<PAGE> 1
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH DOMESTIC MONEY MARKET FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Domestic Money Market Fund (the "Domestic Money Market Fund")
is a diversified fund whose objectives are the preservation of capital,
liquidity and achieving the highest possible current income consistent with the
foregoing objectives by investing in short-term domestic money market
securities. The Domestic Money Market Fund is a separate fund of the Merrill
Lynch Variable Series Funds, Inc. (the "Company"), an open-ended management
investment company that has a wide range of investment objectives among its
eighteen separate funds (hereinafter referred to as the "Funds" or individually
as a "Fund"). Two separate classes of common stock ("Common Stock"), Class A
Common Stock and Class B Common Stock, are issued for each Fund. The Company is
offering shares of its Class A Common Stock for the Domestic Money Market Fund
pursuant to this Prospectus. This Prospectus consists of this four page document
and the attached Appendix. For more information on the Domestic Money Market
Fund's investment objectives and policies, please see page 3 of this document
and the Appendix.
THE DOMESTIC MONEY MARKET FUND ATTEMPTS TO MAINTAIN A STABLE NET ASSET
VALUE OF $1.00 PER SHARE, BUT THERE CAN BE NO ASSURANCE THAT IT WILL BE ABLE TO
DO SO. AN INVESTMENT IN THE DOMESTIC MONEY MARKET FUND IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 2
Yield Information.................. 3
Investment Objectives and
Policies........................ 3
Portfolio Restrictions............. 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Directors............................ A-7
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 2
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
DOMESTIC MONEY MARKET FUND (CLASS A)
---------------------------------------------------------------------
FOR THE PERIOD
FEBRUARY 20,
FOR THE YEAR ENDED DECEMBER 31, 1992+ TO
---------------------------------------------------- DECEMBER 31,
1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- --------------
<S> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net
Asset Value:
Per Share Operating
Performance:
Net asset value, beginning of
period...................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
-------- -------- -------- -------- -------- --------
Investment income -- net...... .0511 .0504 .0547 .0386 .0302 .0302
Realized and unrealized gain
(loss) on
investments -- net.......... .0001 (.0005) .0012 (.0007) .0005 .0013
-------- -------- -------- -------- -------- --------
Total from investment
operations.................. .0512 .0499 .0559 .0379 .0307 .0315
-------- -------- -------- -------- -------- --------
Less dividends and
distributions:
Investment income -- net.... (.0511) (.0504) (.0547) (.0386) (.0302) (.0302)
Realized gain on
investments -- net....... --++ (.0001) (.0002) -- (.0005) (.0010)
-------- -------- -------- -------- -------- --------
Total dividends and
distributions............... (.0511) (.0505) (.0549) (.0386) (.0307) (.0312)
-------- -------- -------- -------- -------- --------
Net asset value, end of
period...................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======== ======== ======== ======== ======== ========
Total Investment Return:**
Based on net asset value per
share....................... 5.24% 5.13% 5.64% 3.93% 3.10% 3.65%*
======== ======== ======== ======== ======== ========
Ratios to Average Net Assets:
Expenses, net of
reimbursement............... .54% .54% .55% .50% .36% .32%*
======== ======== ======== ======== ======== ========
Expenses...................... .54% .54% .55% .57% .63% .88%*
======== ======== ======== ======== ======== ========
Investment income -- net, and
realized gain (loss) on
investments -- net.......... 5.12% 4.97% 5.50% 4.02% 3.03% 3.48%*
======== ======== ======== ======== ======== ========
Supplemental Data:
Net assets, end of period (in
thousands).................. $318,052 $274,756 $303,912 $363,199 $170,531 $ 41,128
======== ======== ======== ======== ======== ========
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Amount is less than $.0001 per share.
2
<PAGE> 3
YIELD INFORMATION
Set forth below is yield information for the Class A Shares of the Domestic
Money Market Fund for the seven-day period ended December 31, 1997, computed to
include and exclude realized and unrealized gains and losses and also computed
to exclude such gains and losses, and information as to the compounded
annualized yield, excluding gains and losses, for the same periods. The yield
quotations may be of limited use for comparative purposes because they do not
reflect charges imposed at the separate account level which, if included, would
decrease the yield.
<TABLE>
<S> <C>
Annualized Yield:
Including gains and losses................................ 5.33%
Excluding gains and losses................................ 5.33%
Compounded Annualized Yield................................. 5.47%
Average maturity of portfolio at end of period.............. 72 Days
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the Domestic Money Market Fund are to preserve
shareholder capital, to maintain liquidity and to achieve the highest possible
current income consistent with the foregoing objectives by investing in
short-term domestic money market securities. There can be no assurance that the
Domestic Money Market Fund will achieve its investment objectives.
The Domestic Money Market Fund will invest in short-term U.S. Government
securities, U.S. Government agency securities, domestic depository institution
money instruments (including certificates of deposit, bankers' acceptances, time
deposits and bank notes), short-term debt securities (such as commercial paper),
variable amount master demand notes and insurance company funding agreements,
repurchase and reverse repurchase agreements of U.S. issuers and other money
market instruments. As a matter of fundamental policy, which may be changed only
with the approval of a majority of the Domestic Money Market Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "Act" or the "Investment Company Act"), the Domestic Money Market Fund may
not purchase securities of foreign issuers (including Eurodollar or Yankeedollar
bank obligations). U.S. Government securities may be purchased on a forward
commitment basis. The types of money market securities in which the Domestic
Money Market Fund may invest are described more fully in Annex A to the Appendix
to this Prospectus. The Domestic Money Market Fund will be subject to portfolio
maturity, quality and diversification restrictions discussed below.
In addition, the Domestic Money Market Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities the potential return of which is based on the
change in particular measurements of value or rate, (i.e. indexed securities). A
further discussion of the investments described in this paragraph and the risks
associated with such investments is set forth in the Appendix to this
Prospectus, including Annex B of the Appendix to this Prospectus, which includes
a discussion of certain portfolio strategies relating to indexed securities.
PORTFOLIO RESTRICTIONS
For purposes of the investment policy of the Domestic Money Market Fund,
the Company defines short-term money market securities as securities having a
maturity of no more than 762 days (25 months) in the case of U.S. Government and
agency securities and no more than 397 days (13 months) in the case of all other
securities. Management of the Company expects that substantially all the assets
of the Domestic Money Market Fund will be invested in securities maturing in
less than one year, but at times some portion may have maturities of up to 25
months. For these purposes, the maturity of a variable rate security is deemed
to be the next coupon date on which the interest rate is adjusted. The
dollar-weighted average maturity of this Fund's portfolio assets will not exceed
90 days.
The Domestic Money Market Fund's investments in short-term debt and
depository institution money instruments will be rated, or will be issued by
issuers who have been rated, in one of the two highest rating categories for
short-term debt obligations by a nationally recognized statistical rating
organization (an
3
<PAGE> 4
"NRSRO") or, if not rated, will be of comparable quality as determined by the
Directors of the Company. The Domestic Money Market Fund's investments in
corporate bonds and debentures (which must have maturities at the date of
purchase of 397 days (13 months) or less) will be in issuers which have received
from an NRSRO a rating, with respect to a class of short-term debt obligations
that is comparable in priority and security with the investment, in one of the
two highest rating categories for short-term obligations or, if not rated, are
of comparable quality as determined by the Directors of the Company. Currently,
there are six NRSROs: Duff & Phelps Inc., Fitch Investors Services, Inc., IBCA
Limited and its affiliate IBCA Inc., Moody's Investor's Service, Inc., Standard
& Poor's Ratings Group and Thomson BankWatch.
A regulation of the Commission limits investments by the Domestic Money
Market Fund in securities issued by any one issuer (other than the U.S.
Government, its agencies or instrumentalities) ordinarily to not more than 5% of
its total assets, or in the event that such securities do not have the highest
rating, not more than 1% of its total assets. In addition, this regulation
requires that not more than 5% of the Fund's total assets be invested in
securities that have a rating lower than the highest rating.
4
<PAGE> 5
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH RESERVE ASSETS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Reserve Assets Fund (the "Reserve Assets Fund") is a
diversified fund whose objectives are the preservation of capital, liquidity and
achieving the highest possible current income consistent with the foregoing
objectives by investing in short-term money market securities. The Reserve
Assets Fund is a separate fund of the Merrill Lynch Variable Series Funds, Inc.
(the "Company"), an open-ended management investment company that has a wide
range of investment objectives among its eighteen separate funds (hereinafter
referred to as the "Funds" or individually as a "Fund"). Two separate classes of
common stock ("Common Stock"), Class A Common Stock and Class B Common Stock,
are issued for each Fund. The Company is offering shares of its Class A Common
Stock for the Reserve Assets Fund pursuant to this Prospectus. This Prospectus
consists of this four page document and the attached Appendix. For more
information on the Reserve Assets Fund's investment objectives and policies,
please see page 3 of this document and the Appendix.
THE RESERVE ASSET FUND ATTEMPTS TO MAINTAIN A STABLE NET ASSET VALUE OF
$1.00 PER SHARE, BUT THERE CAN BE NO ASSURANCE THAT IT WILL BE ABLE TO DO SO. AN
INVESTMENT IN THE RESERVE ASSET FUND IS NEITHER INSURED NOR GUARANTEED BY THE
U.S. GOVERNMENT.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 2
Yield Information.................. 3
Investment Objectives and
Policies........................ 3
Portfolio Restrictions............. 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Directors............................ A-7
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 6
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
RESERVE ASSETS FUND (CLASS A)
-------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net
Asset Value:
Per Share Operating
Performance:
Net asset value, beginning of
year......................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Investment income -- net...... .0506 .0501 .0543 .0371 .0268 .0320 .0546 .0730 .0822 .0661
Realized and unrealized gain
(loss) on
investments -- net........... .0001 (.0005) .0018 (.0009) .0005 .0007 .0014 .0019 .0012 .0002
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total from investment
operations................... .0507 .0496 .0561 .0362 .0273 .0327 .0560 .0749 .0834 .0663
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Less dividends and
distributions:
Investment income -- net..... (.0506) (.0501) (.0543) (.0362) (.0268) (.0320) (.0546) (.0730) (.0822) (.0661)
Realized gain on
investments -- net......... (.0001) (.0001) (.0004) --++ (.0005) (.0005) (.0014)+ (.0019)+ (.0012)+ (.0002)+
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total dividends and
distributions................ (.0507) (.0502) (.0547) (.0362) (.0273) (.0325) (.0560) (.0749) (.0834) (.0663)
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net asset value, end of
year......................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Total Investment Return:*
Based on net asset value per
share........................ 5.19% 5.13% 5.61% 3.79% 2.77% 3.29% 5.68% 7.65% 8.62% 6.85%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Ratios to Average Net Assets:
Expenses...................... .62% .61% .61% .65% .70% .79% .79% .97% 1.03% 1.01%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Investment income -- net, and
realized gain (loss) on
investments -- net........... 5.06% 4.96% 5.47% 3.75% 2.73% 3.36% 5.64% 7.46%+ 8.34%+ 6.65%+
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Supplemental Data:
Net assets, end of year (in
thousands)................... $21,102 $22,885 $25,550 $32,196 $30,168 $26,767 $34,362 $35,871 $29,311 $24,951
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
* Total investment returns exclude insurance-related fees and expenses.
+ Includes unrealized gain (loss).
++ Amount is less than $.0001 per share.
2
<PAGE> 7
YIELD INFORMATION
Set forth below is yield information for the Class A Shares of the Reserve
Assets Fund for the seven-day period ended December 31, 1997, computed to
include and exclude realized and unrealized gains and losses and also computed
to exclude such gains and losses, and information as to the compounded
annualized yield, excluding gains and losses, for the same periods. The yield
quotations may be of limited use for comparative purposes because they do not
reflect charges imposed at the separate account level which, if included, would
decrease the yield.
<TABLE>
<S> <C>
Annualized Yield:
Including gains and losses................................ 5.23%
Excluding gains and losses................................ 5.20%
Compounded Annualized Yield................................. 5.34%
Average maturity of portfolio at end of period.............. 70 Days
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the Reserve Assets Fund are to preserve
shareholder capital, to maintain liquidity and to achieve the highest possible
current income consistent with the foregoing objectives by investing in
short-term money market securities. There can be no assurance that the Reserve
Assets Fund will achieve its investment objectives.
The Reserve Assets Fund will invest in short-term U.S. Government
securities, U.S. Government agency securities, depository institution money
instruments (including certificates of deposit, bankers' acceptances, time
deposits and bank notes), short-term debt securities (such as commercial paper),
variable amount master demand notes and insurance company funding agreements,
securities of foreign issuers (including Eurodollar, Yankeedollar and foreign
bank obligations) and repurchase and reverse repurchase agreements. U.S.
Government securities may be purchased on a forward commitment basis. The types
of money market securities in which the Reserve Assets Fund may invest are
described more fully in Annex A to the Appendix to this Prospectus. The Reserve
Assets Fund will be subject to the portfolio maturity, quality and
diversification restrictions discussed below.
In addition, the Reserve Assets Fund may purchase certain securities that
are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The
Reserve Assets Fund may also invest in securities of foreign issuers and in
securities the potential return of which is based on the change in particular
measurements of value or rate (i.e. indexed securities). A further discussion of
the investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus, which includes a discussion of certain
portfolio strategies relating to indexed securities.
PORTFOLIO RESTRICTIONS
For purposes of the investment policy of the Reserve Assets Fund, the
Company defines short-term money market securities as securities having a
maturity of no more than 762 days (25 months) in the case of U.S. Government and
agency securities and no more than 397 days (13 months) in the case of all other
securities. Management of the Company expects that substantially all the assets
of the Reserve Assets Fund will be invested in securities maturing in less than
one year, but at times some portion may have maturities of up to 25 months. For
these purposes, the maturity of a variable rate security is deemed to be the
next coupon date on which the interest rate is adjusted. The dollar-weighted
average maturity of this Fund's portfolio assets will not exceed 90 days.
The Reserve Asset Fund's investments in short-term debt and depository
institution money instruments will be rated, or will be issued by issuers who
have been rated, in one of the two highest rating categories for short-term debt
obligations by a nationally recognized statistical rating organization (an
"NRSRO") or, if not rated, will be of comparable quality as determined by the
Directors of the Company. The Reserve Assets Fund's investments in corporate
bonds and debentures (which must have maturities at the date of purchase of 397
days (13 months) or less) will be in issuers which have received from an NRSRO a
rating, with respect to a class of
3
<PAGE> 8
short-term debt obligations that is comparable in priority and security with the
investment, in one of the two highest rating categories for short-term
obligations or, if not rated, are of comparable quality as determined by the
Directors of the Company. Currently, there are six NRSROs: Duff & Phelps Inc.,
Fitch Investors Services, Inc., IBCA Limited and its affiliate IBCA Inc.,
Moody's Investors Service, Inc., Standard & Poor's Ratings Group and Thomson
BankWatch.
A regulation of the Commission limits investments by the Reserve Assets
Fund in securities issued by any one issuer (other than the U.S. Government, its
agencies or instrumentalities) ordinarily to not more than 5% of its total
assets, or in the event that such securities do not have the highest rating, not
more than 1% of its total assets. In addition, this regulation requires that not
more than 5% of the Reserve Assets Fund's total assets be invested in securities
that have a rating lower than the highest rating.
4
<PAGE> 9
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH PRIME BOND FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Prime Bond Fund (the "Prime Bond Fund") is a diversified fund
whose objectives are as high a level of current income as is consistent with
prudent investment management, and as a secondary objective, capital
appreciation when consistent with the foregoing objective, by investing
primarily in long-term corporate bonds rated A or better by either Moody's
Investors Service, Inc. ("Moody's") or Standard & Poor's Ratings Group
("Standard & Poor's"). The Prime Bond Fund is a separate fund of the Merrill
Lynch Variable Series Funds, Inc. (the "Company"), an open-ended management
investment company that has a wide range of investment objectives among its
eighteen separate funds (hereinafter referred to as the "Funds" or individually
as a "Fund"). Two separate classes of common stock ("Common Stock"), Class A
Common Stock and Class B Common Stock, are issued for each Fund. The Company is
offering shares of its Class A Common Stock for the Prime Bond Fund pursuant to
this Prospectus. This Prospectus consists of this four page document and the
attached Appendix. For more information on the Prime Bond Fund's investment
objectives and policies, please see page 4 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objectives and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 10
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 11
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
PRIME BOND FUND (CLASS A)
--------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
Per Share Operating Performance:
Net asset value, beginning of
year.......................... $ 11.91 $ 12.45 $ 11.12 $ 12.64 $ 12.04 $ 12.02
-------- -------- -------- -------- -------- -------
Investment income -- net........ .78 .80 .82 .77 .70 .79
Realized and unrealized gain
(loss) on
investments -- net............ .20 (.55) 1.34 (1.36) .71 .04
-------- -------- -------- -------- -------- -------
Total from investment
operations.................... .98 .25 2.16 (.59) 1.41 .83
-------- -------- -------- -------- -------- -------
Less dividends and
distributions:
Investment income -- net...... (.78) (.79) (.83) (.76) (.70) (.81)
Realized gain on
investments -- net.......... -- -- -- -- (.11) --
In excess of realized gain on
investments -- net.......... -- -- -- (.17) -- --
-------- -------- -------- -------- -------- -------
Total dividends and
distributions................. (.78) (.79) (.83) (.93) (.81) (.81)
-------- -------- -------- -------- -------- -------
Net asset value, end of year.... $ 12.11 $ 11.91 $ 12.45 $ 11.12 $ 12.64 $ 12.04
======== ======== ======== ======== ======== =======
Total Investment Return:*
Based on net asset value per
share......................... 8.64% 2.21% 20.14% (4.80)% 12.02% 7.27%
======== ======== ======== ======== ======== =======
Ratios to Average Net Assets:
Expenses........................ .47% .49% .50% .54% .63% .78%
======== ======== ======== ======== ======== =======
Investment income -- net........ 6.62% 6.67% 7.00% 6.74% 5.86% 6.76%
======== ======== ======== ======== ======== =======
Supplemental Data:
Net assets, end of year (in
thousands).................... $527,770 $538,394 $489,838 $391,234 $314,091 $84,810..
======== ======== ======== ======== ======== =======
Portfolio turnover.............. 89.22% 91.88% 90.12% 139.89% 115.26% 82.74%
======== ======== ======== ======== ======== =======
<CAPTION>
PRIME BOND FUND (CLASS A)
-------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
1991 1990 1989 1988
------- ------- ------- -------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
Per Share Operating Performance:
Net asset value, beginning of
year.......................... $ 11.18 $ 11.29 $ 10.81 $ 10.89
------- ------- ------- -------
Investment income -- net........ .90 .88 .90 .87
Realized and unrealized gain
(loss) on
investments -- net............ .84 (.12) .48 (.15)
------- ------- ------- -------
Total from investment
operations.................... 1.74 .76 1.38 .72
------- ------- ------- -------
Less dividends and
distributions:
Investment income -- net...... (.90) (.87) (.90) (.80)
Realized gain on
investments -- net.......... -- -- -- --
In excess of realized gain on
investments -- net.......... -- -- -- --
------- ------- ------- -------
Total dividends and
distributions................. (.90) (.87) (.90) (.80)
------- ------- ------- -------
Net asset value, end of year.... $ 12.02 $ 11.18 $ 11.29 $ 10.81
======= ======= ======= =======
Total Investment Return:*
Based on net asset value per
share......................... 16.41% 7.13% 13.29% 6.75%
======= ======= ======= =======
Ratios to Average Net Assets:
Expenses........................ .78% 1.06% 1.16% 1.07%
======= ======= ======= =======
Investment income -- net........ 7.94% 8.01% 8.12% 8.05%
======= ======= ======= =======
Supplemental Data:
Net assets, end of year (in
thousands).................... $39,743 $34,655 $29,593 $22,499
======= ======= ======= =======
Portfolio turnover.............. 152.18% 155.17% 144.52% 225.81%
======= ======= ======= =======
</TABLE>
- ---------------
* Total investment returns exclude insurance-related fees and expenses.
3
<PAGE> 12
INVESTMENT OBJECTIVES AND POLICIES
The principal investment objective of the Prime Bond Fund is to provide
shareholders with as high a level of current income as is consistent with the
investment policies of the Fund and with prudent investment management. As a
secondary objective, the Prime Bond Fund seeks capital appreciation when
consistent with its principal objective. There can be no assurance that the
Prime Bond Fund will achieve its investment objectives.
The Prime Bond Fund invests primarily in securities rated in the top three
rating categories of either Standard & Poor's (AAA, AA and A) or Moody's (Aaa,
Aa and A). Additional information regarding various bond ratings is set forth in
Annex A to the Appendix to this Prospectus. The financial risk of this Fund
should be minimized by the credit quality of the bonds in which it will invest,
but the long maturities that typically provide the best yield will subject the
Fund to possible substantial price changes resulting from market yield
fluctuations. The market prices of fixed-income securities such as those
purchased by the Prime Bond Fund are affected by changes in interest rates
generally. As interest rates rise, the market value of fixed-income securities
will fall, adversely affecting the net asset value of the Fund. The Fund should
be considered a long-term investment and a vehicle for diversification, and not
as a balanced investment program. The Fund may not be appropriate as the
exclusive investment to fund a variable annuity or variable life insurance
contract ("Contract") for all Contract owners.
Fund management strategy will attempt to mitigate adverse price changes and
optimize favorable price changes through active trading that shifts the maturity
and/or quality structure of the Fund within the overall investment guidelines.
The Prime Bond Fund's investments will vary from time to time depending upon the
judgment of management as to prevailing conditions in the economy and the
securities markets and the prospects for interest rate changes among different
categories of fixed-income securities. The Prime Bond Fund anticipates that
under normal circumstances more than 90% of the assets of the Fund will be
invested in fixed-income securities, including convertible and non-convertible
debt securities and preferred stock. The Prime Bond Fund does not intend to
invest in common stock, rights or other equity securities. Under unusual market
or economic conditions, the Prime Bond Fund for defensive or other purposes may
invest up to 100% of its assets in U.S. Government or Government agency
securities, money market or other fixed-income securities deemed by the
Investment Adviser to be consistent with the objectives of the Fund, or the Fund
may hold its assets in cash.
In addition, the Prime Bond Fund may purchase certain securities that are
not registered under the Securities Act of 1933, as amended, and which therefore
may be subject to restrictions on their transfer or resale. The Fund may also
invest in securities of foreign issuers and may invest in securities the
potential return of which is based on the change in particular measurements of
value or rate (i.e., indexed securities). A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus, which includes a discussion of certain
portfolio strategies relating to indexed securities.
4
<PAGE> 13
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH HIGH CURRENT INCOME FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch High Current Income Fund (the "High Current Income Fund") is
a diversified fund whose objectives are as high a level of current income as is
consistent with its investment policies and prudent investment management, and
as a secondary objective, capital appreciation when consistent with the
foregoing objective. The Fund invests principally in fixed-income securities
that are rated in the lower rating categories of the established rating services
or in unrated securities of comparable quality. The High Current Income Fund is
a separate fund of the Merrill Lynch Variable Series Funds, Inc. (the
"Company"), an open-ended management investment company that has a wide range of
investment objectives among its eighteen separate funds (hereinafter referred to
as the "Funds" or individually as a "Fund"). Two separate classes of common
stock ("Common Stock"), Class A Common Stock and Class B Common Stock, are
issued for each Fund. The Company is offering shares of its Class A Common Stock
for the High Current Income Fund pursuant to this Prospectus. This Prospectus
consists of this four page document and the attached Appendix. For more
information on the High Current Income Fund's investment objectives and
policies, please see page 3 of this document and this Appendix.
