SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934
(Amendment No. ___)
Filed by the Registrant [X]
Filed by a Party other than the Regi[ ]nt
Check the appropriate box:
[X] Preliminary Proxy Statement
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
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INVESCO TAX-FREE INCOME FUNDS, INC.
(Name of Registrant as specified in Its Charter)
INVESCO TAX-FREE INCOME FUNDS, INC.
(Name of Person(s) Filing Proxy Statement)
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14a-6(j)(2). [ ] $500 per each party to the controversy pursuant to
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[ ] Check box if any part of the fee is offset as provided by the Exchange Act
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<PAGE>
August 28, 1995
Dear INVESCO Tax-Free Long-Term Bond Fund Shareholder:
We are pleased to enclose the Proxy Statement for the October 19, 1995 special
shareholders' meeting of your Fund. Please take the time to read the
accompanying Proxy Statement and cast your vote, since the matters we are
submitting for your consideration are important to the Fund and to you as a
shareholder.
Your vote is important.
We are asking shareholders to approve a modification of the Fund's fundamental
investment policies governing investments in futures and options. While the
Fund's current investment policies permit the use of municipal bond futures,
they do not permit the use of options or other types of futures contracts that
may be used to hedge against adverse market movements. Proposal 1 calls for the
adoption of investment policies that would expand the Fund's ability to protect
itself against adverse movements in the market and reduce the overall level of
risk normally associated with the Fund's portfolio.
The Board of Directors believes that this proposal is in the best interests of
shareholders. Therefore, we ask that you read the enclosed material and vote
promptly. Should you have any questions, please feel free to call our client
service representatives at 1-800-525-8085. They will be happy to answer any
questions you may have. If we do not receive sufficient votes to approve this
proposal, it may necessitate a further mailing or a telephone canvass. Thank
you.
Sincerely,
/s/ Dan J. Hesser
----------------------------
Dan J. Hesser
President
INVESCO Tax-Free Income Funds, Inc. -
INVESCO Tax-Free Long-Term Bond Fund
<PAGE>
INVESCO TAX-FREE INCOME FUNDS, INC.
INVESCO TAX-FREE LONG-TERM BOND FUND
7800 East Union Avenue
Denver, Colorado 80237
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON OCTOBER 19, 1995
Notice is hereby given that a special meeting of shareholders (the
"Meeting") of INVESCO Tax-Free Income Funds, Inc. - INVESCO Tax-Free Long-Term
Bond Fund (the "Fund") will be held at the offices of the Fund, 7800 East Union
Avenue, Denver, Colorado 80237 on Thursday, October 19, 1995, at 10:00 a.m.,
Mountain Time, for the following purposes:
1. To approve or disapprove a proposal to modify the Fund's fundamental
investment policies concerning futures and options.
2. To transact such other business as may properly come before the Meeting or
any adjournment(s) thereof.
The directors of the Fund have fixed the close of business on August 23,
1995, as the record date for the determination of shareholders entitled to
notice of and to vote at the Meeting or any adjournment(s) thereof.
A complete list of shareholders of the Fund entitled to vote at the
Meeting will be available and open to the examination of any shareholder of the
Fund for any purpose germane to the Meeting during ordinary business hours after
September 7, 1995, at the offices of the Fund, 7800 East Union Avenue, Denver,
Colorado 80237.
You are cordially invited to attend the Meeting. Shareholders who do not
expect to attend the Meeting in person or by proxy are requested to complete,
date and sign the enclosed form of proxy and return it promptly in the envelope
provided for that purpose. The enclosed proxy is being solicited on behalf of
the board of directors of the Fund.
<PAGE>
IMPORTANT
Please mark, sign, date and return the enclosed proxy in the accompanying
envelope as soon as possible in order to ensure a full representation at the
Meeting. The Meeting will have to be adjourned without conducting any business
if less than one-third of the eligible shares is represented, and the Fund, at
shareholders' expense, will have to continue to solicit votes until a quorum is
obtained. The Meeting also may be adjourned, if necessary, to continue to
solicit votes if less than the required shareholder vote has been obtained to
approve Proposal (1). Your vote, then, could be critical in allowing the Fund to
hold the Meeting as scheduled. By marking, signing, and promptly returning the
enclosed proxy, you may eliminate the need for additional solicitation. Your
cooperation will be appreciated.
By Order of the Board of Directors,
/s/Glen A. Payne
-------------------
Glen A. Payne
Secretary
Denver, Colorado
Dated: August 28, 1995
<PAGE>
INVESCO TAX-FREE INCOME FUNDS, INC.
