. The Corporation, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating
to the other shareholders of the Corporation to the extent
required by Section 16(c) of the 1940 Act.
FEDERAL REGISTRATION OF SHARES
Each Fund's shares are registered for sale under the
Securities Act of 1933. Registration of the Fund's shares is not
required under any state law, but the Fund is required to make
certain filings with and pay fees to the states in order to sell
its shares in the states.
LEGAL COUNSEL
Shereff, Friedman, Hoffman & Goodman, LLP, whose address is
919 Third Avenue, New York, New York 10022, is legal counsel to
the Funds.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, Gateway International II, 1306
Concourse Drive, Suite 100, Linthicum, Maryland 21090-1020, are
independent accountants to the Funds. The financial statements
of the Prime Reserve and New Income Funds for the year ended May
31, 1996, and the report of independent accountants are included
in the Fund's Annual Report for the year ended May 31, 1996. A
copy of the Annual Report accompanies this Statement of
Additional Information. The financial statements of the Equity
Income Fund for the year ended December 31, 1996, and the report
PAGE 105
of independent accountants are included in the Fund's Annual
Report for the year ended December 31, 1996. A copy of the
Annual Report accompanies this Statement of Additional
Information. The financial statements of the International Stock
Fund for the year ended October 31, 1996, and the report of
independent accountants are included in the Fund's Annual Report
for the year ended October 31, 1996. A copy of the Annual Report
accompanies this Statement of Additional Information. The
following financial statements and the report of independent
accountants appearing in the Annual Reports for the fiscal year
ended May 31, 1996, for the year ended December 31, 1994, and for
the fiscal year ended October 31, 1995, are incorporated into
this Statement of Additional Information by reference:
PRIME NEW INCOME
RESERVE FUND FUND
ANNUAL REPORT ANNUAL REPORT
PAGE PAGE
___________ ____________
Report of Independent Accountants 19 18
Statement of Net Assets, May 31, 1996 7-14 7-12
Statement of Operations, fiscal year
ended May 31, 1996 15 13
Statement of Changes in Net Assets,
fiscal year ended May 31, 1996 and
May 31, 1995 16 14
Notes to Financial Statements,
May 31, 1996 17-18 15-17
Financial Highlights 6 6
EQUITY
INCOME FUND
ANNUAL REPORT
PAGE
____________
Report of Independent Accountants 25
Statement of Net Assets, December 31, 1996 9-18
Statement of Operations, year ended
December 31, 1996 19
Statement of Changes in Net Assets, years ended
December 31, 1996 and December 31, 1995 20
Notes to Financial Statements,
December 31, 1996 21-24
Financial Highlights 8
PAGE 106
INTERNATIONAL
STOCK FUND
ANNUAL REPORT
PAGE
______________
Report of Independent Accountants 34
Statement of Net Assets, October 31, 1996 12-28
Statement of Operations, year ended October 31, 199629
Statement of Changes in Net Assets, years ended
October 31, 1996 and October 31, 1995 30
Notes to Financial Statements, October 31, 1996 31-33
Financial Highlights 11
RATINGS OF COMMERCIAL PAPER
Prime Reserve Fund
Moody's Investors Service, Inc. The rating of Prime-1 is the
highest commercial paper rating assigned by Moody's. Among the
factors considered by Moody's in assigning ratings are the
following: valuation of the management of the issuer; economic
evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in
certain areas; evaluation of the issuer's products in relation to
competition and customer acceptance; liquidity; amount and
quality of long-term debt; trend of earnings over a period of 10
years; financial strength of the parent company and the
relationships which exist with the issuer; and recognition by the
management of obligations which may be present or may arise as a
result of public interest questions and preparations to meet such
obligations. These factors are all considered in determining
whether the commercial paper is rated P1, P2, or P3.
Standard & Poor's Corporation. Commercial paper rated A (highest
quality) by S&P has the following characteristics: liquidity
ratios are adequate to meet cash requirements; long-term senior
debt is rated "A" or better, although in some cases "BBB" credits
may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances.
Typically, the issuer's industry is well established and the
issuer has a strong position within the industry. The
reliability and quality of management are unquestioned. The
relative strength or weakness of the above factors determines
whether the issuer's commercial paper is rated A1, A2, or A3.
Fitch Investors Service, Inc.: Fitch 1 - Highest grade.
Commercial paper assigned this rating is regarded as having the
PAGE 107
strongest degree of assurance for timely payment. Fitch 2 - Very
good grade. Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest
issues.
RATINGS OF CORPORATE DEBT SECURITIES
New Income and Equity Income Funds
Moody's Investors Service, Inc.
Aaa - Bonds rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are
generally referred to as "gilt edge."
Aa - Bonds rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds.
A - Bonds rated A possess many favorable investment
attributes and are to be considered as upper-medium grade
obligations.
Baa - Bonds rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly
secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as
well.
Ba - Bonds 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 characterize
bonds in this class.
B - Bonds rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal
payments of or maintenance of other terms of the contract over
any long period of time may be small.
Caa - Bonds rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with
respect to principal or interest.
PAGE 108
Ca - Bonds rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default
or have other marked short-comings.
C - Lowest rated, extremely poor prospects of ever attaining
investment standing.
Standard & Poor's Corporation
AAA - This is the highest rating assigned by Standard &
Poor's 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 pay principal and interest is very
strong.
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 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 the
issuer's 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.
D - In default.
Fitch Investors Service, Inc.
AAA - High grade, broadly marketable, suitable for
investment by trustees and fiduciary institutions, and liable to
but slight market fluctuation other than through changes in the
money rate. The prime feature of a "AAA" bond is the showing of
earnings several times or many times interest requirements for
such stability of applicable interest that safety is beyond
reasonable question whenever changes occur in conditions. Other
features may enter, such as a wide margin of protection through
PAGE 109
collateral, security or direct lien on specific property.
Sinking funds or voluntary reduction of debt by call or purchase
or often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
AA - Of safety virtually beyond question and readily
salable. Their merits are not greatly unlike those of "AAA"
class but a bond so rated may be junior though of strong lien, or
the margin of safety is less strikingly broad. The issue may be
the obligation of a small company, strongly secured, but
influenced as to rating by the lesser financial power of the
enterprise and more local type of market.