THE HIGH CURRENT INCOME FUND INVESTS OR MAY INVEST IN HIGH YIELD BONDS
(COMMONLY KNOWN AS "JUNK BONDS"), WHICH INVOLVE SPECIAL RISKS. SEE "INVESTMENT
OBJECTIVES AND POLICIES OF THE FUNDS -- RISKS OF HIGH YIELD SECURITIES" IN THE
APPENDIX TO THIS PROSPECTUS.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights.................. 2
Investment Objectives and Policies.... 3
Appendix
The Insurance Companies............... A-1
Investment Objectives and Policies of
the Funds........................... A-1
Directors............................. A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser...................... A-8
Portfolio Transactions and Brokerage.... A-11
Purchase of Shares...................... A-11
Redemption of Shares.................... A-11
Dividends, Distributions and Taxes...... A-11
Performance Data........................ A-12
Additional Information.................. A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 14
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
HIGH CURRENT INCOME FUND (CLASS A)
----------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------------------------
1997+ 1996+ 1995 1994 1993 1992 1991 1990 1989 1988
-------- -------- -------- -------- -------- ------- ------ ------ ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net
Asset Value:
Per Share Operating
Performance:
Net asset value, beginning
of year................... $ 11.39 $ 11.25 $ 10.61 $ 12.06 $ 11.13 $ 10.23 $ 8.14 $10.21 $ 10.85 $ 10.55
-------- -------- -------- -------- -------- ------- ------ ------ ------- -------
Investment income -- net... 1.05 1.08 1.09 1.05 .95 1.07 1.19 1.40 1.29 1.21
Realized and unrealized
gain (loss) on
investments -- net........ .14 .12 .65 (1.47) .95 .90 2.10 (2.08) (.64) .20
-------- -------- -------- -------- -------- ------- ------ ------ ------- -------
Total from investment
operations................ 1.19 1.20 1.74 (.42) 1.90 1.97 3.29 (.68) .65 1.41
-------- -------- -------- -------- -------- ------- ------ ------ ------- -------
Less dividends and
distributions:
Investment
income -- net........... (1.04) (1.06) (1.10) (1.03) (.97) (1.07) (1.20) (1.39) (1.29) (1.11)
Realized gain on
investments -- net...... (.02) -- -- -- -- -- -- -- -- --
-------- -------- -------- -------- -------- ------- ------ ------ ------- -------
Total dividends and
distributions............. (1.06) (1.06) (1.10) (1.03) (.97) (1.07) (1.20) (1.39) (1.29) (1.11)
-------- -------- -------- -------- -------- ------- ------ ------ ------- -------
Net asset value, end of
year...................... $ 11.52 $ 11.39 $ 11.25 $ 10.61 $ 12.06 $ 11.13 $10.23 $ 8.14 $ 10.21 $ 10.85
======== ======== ======== ======== ======== ======= ====== ====== ======= =======
Total Investment Return:*
Based on net asset value
per share................. 11.00% 11.27% 17.21% (3.59)% 17.84% 20.05% 43.00% (7.63)% 6.14% 13.87%
======== ======== ======== ======== ======== ======= ====== ====== ======= =======
Ratios to Average Net
Assets:
Expenses................... .54% .54% .55% .61% .72% .89% 1.10% 1.15% 1.22% 1.07%
======== ======== ======== ======== ======== ======= ====== ====== ======= =======
Investment income -- net... 9.11% 9.50% 9.92% 9.73% 8.62% 10.06% 12.49% 14.52% 11.98% 11.22%
======== ======== ======== ======== ======== ======= ====== ====== ======= =======
Supplemental Data:
Net assets, end of year (in
thousands)................ $553,946 $414,615 $356,352 $255,719 $163,428 $26,343 $9,649 $8,106 $12,942 $13,960
======== ======== ======== ======== ======== ======= ====== ====== ======= =======
Portfolio turnover......... 53.63% 48.92% 41.60% 51.88% 35.67% 28.21% 51.54% 26.43% 53.52% 33.91%
======== ======== ======== ======== ======== ======= ====== ====== ======= =======
</TABLE>
- ---------------
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding during the year.
2
<PAGE> 15
INVESTMENT OBJECTIVES AND POLICIES
The primary investment objective of the High Current Income Fund is to
obtain the highest level of current income that is consistent with the
investment policies of the Fund and with prudent investment management. As a
secondary objective, the High Current Income Fund seeks capital appreciation
when consistent with its primary objective. There can be no assurance that the
High Current Income Fund will achieve its investment objectives.
The High Current Income Fund seeks high current income by investing
principally in fixed-income securities that are rated in the lower rating
categories of the established rating services (Baa or lower by Moody's Investors
Service Inc. ("Moody's") and BBB or lower by Standard & Poor's Ratings Group
("Standard & Poor's"), or in unrated securities of comparable quality.
Securities rated below Baa by Moody's and below BBB by Standard & Poor's are
commonly known as "junk bonds." Additional information regarding various bond
ratings is set forth in Annex A to the Appendix to this Prospectus. The market
price of fixed-income securities such as those purchased by the Fund is affected
by changes in interest rates generally. As interest rates rise, the market value
of fixed-income securities will fall, adversely affecting the net asset value of
the Fund.
Although they can be expected to provide higher yields, lower-rated
securities such as those purchased by the High Current Income Fund may be
subject to greater market fluctuations and risks of loss of income and principal
than lower-yielding, higher-rated fixed-income securities. Such securities are
generally issued by corporations that are not as financially secure or as
creditworthy as issuers of higher-rated securities. There is, accordingly, a
greater risk that the issuers of higher-yielding securities will not be able to
pay principal and interest on such securities, especially during periods of
adverse economic conditions. Investment in such high-yield securities entails
relatively greater risk of loss of income or principal. The Fund should be
considered a long-term investment and a vehicle for diversification, and not as
a balanced investment program. The Fund may not be appropriate as the exclusive
investment to fund a variable annuity or variable life insurance contract
("Contract") for all Contract owners. See "Investment Objectives and Policies of
the Funds -- Risks of High Yield Securities" in the Appendix to this Prospectus.
Selection and supervision by the management of the Company regarding
investments in lower-rated fixed-income securities involves continuous analysis
of individual issuers, general business conditions and other factors that may be
too time consuming or too costly for the average investor. The furnishing of
these services does not, of course, guarantee successful results. The analysis
of issuers may include, among other things, historic and current financial
condition, current and anticipated cash flow and borrowing requirements, value
of assets in relation to historical cost, strength of management, responsiveness
to business conditions, credit standing, and current and anticipated results of
operations. Analysis of general business conditions and other factors may
include anticipated changes in economic activity and interest rates, the
availability of new investment opportunities, and the economic outlook for
specific industries. While Merrill Lynch Asset Management, L.P. (the "Investment
Adviser") considers as one factor in its credit analysis the ratings assigned by
the rating services, the Investment Adviser performs its own independent credit
analysis of issuers and consequently, the High Current Income Fund may invest,
without limit, in unrated securities if such securities offer, in the opinion of
the Investment Adviser, a relatively high yield without undue risk. As a result,
the High Current Income Fund's ability to achieve its investment objective may
depend to a greater extent on the Investment Adviser's own credit analysis than
the Funds which invest in higher-rated securities. Although the High Current
Income Fund will invest primarily in lower-rated securities, it will not invest
in securities rated Ca or lower by Moody's and CC or lower by Standard & Poor's
unless the Investment Adviser believes that the financial condition of the
issuer or the protection afforded to the particular securities is stronger than
would otherwise be indicated by such low ratings. However, securities purchased
by the High Current Income Fund may subsequently be downgraded. Such securities
may continue to be held and will be sold only if, in the judgment of the
Investment Adviser, it is advantageous to do so.
When changing economic conditions and other factors cause the yield
difference between lower-rated and higher-rated securities to narrow, the High
Current Income Fund may purchase higher-rated securities if the Investment
Adviser believes that the risk of loss of income and principal may be
substantially reduced with only a relatively small reduction in yield.
The securities in the High Current Income Fund will be varied from time to
time depending upon the judgment of management as to prevailing conditions in
the economy and the securities markets and the prospects for interest rate
changes among different categories of fixed-income securities. It is anticipated
that under normal
3
<PAGE> 16
circumstances more than 90% of the High Current Income Fund's assets will be
invested in fixed-income securities, including convertible and non-convertible
debt securities and preferred stock. Although it is expected that, in general,
the Fund will not invest in common stocks, rights or other equity securities, it
will acquire or hold such securities (if consistent with the objectives of the
Fund) when such securities are acquired in unit offerings with fixed-income
securities or in connection with an actual or proposed conversion or exchange of
fixed-income securities. In addition, under unusual market or economic
conditions, the High Current Income Fund for defensive purposes may invest up to
100% of its assets in U.S. Government or Government agency securities, money
market securities or other fixed-income securities deemed by the Investment
Adviser to be consistent with a defensive posture, or may hold its assets in
cash. The yield on such securities may be lower than the yield on lower-rated
fixed-income securities.
The table below shows the average monthly dollar-weighted market value, by
Standard & Poor's rating category, of securities held by the High Current Income
Fund during the fiscal year ended December 31, 1997.
<TABLE>
<CAPTION>
% MARKET
VALUE
% NET CORPORATE
RATING* ASSETS BONDS
------- ------- ----------
<S> <C> <C>
BBB......................................................... 2.1% 2.5%
BB.......................................................... 28.0 32.0
B........................................................... 51.2 58.1
CCC......................................................... 2.7 3.0
NR**........................................................ 3.8 4.4
-----
100.0%
=====
</TABLE>
- ---------------
* A description of corporate bond ratings of Standard & Poor's is set forth in
Annex A of the Appendix to this Prospectus.
** Bonds that are not rated by Standard & Poor's. Such bonds may be rated by
nationally recognized statistical rating organizations other than Standard &
Poor's, or may not be rated by any other organizations.
In addition, the High Current Income Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities of foreign issuers, and may from time to time
enter into standby commitment agreements. A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus.
4
<PAGE> 17
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH QUALITY EQUITY FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Quality Equity Fund (the "Quality Equity Fund") is a
diversified fund whose objective is the highest total investment return
consistent with prudent risk. The Quality Equity Fund uses a fully managed
investment policy utilizing equity securities, primarily common stocks of
large-capitalization companies, as well as investment grade debt and convertible
securities. The Quality Equity Fund is a separate fund of the Merrill Lynch
Variable Series Funds, Inc. (the "Company"), an open-ended management investment
company that has a wide range of investment objectives among its eighteen
separate funds (hereinafter referred to as the "Funds" or individually as a
"Fund"). Two separate classes of common stock ("Common Stock"), Class A Common
Stock and Class B Common Stock, are issued for each Fund. The Company is
offering shares of its Class A Common Stock for the Quality Equity Fund pursuant
to this Prospectus. This Prospectus consists of this four page document and the
attached Appendix. For more information on the Quality Equity Fund's investment
objective and policies, please see page 4 of this document, and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objective and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 18
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 19
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
QUALITY EQUITY FUND (CLASS A)
--------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1997+ 1996+ 1995+ 1994+ 1993 1992
-------- -------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
Per Share Operating Performance:
Net asset value, beginning of
year.......................... $ 32.83 $ 32.76 $ 27.74 $ 29.02 $ 25.48 $ 26.35
-------- -------- -------- -------- -------- -------
Investment income -- net........ .41 .58 .58 .38 .24 .34
Realized and unrealized gain
(loss) on investments and
foreign currency
transactions -- net........... 6.94 4.44 5.48 (.74) 3.46 .32
-------- -------- -------- -------- -------- -------
Total from investment
operations.................... 7.35 5.02 6.06 (.36) 3.70 .66
-------- -------- -------- -------- -------- -------
Less dividends and
distributions:
Investment income -- net...... (.22) (.66) (.45) (.25) (.12) (.58)
Realized gain on
investments -- net.......... (1.54) (4.29) (.59) (.67) (.04) (.95)
-------- -------- -------- -------- -------- -------
Total dividends and
distributions................. (1.76) (4.95) (1.04) (.92) (.16) (1.53)
-------- -------- -------- -------- -------- -------
Net asset value, end of year.... $ 38.42 $ 32.83 $ 32.76 $ 27.74 $ 29.02 $ 25.48
======== ======== ======== ======== ======== =======
Total Investment Return:*
Based on net asset value per
share......................... 23.70% 17.90% 22.61% (1.20)% 14.57% 2.69%
======== ======== ======== ======== ======== =======
Ratios to Average Net Assets:
Expenses........................ .48% .49% .51% .54% .62% .74%
======== ======== ======== ======== ======== =======
Investment income -- net........ 1.16% 1.89% 1.94% 1.39% 1.07% 1.54%
======== ======== ======== ======== ======== =======
Supplemental Data:
Net assets, end of year (in
thousands).................... $875,064 $794,275 $644,551 $464,360 $309,420 $87,977
======== ======== ======== ======== ======== =======
Portfolio turnover.............. 100.08% 88.30% 140.32% 60.57% 88.25% 62.54%
======== ======== ======== ======== ======== =======
Average commission rate paid#... $ .0545 $ .0615 -- -- -- --
======== ======== ======== ======== ======== =======
<CAPTION>
QUALITY EQUITY FUND (CLASS A)
-------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
1991 1990 1989 1988
------- ------- ------- -------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
Per Share Operating Performance:
Net asset value, beginning of
year.......................... $ 21.72 $ 22.88 $ 17.94 $ 16.00
------- ------- ------- -------
Investment income -- net........ .43 .47 .50 .43
Realized and unrealized gain
(loss) on investments and
foreign currency
transactions -- net........... 5.75 (.38) 4.96 1.73
------- ------- ------- -------
Total from investment
operations.................... 6.18 .09 5.46 2.16
------- ------- ------- -------
Less dividends and
distributions:
Investment income -- net...... (.50) (.41) (.52) (.22)
Realized gain on
investments -- net.......... (1.05) (.84) -- --
------- ------- ------- -------
Total dividends and
distributions................. (1.55) (1.25) (.52) (.22)
------- ------- ------- -------
Net asset value, end of year.... $ 26.35 $ 21.72 $ 22.88 $ 17.94
======= ======= ======= =======
Total Investment Return:*
Based on net asset value per
share......................... 30.18% .66% 30.77% 13.54%
======= ======= ======= =======
Ratios to Average Net Assets:
Expenses........................ .79% .94% 1.05% 1.02%
======= ======= ======= =======
Investment income -- net........ 1.87% 2.36% 2.58% 2.25%
======= ======= ======= =======
Supplemental Data:
Net assets, end of year (in
thousands).................... $55,005 $39,470 $31,467 $20,055
======= ======= ======= =======
Portfolio turnover.............. 55.83% 69.05% 44.23% 32.53%
======= ======= ======= =======
Average commission rate paid#... -- -- -- --
======= ======= ======= =======
</TABLE>
- ---------------
+ Based on average shares outstanding during the period.
* Total investment returns exclude insurance-related fees and expenses.
# For fiscal years beginning on or after September 1, 1995, the Fund is required
to disclose its average commission rate per share for purchases and sales of
equity securities. The "Average Commission Rate Paid" includes commissions
paid in foreign currencies, which have been converted into U.S. dollars using
the prevailing exchange rate on the date of the transaction. Such conversions
may significantly affect the rate shown.
3
<PAGE> 20
INVESTMENT OBJECTIVE AND POLICIES
The Quality Equity Fund seeks to achieve the highest total investment
return, or the aggregate of income and capital value changes, consistent with
prudent risk. To do this, management will shift the emphasis among investment
alternatives for capital growth, capital stability and income as market trends
change. This "fully managed" investment policy distinguishes the Quality Equity
Fund from investment companies which seek either capital growth or income. The
Quality Equity Fund's investment philosophy is based on management's belief that
the structure of the United States economy and its securities markets will
undergo continuous change. The flexibility of the Fund is designed to reduce
overall exposure to risk by achieving below-average volatility in a falling
market and above-average volatility in a rising market. There can be no
assurance that the Quality Equity Fund will achieve its investment objective.
The Fund may employ a variety of investments and techniques to hedge against
market and currency risk. See Annex B to the Appendix of this Prospectus.
The Quality Equity Fund's fully managed investment approach will make use
of equity, debt and convertible securities. The majority of the Fund's equity
portfolio will be in the common stocks of large-capitalization, "quality"
companies. For this purpose, "large capitalization" companies are considered to
be those companies with market capitalizations in excess of $500 million.
Management of the Company believes that a quality company is one which conforms
closely to the following criteria: good financial resources, strong balance
sheet, satisfactory rate of return on capital, good industry position and
superior management skills. The earnings of quality companies generally tend to
grow consistently. Whenever market or financial conditions warrant, the Quality
Equity Fund may, in order to reduce risk and achieve the highest total
investment return, invest in non-convertible, long-term debt securities,
including "deep discount" corporate debt securities of investment grade or
issues of fixed-income convertible securities which give the owner the option of
a later exchange for common stock. Management expects that over longer periods
the larger portion of the Quality Equity Fund's portfolio will consist of equity
securities. The Fund should be considered a long-term investment and a vehicle
for diversification, and not as a balanced investment program. The Fund may not
be appropriate as the exclusive investment to fund a variable annuity or
variable life insurance contract ("Contract") for all Contract owners. During
defensive periods, the Fund may invest in U.S. Government and Government agency
securities, money market securities or other fixed-income securities deemed by
the Merrill Lynch Asset Management L.P. (the "Investment Adviser") to be
consistent with a defensive posture, or cash.
OTHER INVESTMENTS AND RISKS
In addition, the Quality Equity Fund may purchase certain securities that
are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities of foreign issuers, may from time to time be
invested in non-dollar-denominated securities of foreign issuers, and is
authorized to write (i.e., sell) call options on securities held in its
portfolio or securities indices the performance of which is substantially
correlated with securities held in its portfolio. Changes in foreign currency
exchange rates may affect the value of securities in the portfolio and the
unrealized appreciation or depreciation of investments insofar as United States
investors are concerned. Furthermore, the Quality Equity Fund's return on
investments in non-dollar-denominated securities may be reduced or enhanced as a
result of changes in foreign currency rates during the period in which the Fund
holds such investments.
The Quality Equity Fund may engage in transactions, such as currency swaps
and purchasing and selling options on currencies, for purposes of hedging
against the decline in the value of currencies in which its portfolio holdings
are denominated against the US dollar. Although such instruments will be used
with the intention of hedging against adverse currency movements, transactions
in such instruments involve the risk that anticipated currency movements will
not be accurately predicted and that the Fund's hedging strategies will be
ineffective and may cause the Fund to realize losses.
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to options and foreign exchange
transactions.
4
<PAGE> 21
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH SPECIAL VALUE FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Special Value Focus Fund, formerly the Merrill Lynch Equity
Growth Fund (the "Special Value Focus Fund"), is a diversified fund whose
objective is long-term capital growth by investing primarily in common shares of
small companies and of emerging growth companies regardless of size. The Special
Value Focus Fund is a separate fund of the Merrill Lynch Variable Series Funds,
Inc. (the "Company"), an open-ended management investment company that has a
wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class A Common Stock for the Special Value Focus Fund pursuant to this
Prospectus. This Prospectus consists of this four page document and the attached
Appendix. For more information on the Special Value Focus Fund's investment
objectives and policies, please see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 2
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 22
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
SPECIAL VALUE FOCUS FUND# (CLASS A)
----------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------------------------
1997+ 1996+ 1995+ 1994+ 1993+ 1992+ 1991 1990 1989 1988
-------- -------- -------- -------- ------- ------- ------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net
Asset Value:
Per Share Operating
Performance:
Net asset value, beginning
of year.................. $ 26.22 $ 27.98 $ 19.26 $ 20.96 $ 17.80 $ 17.96 $ 11.98 $ 13.70 $ 11.75 $11.47
-------- -------- -------- -------- ------- ------- ------- ------- ------- ------
Investment income
(loss) -- net............ .09 .13 .17 .05 (.01) .01 .09 .05 (.07) (.10)
Realized and unrealized
gain (loss) on
investments -- net....... 2.80 1.84 8.64 (1.56) 3.17 (.10) 5.91 (1.77) 2.02 .60
-------- -------- -------- -------- ------- ------- ------- ------- ------- ------
Total from investment
operations............... 2.89 1.97 8.81 (1.51) 3.16 (.09) 6.00 (1.72) 1.95 .50
-------- -------- -------- -------- ------- ------- ------- ------- ------- ------
Less dividends and
distributions:
Investment
income -- net.......... (.08) (.14) (.09) -- --++ (.07) (.02) -- -- --
Realized gain on
investments -- net..... (1.28) (3.59) -- (.19) -- -- -- -- -- (.22)
-------- -------- -------- -------- ------- ------- ------- ------- ------- ------
Total dividends and
distributions............ (1.36) (3.73) (.09) (.19) -- (.07) (.02) -- -- (.22)
-------- -------- -------- -------- ------- ------- ------- ------- ------- ------
Net asset value, end of
year..................... $ 27.75 $ 26.22 $ 27.98 $ 19.26 $ 20.96 $ 17.80 $ 17.96 $ 11.98 $ 13.70 $11.75
======== ======== ======== ======== ======= ======= ======= ======= ======= ======
Total Investment Return:*
Based on net asset value
per share................ 11.72% 8.11% 45.90% (7.27)% 17.78% (.53)% 50.10% (12.55)% 16.60% 4.25%
======== ======== ======== ======== ======= ======= ======= ======= ======= ======
Ratios to Average Net
Assets:
Expenses, net of
reimbursement............ .80% .81% .81% .83% .96% 1.18% 1.25% 1.25% 1.25% 1.25%
======== ======== ======== ======== ======= ======= ======= ======= ======= ======
Expenses................... .80% .81% .81% .83% .96% 1.18% 1.28% 1.47% 1.53% 1.25%
======== ======== ======== ======== ======= ======= ======= ======= ======= ======
Investment income
(loss) -- net............ .32% .50% .72% .27% (.05)% .04% .51% .14% (.68)% (.56)%
======== ======== ======== ======== ======= ======= ======= ======= ======= ======
Supplemental Data:
Net assets, end of year (in
thousands)............... $481,614 $453,029 $339,921 $170,044 $98,976 $23,167 $11,318 $ 6,851 $ 6,811 $5,521
======== ======== ======== ======== ======= ======= ======= ======= ======= ======
Portfolio turnover......... 147.06% 80.84% 96.79% 88.48% 131.75% 98.64% 79.10% 135.24% 100.49% 68.73%
======== ======== ======== ======== ======= ======= ======= ======= ======= ======
Average Commission rate
paid##................... $ .0555 $ .0598 -- -- -- -- -- -- -- --
======== ======== ======== ======== ======= ======= ======= ======= ======= ======
</TABLE>
- ---------------
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
++ Amount is less than $.01 per share.
# The name of the Equity Growth Fund was changed to the Special Value Focus
Fund effective August 15, 1997.
## For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities.
2
<PAGE> 23
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Special Value Focus Fund is to seek
long-term growth of capital by investing in a diversified portfolio of
securities, primarily common stocks, of relatively small companies that
management of the Company believes have special investment value, and of
emerging growth companies regardless of size. There can be no assurance that the
Special Value Focus Fund will achieve its investment objective. Companies are
selected by management on the basis of their long-term potential for expanding
their size and profitability or for gaining increased market recognition for
their securities. Current income is not a factor in the selection of securities.
The Special Value Focus Fund is intended to provide an opportunity for owners
("Contract Owners") of variable annuity contracts and/or variable life insurance
contracts ("Contracts") who are not ordinarily in a position to perform the
specialized type of research or analysis of small and emerging growth companies.