INVESCO TAX-FREE LONG-TERM BOND FUND
7800 East Union Avenue
Denver, Colorado 80237
PROXY STATEMENT FOR SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD OCTOBER 19, 1995
INTRODUCTION
The enclosed proxy is being solicited by the boad of directors of INVESCO
Tax-Free Income Funds, Inc. - INVESCO Tax-Free Long-Term Bond Fund (the "Fund"),
for use in connection with the special meeting of shareholders (the "Meeting")
to be held at 10:00 a.m., Mountain Time, on Thursday, October 19, 1995, at the
offices of the Fund, 7800 East Union Avenue, Denver, Colorado 80237, and at any
adjournment thereof for the purposes set forth in the foregoing notice. An
Annual Report, including financial statements for the Fund for the fiscal year
ended June 30, 1995, has been included with this proxy. The approximate mailing
date of proxies and this Proxy Statement is August 28, 1995.
If the enclosed proxy is duly executed and returned in time to be voted at
the Meeting, and not subsequently revoked, all shares represented by the proxy
will be voted in accordance with the instructions marked thereon. If no
instructions are given, such shares will be voted FOR Proposal (1). One-third of
the shares of the Fund entitled to vote, represented in person or by proxy,
shall constitute a quorum at the Meeting. The affirmative vote of a "majority of
the outstanding voting securities" of the Fund, defined by the Investment
Company Act of 1940, as amended (the "1940 Act"), as the vote "(A) of 67 per
centum or more of the voting securities present at such meeting, if the holders
of more than 50 per centum of the outstanding voting securities of such company
are present or represented by proxy; or (B) of more than 50 per centum of the
outstanding voting securities of such company, whichever is the less" shall be
required to approve Proposal (1).
Shares held by shareholders present in person or represented by proxy at
the Meeting will be counted both for the purpose of determining the presence of
a quorum and for calculating the votes cast on the issues before the Meeting. An
abstention on a particular vote by a shareholder, either by proxy or by vote in
person at the Meeting, has the same effect as a negative vote, because in order
to be approved, the proposal requires the affirmative vote of 67% of the shares
represented at the Meeting (including abstaining shares), if the holders of more
than 50% of the Fund's outstanding shares are present or represented by proxy,
or more than 50% of the outstanding shares of the Fund, whichever is less.
Shares held by a broker or other fiduciary as record owner for the account of
the beneficial owner are counted toward the required quorum if the beneficial
owner has executed and timely delivered the necessary proxy. Where the broker or
fiduciary does not receive a proxy from the beneficial owner and does not have
discretionary voting power, the shares will not be counted toward the required
quorum and will not be voted on the proposal.
<PAGE>
Execution of the enclosed proxy will not affect a shareholder's right to
attend the Meeting and vote in person, and a shareholder giving a proxy has the
power to revoke it (by written notice to the Fund at Post Office Box 173711,
Denver, Colorado 80217-3711, execution of a subsequent proxy, or oral revocation
at the Meeting) at any time before it is exercised.
Shareholders of the Fund of record at the close of business on August 23,
1995 (the "Record Date"), are entitled to vote at the Meeting, including any
adjournment thereof, and are entitled to one vote for each share, and
corresponding fractional votes for fractional shares, on each matter to be acted
upon at the Meeting. On the Record Date, __________ shares of the Fund's common
stock, $.01 par value per share, were outstanding.
There were no persons known to own beneficially 5% or more of the
outstanding shares of the Fund on the Record Date.
The following table sets forth, as of August 23, 1995, the beneficial
ownership of the Fund's common stock by its directors and executive officers.
Name of Amount & Nature of Percent of
Beneficial Owner Beneficial Ownership(1) Common Stock
--------------
Kenneth T. King
All directors and executive
officers as a group
(1) Each beneficial owner has sole voting power and sole investment power
with respect to the shares listed next to his respective row, unless otherwise
indicated.
In addition to the solicitation of proxies by use of the mail, proxies may
be solicited by officers of the Fund, and by officers and employees of INVESCO
Funds Group, Inc. ("INVESCO"), the investment adviser to the Fund, personally or
by telephone or telegraph, without special compensation. All costs of printing
and mailing proxy materials and the costs and expenses of holding the Meeting
and soliciting proxies will be paid by the Fund.
The board of directors may seek one or more adjournments of the Meeting to
solicit additional shareholders, if necessary, to obtain a quorum for the
Meeting, or to obtain the required shareholder vote to approve Proposal (1). An
adjournment would require the affirmative vote of the holders of a majority of
the shares present at the Meeting (or an adjournment thereof) in person or by
proxy and entitled to vote. If adjournment is proposed in order to obtain the
required shareholder vote on the proposal, the persons named as proxies will
vote in favor of adjournment those shares which they are entitled to vote in
favor of the proposal, and will vote against adjournment those shares required
to be voted against the proposal.
PROPOSAL 1: MODIFICATION OF THE FUND'S FUNDAMENTAL INVESTMENT POLICY
CONCERNING FUTURES AND OPTIONS.
Introduction
The Fund seeks a high level of current income exempt from federal income taxes
through investment in long-term municipal bonds. The Fund currently is
authorized to buy and sell municipal bond futures contracts ("Municipal
Futures") for the purpose of hedging (i.e., protecting) the value of its
securities portfolio. The aggregate market value of the Municipal Futures held
by the Fund cannot exceed 20% of the Fund's total assets, and the Fund is
subject to limits imposed by the Commodities Futures Trading
<PAGE>
Commission to avoid being subject to regulation as a commodity pool (i.e.,
aggregate initial margins on futures contracts cannot exceed 5% of the Fund's
assets). The Fund currently is not authorized to use options or other types of
futures contracts for hedging purposes. For the reasons discussed below, the
Fund's board of directors, including all of the independent directors, is
proposing that shareholders approve modification of the fundamental investment
policies of the Fund to permit the use of options and futures contracts other
than Municipal Futures.
The primary purpose of this change is to permit the Fund to use Treasury Bond
and Note futures ("Treasury Futures") and options on Treasury Futures. Fund
management believes that Treasury Futures offer a number of advantages over
Municipal Futures for use in hedging the Fund's portfolio. First, Treasury
Futures have substantially greater liquidity and are therefore much more
efficient to use than Municipal Futures. As of August 15, 1995, there were
approximately 20,000 Municipal Futures contracts outstanding in the market,
whereas there were approximately 380,000 Treasury Futures contracts outstanding.
An active day in the municipal market may see 10,000 contracts trade, whereas
daily trading in Treasury Futures can exceed 600,000 contracts. Due to these
liquidity issues, municipal bond funds such as the Fund are simply too large to
utilize Municipal Futures to any significant degree without disrupting the
market.
Second, possessing the capability to use Treasury Futures will enhance the
Fund's ability to seek to protect the value of its assets in a declining market.
The fact that there are few dealers in the municipal market exacerbates the
illiquidity that develops in tough market conditions.
Third, Municipal Futures have traded at large variations to their theoretical
values. As a practical matter, this means that Municipal Futures often may be
expensive when the Fund would want to buy contracts as a long hedge and
inexpensive when the Fund would want to sell contracts as a short hedge.
Fourth, trading in Municipal Futures generally concludes at 1:00 p.m., Denver
time, each trading day. Treasury Futures have a reasonably active night session.
This would be especially useful to help manage the interest rate risk from large
purchases of Fund shares received late in the day after the municipal markets
are closed.
Finally, many of the Fund's competitors are authorized to use and actively
utilize Treasury Futures as well as Municipal Futures. The inability to utilize
Treasury Futures puts the Fund at a competitive disadvantage to the potential
detriment of its shareholders.
A brief summary of the features and stated risks of futures contracts and
options is set forth below. A more detailed summary of their potential uses and
risks, and the strategies intended to be employed by the Fund with respect to
these instruments if this proposal is approved by shareholders, is set forth in
Appendix A attached hereto.
In connection with the proposed changes being submitted to shareholders for
approval, the Fund's board of directors has approved expanding the Fund's
futures hedging capability to 30% of total assets from 20% of total assets. If
the Fund is positioned with a longer than neutral duration, it may be necessary
to hedge a greater amount of the portfolio in order to seek to protect
shareholders from adverse interest rate movements. Fund management believes that
a 30% limit would provide the flexibility to act immediately and unwind the
hedge in an orderly fashion as market and liquidity conditions provide the
opportunity to make the appropriate changes to the underlying structure of the
portfolio.
Fund management believes that permitting the Fund to use options, particularly
options on Treasury Futures, as an approved hedging technique would increase the
Fund's flexibility to utilize the most efficient hedging vehicle available.