Management seeks to identify those small emerging growth companies that can
show significant and sustained increases in earnings over an extended period of
time and are in sound financial condition. Management believes that, while these
companies present above-average risks, properly selected companies of this type
also have the potential to increase their earnings at a rate substantially in
excess of the general growth of the economy. The Special Value Focus Fund
attempts to achieve its objective by focusing on the long-range view of a
company's prospects through a fundamental analysis of its management, financial
structure, product development, marketing ability and other relevant factors.
Full development of these companies frequently takes time and, for this reason,
the Special Value Focus Fund should not be considered as a vehicle for seeking
short-term profits. The Fund should be considered a long-term investment and a
vehicle for diversification, and not as a balanced investment program.
Small companies. Management seeks small companies that offer special
investment value in terms of their product or service, research capability, or
other unique attributes, and are relatively undervalued in the marketplace when
compared with similar, but larger, enterprises. The definition of "small
companies" will change over time in response to market conditions; for the Fund,
"small companies" typically have total market capitalization, at the time of
initial purchase by the Fund, in the same range as companies in the Russell 2000
Stock Index, a widely known small cap investment benchmark. Small companies are
generally little known to most individual investors although some may be
dominant in their respective industries. Underlying this strategy is
management's belief that relatively small companies will continue to have the
opportunity to develop into significant business enterprises. Some such
companies may be in a relatively early stage of development; others may
manufacture a new product or perform a new service. Such companies may not be
counted upon to develop into major industrial companies, but management believes
that eventual recognition of their special value characteristics by the
investment community can provide above-average long-term growth to the
portfolio.
Emerging growth companies. In selecting investments for the Special Value
Focus Fund, management also seeks emerging growth companies that either occupy a
dominant position in an emerging industry or subindustry or have a significant
and growing market share in a large, fragmented industry. Management believes
that capable and flexible management is one of the most important criteria of
emerging growth companies and that such companies should employ sound financial
and accounting policies and also demonstrate effective research, successful
product development and marketing, efficient service and pricing flexibility.
Emphasis is given to companies with rapid historical growth rates, above-average
returns on equity and strong current balance sheets, all of which should enable
the company to finance its continued growth. Management of the Company also
analyzes and weighs relevant factors beyond the company itself, such as the
level of competition in the industry, the extent of governmental regulation, the
nature of labor conditions and other related matters.
The Special Value Focus Fund emphasizes investments in companies that do
most of their business in the United States and therefore are free of the
currency exchange problems, foreign tax considerations and potential political
and economic upheavals that many multinational corporations face. Moreover, the
size and kinds of markets that they serve make these companies less susceptible
than larger companies to intervention from the federal government by means of
price controls, regulations or litigation.
While the process of selection and continuous supervision by management
does not, of course, guarantee successful investment results, it does provide
ingredients not available to the average individual due to the time and cost
involved. Careful initial selection is particularly important in this area as
many new enterprises have promise but lack certain of the ingredients necessary
to prosper.
3
<PAGE> 24
It should be apparent that an investment in a fund such as the Special
Value Focus Fund involves greater risk than is customarily associated with more
established companies. The securities of smaller or emerging growth companies
may be subject to more abrupt or erratic market movements than larger, more
established companies or the market average in general. These companies may have
limited product lines, markets or financial resources, or they may be dependent
upon a limited management group. Because of these factors, management of the
Company believes that shares in the Special Value Focus Fund are suitable for
Contract Owners who are in a financial position to assume above-average
investment risk in search of above-average long-term reward. As indicated, the
Special Value Focus Fund is designed for Contract Owners whose investment
objective is growth rather than income. It is definitely not intended for
exclusive funding of Contracts but is designed for Contract Owners who are
prepared to experience above-average fluctuations in net asset value.
The securities in which the Special Value Focus Fund invests will often be
traded only in the over-the-counter market or on a regional securities exchange
and may not be traded every day or in the volume typical of trading on a
national securities exchange. As a result, the disposition by the Fund of
portfolio securities to meet redemptions or otherwise may require the Fund to
sell these securities at a discount from market prices or during periods when in
management's judgment such disposition is not desirable or to make many small
sales over a lengthy period of time.
The investment emphasis of the Special Value Focus Fund is on equities,
primarily common stock and, to a lesser extent, securities convertible into
common stocks and rights to subscribe for common stock, and the Fund will
maintain at least 80% of its net assets invested in equity securities of small
or emerging growth companies except during defensive periods. The Special Value
Focus Fund reserves the right as a defensive measure and to provide for
redemptions to hold other types of securities, including non-convertible
preferred stocks and debt securities, U.S. Government and Government agency
securities, money market securities or other fixed-income securities deemed by
the Investment Adviser to be consistent with a defensive posture, or cash, in
such proportions as, in the opinion of management, prevailing market or economic
conditions warrant.
In addition, the Special Value Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities of foreign issuers and is authorized to write
(i.e., sell) call options on securities held in its portfolio or securities
indices the performance of which is substantially correlated with securities
held in its portfolio. A further discussion of the investments described in this
paragraph and the risks associated with such investments is set forth in the
Appendix to this Prospectus, including Annex B of the Appendix to this
Prospectus, which includes a discussion of certain portfolio strategies relating
to options.
4
<PAGE> 25
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH NATURAL RESOURCES FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Natural Resources Focus Fund (the "Natural Resources Focus
Fund") is a non-diversified fund whose objectives are achieving long-term growth
of capital and protection of the purchasing power of shareholder's capital by
investing primarily in equity securities of domestic and foreign companies with
substantial natural resource assets. The Natural Resources Focus Fund is a
separate fund of the Merrill Lynch Variable Series Funds, Inc. (the "Company"),
an open-ended management investment company that has a wide range of investment
objectives among its eighteen separate funds (hereinafter referred to as the
"Funds" or individually as a "Fund"). Two separate classes of common stock
("Common Stock"), Class A Common Stock and Class B Common Stock, are issued for
each Fund. The Company is offering shares of its Class A Common Stock for the
Natural Resources Focus Fund pursuant to this Prospectus. This Prospectus
consists of this four page document and the attached Appendix. For more
information on the Natural Resources Focus Fund's investment objectives and
policies, please see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 2
Investment Objectives and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 26
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
NATURAL RESOURCES FOCUS FUND (CLASS A)
--------------------------------------------------------------------------------------------------
FOR THE
PERIOD
JUNE 1,
FOR THE YEAR ENDED DECEMBER 31, 1988+ TO
----------------------------------------------------------------------------------- DECEMBER 31,
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
------- ------- ------- ------- ------- ------ ------ ------ ------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net
Asset Value:
Per Share Operating
Performance:
Net asset value, beginning of
period..................... $ 13.12 $ 11.95 $ 10.82 $ 10.82 $ 9.84 $10.06 $10.17 $11.09 $ 9.58 $10.00
------- ------- ------- ------- ------- ------ ------ ------ ------ ------
Investment income -- net..... .14 .18 .20 .17 .11 .18 .25 .22 .24 .12
Realized and unrealized gain
(loss) on investments and
foreign currency
transactions -- net........ (1.68) 1.40 1.15 (.02) .92 (.05) (.11) (.90) 1.49 (.54)
------- ------- ------- ------- ------- ------ ------ ------ ------ ------
Total from investment
operations................. (1.54) 1.58 1.35 .15 1.03 .13 .14 (.68) 1.73 (.42)
------- ------- ------- ------- ------- ------ ------ ------ ------ ------
Less dividends and
distributions:
Investment income -- net... (.06) (.20) (.19) (.15) (.05) (.29) (.25) (.24) (.22) --
Realized gain on
investments -- net....... (.86) (.21) (.03) -- -- (.06) -- -- -- --
------- ------- ------- ------- ------- ------ ------ ------ ------ ------
Total dividends and
distributions.............. (.92) (.41) (.22) (.15) (.05) (.35) (.25) (.24) (.22) --
------- ------- ------- ------- ------- ------ ------ ------ ------ ------
Net asset value, end of
period..................... $ 10.66 $ 13.12 $ 11.95 $ 10.82 $ 10.82 $ 9.84 $10.06 $10.17 $11.09 $ 9.58
======= ======= ======= ======= ======= ====== ====== ====== ====== ======
Total Investment Return:**
Based on net asset value per
share...................... (12.52)% 13.52% 12.65% 1.44% 10.47% 1.36% 1.36% (6.21)% 18.23% (4.20)%#
======= ======= ======= ======= ======= ====== ====== ====== ====== ======
Ratios to Average Net Assets:
Expenses, net of
reimbursement.............. .81% .78% .78% .87% 1.13% 1.25% 1.25% 1.25% 1.25% 1.24%*
======= ======= ======= ======= ======= ====== ====== ====== ====== ======
Expenses..................... .81% .78% .78% .87% 1.13% 1.27% 1.30% 1.38% 1.74% 1.24%*
======= ======= ======= ======= ======= ====== ====== ====== ====== ======
Investment income -- net..... .99% 1.43% 1.75% 1.91% 1.34% 2.00% 2.31% 2.26% 2.26% 2.59%*
======= ======= ======= ======= ======= ====== ====== ====== ====== ======
Supplemental Data:
Net assets, end of period (in
thousands)................. $26,979 $45,197 $43,102 $39,715 $14,778 $4,144 $3,084 $3,247 $2,704 $2,371
======= ======= ======= ======= ======= ====== ====== ====== ====== ======
Portfolio turnover........... 20.93% 31.11% 30.15% 10.94% 58.44% 22.88% 31.38% 27.61% 93.97% 16.31%
======= ======= ======= ======= ======= ====== ====== ====== ====== ======
Average commission rate
paid##..................... $.0308.. $ .0225 -- -- -- -- -- -- -- --
======= ======= ======= ======= ======= ====== ====== ====== ====== ======
</TABLE>
- ---------------
* Annualized
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
# Aggregate total investment return.
## For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into U.S.
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
2
<PAGE> 27
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the Natural Resources Focus Fund are to
achieve long-term growth of capital and to protect the purchasing power of
shareholders' capital by investing primarily in a portfolio of equity securities
(e.g., common stocks and securities convertible into common stocks) of domestic
and foreign companies with substantial natural resource assets. This investment
objective is a fundamental policy and may not be changed without a vote of the
majority of outstanding shares of the Natural Resources Focus Fund. The Natural
Resources Focus Fund also may invest in debt, preferred or convertible
securities, the value of which is related to the market value of some natural
resource asset ("asset-based securities"). Management of the Company will seek
to identify companies or asset-based securities it believes are attractively
priced relative to the intrinsic value of the underlying natural resource assets
or are especially well positioned to benefit during particular portions of
inflationary cycles. The Fund should be considered a long-term investment and a
vehicle for diversification, and not as a balanced investment program. The Fund
may not be appropriate as the exclusive investment to fund a variable annuity or
variable life insurance contract ("Contract") for all Contract owners. There can
be no assurance that the Natural Resources Focus Fund will achieve its
investment objectives.
IN SEEKING TO PROTECT THE PURCHASING POWER OF SHAREHOLDERS' CAPITAL, THE
NATURAL RESOURCES FOCUS FUND HAS RESERVED THE RIGHT, WHEN MANAGEMENT OF THE
COMPANY ANTICIPATES SIGNIFICANT ECONOMIC, POLITICAL OR FINANCIAL INSTABILITY,
SUCH AS HIGH INFLATIONARY PRESSURES OR UPHEAVAL IN THE FOREIGN CURRENCY EXCHANGE
MARKETS, TO INVEST A MAJORITY OF ITS ASSETS IN COMPANIES THAT EXPLORE FOR,
EXTRACT, PROCESS OR DEAL IN GOLD OR IN ASSET-BASED SECURITIES INDEXED TO THE
VALUE OF GOLD BULLION. Such a switch in investment strategies could require the
Fund to liquidate portfolio securities and incur transaction costs. The Company
has been advised by counsel that it is uncertain under the current federal tax
law whether the Fund may concentrate its investments in gold and gold-related
securities without adversely affecting the federal tax status of the Contracts.
Accordingly, management of the Company has determined that the Natural Resources
Focus Fund will not concentrate its investments in such securities until counsel
has advised the Company that such uncertainty has been resolved favorably.
Management attempts to achieve the investment objectives of the Natural
Resources Focus Fund by seeking to identify securities of companies which, in
its opinion, are undervalued relative to the value of natural resource holdings
of such companies in light of current and anticipated economic or financial
conditions. Natural resource assets are materials derived from natural sources
which have economic value. Management will consider a company to have
substantial natural resource assets when, in its opinion, the company's holdings
of the assets are of such magnitude, when compared to the capitalization,
revenues or operating profits of the company, that changes in the economic value
of the assets are expected to affect the market price of the equity securities
of such company. Generally, a company has substantial natural resource assets
when at least 50% of the non-current assets, capitalization, gross revenues or
operating profits of the company in the most recent or current fiscal year are
involved in or result from directly or indirectly through subsidiaries,
exploring, mining, refining, processing, fabricating, dealing in or owning
natural resource assets. Examples of natural resource assets include precious
metals (e.g., gold, silver and platinum), ferrous and nonferrous metals (e.g.,
iron, steel, aluminum and copper), strategic metals (e.g., uranium and
titanium), hydrocarbons (e.g., coal, oil and natural gas), timber land,
undeveloped real property and agricultural commodities. The Fund presently does
not intend to invest directly in natural resource assets or contracts related
thereto.
Management of the Company believes that, based upon past performance, the
securities of specific companies that hold different types of substantial
natural resource assets may move relatively independently of one another during
different stages of inflationary cycles due to different degrees of demand for,
or market values of, their respective natural resource holdings during
particular portions of such inflationary cycles. The Fund's fully managed
investment approach enables it to switch its emphasis among various industry
groups depending upon management's outlook with respect to prevailing trends and
developments.
The Natural Resources Focus Fund at all times, except during defensive
periods, will maintain at least 65% of its total assets invested in companies
with substantial natural resource assets or in asset-based securities. Current
income from dividends and interest will not be a primary consideration in
selecting securities. The Fund reserves the right as a temporary defensive
measure and to provide for redemptions, to hold short-term
3
<PAGE> 28
U.S. Government and Government agency securities, money market securities or
other fixed-income securities deemed by the Investment Adviser to be consistent
with a defensive posture, or cash, in such proportions as, in the opinion of
management, prevailing market or economic conditions warrant.
As indicated above, under certain circumstances, the Natural Resources
Focus Fund has reserved the right to invest a majority of its assets in
gold-related companies or securities. Based on historic experience, during
periods of economic or financial instability, the securities of such companies
may be subject to extreme price fluctuations, reflecting the high volatility of
gold prices during such periods. In addition, the instability of gold prices may
result in volatile earnings of gold-related companies which, in turn, may affect
adversely the financial condition of such companies. Gold mining companies also
are subject to the risks generally associated with mining operations.
The major producers of gold include the Republic of South Africa, Russia,
the United States, Australia, Canada, the People's Republic of China and the
Philippines. Sales of gold by Russia and the People's Republic of China are
largely unpredictable and often relate to political and economic considerations
rather than to market forces. Economic, social and political developments within
Russia, the People's Republic of China and the Republic of South Africa may
affect significantly gold production in those countries.
OTHER INVESTMENTS AND RISKS
In addition, the Natural Resources Focus Fund may purchase certain
securities that are not registered under the Securities Act of 1933, as amended,
and which therefore may be subject to restrictions on their transfer or resale.
The Fund may also engage in transactions for purpose of hedging against the
decline in the value of currencies in which its portfolio holdings are
denominated against the US dollar. The Fund is also authorized to write (i.e.,
sell) and purchase call and put options on securities held in its portfolio, on
securities indices the performance of which is substantially correlated with
securities held in its portfolio or on securities it intends to purchase, may
engage in transactions in futures, and may invest in securities the potential
return of which is based on the change in particular measurements of value or
rate (i.e., indexed and inverse securities).
The Natural Resources Focus Fund may also invest in securities of foreign
issuers and may concentrate its investments in one or more countries.
Investments in foreign securities, particularly those of non-governmental
issuers, involve considerations and risks which are not ordinarily associated
with investing in domestic issuers. These considerations and risks include
changes in currency rates, currency exchange control regulations, the
possibility of expropriation, confiscatory taxation, high rates of inflation,
the unavailability of financial information or the difficulty of interpreting
financial information prepared under foreign accounting standards, less
liquidity and more volatility in foreign securities markets, the impact of
political, social or diplomatic developments, and the difficulty of assessing
economic trends in foreign countries. In addition, net investment income earned
by the Fund on a foreign security may be subject to withholding and other taxes
imposed by foreign governments which will reduce the Fund's net investment
income. The Natural Resources Focus Fund may also from time to time be
substantially invested in non-dollar-denominated securities of foreign issuers.
Changes in foreign currency exchange rates may affect the value of securities in
the portfolio and the unrealized appreciation or depreciation of investments
insofar as United States investors are concerned. Furthermore, the Fund's return
on investments in non-dollar-denominated securities may be reduced or enhanced
as a result of changes in foreign currency rates during the period in which the
Fund holds such investments. See "Other Portfolio Strategies -- Foreign
Securities" in the Appendix to this Prospectus for special considerations
concerning investments in foreign securities.
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed and inverse securities,
options, futures and foreign exchange transactions.
4
<PAGE> 29
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH AMERICAN BALANCED FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch American Balanced Fund (the "American Balanced Fund") is a
diversified fund whose objective is a level of current income and a degree of
stability or principal not normally available from an investment solely in
equity securities and the opportunity for capital appreciation greater than is
normally available from an investment solely in debt securities by investing in
a balanced portfolio of fixed-income and equity securities. The American
Balanced Fund is a separate fund of the Merrill Lynch Variable Series Funds,
Inc. (the "Company"), an open-ended management investment company that has a
wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class A Common Stock for the American Balanced Fund pursuant to this
Prospectus. This Prospectus consists of this four page document and the attached
Appendix. For more information on the American Balanced Fund's investment
objective and policies, please see page 4 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objective and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 30
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 31
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
AMERICAN BALANCED FUND (CLASS A)
----------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
Per Share Operating Performance:
Net asset value, beginning of
period.......................... $ 16.01 $ 15.17 $ 13.08 $ 14.08 $ 12.85
-------- -------- -------- -------- --------
Investment income -- net......... .54 .53 .59 .48 .32
Realized and unrealized gain
(loss) on investments -- net.... 1.87 .89 2.06 (1.06) 1.37
-------- -------- -------- -------- --------
Total from investment
operations...................... 2.41 1.42 2.65 (.58) 1.69
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income -- net........ (.27) (.56) (.56) (.37) (.34)
Realized gain on investments --
net........................... (1.56) (.02) -- -- (.12)
In excess of realized gain on
investments -- net............ -- -- -- (.05) --
-------- -------- -------- -------- --------
Total dividends and
distributions................... (1.83) (.58) (.56) (.42) (.46)
-------- -------- -------- -------- --------
Net asset value, end of period... $ 16.59 $ 16.01 $ 15.17 $ 13.08 $ 14.08
======== ======== ======== ======== ========
Total Investment Return:**
Based on net asset value per
share........................... 17.11% 9.73% 20.81% (4.19)% 13.49%
======== ======== ======== ======== ========
Ratios to Average Net Assets:
Expenses, net of reimbursement... .60% .60% .61% .63% .70%
======== ======== ======== ======== ========
Expenses......................... .60% .60% .61% .63% .70%
======== ======== ======== ======== ========
Investment income -- net......... 3.17% 3.39% 4.22% 3.95% 3.20%
======== ======== ======== ======== ========
Supplemental Data:
Net Assets, end of period (in
thousands)...................... $194,747 $212,047 $212,912 $158,951 $115,420
======== ======== ======== ======== ========
Portfolio turnover............... 136.71% 236.50% 38.40% 35.36% 12.55%
======== ======== ======== ======== ========
Average commission rate paid##... $ .0608 $ .0610 -- -- --
======== ======== ======== ======== ========
<CAPTION>
AMERICAN BALANCED FUND (CLASS A)
-------------------------------------------------
FOR THE
PERIOD
JUNE 1,
FOR THE YEAR ENDED DECEMBER 31, 1988+ TO
---------------------------------- DECEMBER 31,
1992 1991 1990 1989 1988
------- ------ ------ ------ ------------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
Per Share Operating Performance:
Net asset value, beginning of
period.......................... $ 12.82 $11.26 $11.74 $10.41 $10.00
------- ------ ------ ------ ------
Investment income -- net......... .31 .47 .47 .44 .29
Realized and unrealized gain
(loss) on investments -- net.... .37 1.76 (.35) 1.40 .12
------- ------ ------ ------ ------
Total from investment
operations...................... .68 2.23 .12 1.84 .41
------- ------ ------ ------ ------
Less dividends and distributions:
Investment income -- net........ (.37) (.49) (.46) (.50) --
Realized gain on investments --
net........................... (.28) (.18) (.14) (.01) --
In excess of realized gain on
investments -- net............ -- -- -- -- --
------- ------ ------ ------ ------
Total dividends and
distributions................... (.65) (.67) (.60) (.51) --
------- ------ ------ ------ ------
Net asset value, end of period... $ 12.85 $12.82 $11.26 $11.74 $10.41
======= ====== ====== ====== ======
Total Investment Return:**
Based on net asset value per
share........................... 5.72% 20.65% 1.22% 18.11% 4.10%#
======= ====== ====== ====== ======
Ratios to Average Net Assets:
Expenses, net of reimbursement... .97% 1.20% 1.25% 1.25% 1.25%*
======= ====== ====== ====== ======
Expenses......................... .97% 1.20% 1.50% 2.29% 1.25%*
======= ====== ====== ====== ======
Investment income -- net......... 3.71% 4.16% 4.71% 4.71% 5.13%*
======= ====== ====== ====== ======
Supplemental Data:
Net Assets, end of period (in
thousands)...................... $24,918 $7,937 $5,675 $3,854 $2,276
======= ====== ====== ====== ======
Portfolio turnover............... 36.34% 50.82% 23.52% 37.60% 2.04%
======= ====== ====== ====== ======
Average commission rate paid##... -- -- -- -- --
======= ====== ====== ====== ======
</TABLE>
- ---------------
* Annualized.
** Total Investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
# Aggregate total investment return.
## For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities.
3
<PAGE> 32
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the American Balanced Fund is to seek a level
of current income and a degree of stability of principal not normally available
from an investment solely in equity securities and the opportunity for capital
appreciation greater than is normally available from an investment solely in
debt securities by investing in a balanced portfolio of fixed income and equity
securities. This investment objective is a fundamental policy and may not be
changed without a vote of the majority of the outstanding shares of the American
Balanced Fund. The American Balanced Fund will seek current income by investing
a portion of its assets in a portfolio of intermediate to long-term debt,
convertible debt, non-convertible and convertible term preferred stock and money
market securities. The American Balanced Fund will seek capital appreciation
primarily by investing a portion of its assets in equity securities, including
perpetual preferred and convertible perpetual preferred stock. At all times the
Fund will maintain at least 25% of its net assets in senior fixed income
securities. As a non-fundamental policy, the Fund is not permitted to invest in
securities of foreign issuers. There can be no assurance that the American
Balanced Fund will achieve its investment objective.
The Fund will normally limit its allocation of assets to equity securities
to no more than 65% of its net assets. To the extent its equity position exceeds
this limitation, because of changes in the value of portfolio securities or
otherwise, the Fund will seek to reduce its equity position to less than 65% of
net assets by selling such securities at such times and in such amounts as
management of the Company deems appropriate in light of market conditions and
other pertinent factors. See "Dividends, Distributions and Taxes -- Tax
Treatment of the Company" in the Appendix to this Prospectus.