The board of directors has determined that the ability to invest in Treasury
Futures and options would
<PAGE>
provide the Fund with additional means for seeking to hedge the value of its
portfolio, i.e., attempting to reduce the overall level of investment risk that
normally would be expected to be associated with the Fund's portfolio and to
attempt to protect itself against market movements that might adversely affect
the value of the Fund's securities or the price of securities that the Fund is
considering purchasing. The directors believe that the Fund would benefit from
having the flexibility to purchase and sell Treasury Futures and options, in
addition to its other investments, and that the Fund's investments in these
instruments would be consistent with the Fund's investment objective and
policies. There can be no assurance, however, that the use of these instruments
by the Fund will assist it in achieving its investment objective.
The use of these instruments requires skills and involves risks different from
those involved in trading the other instruments in which the Fund invests. Among
these risks is the possibility that there may be imperfect correlation, or no
correlation at all, between price movements in an option or future and the
underlying instrument being hedged. The successful use of these instruments will
depend upon the ability of Fund Management to forecast price and interest rate
movements correctly. Should prices move in an unexpected manner, the Fund may
not achieve the potential benefits of these instruments or may realize losses
and thus be in a worse position than if such strategies had not been used. The
reader's attention is directed specifically to the descriptions of these
instruments under this proposal and to Appendix A attached hereto which further
describes these risks.
The board of directors of the Fund has concluded that the adoption of the
investment policies concerning options and futures set forth in paragraphs A and
B below, is in the best interests of the Fund and its shareholders.
If approved, the proposal will take effect as soon as possible after any
remaining legal prerequisites to implementation of the proposal have been
satisfied. If the proposal is not approved, the Fund's current investment
policies on these subjects will remain unchanged.
A. AMENDMENT OF THE FUND'S FUNDAMENTAL INVESTMENT POLICY CONCERNING
FUTURES.
Current Fundamental Policy
The Fund's current fundamental investment policy concerning investing in
futures is as follows:
"The Tax-Free Long-Term Bond Fund may not. . . buy or sell commodities or
commodity contracts, oil, gas, or other mineral interest or exploration
programs, or real estate or interests therein. However, the Fund may
purchase municipal bonds or other permitted securities secured by real
estate or which may represent indirect interests therein and may buy and
sell municipal bond futures contracts for the purpose of hedging the value
of its securities portfolio, provided that the Fund will not enter into
futures contracts for which the aggregate initial margins exceed 5% of the
fair market value of the Fund's assets;"
Proposed Fundamental Policy
Subject to shareholder approval, the directors have approved amending the
second sentence of the Fund's current fundamental investment policy to read as
follows:
"However, the Fund may purchase municipal bonds or other permitted
securities secured by real estate or which may represent indirect
interests therein and may buy and sell options and futures contracts for
the purpose of hedging the value of its securities portfolio, provided
that the Fund will not enter into futures contracts for which the
aggregate initial margins exceed 5% of the fair market value of the Fund's
total assets;"
<PAGE>
If this proposal is approved, it will not be possible to change the new
fundamental investment policy concerning the purchase and sale of options and
futures contracts without a future vote of the shareholders.
Adoption of the proposed amendment would enable the Fund to enter into
options and futures contracts other than Municipal Futures. Transactions in
futures contracts by the Fund would not be made for speculation and would not be
made other than to hedge against potential changes in interest rates or in the
price of a security or a securities index, which changes might adversely affect
either the value of the Fund's portfolio securities or the prices of securities
which the Fund would be considering to buy at a later date.
The reader's attention is directed to Appendix A attached hereto for a
detailed description of the potential uses and risks of these instruments.
B. AMENDMENT OF THE FUND'S FUNDAMENTAL INVESTMENT POLICY CONCERNING PUT
AND CALL OPTIONS
Current Fundamental Investment Policy
"The Tax-Free Long-Term Bond Fund may not. . participate on a joint or a
joint and several basis in any securities trading account, or purchase
warrants, or write, purchase or sell puts, calls, straddles or any other
option contracts or combination thereof;"
Proposed Modification of Fundamental Investment Policy
Subject to shareholder approval, the directors have approved amending this
policy as follows:
"The Tax-Free Long-Term Bond Fund may not. . .participate on a joint or a
joint and several basis in any securities trading account or purchase
warrants;"
The proposed fundamental policy would delete the prohibition against
investment by the Fund in "puts, calls. . . or combinations thereof" and would
permit the Fund to write covered put and call options and to buy put and call
options. Specifically, the Fund would be able to write and buy options on the
same types of securities that the Fund could buy directly, options on futures
contracts and options on financial indices.