The American Balanced Fund will generally emphasize investment in common
stocks of larger-capitalization issuers and in investment-grade debt
obligations. The Fund may also seek to enhance the return on its common stock
portfolio by writing covered call options listed on United States securities
exchanges. Under unusual market or economic conditions, the Fund for defensive
purposes may invest up to 100% of its assets in short-term U.S. Government or
Government agency securities, money market securities or other fixed-income
securities deemed by the Investment Adviser to be consistent with a defensive
posture, or cash.
In addition, the American Balanced Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Fund
is authorized to write (i.e., sell) call options on securities held in its
portfolio or securities indices the performance of which is substantially
correlated with securities held in its portfolio. A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus, which includes a discussion of certain
portfolio strategies relating to options.
4
<PAGE> 33
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GLOBAL STRATEGY FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Global Strategy Focus Fund (the "Global Strategy Focus Fund")
is a non-diversified fund whose objective is high total investment return by
investing primarily in a portfolio of equity and fixed income securities of U.S.
and foreign issuers. The Global Strategy Focus Fund is a separate fund of the
Merrill Lynch Variable Series Funds, Inc. (the "Company"), an open-ended
management investment company that has a wide range of investment objectives
among its eighteen separate funds (hereinafter referred to as the "Funds" or
individually as a "Fund"). Two separate classes of common stock ("Common
Stock"), Class A Common Stock and Class B Common Stock, are issued for each
Fund. The Company is offering shares of its Class A Common Stock for the Global
Strategy Focus Fund pursuant to this Prospectus. This Prospectus consists of
this four page document and the attached Appendix. For more information on the
Global Strategy Focus Fund's investment objective and policies, please see page
3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 2
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................. A-8
Portfolio Transactions and
Brokerage....................... A-11
Purchase of Shares................. A-11
Redemption of Shares............... A-11
Dividends, Distributions and
Taxes........................... A-11
Performance Data................... A-12
Additional Information............. A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 34
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
GLOBAL STRATEGY FOCUS FUND (CLASS A)
---------------------------------------------------------------------
FOR THE PERIOD
FEBRUARY 28,
FOR THE YEAR ENDED DECEMBER 31, 1992+ TO
---------------------------------------------------- DECEMBER 31,
1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- --------------
<S> <C> <C> <C> <C> <C> <C>
Increase (Decrease) In Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period.... $ 13.87 $ 12.55 $ 11.73 $ 12.17 $ 10.22 $ 10.00
-------- -------- -------- -------- -------- -------
Investment income -- net................ .35 .28 .39 .30 .16 .13
Realized and unrealized gain (loss) on
investments and foreign currency
transactions -- net................... 1.21 1.33 .82 (.48) 1.96 .13
-------- -------- -------- -------- -------- -------
Total from investment operations........ 1.56 1.61 1.21 (.18) 2.12 .26
-------- -------- -------- -------- -------- -------
Less dividends and distributions:
Investment income -- net.............. (.30) (.29) (.39) (.21) (.17) (.04)
Realized gain on investments -- net... (.42) -- --++ (.04) -- --
In excess of realized gain on
investments -- net.................. -- -- -- (.01) -- --
-------- -------- -------- -------- -------- -------
Total dividends and distributions....... (.72) (.29) (.39) (.26) (.17) (.04)
-------- -------- -------- -------- -------- -------
Net asset value, end of period.......... $ 14.71 $ 13.87 $ 12.55 $ 11.73 $ 12.17 $ 10.22
======== ======== ======== ======== ======== =======
Total Investment Return:**
Based on net asset value per share...... 11.94% 13.17% 10.60% (1.46)% 21.03% 2.62%#
======== ======== ======== ======== ======== =======
Ratios To Average Net Assets:
Expenses, net of reimbursement.......... .73% .71% .72% .77% .88% 1.25%*
======== ======== ======== ======== ======== =======
Expenses................................ .73% .71% .72% .77% .88% 1.35%*
======== ======== ======== ======== ======== =======
Investment income -- net................ 2.33% 2.68% 3.33% 2.85% 2.41% 2.66%*
======== ======== ======== ======== ======== =======
Supplemental Data:
Net assets, end of period (in
thousands)............................ $869,647 $870,203 $540,242 $515,407 $269,627 $15,527
======== ======== ======== ======== ======== =======
Portfolio turnover...................... 108.66% 173.44% 27.23% 21.03% 17.07% 14.47%
======== ======== ======== ======== ======== =======
Average commission rate paid***......... $ .0149 $ .0143 -- -- -- --
======== ======== ======== ======== ======== =======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into U.S.
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
+ Commencement of Operations.
++ Amount is less than $.01 per share.
# Aggregate total investment return.
2
<PAGE> 35
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Global Strategy Focus Fund is to seek high
total investment return by investing primarily in a portfolio of equity and
fixed income securities, including convertible securities, of U.S. and foreign
issuers. Total investment return consists of interest, dividends, discount
accruals and capital changes, including changes in the value of non-dollar
denominated securities and other assets and liabilities resulting from currency
fluctuations. There can be no assurance that the Global Strategy Focus Fund will
achieve its investment objective. Investing on an international basis involves
special considerations. See "Other Investments and Risks" below.
The Global Strategy Focus Fund seeks to achieve its objective by investing
primarily in the securities of issuers located in the United States, Canada,
Western Europe, the Far East and Latin America. There are no prescribed limits
on the geographical allocation of the Fund among these regions. Such allocation
will be made primarily on the basis of the anticipated total return from
investments in the securities of issuers wherever located, considering such
factors as the condition and growth potential of the various economies and
securities markets and the issuers domiciled therein, anticipated movements in
interest rates in the various capital markets and in the value of foreign
currencies relative to the U.S. dollar, tax considerations and economic, social,
financial, national and political factors which may affect the climate for
investing within such securities markets. When, in the judgment of Merrill Lynch
Asset Management L.P. (the "Investment Adviser"), economic or market conditions
warrant, the Fund reserves the right to concentrate its investments in one or
more capital markets, including the United States. The Fund should be considered
a long-term investment and a vehicle for diversification, and not as a balanced
investment program. The Fund may not be appropriate as the exclusive investment
to fund a variable annuity or variable life insurance contract ("Contract") for
all owners.
The corporate debt securities, including convertible debt securities, in
which the Fund may invest will be rated BBB or better by Standard and Poor's
Ratings Group ("Standard & Poor's") or Baa or better by Moody's Investors
Service, Inc. ("Moody's") or, in the opinion of the Investment Adviser, of
comparable quality. The Fund may also invest in debt obligations issued or
guaranteed by sovereign governments, political subdivisions thereof (including
states, provinces and municipalities) or their agencies or instrumentalities or
issued or guaranteed by international organizations designated or supported by
governmental entities to promote economic reconstruction or development
("supranational entities") such as the International Bank for Reconstruction and
Development (the "World Bank") and the European Coal and Steel Community.
Investments in securities of supranational entities are subject to the risk that
member governments will fail to make required capital contributions and that a
supranational entity will thus be unable to meet its obligations.
When market or financial conditions warrant, the Global Strategy Focus Fund
may invest as a temporary defensive measure up to 100% of its assets in U.S.
Government or Government agency securities, money market securities or other
fixed income securities deemed by the Investment Adviser to be consistent with a
defensive posture, or may hold its assets in cash.
The Global Strategy Focus Fund may use derivatives in connection with
certain trading strategies. See Annex B of the Appendix to this Prospectus.
OTHER INVESTMENTS AND RISKS
In addition, the Global Strategy Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Global
Strategy Focus Fund may also invest in securities of foreign issuers and may
concentrate its investments in one or more countries. Investments in foreign
securities, particularly those of non-governmental issuers, involve
considerations and risks that are not ordinarily associated with investing in
domestic issuers. These considerations and risks include changes in currency
rates, currency exchange control regulations, the possibility of expropriation,
confiscatory taxation, high rates of inflation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of political, social or diplomatic
developments, and the difficulty of assessing economic trends in foreign
countries. In addition, net investment income earned by the Fund on a foreign
security may be subject to withholding and other taxes imposed by foreign
governments, which will reduce the Fund's net investment income. The Fund may
also from time to time be substantially invested in non-dollar-denominated
securities of foreign issuers. Changes in foreign currency
3
<PAGE> 36
exchange rates may affect the value of securities in the portfolio and the
unrealized appreciation or depreciation of investments insofar as United States
investors are concerned. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. For additional information concerning the risks of investing in
foreign securities, see "Other Portfolio Strategies -- Foreign Securities" in
the Appendix to this Prospectus.
The Global Strategy Focus Fund may engage in transactions, such as currency
swaps and purchasing and selling options on currencies, for purposes of hedging
against the decline in the value of currencies in which its portfolio holdings
are denominated against the US dollar. The Fund is also authorized to purchase
and to write (i.e., sell) call and put options on securities held in its
portfolio, securities indices the performance of which is substantially
correlated with securities held in its portfolio or on securities it intends to
purchase and to purchase put options on securities held in its portfolio and may
also invest in futures and in securities the potential return of which is based
on the change in particular measurements of value of rate (i.e. indexed and
inverse securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed and inverse securities,
options, futures and foreign exchange transactions.
4
<PAGE> 37
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH BASIC VALUE FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Basic Value Focus Fund (the "Basic Value Focus Fund") is a
diversified fund whose objectives are capital appreciation and, secondarily,
income by investing in securities, primarily equities, that management of the
Fund believes are undervalued and therefore represent basic investment value.
The Basic Value Focus Fund is a separate fund of the Merrill Lynch Variable
Series Funds, Inc. (the "Company"), an open-ended management investment company
that has a wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class A Common Stock for the Basic Value Focus Fund pursuant to this
Prospectus. This Prospectus consists of this four page document and the attached
Appendix. For more information on the Basic Value Focus Fund's investment
objectives and policies, please see page 4 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objectives and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 38
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 39
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
BASIC VALUE FOCUS FUND (CLASS A)
--------------------------------------------------------
FOR THE
PERIOD
JULY 1,
FOR THE YEAR ENDED DECEMBER 31, 1993+ TO
----------------------------------------- DECEMBER 31,
1997 1996 1995 1994 1993
-------- -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) In Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period..... $ 14.74 $ 13.10 $ 11.10 $ 10.95 $ 10.00
-------- -------- -------- -------- -------
Investment income -- net................. .19 .17 .18 .17 .04
Realized and unrealized gain on
investments -- net..................... 2.52 2.37 2.49 .08 .91
-------- -------- -------- -------- -------
Total from investment operations......... 2.71 2.54 2.67 .25 .95
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income -- net............... (.09) (.18) (.19) (.10) --
Realized gain on investments -- net.... (1.52) (.72) (.48) -- --
-------- -------- -------- -------- -------
Total dividends and distributions........ (1.61) (.90) (.67) (.10) --
-------- -------- -------- -------- -------
Net asset value, end of period........... $ 15.84 $ 14.74 $ 13.10 $ 11.10 $ 10.95
======== ======== ======== ======== =======
Total Investment Return:**
Based on net asset value per share....... 20.62% 20.69% 25.49% 2.36% 9.50%#
======== ======== ======== ======== =======
Ratios To Average Net Assets:
Expenses................................. .65% .66% .66% .72% .86%*
======== ======== ======== ======== =======
Investment income -- net................. 1.36% 1.37% 1.68% 2.08% 1.69%*
======== ======== ======== ======== =======
Supplemental Data:
Net assets, end of period (in
thousands)............................. $671,325 $524,930 $306,463 $164,307 $47,207
======== ======== ======== ======== =======
Portfolio turnover....................... 95.52% 68.41% 74.10% 60.55% 30.86%
======== ======== ======== ======== =======
Average commission rate paid##........... $ .0562 $ .0549 -- -- --
======== ======== ======== ======== =======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
# Aggregate total investment return.
## For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities.
3
<PAGE> 40
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the Basic Value Focus Fund are to seek capital
appreciation and, secondarily, income by investing in securities, primarily
equities, that management of the Fund believes are undervalued and therefore
represent basic investment value. There can be no assurance that the Basic Value
Focus Fund will achieve its investment objectives. The Fund seeks special
opportunities in securities that are selling at a discount, either from book
value or historical price-earnings ratios, or seem capable of recovering from
temporarily out of favor considerations. Particular emphasis is placed on
securities that provide an above-average dividend return and sell at a
below-average price-earnings ratio. The Fund should be considered a long-term
investment and a vehicle for diversification, and not as a balanced investment
program. The Fund may not be appropriate as the exclusive investment to fund a
variable annuity or variable life insurance contract ("Contract") for all
Contract owners.
The investment policy of the Basic Value Focus Fund is based on the belief
that the pricing mechanism of the securities market lacks total efficiency and
has a tendency to inflate prices of securities in favorable market climates and
depress prices of securities in unfavorable climates. Based on this premise,
management believes that favorable changes in market prices are more likely to
begin when securities are out of favor, earnings are depressed, price-earnings
ratios are relatively low, investment expectations are limited, and there is no
real general interest in the particular security or industry involved. On the
other hand, management believes that negative developments are more likely to
occur when investment expectations are generally high, stock prices are
advancing or have advanced rapidly, price-earnings ratios have been inflated,
and the industry or issue continues to gain new investment acceptance on an
accelerated basis. In other words, management believes that market prices of
securities with relatively high price-earnings ratios are more susceptible to
unexpected adverse developments while securities with relatively low
price-earnings ratios are more favorably positioned to benefit from favorable,
but generally unanticipated, events. This investment policy departs from
traditional philosophy. Management of the Fund believes that the market risk
involved in this policy is moderated somewhat by an emphasis on securities with
above-average dividend returns.
The current institutionally-dominated market tends to ignore, to some
extent, the numerous secondary issues whose market capitalizations are below
those of the relatively few larger size growth companies. It is expected that
the Basic Value Focus Fund's portfolio generally will have significant
representation in this secondary segment of the market. The basic orientation of
the Fund's investment policies is such that at times a large portion of its
common stock holdings may carry less than favorable research ratings from
research analysts.
Investment emphasis is on equities, primarily common stock and, to a lesser
extent, securities convertible into common stocks. The Basic Value Focus Fund
also may invest in preferred stocks and non-convertible debt securities rated
investment grade and utilize covered call options with respect to portfolio
securities as described in Annex B to the Appendix of this Prospectus. The Fund
reserves the right as a defensive measure to hold other types of securities,
including U.S. Government and Government agency securities, money market
securities or other fixed-income securities deemed by the Investment Adviser to
be consistent with a defensive posture, or cash, in such proportions as, in the
opinion of management, prevailing market or economic conditions warrant. The
Fund may invest up to 10% of its total assets, taken at market value at the time
of acquisition, in the securities of foreign issuers.
In addition, the Basic Value Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Fund
is also authorized to write (i.e., sell) call options on securities held in its
portfolio or securities indices the performance of which is substantially
correlated with securities held in its portfolio. A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus, which includes a discussion of certain
portfolio strategies relating to options.
4
<PAGE> 41
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GLOBAL BOND FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Global Bond Focus Fund, formerly, the Merrill Lynch World
Income Focus Fund, (the "Global Bond Focus Fund") is a non-diversified fund
whose objective is high total investment return by investing in a global
portfolio of fixed income securities denominated in various currencies,
including multinational currency units. The Global Bond Focus Fund is a separate
fund of the Merrill Lynch Variable Series Funds, Inc. (the "Company"), an
open-ended management investment company that has a wide range of investment
objectives among its eighteen separate funds (hereinafter referred to as the
"Funds" or individually as a "Fund"). Two separate classes of common stock
("Common Stock"), Class A Common Stock and Class B Common Stock, are issued for
each Fund. The Company is offering shares of its Class A Common Stock for the
Global Bond Focus Fund pursuant to this Prospectus. This Prospectus consists of
this six page document and the attached Appendix. For more information on the
Global Bond Focus Fund's investment objective and policies, please see page 4 of
this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objective and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 42
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 43
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
GLOBAL BOND FOCUS FUND (CLASS A)
----------------------------------------------------
FOR THE
PERIOD
JULY 1,
FOR THE YEAR ENDED DECEMBER 31, 1993+ TO
------------------------------------- DECEMBER 31,
1997++ 1996++ 1995++ 1994 1993
------- ------- ------- ------- ------------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period.......... $ 9.76 $ 9.79 $ 9.17 $ 10.38 $ 10.00
------- ------- ------- ------- -------
Investment income -- net...................... .56 .78 .85 .76 .25
Realized and unrealized gain (loss) on
investments and foreign currency
transactions -- net......................... (.40) (.03) .61 (1.19) .33
------- ------- ------- ------- -------
Total from investment operations.............. .16 .75 1.46 (.43) .58
------- ------- ------- ------- -------
Less dividends and distributions:
Investment income -- net.................... (.29) (.78) (.84) (.76) (.20)
Return of capital........................... (.28) -- -- -- --
In excess of investment income-net.......... (.03) -- -- -- --
In excess of realized gain on
investments -- net....................... -- -- -- (.02) --
------- ------- ------- ------- -------
Total dividends and distributions............. (.60) (.78) (.84) (.78) (.20)
------- ------- ------- ------- -------
Net asset value, end of period................ $ 9.32 $ 9.76 $ 9.79 $ 9.17 $ 10.38
======= ======= ======= ======= =======
Total Investment Return:**
Based on net asset value per share............ 1.95% 8.02% 16.69% (4.21)% 5.90%#
======= ======= ======= ======= =======
Ratios to Average Net Assets:
Expenses...................................... .73% .69% .68% .75% .94%*
======= ======= ======= ======= =======
Investment income -- net...................... 6.11% 7.95% 8.99% 8.01% 6.20%*
======= ======= ======= ======= =======
Supplemental Data:
Net assets, end of period (in thousands)...... $76,107 $93,790 $81,845 $75,150 $50,737
======= ======= ======= ======= =======
Portfolio turnover............................ 568.76% 267.13% 132.57% 117.58% 54.80%
======= ======= ======= ======= =======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
3
<PAGE> 44
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Global Bond Focus Fund is to seek to
provide shareholders a high total investment return by investing in a global
portfolio of fixed income securities denominated in various currencies,
including multi-national currency units. The Fund will, under normal conditions,
invest at least 90% of its total assets in such fixed income securities. In
pursuing its investment objective, the Global Bond Focus Fund will allocate its
investments among different types of fixed income securities denominated in
various currencies based upon Merrill Lynch Asset Management L.P.'s (the
"Investment Adviser") analysis of the yield, maturity, potential appreciation
and currency considerations affecting such securities. There can be no assurance
that the Global Bond Focus Fund will achieve its investment objective. Investing
on an international basis involves special considerations. See "Other
Investments and Risks" below. The Fund should be considered a long-term
investment and a vehicle for diversification, and not as a balanced investment
program. The Fund may not be appropriate as the exclusive investment to fund a
variable annuity or variable life insurance contract ("Contract") for all
Contract owners.
The Global Bond Focus Fund may invest in United States and foreign
government and corporate fixed income securities that have a credit rating of A
or better by Standard & Poor's Rating Group ("Standard & Poor's") or by Moody's
Investors Service, Inc. ("Moody's") or commercial paper rated A-1 by Standard &
Poor's or Prime-1 by Moody's or obligations that the Investment Adviser has
determined to be of similar creditworthiness. The Fund may purchase fixed income
securities issued by United States or foreign corporations or financial
institutions, including debt securities of all types and maturities, convertible
securities and preferred stocks. The Fund also may purchase securities issued or
guaranteed by United States or foreign governments (including foreign states,
provinces and municipalities) or their agencies and instrumentalities
("governmental entities") or issued or guaranteed by international organizations
designated or supported by multiple governmental entities to promote economic
reconstruction or development ("supranational entities").
International Investing. The Global Bond Focus Fund may invest in fixed
income securities denominated in any currency or multinational currency unit. An
illustration of a multinational currency unit is the European Currency Unit
("ECU"), which is a "basket" consisting of specified amounts of the currencies
of certain of the twelve member states of the European Community, a Western
European economic cooperative association including France, Germany, the
Netherlands and the United Kingdom. The specific amounts of currencies
comprising the ECU may be adjusted by the Council of Ministers of the European
Community to reflect changes in relative values of the underlying currencies.
The Investment Adviser does not believe that such adjustments will adversely
affect holders of ECU-denominated obligations or the marketability of such
securities. European supranational entities (described further below), in
particular, issue ECU-denominated obligations. The Fund may invest in securities
denominated in the currency of one nation although issued by a governmental
entity, corporation or financial institution of another nation. For example, the
Fund may invest in a British pound sterling-denominated obligation issued by a
United States corporation. Such investments involve credit risks associated with
the issuer and currency risks associated with the currency in which the
obligation is denominated. See "Other Investments and Risks" below.
It is anticipated that under current conditions the Global Bond Focus Fund
will invest primarily in marketable securities denominated in the currencies of
the United States, Canada, Western European nations, New Zealand and Australia,
as well as in ECUs. Further, it is anticipated that such securities will be
issued primarily by entities located in such countries and by supranational
entities. Under normal conditions, the Fund's investments will be denominated in
at least three currencies or multinational currency units. Under certain adverse
conditions, the Fund may restrict the financial markets or currencies in which
its assets will be invested. The Fund presently intends to invest its assets
solely in the United States financial markets or United States
dollar-denominated obligations only for temporary defensive purposes.
The obligations of foreign governmental entities have various kinds of
government support and include obligations issued or guaranteed by foreign
governmental entities with taxing power. These obligations may or may not be
supported by the full faith and credit of a foreign government. The Global Bond
Focus Fund will invest in foreign government securities of issuers considered
stable by the Investment Adviser. While investments in foreign government debt
securities may involve special risks, the Investment Adviser does not believe
that the credit risk inherent in the obligations of stable foreign governments
is significantly greater than that of
4
<PAGE> 45
U.S. Government securities. See "Other Portfolio Strategies -- Foreign
Securities" in the Appendix to this Prospectus.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the "World Bank"), the European Steel and Coal Community, the Asian
Development Bank and the Inter-American Development Bank. The government
members, or "stockholders," usually make initial capital contributions to the
supranational entity and in many cases are committed to make additional capital
contributions if the supranational entity is unable to repay its borrowings.
Allocation of Investments. In seeking to meet its investment objective,
high current income will be only one of the factors that the Investment Adviser
will consider in selecting portfolio securities for the Global Bond Focus Fund.
As a general matter, in evaluating investments for the Fund, the Investment
Adviser will consider, among other factors, the relative levels of interest
rates prevailing in various countries, the potential appreciation of such
investments in their denominated currencies and, for debt instruments not
denominated in U.S. dollars, the potential movement in the value of such
currencies compared to the U.S. dollar. Additionally, the Fund, in seeking
capital appreciation, may invest in relatively low yielding instruments in
expectation of favorable currency fluctuations or interest rate movements,
thereby potentially reducing the Fund's current yield. In seeking income, the
Fund may invest in short term instruments with relatively high yields (as
compared to other debt securities) meeting the Fund's investment criteria,
notwithstanding that the Fund may not anticipate that such instruments will
experience substantial capital appreciation.
The average maturity of the Global Bond Focus Fund's portfolio securities
will vary based upon the Investment Adviser's assessment of economic and market
conditions. As with all fixed income securities, changes in market yields will
affect the Fund's asset value as the prices of portfolio securities generally
increase when interest rates decline and decrease when interest rates rise.
Prices of longer-term securities generally fluctuate more in response to
interest rate changes than do shorter-term securities. The Global Bond Focus
Fund does not expect the average maturity of its portfolio to exceed ten years.
OTHER INVESTMENTS AND RISKS
In addition, the Global Bond Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may invest in securities of foreign issuers. Investments in foreign securities,
particularly those of non-governmental issuers, involve considerations and risks
that are not ordinarily associated with investing in domestic issuers. These
considerations and risks include changes in currency rates, currency exchange
control regulations, the possibility of expropriation, confiscatory taxation,
high rates of inflation, the unavailability of financial information or the
difficulty of interpreting financial information prepared under foreign
accounting standards, less liquidity and more volatility in foreign securities
markets, the impact of political, social or diplomatic developments, and the
difficulty of assessing economic trends in foreign countries. In addition, net
investment income earned by the Fund on a foreign security may be subject to
withholding and other taxes imposed by foreign governments, which will reduce
the Fund's net investment income. The Global Bond Focus Fund may also from time
to time be substantially invested in non-dollar-denominated securities of
foreign issuers. The value of the Global Bond Focus Fund's holdings denominated
in currencies other than the U.S. dollar and the unrealized appreciation or
depreciation of those investments insofar as United States investors are
concerned will be affected by changes in the value of such currencies relative
to the U.S. dollar. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. Such currency fluctuations may have a substantial impact on the
value of the Fund's holdings. The Fund may engage in transactions, such as
currency swaps and purchasing and selling options on currencies, for purposes of
hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the US dollar. Although such instruments will
be used with the intention of hedging against adverse currency movements,
transactions in such instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective and may cause the Fund to realize losses. The
Global Bond Focus Fund may also invest in debt securities issued by foreign
governments. See
5
<PAGE> 46
"Other Portfolio Strategies -- Foreign Securities" in the Appendix and Annex B
of the Appendix to this Prospectus.
The Global Bond Focus Fund is authorized to write (i.e., sell) and to
purchase call and put options on securities held in its portfolio or securities
indices the performance of which is substantially correlated with securities
held in its portfolio, may engage in transactions in futures and may invest in
securities the potential return of which is based on the change in particular
measurements of value or rate (i.e., indexed securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed securities, options and
futures.
6
<PAGE> 47
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GLOBAL UTILITY FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Global Utility Focus Fund, (the "Global Utility Focus Fund")
is a diversified fund whose objective is capital appreciation and current income
through investment of at least 65% of its total assets in equity and debt
securities issued by domestic and foreign companies which are, in the opinion of
the Investment Adviser (defined below), primarily engaged in the ownership or
operation of facilities used to generate, transmit or distribute electricity,
telecommunications, gas or water. The Global Utility Focus Fund is a separate
fund of the Merrill Lynch Variable Series Funds, Inc. (the "Company"), an
open-ended management investment company that has a wide range of investment
objectives among its eighteen separate funds (hereinafter referred to as the
"Funds" or individually as a "Fund"). Two separate classes of common stock
("Common Stock"), Class A Common Stock and Class B Common Stock, are issued for
each Fund. The Company is offering shares of its Class A Common Stock for the
Global Utility Focus Fund pursuant to this Prospectus. This Prospectus consists
of this eight page document and the attached Appendix. For more information on
the Global Utility Focus Fund's investment objective and policies, please see
page 4 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objective and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 48
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 49
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
GLOBAL UTILITY FOCUS FUND (CLASS A)
--------------------------------------------------------
FOR THE
PERIOD
JULY 1,
FOR THE YEAR ENDED DECEMBER 31, 1993+ TO
----------------------------------------- DECEMBER 31,
1997 1996 1995 1994 1993
-------- -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) In Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period...... $ 12.19 $ 11.30 $ 9.45 $ 10.66 $ 10.00
-------- -------- -------- -------- --------
Investment income -- net.................. .43 .46 .45 .35 .04
Realized and unrealized gain (loss) on
investments and foreign currency
transactions -- net..................... 2.66 .95 1.79 (1.25) .64
-------- -------- -------- -------- --------
Total from investment operations.......... 3.09 1.41 2.24 (.90) .68
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income -- net.................. (.44) (.52) (.39) (.29) (.02)
In excess of realized gain on
investments -- net...................... -- -- -- (.02) --
-------- -------- -------- -------- --------
Total dividends and distributions......... (.44) (.52) (.39) (.31) (.02)
-------- -------- -------- -------- --------
Net asset value, end of period............ $ 14.84 $ 12.19 $ 11.30 $ 9.45 $ 10.66
======== ======== ======== ======== ========
Total Investment Return:**
Based on net asset value per share........ 25.90% 12.96% 24.33% (8.51)% 6.85%#
======== ======== ======== ======== ========
Ratios To Average Net Assets:
Expenses.................................. .67% .66% .66% .73% .89%*
======== ======== ======== ======== ========
Investment income -- net.................. 3.21% 3.90% 4.44% 3.68% 2.84%*
======== ======== ======== ======== ========
Supplemental Data:
Net assets, end of period (in
thousands).............................. $138,206 $142,438 $148,225 $126,243 $104,517
======== ======== ======== ======== ========
Portfolio turnover........................ 7.70% 11.39% 11.05% 9.52% 1.72%
======== ======== ======== ======== ========
Average commission rate paid***........... $ .0273 $ .0522 -- -- --
======== ======== ======== ======== ========
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into U.S.
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
+ Commencement of Operations.
# Aggregate total investment return.
3
<PAGE> 50
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Global Utility Focus Fund is to seek both
capital appreciation and current income through investment of at least 65% of
its total assets in equity and debt securities issued by domestic and foreign
companies which are, in the opinion of Merrill Lynch Asset Management, L.P. (the
"Investment Adviser"), primarily engaged in the ownership or operation of
facilities used to generate, transmit or distribute electricity,
telecommunications, gas or water. There can be no assurance that the Global
Utility Focus Fund will achieve its investment objective. The Fund may employ a
variety of instruments and techniques to enhance income and to hedge against
market and currency risk, as described in Annex B to the Appendix to this
Prospectus. Investing on an international basis involves special considerations.
See "Other Investments and Risks" below. The Fund should be considered a
long-term investment and a vehicle for diversification, and not as a balanced
investment program. The Fund may not be appropriate as the exclusive investment
to fund a variable annuity or variable life insurance contract ("Contract") for
all Contract owners.
The Global Utility Focus Fund at all times, except during temporary
defensive periods, will maintain at least 65% of its total assets invested in
equity and debt securities issued by domestic and foreign companies in the
utilities industries. The Fund reserves the right to hold, as a temporary
defensive measure or as a reserve for redemptions, short-term U.S. Government
securities, money market securities, including repurchase agreements, or cash in
such proportions as, in the opinion of the Investment Adviser, prevailing market
or economic conditions warrant. Except during temporary defensive periods, such
securities or cash will not exceed 20% of its total assets. Under normal
circumstances, the Fund will invest at least 65% of its total assets in issuers
domiciled in at least three countries, one of which may be the United States,
although the Investment Adviser expects the Fund's portfolio to be more
geographically diversified. Under normal conditions, it is anticipated that the
percentage of assets invested in U.S. securities will be higher than that
invested in securities of any other single country. It is possible that at times
the Fund may have 65% or more of its total assets invested in foreign
securities.
The Global Utility Focus Fund will invest in common stocks (including
preferred or debt securities convertible into common stocks), preferred stocks
and debt securities. The relative weightings among common stocks, debt
securities and preferred stocks will vary from time to time based upon the
Investment Adviser's judgment of the extent to which investments in each
category will contribute to meeting the Fund's investment objective. Fixed
income securities in which the Fund will invest generally will be limited to
those rated investment grade, that is, rated in one of the four highest rating
categories by Standard & Poor's Ratings Group ("Standard & Poor's") or Moody's
Investors Service, Inc. ("Moody's") (i.e., securities rated at least BBB by
Standard & Poor's or Baa by Moody's), or deemed to be of equivalent quality in
the judgment of the Investment Adviser. Securities rated Baa by Moody's are
described by it as having speculative characteristics and, according to Standard
& Poor's, fixed income securities rated BBB normally exhibit adequate protection
parameters, although adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal.
The Fund's commercial paper investments at the time of purchase will be rated
"A-1" or "A-2" by Standard & Poor's or "Prime-1" or "Prime-2" by Moody's or, if
not rated, will be of comparable quality as determined by the Investment
Adviser. The Fund may also invest up to 5% of its total assets at the time of
purchase in fixed income securities having a minimum rating no lower than Caa by
Moody's or CCC by Standard & Poor's. The Fund may, but need not, dispose of any
security if it is subsequently downgraded. For a description of ratings of debt
securities, see Annex A to the Appendix to this Prospectus.
A change in prevailing interest rates is likely to affect the Fund's net
asset value because prices of debt and equity securities of utility companies
tend to increase when interest rates decline and decrease when interest rates
rise.
Utility Industries -- Description and Risks. Under normal circumstances,
the Global Utility Focus Fund will invest at least 65% of its total assets in
common stocks (including preferred or debt securities convertible into common
stocks), debt securities and preferred stocks of domestic and/or foreign
companies in the utility industries. To meet its objective of current income,
the Fund may invest in domestic utility companies that pay higher than average
dividends, but have a lesser potential for capital appreciation. The average
dividend yields of common stocks issued by domestic utility companies
historically have significantly exceeded those of industrial companies' common
stocks, while the prices of domestic utility stocks have tended to be less
volatile than stocks of industrial companies. The Investment Adviser believes
that the average dividend yields of common stocks
4
<PAGE> 51
issued by foreign utility companies have also historically exceeded those of
foreign industrial companies' common stocks. To pursue its objective of capital
appreciation, the Fund may invest in foreign utility companies that pay lower
than average dividends, but have a greater potential for capital appreciation.
The utility companies in which the Fund will invest include companies that
are, in the opinion of the Investment Adviser, primarily engaged in the
ownership or operation of facilities used to generate, transmit or distribute
electricity, telecommunications, gas or water.
Investments in utility industries bear certain risks, including difficulty
in obtaining an adequate return on invested capital, difficulty in financing
large construction programs during an inflationary period, restrictions on
operations and increased cost and delays attributable to environmental
considerations and regulation, difficulty in raising capital in adequate amounts
on reasonable terms in periods of high inflation and unsettled capital markets,
technological innovations which may render existing plants, equipment or
products obsolete, the potential impact of natural or man-made disasters,
increased costs and reduced availability of certain types of fuel, occasionally
reduced availability and high costs of natural gas for resale, the effects of
energy conservation, the effects of a national energy policy and lengthy delays
and greatly increased costs and other problems associated with design,
construction, licensing, regulation and operation of nuclear facilities for
electric generation, including, among other considerations, the problems
associated with the use of radioactive materials and the disposal of radioactive
wastes. There are substantial differences between the regulatory practices and
policies of various jurisdictions, and any given regulatory agency may make
major shifts in policy from time to time. There is no assurance that regulatory
authorities will, in the future, grant rate increases or that such increases
will be adequate to permit the payment of dividends on common stocks.
Additionally, existing and possible future regulatory legislation may make it
even more difficult for these utilities to obtain adequate relief. Certain of
the issuers of securities in the portfolio may own or operate nuclear generating
facilities. Governmental authorities may from time to time review existing
policies, and impose additional requirements governing the licensing,
construction and operation of nuclear power plants.
Utility companies in the United States and in foreign countries are
generally subject to regulation. In the United States, most utility companies
are regulated by state and/or federal authorities. Such regulation is intended
to ensure appropriate standards of service and adequate capacity to meet public
demand. Generally, prices are also regulated in the United States and in foreign
countries with the intention of protecting the public while ensuring that the
rate of return earned by utility companies is sufficient to allow them to
attract capital in order to grow and continue to provide appropriate services.
There can be no assurance that such pricing policies or rates of return will
continue in the future. The nature of regulation of the utility industries is
evolving both in the United States and in foreign countries. Changes in
regulation in the United States increasingly allow utility companies to provide
services and products outside their traditional geographic areas and lines of
business, creating new areas of competition within the industries. In some
instances, utility companies are operating on an unregulated basis. Because of
trends toward deregulation and the evolution of independent power producers as
well as new entrants to the field of telecommunications, non-regulated providers
of utility services have become a significant part of their respective
industries. The Investment Adviser believes that the emergence of competition
and deregulation will result in certain utility companies being able to earn
more than their traditional regulated rates of return, while others may be
forced to defend their core businesses from increased competition and may be
less profitable. The Investment Adviser seeks to take advantage of favorable
investment opportunities that are expected to arise from these structural
changes. Of course, there can be no assurance that favorable developments will
occur in the future.
Foreign utility companies are also subject to regulation, although such
regulations may or may not be comparable to that in the United States. Foreign
utility companies may be more heavily regulated by their respective governments
than utilities in the United States and, as in the U.S., generally are required
to seek government approval for rate increases. In addition, many foreign
utilities use fuels that cause more pollution than those used in the United
States, which may require such utilities to invest in pollution control
equipment to meet any proposed pollution restrictions. Foreign regulatory
systems vary from country to country and may evolve in ways different from
regulation in the United States.
The principal sectors of the global utility industries are discussed below.
Electric. The electric utility industry consists of companies that are
engaged principally in the generation, transmission and sale of electric energy,
although many also provide other energy-related services. Domestic
5
<PAGE> 52
electric utility companies, in general, recently have been favorably affected by
lower fuel and financing costs and the full or near completion of major
construction programs. In addition, certain of these companies generate cash
flows in excess of current operating expenses and construction expenditures,
permitting some degree of diversification into unregulated businesses. Some
electric utilities have also taken advantage of the right to sell power outside
of their traditional geographic areas. Electric utility companies have
historically been subject to the risks associated with increases in fuel and
other operating costs, high interest costs on borrowings needed for capital
construction programs, costs associated with compliance with environmental and
safety regulations and changes in the regulatory climate. As interest rates have
declined, many utilities have refinanced high cost debt and in doing so have
improved their fixed charges coverage. Regulators, however, have lowered allowed
rates of return as interest rates have declined and thereby caused the benefits
of the rate declines to be shared wholly or in part with customers.
In the United States, the construction and operation of nuclear power
facilities is subject to increased scrutiny by, and evolving regulations of, the
Nuclear Regulatory Commission and state agencies having comparable jurisdiction.
Increased scrutiny might result in higher operating costs and higher capital
expenditures, with the risk that the regulators may disallow inclusion of these
costs in rate authorizations or the risk that a company may not be permitted to
operate or complete construction of a facility. In addition, operators of
nuclear power plants may be subject to significant costs for disposal of nuclear
fuel and for decommissioning of such plants.
In October 1993, Standard & Poor's stiffened its debt-ratings formula for
the electric utility industry, stating that the industry is in long-term
decline. In addition, Moody's stated that it expected a drop in the next three
years in its average credit ratings for the industry. Reasons set forth for
these outlooks included slowing demand and increasing cost pressures as a result
of competition from rival providers.
Telecommunications. The telephone industry is large and highly
concentrated. Companies that distribute telephone services and provide access to
the telephone networks comprise the greatest portion of this segment. Telephone
companies in the United States are still experiencing the effects of the breakup
of American Telephone & Telegraph Company, which occurred in 1984. Since 1984,
companies engaged in telephone communication services have expanded their
non-regulated activities into other businesses, including cellular telephone
services, data processing, equipment retailing, computer software and hardware
services, and financial services. This expansion has provided significant
opportunities for certain telephone companies to increase their earnings and
dividends at faster rates than had been allowed in traditional regulated
businesses. Increasing competition, technological innovations and other
structural changes, however, could adversely affect the profitability of such
utilities. Technological breakthroughs and the merger of telecommunications with
video and entertainment is now associated with the expansion of the role of
cable companies as providers of utility services in the telecommunications
industry and the competitive response of traditional telephone companies. Given
mergers and certain marketing tests currently underway, it is likely that both
traditional telephone companies and cable companies will soon provide a greatly
expanded range of utility services, including two-way video and informational
services.
Gas. Gas transmission companies and gas distribution companies are also
undergoing significant changes. In the United States, interstate transmission
companies are regulated by the Federal Energy Regulatory Commission, which is
reducing its regulation of the industry. Many companies have diversified into
oil and gas exploration and development, making returns more sensitive to energy
prices. In the recent decades, gas utility companies have been adversely
affected by disruptions in the oil industry and have also been affected by
increased concentration and competition.
Water. Water supply utilities are companies that collect, purify,
distribute and sell water. In the United States and around the world, the
industry is highly fragmented because most of the supplies are owned by local
authorities. Companies in this industry are generally mature and are
experiencing little or no per capita volume growth.
Investment Outside the Utility Industries. The Global Utility Focus Fund
is permitted to invest up to 35% of its assets in securities of issuers that are
outside the utility industries. Such investments may include common stocks, debt
securities or preferred stocks and will be selected to meet the Fund's
investment objective of both capital appreciation and current income. These
securities may be issued by either U.S. or non-U.S. companies. Some of these
issuers may be in industries related to utility industries and, therefore, may
be subject to similar
6
<PAGE> 53
risks. Securities that are issued by foreign companies or are denominated in
foreign currencies are subject to certain risks. See "Other Investments and
Risks" below.
The Global Utility Focus Fund is also permitted to invest in securities
issued or guaranteed by the U.S. Government, its agencies or instrumentalities
and in securities issued or guaranteed by foreign governments. Foreign
government securities are typically denominated in foreign currencies and are
subject to the currency fluctuation and other risks of foreign securities
investments. The foreign government securities in which the Fund intends to
invest generally will consist of obligations supported by national, state or
local governments or similar political subdivisions. Foreign government
securities also include debt obligations of supranational entities, including
international organizations designated or supported by governmental entities to
promote economic reconstruction or development and international banking
institutions and related government agencies. Examples include the International
Bank for Reconstruction and Development (the "World Bank"), the European
Investment Bank, the Asian Development Bank and the Inter-American Development
Bank.
Foreign government securities also include debt securities of
"quasi-governmental agencies" and debt securities denominated in multinational
currency units. An example of a multinational currency unit is the European
Currency Unit. A European Currency Unit represents specified amounts of the
currencies of certain of the twelve member states of the European Economic
Community. Debt securities of quasi-governmental agencies are issued by entities
owned by either a national or local government or are obligations of a political
unit that is not backed by the national government's full faith and credit and
general taxing powers. Foreign government securities will not be considered
government securities for purposes of determining the Fund's compliance with
diversification and concentration policies.
OTHER INVESTMENTS AND RISKS
In addition, the Global Utility Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Global
Utility Focus Fund may also invest in securities of foreign issuers. Investments
in foreign securities, particularly those of non-governmental issuers, involve
considerations and risks that are not ordinarily associated with investing in
domestic issuers. These considerations and risks include changes in currency
rates, currency exchange control regulations, the possibility of expropriation,
confiscatory taxation, high rates of inflation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of political, social or diplomatic
developments, and the difficulty of assessing economic trends in foreign
countries. In addition, net investment income earned by the Fund on a foreign
security may be subject to withholding and other taxes imposed by foreign
governments which will reduce the Fund's net investment income. The Global
Utility Focus Fund may from time to time be substantially invested in
non-dollar-denominated securities of foreign issuers. Changes in the foreign
currency exchange rates may affect the value of securities in the portfolio and
the unrealized appreciation or depreciation of investments insofar as United
States investors are concerned. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. The Global Utility Focus Fund may also engage in transactions, such
as currency swaps and purchasing and selling options on currencies, for purposes
of hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the US dollar. Although such instruments will
be used with the intention of hedging against adverse currency movements,
transactions in such instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective and may cause the Fund to realize losses. See
"Other Portfolio Strategies -- Foreign Securities" in the Appendix to this
Prospectus.
The Global Utility Focus Fund may from time to time enter into standby
commitment agreements, engage in transactions in futures, invest in securities
the potential return of which is based on the change in particular measurements
of value or rate (i.e. indexed securities), and, is authorized to write (i.e.,
sell) call and put options and purchase put options on securities held in its
portfolio or securities indices the performance of which is substantially
correlated with securities held in its portfolio.
7
<PAGE> 54
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed securities, options, futures
and foreign exchange transactions.
8
<PAGE> 55
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH INTERNATIONAL EQUITY FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch International Equity Focus Fund, (the "International Equity
Focus Fund") is a diversified fund whose objectives are capital appreciation
and, secondarily, income, through investment in securities, principally
equities, of issuers in countries other than the United States. The
International Equity Focus Fund is a separate fund of the Merrill Lynch Variable
Series Funds, Inc. (the "Company"), an open-ended management investment company
that has a wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class A Common Stock for the International Equity Focus Fund pursuant to
this Prospectus. This Prospectus consists of this six page document and the
attached Appendix. For more information on the International Equity Focus Fund's
investment objectives and policies, please see page 4 of this documents and the
Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objectives and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 56
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 57
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
INTERNATIONAL EQUITY FOCUS FUND (CLASS A)
--------------------------------------------------------
FOR THE
PERIOD
JULY 1,
FOR THE YEAR ENDED DECEMBER 31, 1993+ TO
----------------------------------------- DECEMBER 31,
1997++ 1996++ 1995 1994 1993
-------- -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period..... $ 11.63 $ 11.06 $ 10.90 $ 11.03 $ 10.00
-------- -------- -------- -------- -------
Investment income -- net................. .20 .23 .20 .19 .01
Realized and unrealized gain (loss) on
investments and foreign currency
transactions -- net.................... (.71) .49 .37 (.13) 1.02
-------- -------- -------- -------- -------
Total from investment operations......... (.51) .72 .57 .06 1.03
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income -- net............... (.23) (.15) (.01) (.18) --
Realized gain on investments -- net.... (.09) -- (.17) (.01) --
In excess of realized gain on
investments -- net.................. -- -- (.23) -- --
-------- -------- -------- -------- -------
Total dividends and distributions........ (.32) (.15) (.41) (.19) --
-------- -------- -------- -------- -------
Net asset value, end of period........... $ 10.80 $ 11.63 $ 11.06 $ 10.90 $ 11.03
======== ======== ======== ======== =======
Total Investment Return:**
Based on net asset value per share....... (4.55)% 6.62% 5.48% .55% 10.30%#
======== ======== ======== ======== =======
Ratios to Average Net Assets:
Expenses................................. .90% .89% .89% .97% 1.14%*
======== ======== ======== ======== =======
Investment income -- net................. 1.69% 1.96% 1.95% 1.09% .30%*
======== ======== ======== ======== =======
Supplemental Data:
Net assets, end of period (in
thousands)............................. $425,223 $349,080 $265,602 $247,884 $76,906
======== ======== ======== ======== =======
Portfolio turnover....................... 127.96% 49.87% 100.02% 58.84% 17.39%
======== ======== ======== ======== =======
Average commission rate paid***.......... $ .0011 $ .0004 -- -- --
======== ======== ======== ======== =======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into U.S.
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
+ Commencement of Operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
3
<PAGE> 58
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the International Equity Focus Fund are to
seek capital appreciation and, secondarily, income by investing in a diversified
portfolio of equity securities of issuers located in countries other than the
United States. Under normal conditions, at least 65% of the Fund's net assets
will be invested in such equity securities and at least 65% of the Fund's total
assets will be invested in the securities of issuers from at least three
different foreign countries. The investment objective of the Fund is a
fundamental policy and may not be changed without approval of a majority of the
Fund's outstanding shares. There can be no assurance that the International
Equity Focus Fund will achieve its investment objectives. The Fund may employ a
variety of investments and techniques to hedge against market and currency risk.