The Fund's ability to invest in the instruments set forth above will be
limited to 30% of total assets. Fund management believes that a 30% limit would
provide the flexibility to hedge the portfolio to seek to protect shareholders
from adverse interest rate movements.
THE DIRECTORS UNANIMOUSLY RECOMMEND THAT THE FUND'S SHAREHOLDERS VOTE
IN FAVOR OF PROPOSAL 1.
INFORMATION CONCERNING INVESCO
INVESCO Funds Group, Inc. ("INVESCO"), 7800 East Union Avenue, Denver,
Colorado 80237, serves as the Fund's investment adviser and distributor, and
administers the business affairs of the Fund. INVESCO is an indirect
wholly-owned subsidiary of INVESCO PLC. INVESCO PLC is a financial holding
company which, through its subsidiaries, engages in the business of investment
management on an international basis. INVESCO was established in 1932 and as of
August 28, 1995, managed 38 mutual funds.
<PAGE>
OTHER BUSINESS
The management of the Fund has no business to bring before the Meeting
other than the matters described above. Should any other business be presented
at the Meeting, it is the intention of the persons named in the accompanying
proxy to vote on such matters in accordance with their best judgment.
SHAREHOLDER PROPOSALS
The Fund does not hold annual meetings of shareholders. Shareholders
wishing to submit proposals for inclusion in a proxy statement and form of proxy
for a subsequent shareholders' meeting should send their written proposals to
the Secretary of the Fund, 7800 East Union Avenue, Denver, Colorado 80237.
By Order of the Board of Directors,
Glen A. Payne
------------------
Glen A. Payne
Secretary
August 28, 1995
<PAGE>
APPENDIX A
SUMMARY CONCERNING FUTURES AND OPTIONS
Futures Contracts and Options on Futures Contracts.
U.S. futures contracts are traded on exchanges which have been designated
"contract markets" by the Commodity Futures Trading Commission ("CFTC") and must
be executed through a futures commission merchant (an "FCM"), or brokerage firm,
which is a member of the relevant contract market. Although futures contracts by
their terms call for the delivery or acquisition of the underlying commodities
or a cash payment based on the value of the underlying commodities, in most
cases the contractual obligation is offset before the delivery date of the
contract by buying, in the case of a contractual obligation to sell, or selling,
in the case of a contractual obligation to buy, an identical futures contract on
a commodities exchange. Such a transaction cancels the obligation to make or
take delivery of the commodities.
The acquisition or sale of a futures contract could occur, for example, if
a Fund held or considered purchasing debt securities and sought to protect
itself from fluctuations in prices without buying or selling those securities.
For example, if prices were expected to decrease, the Fund could sell Treasury
Futures, thereby hoping to offset a potential decline in the value of debt
securities in the portfolio by a corresponding increase in the value of the
futures contract position held by the Fund and thereby prevent the Fund's net
asset value from declining as much as it otherwise would have. The Fund also
could protect against potential price declines by selling portfolio securities
and investing in money market instruments. However, since the futures market is
more liquid than the cash market, the use of futures contracts as an investment
technique would allow the Fund to maintain a defensive position without having
to sell portfolio securities.
Similarly, when prices of debt securities are expected to increase,
futures contracts could be bought to attempt to hedge against the possibility of
having to buy debt securities at higher prices. This technique is sometimes
known as an anticipatory hedge. Since the fluctuations in the value of futures
contracts should be similar to those of debt securities, the Fund could take
advantage of the potential rise in the value of debt securities without buying
them until the market has stabilized. At that time, the futures contracts could
be liquidated and the Fund could buy debt securities on the cash market.
The ordinary spreads between prices in the cash and futures markets, due
to differences in the nature of those markets, are subject to distortions.
First, the ability of investors to close out futures contracts through
offsetting transactions could distort the normal price relationship between the
cash and futures markets. Second, to the extent participants decide to make or
take delivery, liquidity in the futures market could be reduced and prices in
the futures market distorted. Third, from the point of view of speculators, the
margin deposit requirements in the futures market are less onerous than margin
requirements in the securities market. Therefore, increased participation by
speculators in the futures market may cause temporary price distortions. Due to
the possibility of the foregoing distortions, a correct forecast of general
price trends still may not result in a successful use of futures.
Futures contracts entail risks. Although the Fund believes that use of
such contracts could benefit the Fund, if the judgment of INVESCO Funds Group,
Inc. or INVESCO Trust Company (collectively, "Fund Management"), the Fund's
investment advisor and sub-advisor, was incorrect, the Fund's overall
performance could be worse than if the Fund had not entered into futures
contracts. For example, if the Fund hedged against the effects of a possible
decrease in prices of securities held in the Fund's portfolio and prices
increase instead, the Fund would lose part or all of the benefit of the
increased value of these securities because of offsetting losses in the Fund's
futures positions. In addition, if the Fund had insufficient cash, it might have
to sell securities from its portfolio to meet daily variation margin
requirements. Those sales could be at increased prices which reflect the rising
market and could occur at a time when the sales would be disadvantageous to the
Fund.
<PAGE>
The prices of futures contracts depend primarily on the value of their
underlying instruments. Because there are a limited number of types of futures
contracts, it is possible that the standardized futures contracts available to
the Fund would not match exactly the Fund's current or potential investments.
The Fund would be able to buy and sell futures contracts based on underlying
instruments with different characteristics from the securities in which it would
typically invest -- for example, by hedging investments in portfolio securities
with a futures contract based on a broad index of securities -- which involves a
risk that the futures position might not correlate precisely with the
performance of the Fund's investments.
Futures prices can also diverge from the prices of their underlying
instruments, even if the underlying instruments closely correlate with the
Fund's investments. Futures prices are affected by such factors as current and
anticipated short-term interest rates, changes in volatility of the underlying
instruments and the time remaining until expiration of the contract. Those
factors may affect securities prices differently from futures prices. Imperfect
correlations between the Fund's investments and its futures positions could also
result from differing levels of demand in the futures markets and the securities
markets, from structural differences in how futures and securities are traded,
and from imposition of daily price fluctuation limits for futures contracts. The
Fund would be able to buy or sell futures contracts with a greater or lesser
value than the securities it wished to hedge or was considering purchasing in
order to attempt to compensate for differences in historical volatility between
the futures contract and the securities, although this might not be successful
in all cases. If price changes in the Fund's futures positions were poorly
correlated with its other investments, its futures positions could fail to
produce desired gains or result in losses that would not be offset by the gains
in the Fund's other investments.
Because futures contracts are generally settled within a day from the date
they are closed out, compared with a settlement period of three business days
for some types of securities, the futures markets can provide superior liquidity
to the securities markets. Nevertheless, there is no assurance a liquid
secondary market will exist for any particular futures contract at any
particular time. In addition, futures exchanges may establish daily price
fluctuation limits for futures contracts and may halt trading if a contract's
price moves upward or downward more than the limit in a given day. On volatile
trading days when the price fluctuation limit is reached, it would be impossible
for the Fund to enter into new positions or close out existing positions. If the
secondary market for a futures contract were not liquid because of price
fluctuation limits or otherwise, the Fund would not be able to promptly
liquidate unfavorable futures positions and potentially could be required to
continue to hold a futures position until the delivery date, regardless of
changes in its value. As a result, a Fund's access to other assets held to cover
its futures positions also could be impaired.
Although the buyer or seller of a futures contract is not required to
deliver or pay for the underlying instrument unless the contract is held until
the delivery date, both the buyer and seller are required to deposit "initial
margin" for the benefit of an FCM when the contract is entered into equal to a
percentage of the contract's value. If the value of either party's position
declines, that party will be required to make additional "variation margin"
payments with an FCM to settle the change in value on a daily basis. The party
that has a gain may be entitled to receive all or a portion of this amount.
Initial and variation margin payments are similar to good faith deposits or
performance bonds, unlike margin extended by a securities broker, and initial
and variation margin payments do not constitute purchasing securities on margin
for purposes of the Fund's investment policies. In the event of the bankruptcy
of an FCM that holds margin on behalf of the Fund, the Fund would be entitled to
return of margin owed to the Fund only in proportion to the amount received by
the FCM's other customers. Fund Management will attempt to minimize the risk by
careful monitoring of the creditworthiness of the FCMs with which the Fund would
do business and by depositing margin payments in a segregated account with the
custodian when practical or otherwise required by law.