See Annex B of the Appendix to this Prospectus. Investing on an international
basis involves special considerations. Investing in smaller capital markets
entails the risk of significant volatility in the Fund's security prices. The
Fund is designed for investors seeking to complement their U.S. holdings through
foreign investments. The Fund should be considered a long-term investment and a
vehicle for diversification, and not as a balanced investment program. The Fund
may not be appropriate as the exclusive investment to fund a variable annuity or
variable life insurance contract ("Contract") for all Contract owners.
The International Equity Focus Fund will invest in an international
portfolio of securities of foreign companies located throughout the world. While
there are no prescribed limits on the geographic allocation of the Fund's
investments, management of the Fund anticipates that a substantial portion of
its assets will be invested in the developed countries of Europe and the Far
East. For the reasons stated below, management of the Fund will give special
attention to investment opportunities in the developing countries of the world,
including, but not limited to Latin America, the Far East and Eastern Europe. It
is anticipated that a significant portion of the Fund's assets may be invested
in such developing countries.
The allocation of the International Equity Focus Fund's assets among the
various foreign securities markets will be determined by Merrill Lynch Asset
Management, L.P. (the "Investment Adviser") based primarily on its assessment of
the relative condition and growth potential of the various economies and
securities markets, currency and taxation considerations and other pertinent
financial, social, national and political factors. Within such allocations, the
Investment Adviser will seek to identify equity investments in each market that
are expected to provide a total return that equals or exceeds the return of such
market as a whole.
A significant portion of the International Equity Focus Fund's assets may
be invested in developing countries. This allocation of the Fund's assets
reflects the belief that attractive investment opportunities may result from an
evolving long-term international trend favoring more market-oriented economies,
a trend that may especially benefit certain developing countries with smaller
capital markets. This trend may be facilitated by local or international
political, economic or financial developments that could benefit the capital
markets of such countries. Certain such countries, particularly so-called
"emerging" countries (such as Malaysia, Mexico and Thailand), which may be in
the process of developing more market-oriented economies, may experience
relatively high rates of economic growth. Because of the general illiquidity of
the capital markets in certain developing countries, the Fund may invest in a
relatively small number of leading or relatively actively traded companies in
the capital markets of such a country in the expectation that the investment
experience of the securities of such companies will substantially represent the
investment experience of that country's capital markets as a whole.
While the International Equity Focus Fund will primarily emphasize
investments in common stock, the Fund may also invest in preferred stocks,
convertible debt securities and other instruments the return on which is linked
to the performance of a common stock or a basket or index of common stocks
(collectively, "equity securities"). The Fund may also invest in non-equity
securities, including debt securities, cash or cash equivalents denominated in
U.S. dollars or foreign currencies and short-term securities, including money
market instruments. Under certain adverse investment conditions, for defensive
purposes, the Fund may restrict the markets in which its assets will be invested
and may increase the proportion of assets invested in short-term obligations of
U.S. issuers. Investments made for defensive purposes will be maintained only
during periods in which the Investment Adviser determines that economic or
financial conditions are adverse for holding or being fully invested in equity
securities of foreign issuers.
The International Equity Focus Fund also may invest up to 35% of its net
assets in longer-term, non-convertible debt securities emphasizing debt
securities which offer the opportunity for capital appreciation.
4
<PAGE> 59
Capital appreciation in debt securities may arise as a result of a favorable
change in relative foreign exchange rates, in relative interest rate levels, or
in the creditworthiness of issuers. In accordance with its investment objective,
the Fund will not seek to benefit from anticipated short-term fluctuations in
currency exchange rates. The Fund may, from time to time, invest in debt
securities with relatively high yields (as compared to other debt securities
meeting the Fund's investment criteria), notwithstanding that the Fund may not
anticipate that such securities will experience substantial capital
appreciation. Such income can be used, however, to offset the operating expenses
of the Fund.
The International Equity Focus Fund may invest in debt securities issued or
guaranteed by foreign governments (including foreign states, provinces and
municipalities) or their agencies and instrumentalities ("governmental
entities"), issued or guaranteed by international organizations designated or
supported by multiple foreign governmental entities (which are not obligations
of foreign governments) to promote economic reconstruction or development
("supranational entities"), or issued by foreign corporations or financial
institutions.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the "World Bank"), the European Steel and Coal Community, the Asian
Development Bank and the Inter-American Development Bank. The governmental
members, or "stockholders," usually make initial capital contributions to the
supranational entity and in many cases are committed to make additional capital
contributions if the supranational entity is unable to repay its borrowings.
OTHER INVESTMENTS AND RISKS
In addition, the International Equity Focus Fund may purchase certain
securities that are not registered under the Securities Act of 1933, as amended,
and which therefore may be subject to restrictions on their transfer or resale.
The International Equity Focus Fund has established no rating criteria for
the debt securities in which it may invest, and such securities may not be rated
at all for creditworthiness. Securities rated in the medium to lower rating
categories of nationally recognized statistical rating organizations and unrated
securities of comparable quality are predominantly speculative with respect to
the capacity to pay interest and repay principal in accordance with the terms of
the security and generally involve a greater volatility of price than securities
in higher rating categories. In purchasing such securities, the Fund will rely
on the Investment Adviser's judgment, analysis and experience in evaluating the
creditworthiness of an issuer of such securities. The Investment Adviser will
take into consideration, among other things, the issuer's financial resources,
its sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters. The Fund does not
intend to purchase debt securities that are in default or that the Investment
Adviser believes will be in default. See "Risks of High Yield Securities" in the
Appendix to this Prospectus.
The Fund may invest in securities of foreign issuers. Investments in
foreign securities, particularly those of non-governmental issuers, involve
considerations and risks that are not ordinarily associated with investing in
domestic issuers. These considerations and risks include changes in currency
rates, currency exchange control regulations, the possibility of expropriation,
confiscatory taxation, high rates of inflation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of political, social or diplomatic
developments, and the difficulty of assessing economic trends in foreign
countries. In addition, net investment income earned by the Fund on a foreign
security may be subject to withholding and other taxes imposed by foreign
governments, which will reduce the Fund's net investment income. The Fund may
from time to time be substantially invested in non-dollar-denominated securities
of foreign issuers. Changes in foreign currency exchange rates may affect the
value of securities in the portfolio and the unrealized appreciation or
depreciation of investments insofar as United States investors are concerned.
Furthermore, the Fund's return on investments in non-dollar-denominated
securities may be reduced or enhanced as a result of changes in foreign currency
rates during the period in which the Fund holds such investments. See "Other
Portfolio Strategies -- Foreign Securities" in the Appendix to this Prospectus.
5
<PAGE> 60
The International Equity Focus Fund may engage in transactions, such as
currency swaps and purchasing and selling options on currencies, for purposes of
hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the US dollar. Although such instruments will
be used with the intention of hedging against adverse currency movements,
transactions in such instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the International Equity
Focus Fund's hedging strategies will be ineffective and may cause the Fund to
realize losses.
The International Equity Focus Fund may also invest a significant portion
of its assets in securities of foreign issuers in smaller capital markets.
Foreign investments involve risks that are often heightened for investments in
smaller capital markets. There may be less publicly available information about
an issuer in a smaller capital market than would be available about a United
States company, and it may not be subject to accounting, auditing and financial
reporting standards and requirements comparable to those of United States
companies. Furthermore, smaller capital markets have substantially less volume
than United States markets so securities in many smaller capital markets are
less liquid and their prices may be more volatile than securities of comparable
United States companies. As a result, traditional investment measurements, such
as price/earnings ratios, as used in the United States, may not be applicable in
certain capital markets. See "Other Portfolio Strategies -- Foreign Securities"
in the Appendix to this Prospectus.
The International Equity Focus Fund is also authorized to write (i.e.,
sell) and purchase call and put options on securities held in its portfolio or
securities indices the performance of which is substantially correlated with
securities held in its portfolio, engage in transactions in futures and options
thereon, and may invest in securities the potential return of which is based on
the change in particular measurements of value or rate (i.e. indexed and inverse
securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed and inverse securities,
options, futures and foreign exchange transactions.
6
<PAGE> 61
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH DEVELOPING CAPITAL MARKETS FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Developing Capital Markets Focus Fund, (the "Developing
Capital Markets Focus Fund") is a non-diversified fund whose objective is
long-term capital appreciation by investing in securities, principally equities,
of issuers in countries having smaller capital markets. The Developing Capital
Markets Focus Fund is a separate fund of the Merrill Lynch Variable Series
Funds, Inc. (the "Company"), an open-ended management investment company that
has a wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class A Common Stock for the Developing Capital Markets Focus Fund
pursuant to this Prospectus. This Prospectus consists of this six page document
and the attached Appendix. For more information on the Developing Capital
Markets Focus Fund's investment objective and policies, please see page 4 of
this document and the Appendix.
THE DEVELOPING CAPITAL MARKETS FOCUS FUND INVESTS OR MAY INVEST IN HIGH
YIELD BONDS (COMMONLY KNOWN AS "JUNK BONDS"), WHICH INVOLVE SPECIAL RISKS. SEE
"INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS -- RISKS OF HIGH YIELD
SECURITIES" IN THE APPENDIX TO THIS PROSPECTUS.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objective and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 62
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 63
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
DEVELOPING CAPITAL MARKETS FOCUS FUND (CLASS A)
--------------------------------------------------
FOR THE
PERIOD
MAY 2,
FOR THE YEAR ENDED DECEMBER 31, 1994+ TO
--------------------------------- DECEMBER 31,
1997 1996 1995 1994
--------- -------- -------- -------------
<S> <C> <C> <C> <C>
Increase (Decrease) In Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period.............. $ 10.05 $ 9.32 $ 9.51 $ 10.00
-------- ------- ------- -------
Investment income -- net.......................... .11 .20 .20 .09
Realized and unrealized gain (loss) on investments
and foreign currency transactions -- net........ (.75) .76 (.30) (.58)
-------- ------- ------- -------
Total from investment operations.................. (.64) .96 (.10) (.49)
-------- ------- ------- -------
Less dividends:
Investment income -- net.......................... (.19) (.23) (.09) --
-------- ------- ------- -------
Total dividends................................... (.19) (.23) (.09) --
-------- ------- ------- -------
Net asset value, end of period.................... $ 9.22 $ 10.05 $ 9.32 $ 9.51
======== ======= ======= =======
Total Investment Return:**
Based on net asset value per share................ (6.53)% 10.59% (1.08)% (4.90)%#
======== ======= ======= =======
Ratios To Average Net Assets:
Expenses, net of reimbursement.................... 1.25% 1.25% 1.25% 1.29%*
======== ======= ======= =======
Expenses.......................................... 1.42% 1.31% 1.36% 1.35%*
======== ======= ======= =======
Investment income -- net.......................... 1.15% 2.42% 2.73% 2.18%*
======== ======= ======= =======
Supplemental Data:
Net assets, end of period (in thousands).......... $141,451 $95,599 $55,209 $36,676
======== ======= ======= =======
Portfolio turnover................................ 93.62% 87.33% 62.53% 29.79%
======== ======= ======= =======
Average commission rate paid***................... $ .0015 $ .0003 -- --
======== ======= ======= =======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into U.S.
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
+ Commencement of Operations.
# Aggregate total investment return.
3
<PAGE> 64
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Developing Capital Markets Focus Fund is to
seek long-term capital appreciation by investing in securities, principally
equities, of issuers in countries having smaller capital markets. Under normal
conditions, at least 65% of the Fund's net assets will be invested in such
equity securities. The investment objective of the Fund is a fundamental policy
and may not be changed without approval of a majority of the Fund's outstanding
shares. There can be no assurance that the Fund will achieve its investment
objective. The Developing Capital Markets Focus Fund may employ a variety of
investments and techniques to hedge against market and currency risk. See Annex
B to the Appendix to this Prospectus. Investing on an international basis
involves special considerations. Investing in smaller capital markets entails
the risk of significant volatility in the Fund's security prices. See "Other
Investments and Risks" below. The Developing Capital Markets Focus Fund is
designed for investors seeking to complement their U.S. holdings through foreign
investments. The Fund should be considered a long-term investment and a vehicle
for diversification, and not as a balanced investment program. The Fund may not
be appropriate as the exclusive investment to fund a variable annuity or
variable life insurance contract ("Contract") for all Contract owners.
For purposes of its investment objective, the Developing Capital Markets
Focus Fund considers countries having smaller capital markets to be all
countries other than the four countries having the largest equity market
capitalizations. Currently, these four countries are Japan, the United Kingdom,
the United States and Germany. At December 31, 1997, those countries' equity
market capitalizations totalled approximately 75% of the world's equity market
capitalization according to data provided by Morgan Stanley Capital
International. The Fund will at all times, except during defensive periods,
maintain investments in at least three countries having smaller capital markets.
The Developing Capital Markets Focus Fund seeks to benefit from economic
and other developments in smaller capital markets. The investment objective of
the Fund reflects the belief that investment opportunities may result from an
evolving long-term international trend favoring more market-oriented economies,
a trend that may especially benefit certain countries having smaller capital
markets. This trend may be facilitated by local or international political,
economic or financial developments that could benefit the capital markets of
such countries. Certain such countries, particularly so-called "emerging"
countries (such as Malaysia, Mexico and Thailand) which may be in the process of
developing more market-oriented economies, may experience relatively high rates
of economic growth. Other countries (such as France, the Netherlands and Spain),
although having relatively mature smaller capital markets, may also be in a
position to benefit from local or international developments encouraging greater
market orientation and diminishing governmental intervention in economic
affairs.
Many investors, particularly individuals, lack the information, capability
or inclination to invest in countries having smaller capital markets. It also
may not be permissible for such investors to invest directly in certain such
markets. Unlike many intermediary investment vehicles, such as closed-end
investment companies that invest in a single country, the Fund intends to
diversify investment risk among the capital markets of a number of countries.
The Fund will not necessarily seek to diversify investments on a geographical
basis or on the basis of the level of economic development of any particular
country.
In its investment decision-making, Merrill Lynch Asset Management, L.P.
(the "Investment Adviser") will emphasize the allocation of assets among certain
countries' capital markets, rather than the selection of particular industries
or issuers. Because of the general illiquidity of the capital markets in some
countries, the Fund may invest in a relatively small number of leading or
actively traded companies in a country's capital markets in the expectation that
the investment experience of the securities of such companies will substantially
represent the investment experience of the country's capital markets as a whole.
The Developing Capital Markets Focus Fund also may invest in debt
securities of issuers in countries having smaller capital markets. Capital
appreciation in debt securities may arise as a result of a favorable change in
relative foreign exchange rates, in relative interest rate levels, or in the
creditworthiness of issuers. In accordance with its investment objective, the
Fund will not seek to benefit from anticipated short-term fluctuations in
currency exchange rates. The Fund may, from time to time, invest in debt
securities with relatively high yields (as compared to other debt securities
meeting the Fund's investment criteria), notwithstanding that the Fund may not
anticipate that such securities will experience substantial capital
appreciation. See "Other Investments and Risks" below. Such income can be used,
however, to offset the operating expenses of the Fund.
4
<PAGE> 65
The Developing Capital Markets Focus Fund may invest in debt securities
issued or guaranteed by foreign governments (including foreign states, provinces
and municipalities) or their agencies and instrumentalities ("governmental
entities"), issued or guaranteed by international organizations designated or
supported by multiple foreign governmental entities (which are not obligations
of foreign governments) to promote economic reconstruction or development
("supranational entities"), or issued by foreign corporations or financial
institutions.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the "World Bank"), the European Steel and Coal Community, the Asian
Development Bank and the Inter-American Development Bank. The governmental
members, or "stockholders," usually make initial capital contributions to the
supranational entity and in many cases are committed to make additional capital
contributions if the supranational entity is unable to repay its borrowings.
For purposes of the Developing Capital Markets Focus Fund's investment
objective, an issuer ordinarily will be considered to be located in the country
where the primary trading market of its securities is located. The Fund,
however, may consider a company to be located in countries having smaller
capital markets, without reference to its domicile or to the primary trading
market of its securities, when at least 50% of its non-current assets,
capitalization, gross revenues or profits in any one of the two most recent
fiscal years represents (directly or indirectly through subsidiaries) assets or
activities located in such countries. The Fund also may consider closed-end
investment companies to be located in the country or countries in which they
primarily make their portfolio investments.
The Developing Capital Markets Focus Fund may invest a significant portion
of its assets in securities of foreign issuers in smaller capital markets.
Foreign investments involve risks, which are often heightened for investments in
smaller capital markets, including fluctuations in foreign exchange rates,
future political and economic developments, different legal systems and the
existence or possible imposition of exchange controls or other foreign or United
States governmental laws or restrictions applicable to such investments. With
respect to certain countries, there may be the possibility of expropriation of
assets, confiscatory taxation, high rates of inflation, political or social
instability or diplomatic developments which could affect investment in those
countries. In addition, certain foreign investments may be subject to foreign
withholding taxes. See "Other Investments and Risks" below.
There may be less publicly available information about an issuer in a
smaller capital market than would be available about a United States company,
and it may not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those of United States companies. As a
result, traditional investment measurements, such as price/earnings ratios, as
used in the United States, may not be applicable in certain capital markets.
Furthermore, smaller capital markets have substantially less volume than United
States markets so securities in many smaller capital markets are less liquid and
their prices may be more volatile than securities of comparable United States
companies. See "Other Portfolio Strategies -- Foreign Securities" in the
Appendix to this Prospectus.
OTHER INVESTMENTS AND RISKS
In addition, the Fund may purchase certain securities that are not
registered under the Securities Act of 1933, as amended, and which therefore may
be subject to restrictions on their transfer or resale.
The Developing Capital Markets Focus Fund has established no rating
criteria for the debt securities in which it may invest, and such securities may
not be rated at all for creditworthiness. Securities rated in the medium to
lower rating categories of nationally recognized statistical rating
organizations and unrated securities of comparable quality are predominantly
speculative with respect to the capacity to pay interest and repay principal in
accordance with the terms of the security and generally involve a greater
volatility of price than securities in higher rating categories. In purchasing
such securities, the Fund will rely on the Investment Adviser's judgment,
analysis and experience in evaluating the creditworthiness of an issuer of such
securities. The Investment Adviser will take into consideration, among other
things, the issuer's financial resources, its sensitivity to economic conditions
and trends, its operating history, the quality of the issuer's management and
regulatory
5
<PAGE> 66
matters. The Fund does not intend to purchase debt securities that are in
default or which the Investment Adviser believes will be in default. See "Risks
of High Yield Securities" in the Appendix to this Prospectus.
The Developing Capital Markets Focus Fund invests in securities of foreign
issuers. Investments in foreign securities, particularly those of
non-governmental issuers, involve considerations and risks that are not
ordinarily associated with investing in domestic issuers. These considerations
and risks include changes in currency rates, currency exchange control
regulations, the possibility of expropriation, confiscatory taxation, high rates
of inflation, the unavailability of financial information or the difficulty of
interpreting financial information prepared under foreign accounting standards,
less liquidity and more volatility in foreign securities markets, the impact of
political, social or diplomatic developments, and the difficulty of assessing
economic trends in foreign countries. In addition, net investment income earned
by the Fund on a foreign security may be subject to withholding and other taxes
imposed by foreign governments, which will reduce the Fund's net investment
income. The Fund may from time to time be substantially invested in
non-dollar-denominated securities of foreign issuers. Changes in foreign
currency exchange rates may affect the value of securities in the portfolio and
the unrealized appreciation or depreciation of investments insofar as United
States investors are concerned. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. See "Other Portfolio Strategies -- Foreign Securities" in the
Appendix to this Prospectus.
The Developing Capital Markets Focus Fund may engage in transactions, such
as currency swaps and purchasing and selling options on currencies, for purposes
of hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the US dollar. Although such instruments will
be used with the intention of hedging against adverse currency movements,
transactions in such instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective and may cause the Fund to realize losses.
The Developing Capital Markets Focus Fund may from time to time enter into
standby commitment agreements and is authorized to write (i.e., sell) and
purchase call and put options on securities held in its portfolio or securities
indices the performance of which is substantially correlated with securities
held in its portfolio, may engage in transactions in futures and may invest in
securities the potential return of which is based on the change in particular
measurements of value or rate (i.e., indexed and inverse securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed and inverse securities,
options, futures and foreign exchange transactions.
6
<PAGE> 67
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GOVERNMENT BOND FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Government Bond Fund, formerly, Merrill Lynch Intermediate
Government Bond Fund (the "Government Bond Fund") is a diversified fund whose
objective is the highest possible current income consistent with the protection
of capital afforded by investing in debt securities issued or guaranteed by the
United States Government, its agencies or instrumentalities. The Government Bond
Fund is a separate fund of the Merrill Lynch Variable Series Funds, Inc. (the
"Company"), an open-ended management investment company that has a wide range of
investment objectives among its eighteen separate funds (hereinafter referred to
as the "Funds" or individually as a "Fund"). Two separate classes of common
stock ("Common Stock"), Class A Common Stock and Class B Common Stock, are
issued for each Fund. The Company is offering shares of its Class A Common Stock
for the Government Bond Fund pursuant to this Prospectus. This Prospectus
consists of this four page document and the attached Appendix. For more
information on the Government Bond Fund's investment objective and policies,
please see page 4 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objective and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 68
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 69
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
GOVERNMENT BOND FUND (CLASS A)
--------------------------------------------------
FOR THE
PERIOD MAY 2,
FOR THE YEAR ENDED DECEMBER 31, 1994+ TO
--------------------------------- DECEMBER 31,
1997 1996 1995 1994
--------- -------- -------- -------------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period.............. $ 10.40 $ 10.79 $ 9.97 $ 10.00
-------- ------- ------- -------
Investment income -- net.......................... .63 .65 .62 .25
Realized and unrealized gain (loss) on
investments -- net.............................. .25 (.36) .81 (.07)
-------- ------- ------- -------
Total from investment operations.................. .88 .29 1.43 .18
-------- ------- ------- -------
Less dividends and distributions:
Investment income -- net........................ (.63) (.64) (.61) (.21)
Realized gain on investments -- net............. (.05) (.04) -- --
In excess of realized gain on
investments -- net........................... --++ -- -- --
-------- ------- ------- -------
Total dividends and distributions................. (.68) (.68) (.61) (.21)
-------- ------- ------- -------
Net asset value, end of period.................... $ 10.60 $ 10.40 $ 10.79 $ 9.97
======== ======= ======= =======
Total Investment Return:**
Based on net asset value per share................ 8.88% 2.86% 14.83% 1.79%#
======== ======= ======= =======
Ratios to Average Net Assets:
Expenses, net of reimbursement.................... .51% .15% .00% .00%*
======== ======= ======= =======
Expenses.......................................... .57% .59% .66% .80%*
======== ======= ======= =======
Investment income -- net.......................... 6.26% 6.39% 6.28% 4.66%*
======== ======= ======= =======
Supplemental Data:
Net assets, end of period (in thousands).......... $179,820 $89,581 $40,996 $17,811
======== ======= ======= =======
Portfolio turnover................................ 117.65% 21.23% 45.39% 103.03%
======== ======= ======= =======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Amount is less than $.01 per share.
# Aggregate total investment return.
3
<PAGE> 70
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Government Bond Fund is to seek the highest
possible current income consistent with the protection of capital afforded by
investing in debt securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities. Under normal circumstances, all or substantially
all of the Fund's assets will be invested in such securities. Depending on
market conditions, an average maturity of six to fifteen years is anticipated.
When, in the opinion of management, prevailing market or economic conditions
warrant, a portion of the Fund may be invested in money market securities or a
liquid asset fund to effectively utilize cash reserves. There can be no
assurance that the Government Bond Fund will achieve its investment objective.
Certain of the securities in which the Government Bond Fund invests are
supported by the full faith and credit of the U.S. Government, such as U.S.
Treasury obligations. Other of the securities in which the Fund invests are not
supported by the full faith and credit of the U.S. Government but are issued by
U.S. Government agencies, instrumentalities or government-sponsored enterprises.
Such securities are generally supported only by the credit of the agency,
instrumentality or enterprise issuing the security and are generally considered
to have a low principal risk. However, because of the longer-term maturities of
the securities in which the Fund will invest, interest rate fluctuations may
adversely affect the market value of such securities. As interest rates rise,
the value of fixed-income securities will fall, adversely affecting the net
asset value of the Fund. The Fund should be considered a long-term investment
and a vehicle for diversification, and not as a balanced investment program. The
Fund may not be appropriate as the exclusive investment to fund a variable
annuity or variable life insurance contract ("Contract") for all Contract
owners.
The U.S. Treasury Department has enacted regulations prescribing
diversification standards to be met by investment company portfolios to which
the investment base for any variable annuity policy has been allocated as a
condition to such policies being treated as variable annuity contracts under the
Internal Revenue Code of 1986, as amended. The regulations limit the percentage
of the total assets of any investment company portfolio which may be invested in
securities of any five or fewer issuers, including a requirement that no more
than 55% of a portfolio's total assets be invested in the securities of any one
issuer. Direct obligations of the U.S. Treasury are not excepted from the
diversification requirements. Each government agency or instrumentality issuing,
guaranteeing or insuring securities will be treated as a separate issuer for
purposes of the diversification standards.
In addition, the Government Bond Fund may purchase certain securities that
are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities the potential return of which is based on the
change in particular measurements of value or rate (i.e., indexed securities). A
further discussion of the investments described in this paragraph and the risks
associated with such investments is set forth in the Appendix to this
Prospectus, including Annex B of the Appendix to this Prospectus, which includes
a discussion of certain portfolio strategies relating to indexed securities.
4
<PAGE> 71
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH INDEX 500 FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Index 500 Fund (the "Index 500 Fund") is a non-diversified
fund whose objective is investment results that, before expenses, correspond to
the aggregate price and yield performance of the Standard & Poor's 500 Composite
Stock Price Index (the "S&P 500 Index"). The Index 500 Fund is a separate fund
of the Merrill Lynch Variable Series Funds, Inc. (the "Company"), an open-ended
management investment company that has a wide range of investment objectives
among its eighteen separate funds (hereinafter referred to as the "Funds" or
individually as a "Fund"). Two separate classes of common stock ("Common
Stock"), Class A Common Stock and Class B Common Stock, are issued for each
Fund. The Company is offering shares of its Class A Common Stock for the Index
500 Fund pursuant to this Prospectus. This Prospectus consists of this four page
document and the attached Appendix. For more information on the Index 500 Fund's
investment objective and policies, please see page 3 of this document and the
Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 2
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 72
FINANCIAL HIGHLIGHTS
The financial information in the table below, has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
INDEX 500
FUND (CLASS A)
---------------------------
FOR THE
FOR THE PERIOD
YEAR DEC. 13,
ENDED 1996+ TO
DECEMBER 31, DEC. 31,
1997 1996
------------ -----------
<S> <C> <C>
Increase (Decrease) in Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period........................ $ 10.17 $ 10.00
-------- -------
Investment income -- net.................................... .17 .02
Realized and unrealized gain on investments -- net.......... 3.16 .15
-------- -------
Total from investment operations............................ 3.33 .17
-------- -------
Less dividends and distributions:
Investment income -- net.................................. (.02) --
Realized gain on investments -- net....................... --++ --
-------- -------
Total dividends and distributions........................... (.02) --
-------- -------
Net asset value, end of period.............................. $ 13.48 $ 10.17
======== =======
Total Investment Return:**
Based on net asset value per share.......................... 32.81% 1.68%#
======== =======
Ratios to Average Net Assets:
Expenses, net of reimbursement.............................. .34% .00%*
======== =======
Expenses.................................................... .40% .60%*
======== =======
Investment income -- net.................................... 2.01% 3.08%*
======== =======
Supplemental Data:
Net assets, end of period (in thousands).................... $215,234 $10,752
======== =======
Portfolio turnover.......................................... 36.85% .04%
======== =======
Average commission rate paid................................ $ .0158 $ .0120
======== =======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
++ Amount is less than $.01 per share.
# Aggregate total investment return.
2
<PAGE> 73
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Index 500 Fund is to seek to provide
investment results that, before expenses, correspond to the aggregate price and
yield performance of the S&P 500 Index. There can be no assurance that the Fund
will achieve its investment objective. The Fund should be considered a long-term
investment and a vehicle for diversification, and not as a balanced investment
program. The Fund may not be appropriate as the exclusive investment to fund a
variable annuity or variable life insurance contract ("Contract") for all
Contract owners.
The S&P 500 Index is a market-weighted index composed of 500 common stocks
issued by companies in a wide range of businesses and which collectively
represent a substantial portion of all common stocks publicly traded in the U.S.
The composition of the S&P 500 Index is determined by Standard & Poor's Rating
Group ("Standard & Poor's"), a division of the McGraw-Hill Companies, Inc.
Standard & Poor's criteria for selecting common stocks to include in the S&P 500
Index is based on factors such as market capitalization, trading activity and
the adequacy of representation of particular industries, and favors U.S.-traded
stocks of large companies that are among the most dominant in their industries.
The S&P 500 Index is generally considered broadly representative of the
performance of large-capitalization publicly traded common stocks in the U.S.
The inclusion of a stock in the S&P 500 Index does not imply that Standard &
Poor's believes the stock to be an attractive investment.
The Index 500 Fund will not attempt to buy or sell securities based on
Merrill Lynch Asset Management, L.P.'s (the "Investment Adviser") economic,
financial or market analysis, but will instead employ a "passive" approach that
attempts to remain invested at all times in a portfolio of assets the
performance of which is expected to be strongly correlated with that of the S&P
500 Index. The Index 500 Fund may invest in all 500 stocks in the S&P 500 Index
in approximately the same proportions as their weightings in the S&P 500 Index,
or may invest in a statistically selected sample of the 500 stocks which
comprise the S&P 500 Index designed, based on market capitalizations, industry
weightings and financial attributes, to have aggregate investment
characteristics similar to those of the S&P 500 Index as a whole. The Index 500
Fund may also (i) purchase common stocks not included in the S&P 500 Index as a
proxy for certain common stocks included in the S&P 500 Index when the
Investment Adviser believes it is an efficient means of replicating the
performance of that index to do so, and (ii) invest in options and future
contracts linked to the performance of the S&P 500 Index or of common stocks
represented in the index.
Under normal circumstances, it is expected that the Index 500 Fund will
invest at least 90% (65% if the Index 500 Fund's assets are below $20 million)
of its assets in common stocks represented in the S&P 500 Index and related
options and futures contracts. The Index 500 Fund may invest a substantial
portion of its assets in options and futures contracts in order to gain market
exposure efficiently in the event of subscriptions, to maintain liquidity in the
event of redemptions and to minimize trading costs. The Index 500 Fund may also
invest in short-term fixed income instruments as cash reserves. The Index 500
Fund will not invest in short-term fixed income instruments, options or futures
contracts for the purpose of implementing a defensive market strategy by
lowering the Fund's exposure to common stocks to protect against a potential
stock market decline, but instead will attempt to remain fully invested without
regard to the Investment Adviser's market analysis. The Fund may, however, hold
short-term fixed income instruments for temporary cash management purposes.
The foregoing investment techniques are expected to be an effective means
of substantially duplicating the aggregate price and yield performance of the
S&P 500 Index at such times when the Index 500 Fund is not fully invested in all
500 stocks in the S&P 500 Index in approximately the same proportions as their
weightings in that index. To the extent the Index 500 Fund utilizes the
foregoing investment techniques, the Fund may not track the S&P 500 Index with
the same degree of accuracy as the Fund would if it were fully invested in all
500 stocks in the S&P 500 Index in approximately the same proportions as their
weightings in that index. However, the principal advantage of the foregoing
investment techniques is to provide an efficient means to invest in the universe
of stocks of the S&P 500 Index. The Fund is expected to provide broad
diversification, and will seek to operate at low costs due to its "passive"
approach to portfolio management and anticipated low portfolio turnover rate.
In addition, the Index 500 Fund may purchase certain securities that are
not registered under the Securities Act of 1933, as amended, and which therefore
may be subject to restrictions on their transfer or resale. The Index 500 Fund
may also invest in securities of foreign issuers to the extent such issuers are
included in the S&P 500
3
<PAGE> 74
Index. See "Other Portfolio Strategies -- Foreign Securities" in the Appendix to
this Prospectus. The Fund is also authorized to write (i.e., sell) and purchase
call and put options on securities held in its portfolio or securities indices
the performance of which is substantially correlated with securities held in its
portfolio and may engage in transactions in futures and may invest in securities
the potential return of which is based on the change in particular measurements
of value or rate (i.e., indexed securities). A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus which includes a discussion of certain
portfolio strategies relating to indexed securities, options and futures.
4
<PAGE> 75
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GLOBAL GROWTH FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Global Growth Focus Fund, (the "Global Growth Focus Fund") is
a diversified fund whose objective is long-term growth of capital. The Global
Growth Focus Fund will seek to achieve its investment objective by investing in
a diversified portfolio of equity securities of issuers located in various
foreign countries and the United States, placing particular emphasis on
companies that have exhibited above-average growth rates in earnings. The Global
Growth Focus Fund should be considered a long-term investment and a vehicle for
diversification and not as a balanced investment program. The Global Growth
Focus Fund is a separate fund of the Merrill Lynch Variable Series Funds, Inc.
(the "Company"), an open-ended management investment company that has a wide
range of investment objectives among its eighteen separate funds (hereinafter
referred to as the "Funds" or individually as a "Fund"). Two separate classes of
common stock ("Common Stock"), Class A Common Stock and Class B Common Stock,
are issued for each Fund. The Company is offering shares of its Class A Common
Stock for the Global Growth Focus Fund pursuant to this Prospectus. This
Prospectus consists of this four page document and the attached Appendix. THE
GLOBAL GROWTH FOCUS FUND IS EXPECTED TO COMMENCE OPERATIONS IN JUNE 1998. For
more information on the Global Growth Focus Fund's investment objective and
policies, please see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 76
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 77
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Global Growth Focus Fund is to seek
long-term growth of capital. The Global Growth Focus Fund will seek to achieve
its investment objective by investing in a diversified portfolio of equity
securities of issuers located in various foreign countries and the United
States, placing particular emphasis on companies that have exhibited
above-average growth rates in earnings. The Fund may be appropriate only for
long-term investors who can assume the risk of loss of principal, and do not
seek current income. There can be no assurance that the Global Growth Focus Fund
will achieve its investment objective. The Global Growth Focus Fund may employ a
variety of techniques, including derivative investments, in connection with
certain trading strategies, including to hedge against market and currency risk,
to enhance total return or to gain exposure to equity markets. See Annex B of
the Appendix to this Prospectus. Investments on an international basis in
foreign securities markets involve risks and special considerations not
typically associated with investments in securities of United States issuers.
See "Other Investments and Risks" below. The Fund should be considered a
long-term investment and a vehicle for diversification, and not as a balanced
investment program.
Issuers may achieve above-average growth rates in earnings from a variety
of factors including, but not limited to, above-average growth rates in sales,
profit margin improvement, proprietary or niche products or services, leading
market shares, and underlying strong industry growth. Management of the Fund
believes that companies which possess above-average earnings growth frequently
provide the prospect of above-average stock market returns, although such
companies tend to have higher relative stock market valuations. Emphasis also
will be given to companies having medium to large stock market capitalizations
($2 billion or more). Investment in companies with lower market capitalizations,
especially those under $1 billion, may involve special risks including limited
product lines, market or financial resources or a limited management group. In
addition, many smaller company stocks trade less frequently and in smaller
volume, and may be subject to more abrupt or erratic price movements or may be
more sensitive to market fluctuations, than stocks of larger companies.
The Global Growth Focus Fund will emphasize investments in equity
securities, primarily common stock, and, to a lesser extent, securities
convertible into common stock, preferred stock, rights to subscribe for common
stock and other investments the return on which is determined by the performance
of a common stock or a basket or index of common stocks. Under normal market
conditions, at least 65% of the Fund's total assets will be invested in equity
securities of issuers from at least three different countries. The Fund reserves
the right, as a defensive measure and to provide for redemptions, to hold other
types of securities, including non-convertible preferred stocks and debt
securities rated investment grade by a nationally recognized statistical rating
organization, U.S. Government and money market securities, including repurchase
agreements, or cash, in such proportions, including up to 100%, as in the
opinion of Merrill Lynch Asset Management L.P. (the "Investment Adviser")
prevailing market or economic conditions warrant.
OTHER INVESTMENTS AND RISKS
In addition, the Global Growth Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale.
Because a substantial portion of the Fund's assets may be invested in
securities of non-U.S. issuers, an investor in the Fund should be aware of
certain risk factors and special considerations relating to international
investing, which may involve risks that are not typically associated with
investments in the securities of U.S. issuers. Investing on an international
basis involves certain risks not involved in domestic investments, including
fluctuations in foreign exchange rates, future political and economic
developments, different legal systems and the possible imposition of exchange
controls or other foreign governmental laws or restrictions. Securities prices
in different countries are subject to different economic, financial, political
and social factors. Since the Fund invests heavily in securities denominated or
quoted in currencies other than the U.S. dollar, changes in foreign currency
exchange rates will affect the value of securities in the Fund and the
unrealized appreciation or depreciation of investments. Currencies of certain
countries may be volatile and therefore may affect the value of securities
denominated in such currencies. In addition, with respect to certain foreign
countries, there is the possibility of expropriation of assets, confiscatory
taxation, difficulty in obtaining or enforcing a court judgment, economic,
political or social instability or diplomatic developments that could affect
investments in those countries. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross domestic product, rates of inflation, capital reinvestment,
3
<PAGE> 78
resources, self-sufficiency and balance of payments position. Certain foreign
investments also may be subject to foreign withholding taxes, These risks often
are heightened for investments in smaller, emerging capital markets. For
additional information concerning the risks of investing in foreign securities.
See "Other Portfolio Strategies -- Foreign Securities" in the Appendix to this
Prospectus.
The Global Growth Focus Fund may also engage in transactions, such as
currency swaps and purchasing and selling options on currencies, for purposes of
hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the U.S. dollar. The Fund is also authorized to
write (i.e., sell) and purchase both call and put options on securities held in
its portfolio, securities indices the performance of which is substantially
correlated with securities held in its portfolio or on securities it intends to
purchase and may also invest in futures and in securities the potential return
of which is based on the change in particular measurements of value or rate
(i.e., indexed securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed securities, options, futures
and foreign exchange transactions.
4
<PAGE> 79
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH CAPITAL FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Capital Focus Fund (the "Capital Focus Fund") is a
diversified fund whose objective is the highest total investment return
consistent with prudent risk. The Capital Focus Fund will seek to achieve its
investment objective through a fully managed investment policy utilizing equity,
debt (including money market) and convertible securities. The Capital Focus Fund
is a separate fund of the Merrill Lynch Variable Series Funds, Inc. (the
"Company"), an open-ended management investment company that has a wide range of
investment objectives among its eighteen separate funds (hereinafter referred to
as the "Funds" or individually as a "Fund"). Two separate classes of common
stock ("Common Stock"), Class A Common Stock and Class B Common Stock, are
issued for each Fund. The Company is offering shares of its Class A Common Stock
for the Capital Focus Fund pursuant to this Prospectus. This Prospectus consists
of this four page document and the attached Appendix. THE CAPITAL FOCUS FUND IS
EXPECTED TO COMMENCE OPERATIONS IN JUNE 1998. For more information on the
Capital Focus Fund's investment objective and policies, please see page 2 of
this document and the Appendix.
THE CAPITAL FOCUS FUND INVESTS OR MAY INVEST IN HIGH YIELD BONDS (COMMONLY
KNOWN AS "JUNK BONDS"), WHICH INVOLVE SPECIAL RISKS. SEE "INVESTMENT OBJECTIVES
AND POLICIES OF THE FUNDS -- RISKS OF HIGH YIELD SECURITIES" IN THE APPENDIX TO
THIS PROSPECTUS.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 2
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-7
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-11
Dividends, Distributions and Taxes... A-11
Performance Data..................... A-12
Additional Information............... A-13
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 80
INVESTMENT OBJECTIVE AND POLICIES
The Capital Focus Fund's investment objective is to achieve the highest
total investment return consistent with prudent risk. To do this, management of
the Fund shifts the emphasis among equity, debt (including money market) and
convertible securities. This flexible, total investment return approach is
called a "fully managed" investment policy. It distinguishes the Capital Focus
Fund from other investment companies, which often seek either capital growth or
current income. This approach permits management of the Fund to vary investment
policy based on its evaluation of changes in economic and market trends. Total
investment return is the aggregate of income and capital value changes.
Consistent with this policy, the Capital Focus Fund's portfolio may, at any
given time, be invested substantially in equity securities, corporate bonds or
money market securities. It is the expectation of management that, over longer
periods, a major portion of the Fund's portfolio will consist of equity
securities of larger market capitalization, quality companies. There can be no
assurance that the Fund will achieve its investment objective. The Capital Focus
Fund may employ a variety of investments and techniques to hedge against market
and currency risk. See Annex B to the Appendix to this Prospectus
The Capital Focus Fund's investment philosophy is based on the belief that,
as in the past, the structure of the United States' economy and the economies
and securities markets of other countries will undergo continuous change. Thus,
the fully managed approach puts maximum emphasis on investment flexibility. The
two principal features of the Fund's management approach are flexibility and
concentration in "quality" companies.
Flexibility. The Capital Focus Fund's fully managed investment approach
makes use of equity, debt (including money market) and convertible securities.
Freedom to move among these different types of securities as prevailing trends
change is the keystone of the Fund's investment policy.
Concentration in "Quality" Companies. The earnings of quality companies
generally tend to grow consistently. Their internal strengths -- good financial
resources, a strong balance sheet, satisfactory rate of return on capital, a
good industry position and superior management skills -- give the Fund
confidence that these companies consistently will perform at high levels. The
Fund considers quality companies to be those that conform most closely to these
characteristics. Most of the Fund's equity portfolio is in the common stocks of
these quality companies.
Sometimes, to reduce risk and to achieve the highest total investment
return, the Capital Focus Fund may invest in other securities:
-- Non-convertible, long-term debt securities, including "deep discount"
corporate debt securities, mortgage-backed securities issued or guaranteed by
governmental entities or private issuers, and debt securities issued or
guaranteed by governments, their agencies and instrumentalities. Such debt
securities generally will be "investment grade." However, the Fund has
established no rating criteria for the debt securities in which it may invest,
and the Fund may invest in securities that are rated below Baa by Moody's
Investors Service, Inc. ("Moody's") or below BBB by Standard & Poor's Ratings
Services ("S&P") or which, in the judgment of Merrill Lynch Asset Management,
L.P. (the "Investment Adviser") possess similar credit characteristics. Such
securities, sometimes referred to as "high yield/high risk securities" or "junk
bonds", are predominantly speculative with respect to the capacity to pay
interest and repay principal in accordance with the terms of the security and
generally involve a greater volatility of price than securities in higher rating
categories. See "Other Investment and Risks" below and "Risks of High Yield
Securities" in the Appendix to this Prospectus. The Fund does not intend to
purchase debt securities that are in default or which the Investment Adviser
believes will be in default. The Fund does not intend to invest in excess of 35%
of its total assets in securities that are rated below Baa by Moody's or below
BBB by S&P or that the Investment Adviser believes have characteristics similar
to those securities.
-- Convertible securities, i.e., fixed income issues that give the owner
the option of a later exchange for common stock. Convertible securities entitle
the holder to receive interest payments paid on corporate debt securities or the
dividend preference on a preferred stock until such time as the convertible
security matures or is redeemed or until the holder elects to exercise the
conversion privilege. The value of convertible securities is influenced by both
the yield of nonconvertible securities of comparable issuers and by the value of
the underlying common stock. The value of a convertible security viewed without
regard to its conversion feature (i.e., strictly on the basis of its yield) is
sometimes referred to as its "investment value." To the extent interest rates
change, the investment value of the convertible security typically will
fluctuate. However, at the same time, the value of the
2
<PAGE> 81
convertible security will be influenced by its "conversion value," which is the
market value of the underlying common stock that would be obtained if the
convertible security were converted. Conversion value fluctuates directly with
the price of the underlying common stock. If, because of a low price for the
common stock, the conversion value is substantially below the investment value
of the convertible security, the price of the convertible security will be
governed principally by its investment value.
-- Cash or money-market securities to produce interest income during
periods of defensive investment.
The Investment Adviser expects that over longer periods a larger portion of
the Fund's portfolio will consist of equity securities. However, the flexible
fully managed investment approach enables the Fund to switch its emphasis to
debt and convertible securities if, in the opinion of the Investment Adviser,
prevailing market or economic conditions warrant. The Investment Adviser will
determine the emphasis among equity and debt securities, including convertible
securities, based on its evaluation as to the types of securities presently
providing the opportunity for the highest total investment return consistent
with prudent risk.
OTHER INVESTMENTS AND RISKS
In addition, the Capital Focus Fund may purchase securities that are not
registered under the Securities Act of 1933, as amended, and which therefore may
be subject to restrictions on their transfer or resale.
The Capital Focus Fund may invest up to 25% of its total assets in
securities of foreign issuers. Investments in securities of foreign issuers
involve certain risks, including fluctuations in foreign exchange rates, future
political and economic developments, and the possible imposition of exchange
controls or other foreign governmental laws or restrictions. In addition,
foreign companies may not be subject to accounting, auditing and financial
reporting standards and requirements comparable to those of U.S. companies. The
foreign markets also have different clearance and settlement procedures, and in
certain markets there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Delays in settlement could result in temporary periods when
assets of the Fund are uninvested and no return is earned thereon. The inability
of the Fund to make intended security purchases due to settlement problems could
cause the Fund to miss attractive investment opportunities. Inability to dispose
of a portfolio security due to settlement problems could result either in losses
to the Fund due to subsequent declines in the value of such portfolio security
or, if the Fund has entered into a contract to sell the security, could result
in possible liability to the purchaser. To the extent such investments are
subject to withholding or other taxes or to regulations relating to repatriation
of assets, the Fund's distributable income will be reduced. The prices of
securities in different countries may be subject to different economic,
financial, political and social factors.
The Capital Focus Fund may from time to time be invested in
non-dollar-denominated securities of foreign issuers. Changes in foreign
currency exchange rates may affect the value of securities in the portfolio and
the unrealized appreciation or depreciation of investments insofar as United
States investors are concerned. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. See "Other Portfolio Strategies-Foreign Securities" in the Appendix
to this Prospectus.
The Capital Focus Fund has established no rating criteria for the debt
securities in which it may invest, and such securities may not be rated at all
for creditworthiness. Securities rated in the medium to lower rating categories
of nationally recognized statistical rating organizations and unrated securities
of comparable quality are predominantly speculative with respect to the capacity
to pay interest and repay principal in accordance with the terms of the security
and generally involve a greater volatility of price than securities in higher
rating categories. In purchasing such securities, the Fund will rely on the
Investment Adviser's judgment, analysis and experience in evaluating the
creditworthiness of an issuer of such securities. The Investment Adviser will
take into consideration, among other things, the issuer's financial resources,
its sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters. The Fund does not
intend to purchase debt securities that are in default or that the Investment
Adviser believes will be in default. See "Risks of High Yield Securities" in the
Appendix to this Prospectus.