<PAGE>
The purchase of a call option on a futures contract is similar in some
respects to the purchase of a call option on an individual security. (See
"Options on Securities" below.) Depending on the pricing of the option compared
to either the price of the futures contract upon which it is based or the price
of the underlying instrument, ownership of the option may or may not be less
risky than ownership of the futures contract or the underlying instrument. As
with the purchase of futures contracts, when the Fund is not fully invested it
could buy a call option on a futures contract to hedge against a market advance.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the security which is deliverable under, or of
the index comprising, the futures contract. If the futures price at the
expiration of the option were below the exercise price, the Fund would retain
the full amount of the option premium which would provide a partial hedge
against any decline that may have occurred in the Fund's portfolio holdings. The
writing of a put option on a futures contract constitutes a partial hedge
against increasing prices of the security which is deliverable under, or of the
index comprising, the futures contract. If the futures price at expiration of
the option was higher than the exercise price, a Fund would retain the full
amount of the option premium which would provide a partial hedge against any
increase in the price of securities which the Fund was considering to buy. If a
call or put option the Fund had written was exercised, the Fund would incur a
loss which would be reduced by the amount of the premium it received. Depending
on the degree of correlation between change in the value of its portfolio
securities and changes in the value of the futures positions, the Fund's losses
from existing options on futures could to some extent be reduced or increased by
changes in the value of portfolio securities.
The purchase of a put option on a futures contract is similar in some
respects to the purchase of protective put options on portfolio securities. For
example, the Fund would be able to buy a put option on a futures contract to
hedge the Fund's portfolio against the risk of falling prices.
The amount of risk the Fund would assume if it bought an option on a
futures contract would be the premium paid for the option plus related
transaction costs. In addition to the correlation risks discussed above, the
purchase of an option also entails the risk that changes in the value of the
underlying futures contract will not be fully reflected in the value of the
options bought.
Options on Securities.
A put option gives the holder the right, upon payment of a premium, to
deliver a specified amount of a security to the writer of the option on or
before a fixed date at a predetermined price. A call option gives the holder the
right, upon payment of a premium, to call upon the writer to deliver a specified
amount of a security on or before a fixed date at a predetermined price. In
purchasing an option, the Fund would be in a position to realize a gain if,
during the option period, the price of the underlying security increased (in the
case of a call) or decreased (in the case of a put) by an amount in excess of
the premium paid and would realize a loss if the price of the underlying
security did not increase (in the case of a call) or decrease (in the case of a
put) during the period by more than the amount of the premium. If a put or call
option bought by a Fund were permitted to expire without being sold or
exercised, the Fund would lose the amount of the premium.
If a put option or call option written by a Fund were exercised, the Fund
would be obligated to buy or sell the underlying security at the exercise price.
Writing a put option involves the risk of a decrease in the market value of the
underlying security, in which case the option could be exercised and the
underlying security would then be sold by the option holder to the Fund at a
higher price than its current market value. Writing a call option involves the
risk of an increase in the market value of the underlying security, in which
case the option could be exercised and the underlying security would then be
sold by the Fund to the option holder at a lower price than its current market
value. Those risks could be reduced by entering into an offsetting transaction.
The Fund would retain the premium received from writing a put or call option
whether or not the option were exercised.
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The Fund also would be able to buy or write options in privately
negotiated transactions on the types of securities and indexes based on the
types of securities in which the Fund were permitted to invest directly. The
Fund would effect such transactions only with investment dealers and other
financial institutions (such as commercial banks or savings and loan
institutions) deemed creditworthy, and only pursuant to procedures adopted, by
Fund Management for monitoring the creditworthiness of those entities. The Fund
is not permitted to invest in securities for which there is no readily available
market. Therefore, the Fund could not invest in illiquid options.
A put option written by a Fund would be "covered" if the Fund (i)
maintained cash not available for investment or high-grade liquid assets with a
value equal to the exercise price in a segregated account with its custodian or
(ii) held a put on the same security and in the same principal amount as the put
written and the exercise price of the put held were equal to or greater than the
exercise price of the put written. A call option written by a Fund would be
"covered" if the Fund owned the underlying security covered by the call or had
an absolute and immediate right to acquire that security without additional cash
consideration (or for additional cash consideration held in a segregated account
by its custodian) upon conversion or exchange of other securities held in its
portfolio. A call option also would be deemed to be covered if a Fund held a
call on the same security and in the same principal amount as the call written
and the exercise price of the call held (i) were equal to or less than the
exercise price of the call written or (ii) were greater than the exercise price
of the call written if the difference were maintained by the Fund in cash and
high-grade liquid assets in a segregated account with its custodian.
The Fund also would be able to write covered call options for
cross-hedging purposes. A call option is written for cross-hedging purposes if
the Fund does not own the underlying security, and the option is designed to
provide a hedge against a decline in value in another security which the Fund
owns or has the right to acquire.
The Fund would collateralize its obligation under a written call option
for cross-hedging purposes by maintaining in a segregated account with its
custodian cash or high-grade liquid assets in an amount not less than the market
value of the underlying security, marked to market daily. The Fund would write a
call option for cross-hedging purposes, instead of writing a covered call
option, when the premium to be received from the cross-hedge transaction would
exceed that which would be received from writing a covered call option and when
the Fund believed that writing the option would achieve the desired hedge.
The writer of an option may have no control when the underlying securities
must be sold, in the case of a call option, or bought, in the case of a put
option, since with regard to certain options, the writer may be assigned an
exercise notice at any time prior to the termination of the obligation. Whether
or not an option expires unexercised, the writer retains the amount of the
premium. This amount, of course, may, in the case of a covered call option, be
offset by a decline in the market value of the underlying security during the
option period. If a call option is exercised, the writer experiences a profit or
loss from the sale of the underlying security. If a put option is exercised, the
writer must fulfill the obligation to buy the underlying security at the
exercise price, which will usually exceed the then market value of the
underlying security.
The writer of an option that wishes to terminate its obligation may effect
a "closing purchase transaction". This is accomplished by buying an option of
the same series as the option previously written. The effect of the purchase is
that the writer's position will be cancelled by the clearing corporation.
However, a writer may not effect a closing purchase transaction after being
notified of the exercise of an
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option. Likewise, an investor who is the holder of an option may liquidate its
position by effecting a "closing sale transaction". This is accomplished by
selling an option of the same series as the option previously bought. There is
no guarantee that either a closing purchase or a closing sale transaction can be
effected. Effecting a closing transaction in the case of a written call option
would permit the Fund to write another call option on the underlying security
with either a different exercise price or expiration date or both or, in the
case of a written put option, would permit the Fund to write another put option
to the extent that the exercise price thereof is secured by deposited high-grade
liquid assets.
The Fund would realize a profit from a closing transaction if the price of
the purchase transaction were less than the premium received from writing the
option or the price received from a sale transaction were more than the premium
paid to buy the option; the Fund would realize a loss from a closing transaction
if the price of the purchase transaction were more than the premium received
from writing the option or the price received from a sale transaction were less
than the premium paid to buy the option. Because increases in the market of a
call option generally will reflect increases in the market price of the
underlying security, any loss resulting from the repurchase of a call option
likely would be offset in whole or in part by appreciation of the underlying
security owned by the Fund.
<PAGE>
Risk Factors of Investing in Futures and Options.
The successful use of the investment practices described above with
respect to futures contracts, options on futures contracts and options on draws
upon skills and experience which are different from those needed to select the
other instruments in which the Fund invests. Should interest rates or the prices
of securities or financial indexes move in an unexpected manner, the Fund may
not achieve the desired benefits of futures and options or may realize losses
and thus be in a worse position than if such strategies had not been used.
Unlike many exchange-traded futures contracts and options on futures contracts,
there are no daily price fluctuation limits with respect to negotiated or
over-the-counter instruments, and adverse market movements could therefore
continue to an unlimited extent over a period of time. In addition, the
correlation between movements in the price of the securities hedged or used for
cover will not be perfect and could produce unanticipated losses.
The Fund's ability to dispose of its positions in the foregoing
instruments will depend on the availability of liquid markets in the
instruments. Markets in a number of the instruments are relatively new and still
developing, and it is impossible to predict the amount of trading interest that
may exist in those instruments in the future. Particular risks exist with
respect to the use of each of the foregoing instruments and could result in such
adverse consequences to the Fund as the possible loss of the entire premium paid
for an option bought by the Fund, the inability of the Fund, as the writer of a
covered call option, to benefit from the appreciation of the underlying
securities above the exercise price of the option and the possible need to defer
closing out positions in certain instruments to avoid adverse tax consequences.
As a result, no assurance can be given that the Fund will be able to use those
instruments effectively for the purposes set forth above.
In connection with its transactions in futures and option writing, the
Fund would be required to place assets in a segregated account with the Fund's
custodian bank to ensure that the Fund would be able to meet its obligations
under these instruments. Assets held in a segregated account generally may not
be disposed of for so long as the Fund maintains the positions giving rise to
the segregation requirement. Segregation of a large percentage of the Fund's
assets could impede implementation of the Fund's investment policies or the
Fund's ability to meet redemption requests or other current obligations.