Among the risks to which an investment in the Capital Focus Fund is subject
are interest rate risk and credit risk. Interest rate risk is the risk that the
portion of the Fund's net asset value attributable to the Fund's fixed-income
securities may fall when interest rates rise and rise when interest rates fall.
In general, fixed-income
3
<PAGE> 82
securities with longer maturities will be subject to greater volatility
resulting from interest rate fluctuations than will fixed-income securities with
shorter maturities. Credit risk is the risk that an issuer of fixed-income
securities that the Fund owns will not make timely payments of interest or
repayments of principal from the issuer. Credit risk is generally greater in
lower-rated securities.
The Capital Focus Fund may invest in the securities of smaller or emerging
growth companies. The securities of smaller or emerging growth companies may be
subject to more abrupt or erratic market movements than larger, more established
companies or the market average in general. These companies may have limited
product lines, markets or financial resources, or they may be dependent on a
limited management group.
The Capital Focus Fund may engage in transactions, such as currency swaps
and purchasing and selling options on currencies, for purposes of hedging
against the decline in the value of currencies in which its portfolio holdings
are denominated against the US dollar. Although such instruments will be used
with the intention of hedging against adverse currency movements, transactions
in such instruments involve the risk that anticipated currency movements will
not be accurately predicted and that the Fund's hedging strategies will be
ineffective and may cause the Fund to realize losses.
The Capital Focus Fund may from time to time write (i.e., sell) covered
call options on its portfolio securities.
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix of this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to options and foreign exchange
transactions.
4
<PAGE> 83
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
APPENDIX
This Appendix constitutes part of the Prospectus for the Class A Shares of
Merrill Lynch Domestic Money Market Fund, Merrill Lynch Reserve Assets Fund,
Merrill Lynch Prime Bond Fund, Merrill Lynch High Current Income Fund, Merrill
Lynch Quality Equity Fund, Merrill Lynch Special Value Focus Fund, Merrill Lynch
Natural Resources Focus Fund, Merrill Lynch American Balanced Fund, Merrill
Lynch Global Strategy Focus Fund, Merrill Lynch Basic Value Focus Fund, Merrill
Lynch Global Bond Focus Fund, Merrill Lynch Global Utility Focus Fund, Merrill
Lynch International Equity Focus Fund, Merrill Lynch Developing Capital Markets
Focus Fund, Merrill Lynch Government Bond Fund, Merrill Lynch Global Growth
Focus Fund, Merrill Lynch Capital Focus Fund and Merrill Lynch Index 500 Fund
(hereinafter referred to as the "Funds" or individually as a "Fund").
TABLE OF CONTENTS
<TABLE>
<S> <C>
THE INSURANCE COMPANIES..................................... A-1
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS............. A-1
DIRECTORS................................................... A-7
INVESTMENT ADVISER.......................................... A-8
PORTFOLIO TRANSACTIONS AND BROKERAGE........................ A-11
PURCHASE OF SHARES.......................................... A-11
REDEMPTION OF SHARES........................................ A-11
DIVIDENDS, DISTRIBUTIONS AND TAXES.......................... A-11
PERFORMANCE DATA............................................ A-12
ADDITIONAL INFORMATION...................................... A-13
ANNEX A-- DESCRIPTION OF TEMPORARY INVESTMENTS AND CORPORATE BOND
RATINGS..................................................... Annex A-1
ANNEX
B -- DESCRIPTION OF DERIVATIVE INSTRUMENTS....................... Annex B-1
</TABLE>
<PAGE> 84
APPENDIX
THE INSURANCE COMPANIES
Shares of the Funds currently are sold to separate accounts ("Separate
Accounts") of Merrill Lynch Life Insurance Company ("MLLIC") and ML Life
Insurance Company of New York ("ML of New York"), as well as other insurance
companies not affiliated with MLLIC or ML of New York (together with MLLIC and
ML of New York, "Insurance Companies") to fund certain variable life insurance
contracts and/or variable annuities (together, "Contracts") issued by such
companies. The rights of the Insurance Companies as shareholders should be
distinguished from the rights of a Contract owner, which are set forth in the
Contract. A Contract owner has no interest in the shares of a Fund, but only in
the Contract. A Contract is described in the prospectus for that Contract. That
prospectus describes the relationship between increases or decreases in the net
asset value of shares of a Fund, and any distributions on such shares, and the
benefits provided under a Contract. The prospectus for the Contracts also
describes various fees payable to the Insurance Companies and charges to the
Separate Accounts made by the Insurance Companies with respect to the Contracts.
Since shares of the Funds will be sold only to the Insurance Companies for the
Separate Accounts, the terms "shareholder" and "shareholders" in this Prospectus
refer to the Insurance Companies. MLLIC and ML of New York are wholly owned
subsidiaries of ML&Co., as is the Investment Adviser.
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS
INVESTMENT OBJECTIVES
Each Fund of the Company has its own investment objective, which it pursues
through separate investment policies as described in the Fund's Prospectus (of
which this Appendix is a part). The differences in objectives and policies among
the Funds can be expected to affect the return of each Fund and the degree of
market and financial risk to which each Fund is subject. Each Fund is classified
as "diversified," as defined in the Investment Company Act of 1940, as amended
(the "Investment Company Act" or the "Act") except for the Developing Capital
Markets Focus Fund, the Global Bond Focus Fund, the Global Strategy Focus Fund,
the Index 500 Fund, and the Natural Resources Focus Fund, each of which is
classified as "non-diversified." The investment objectives and classification of
each Fund may not be changed without the approval of the holders of a majority
of the outstanding shares of each Fund affected.
Fixed Income Security Ratings. No Fund other than the Developing Capital
Markets Focus Fund, the High Current Income Fund, the Capital Focus Fund and the
International Equity Focus Fund invests in fixed-income securities rated below
investment grade (i.e., securities rated Ba or below by Moody's Investors
Service, Inc. ("Moody's") or BB or below by Standard & Poor's Ratings Group
("Standard & Poor's") at the time of investment). However, securities purchased
by a Fund may subsequently be downgraded. Such securities may continue to be
held and will be sold only if, in the judgment of the Investment Adviser, it is
advantageous to do so. Securities in the lowest category of investment grade
debt securities may have speculative characteristics, which may lead to weakened
capacity to pay interest and principal during periods of adverse economic
conditions. See Annex A of this Appendix for a fuller description of corporate
bond ratings.
NON-DIVERSIFIED FUNDS
The Developing Capital Markets Focus, Global Bond Focus, Global Strategy
Focus, Index 500, and Natural Resources Focus Funds are classified as
non-diversified investment companies under the Investment Company Act. However,
each Fund will have to limit its investments to the extent required by the
diversification requirements applicable to regulated investment companies under
the Internal Revenue Code of 1986, as amended (the "Code" or the "Internal
Revenue Code"). To qualify as a regulated investment company, a Fund, at the
close of each fiscal quarter, may not have more than 25% of its total assets
invested in the securities (except obligations of the U.S. Government, its
agencies or instrumentalities) of any one issuer and with respect to 50% of its
assets, (i) may not have more than 5% of its total assets invested in the
securities of any one issuer and (ii) may not own more than 10% of the
outstanding voting securities of any one issuer.
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INVESTMENT RESTRICTIONS
The Company has adopted a number of restrictions and policies relating to
the investment of its assets and its activities which are fundamental policies
and may not be changed without the approval of the holders of the Company's
outstanding voting securities (including a majority of the shares of each Fund).
Investors are referred to the Statement of Additional Information for a complete
description of such restrictions and policies.
OTHER PORTFOLIO STRATEGIES
Restricted Securities. Each of the Funds is subject to limitations on the
amount of illiquid securities it may purchase; however, each Fund may purchase
without regard to that limitation certain securities that are not registered
under the Securities Act of 1933, as amended (the "Securities Act"), including
(a) commercial paper exempt from registration under Section 4(2) of the
Securities Act, and (b) securities that can be offered and sold to "qualified
institutional buyers" under Rule 144A under the Securities Act, provided that
the Company's Board of Directors continuously determines, based on the trading
markets for the specific Rule 144A security, that it is liquid. The Board of
Directors may adopt guidelines and delegate to the Investment Adviser the daily
function of determining and monitoring liquidity of restricted securities. The
Board has determined that securities sold under Rule 144A that are freely
tradeable in their primary market offshore should be deemed liquid. The Board,
however, will retain sufficient oversight and be ultimately responsible for the
determinations.
Since it is not possible to predict with assurance exactly how the market
for restricted securities sold and offered under Rule 144A will develop, the
Board of Directors will carefully monitor the Funds' investments in these
securities, focusing on such factors, among others, as valuation, liquidity and
availability of information. This investment practice could have the effect of
increasing the level of illiquidity in a Fund to the extent that qualified
institutional buyers become for a time uninterested in purchasing these
restricted securities.
Foreign Securities. The Basic Value Focus, Developing Capital Markets
Focus, Special Value Focus, Global Strategy Focus, Global Bond Focus, Global
Utility Focus, High Current Income, International Equity Focus, Natural
Resources Focus, Prime Bond, Quality Equity, Global Growth Focus, Capital Focus
and Reserve Assets Funds may invest in securities of foreign issuers. The Index
500 Fund may also invest in securities of foreign issuers to the extent such
issuers are included in the Standard & Poor's 500 Composite Stock Price Index
(the "S&P Index"). Investments in foreign securities, particularly those of
non-governmental issuers, involve considerations and risks which are not
ordinarily associated with investing in domestic issuers. These considerations
and risks include changes in currency rates, currency exchange control
regulations, the possibility of expropriation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of economic, political, social or
diplomatic developments, and the difficulty of assessing economic trends in
foreign countries. Foreign legal systems may differ from the U.S. legal system,
and if it should become necessary, a Fund could encounter greater difficulties
in invoking legal processes abroad than would be the case in the United States.
Transaction costs in foreign securities may be higher. The operating expense
ratio of a Fund investing in foreign securities can be expected to be higher
than that of an investment company investing exclusively in United States
securities because the expenses of the Fund, such as custodial costs, are
higher. In addition, net investment income earned by a Fund on a foreign
security may be subject to withholding and other taxes imposed by foreign
governments which will reduce a Fund's net investment income. The Investment
Adviser will consider these and other factors before investing in foreign
securities, and will not make such investments unless, in its opinion, such
investments will meet the standards and objectives of a particular Fund. No Fund
that may invest in foreign securities, other than the Natural Resources Focus
and Global Strategy Focus Funds, will concentrate its investments in any
particular country. The Developing Capital Markets Focus, Global Bond Focus,
Global Strategy Focus, Global Utility Focus, International Equity Focus, Global
Growth Focus Fund and Natural Resources Focus Funds may from time to time be
substantially invested in non-dollar-denominated securities of foreign issuers.
For a Fund that invests in foreign securities denominated or quoted in
currencies other than the United States dollar, changes in foreign currency
exchange rates may directly affect the value of securities in the portfolio and
the unrealized appreciation or depreciation of investments insofar as United
States investors are concerned, and a Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. Foreign currency exchange rates are determined by forces of supply
and demand in the foreign exchange markets. These forces are, in turn, affected
by international balance of payments and other
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economic and financial conditions, government intervention, speculation and
other factors. With respect to certain countries, there may be the possibility
of expropriation of assets, confiscatory taxation, high rates of inflation,
political or social instability or diplomatic developments which could affect
investment in those countries. Each Fund of the Company other than the
Developing Capital Markets Focus, Global Bond Focus, Global Strategy Focus,
Global Utility Focus, International Equity Focus, Natural Resources Focus,
Global Growth Focus, Capital Focus Fund and Quality Equity Funds will purchase
only securities issued in dollar denominations.
The securities markets of many countries at times in the past have moved
relatively independently of one another due to different economic, financial,
political and social factors. When such lack of correlation, or negative
correlation, in movements of these securities markets occurs, it may reduce risk
for a Fund's portfolio as a whole. This negative correlation also may offset
unrealized gains a Fund has derived from movements in a particular market. To
the extent the various markets move independently, total portfolio volatility is
reduced when the various markets are combined into a single portfolio. Of
course, movements in the various securities markets may be offset by changes in
foreign currency exchange rates. Exchange rates frequently move independently of
securities markets in a particular country. As a result, gains in a particular
securities market may be affected by changes in exchange rates.
Each of the International Equity Focus Fund and Developing Capital Markets
Focus Fund may invest a significant portion of its assets in securities of
foreign issuers in smaller capital markets, while each of the other Funds which
is permitted to invest in foreign securities may from time to time invest in
securities of such foreign issuers. Foreign investments involve risks, including
fluctuations in foreign exchange rates, future political and economic
developments, different legal systems, the existence or possible imposition of
exchange controls, or other foreign or United States governmental laws or
restrictions, that are often heightened for investments in smaller capital
markets.
There may be less publicly available information about an issuer in a
foreign market, particularly one in a smaller capital market, than would be
available about a United States company, and it may not be subject to
accounting, auditing and financial reporting standards and requirements
comparable to those of United States companies. As a result, traditional
investment measurements, such as price/earnings ratios, as used in the United
States, may not be applicable in certain capital markets.
Smaller capital markets, while often growing in trading volume, have
substantially less volume than United States markets, and securities in many
smaller capital markets are less liquid and their prices may be more volatile
than securities of comparable United States companies. Brokerage commissions,
custodial services, and other costs relating to investment in smaller capital
markets are generally more expensive than in the United States. Such markets
have different clearance and settlement procedures, and in certain markets there
have been times when settlements have been unable to keep pace with the volume
of securities transactions, making it difficult to conduct such transactions.
Further, satisfactory custodial services for investment securities may not be
available in some countries having smaller capital markets, which may result in
a Fund which invests in these markets incurring additional costs and delays in
transporting and custodying such securities outside such countries. Delays in
settlement could result in temporary periods when assets of such a Fund are
uninvested and no return is earned thereon. The inability of a Fund to make
intended security purchases due to settlement problems could cause the Fund to
miss attractive investment opportunities. Inability to dispose of a portfolio
security due to settlement problems could result either in losses to the Fund
due to subsequent declines in value of the portfolio security or, if the Fund
has entered into a contract to sell the security, could result in possible
liability to the purchaser. There is generally less government supervision and
regulation of exchanges, brokers and issuers in countries having smaller capital
markets than there is in the United States.
As a result, management of a Fund that invests in foreign securities may
determine that, notwithstanding otherwise favorable investment criteria, it may
not be practicable or appropriate to invest in a particular country. A Fund may
invest in countries in which foreign investors, including management of the
Fund, have had no or limited prior experience.
Certain of the Funds may invest in debt securities issued by foreign
governments. Investments in foreign government debt securities, particularly
those of emerging market country governments, involve special risks. Certain
emerging market countries have historically experienced, and may continue to
experience, high rates of inflation, high interest rates, exchange rate
fluctuations, large amounts of external debt, balance of payments and
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trade difficulties and extreme poverty and unemployment. The issuer or
governmental authority that controls the repayment of an emerging market
country's debt may not be able or willing to repay the principal and/or interest
when due in accordance with the terms of such debt. A debtor's willingness or
ability to repay principal and interest due in a timely manner may be affected
by, among other factors, its cash flow situation, and, in the case of a
government debtor, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole and the political constraints
to which a government debtor may be subject. Government debtors may default on
their debt and may also be dependent on expected disbursements from foreign
governments, multilateral agencies and others abroad to reduce principal and
interest arrearages on their debt. Holders of government debt, including the
Fund, may be requested to participate in the rescheduling of such debt and to
extend further loans to government debtors.
As a result of the foregoing, a government obligor may default on its
obligations. If such an event occurs, a Fund may have limited legal recourse
against the issuer and/or guarantor. Remedies must, in some cases, be pursued in
the courts of the defaulting party itself, and the ability of the holder of
foreign government debt securities to obtain recourse may be subject to the
political climate in the relevant country. Government obligors in developing and
emerging market countries are among the world's largest debtors to commercial
banks, other governments, international financial organizations and other
financial institutions. Some issuers of the government debt securities in which
a Fund may invest have in the past experienced substantial difficulties in
servicing their external debt obligations, which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements.
The Global Utility Focus Fund, International Equity Focus Fund, Developing
Capital Markets Focus Fund, Capital Focus Fund and the Global Growth Focus Fund
may invest in the securities of foreign issuers in the form of American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") or other
securities convertible into securities of foreign issuers. These securities may
not necessarily be denominated in the same currency as the securities into which
they may be converted. ADRs are receipts typically issued by an American bank or
trust company which evidence ownership of underlying securities issued by a
foreign corporation. EDRs are receipts issued in Europe which evidence a similar
ownership arrangement. Generally, ADRs, which are issued in registered form, are
designated for use in the United States securities markets, and EDRs, which are
issued in bearer form, are designed for use in European securities markets. The
Funds may invest in ADRs and EDRs through both sponsored and unsponsored
arrangements. In a sponsored ADR or EDR arrangement, the foreign issuer assumes
the obligation to pay some or all of the depository's transaction fees, whereas
in an unsponsored arrangement the foreign issuer assumes no obligations and the
depository's transaction fees are paid by the ADR or EDR holders. Foreign
issuers in respect of whose securities unsponsored ADRs or EDRs have been issued
are not necessarily obligated to disclose material information in the markets in
which the unsponsored ADRs or EDRs are traded and, therefore, there may not be a
correlation between such information and the market value of such securities.
The Developing Capital Markets Focus and International Equity Focus Funds
intend to invest in securities of foreign issuers in smaller capital markets.
Some countries with smaller capital markets prohibit or impose substantial
restrictions on investments in their capital markets, particularly their equity
markets, by foreign entities such as the Fund. As illustrations, certain
countries require governmental approval prior to investments by foreign persons,
or limit the amount of investment by foreign persons in a particular company, or
limit the investment by foreign persons to only a specific class of securities
of a company which may have less advantageous terms than securities of the
company available for purchase by nationals.
A number of countries, such as South Korea, Taiwan and Thailand, have
authorized the formation of closed-end investment companies to facilitate
indirect foreign investment in their capital markets. In accordance with the
Investment Company Act, the Developing Capital Markets Focus, Global Growth
Focus and International Equity Focus Funds each may invest up to 10% of its
total assets in securities of such closed-end investment companies. This
restriction on investments in securities of closed-end investment companies may
limit opportunities for the Fund to invest indirectly in certain smaller capital
markets. Shares of certain closed-end investment companies may at times be
acquired only at market prices representing premiums to their net asset values.
If a Fund acquires shares in closed-end investment companies, shareholders would
bear both their proportionate share of expenses in the Fund (including
management and advisory fees) and, indirectly, the
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expenses of such closed-end investment companies. A Fund also may seek, at its
own cost, to create its own investment entities under the laws of certain
countries.
In some countries, banks or other financial institutions may constitute a
substantial number of the leading companies or the companies with the most
actively traded securities. Also, the Investment Company Act restricts a Fund's
investments in any equity security of an issuer which, in its most recent fiscal
year, derived more than 15% of its revenues from "securities related
activities," as defined by the rules thereunder. These provisions may also
restrict a Fund's investments in certain foreign banks and other financial
institutions.
Rules adopted under the Investment Company Act permit the Funds to maintain
their foreign securities and cash in the custody of certain eligible non-U.S.
banks and securities depositories. Certain banks in foreign countries may not be
eligible sub-custodians for the Funds, in which event the Funds may be precluded
from purchasing securities in certain foreign countries in which they otherwise
would invest or the Funds may incur additional costs and delays in providing
transportation and custody services for such securities outside of such
countries. The Funds may encounter difficulties in effecting on a timely basis
portfolio transactions with respect to any securities of issuers held outside
their countries. Other banks that are eligible foreign sub-custodians may be
recently organized or otherwise lack extensive operating experience. In
addition, in certain countries there may be legal restrictions or limitations on
the ability of the Funds to recover assets held in custody by foreign sub-
custodians in the event of the bankruptcy of the sub-custodian.
Lending of Portfolio Securities. Each Fund of the Company may from time to
time lend securities (but not in excess of 20% or, in the case of the Global
Growth Focus Fund 33 1/3%) of its total assets from its portfolio to brokers,
dealers and financial institutions and receive collateral in cash or securities
issued or guaranteed by the U.S. Government which, while the loan is
outstanding, will be maintained at all times in an amount equal to at least 100%
of the current market value of the loaned securities plus accrued interest. Such
cash collateral will be invested in short-term securities, the income from which
will increase the return to the Fund.
Forward Commitments. Each of the Funds may purchase securities on a
when-issued basis, and they may purchase or sell such securities for delayed
delivery. These transactions occur when securities are purchased or sold by a
Fund with payment and delivery taking place in the future to secure what is
considered an advantageous yield and price to the Fund at the time of entering
into the transaction. The value of the security on the delivery date may be more
or less than its purchase price. A Fund entering into such transactions will
maintain a segregated account with its custodian of cash or liquid securities in
an aggregate amount equal to the amount of its commitments in connection with
such delayed delivery and purchase transactions.
Standby Commitment Agreements. The Developing Capital Markets Focus,
Global Utility Focus, Global Growth Focus and High Current Income Funds may from
time to time enter into standby commitment agreements. Such agreements commit
the respective Fund, for a stated period of time, to purchase a stated amount of
a fixed income security which may be issued and sold to the Fund at the option
of the issuer. The price and coupon of the security is fixed at the time of the
commitment. At the time of entering into the agreement the Fund is paid a
commitment fee which is typically approximately 0.5% of the aggregate purchase
price of the security which the Fund has committed to purchase. The Fund will at
all times maintain a segregated account with its custodian of cash or liquid
securities in an amount equal to the purchase price of the securities underlying
the commitment. There can be no assurance that the securities subject to a
standby commitment will be issued, and the value of the security, if issued, on
the delivery date may be more or less than its purchase price.
Portfolio Strategies Involving Indexed and Inverse Securities, Options,
Futures and Foreign Exchange Transactions. Certain Funds may use derivative
instruments, including indexed and inverse securities, options and futures and
purchase and sell foreign exchange. Transactions involving such instruments
expose these Funds to certain risks. Each Fund's use of these instruments and
the associated risks are described in detail in Annex B of the Appendix attached
to this Prospectus.
RISKS OF HIGH YIELD SECURITIES
The Developing Capital Markets Focus Fund, High Current Income Fund,
International Equity Focus Fund and Capital Focus Fund may invest a substantial
portion of their assets in high yield, high risk securities or junk bonds, which
are regarded as being predominantly speculative as to the issuer's ability to
make payments of principal and interest. Investment in such securities involves
substantial risk. Issuers of junk bonds may be highly
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leveraged and may not have available to them more traditional methods of
financing. Therefore, the risks associated with acquiring the securities of such
issuers generally are greater than is the case with higher-rated securities. For
example, during an economic downturn or a sustained period of rising interest
rates, issuers of high yield securities may be more likely to experience
financial stress, especially if such issuers are highly leveraged. During
recessionary periods, such issuers may not have sufficient revenues to meet
their interest payment obligations. The issuer's ability to service its debt
obligations also may be adversely affected by specific issuer developments, or
the issuer's inability to meet specific projected business forecasts, or the
unavailability of additional financing. The risk of loss due to default by the
issuer is significantly greater for the holders of junk bonds because such
securities may be unsecured and may be subordinated to other creditors of the
issuer. While the high yield securities in which the Developing Capital Markets
Focus Fund, High Current Income Fund, International Equity Focus Fund and
Capital Focus Fund may invest normally do not include securities which, at the
time of investment, are in default or the issuers of which are in bankruptcy,
there can be no assurance that such events will not occur after a Fund purchases
a particular security, in which case a Fund may experience losses and incur
costs.
In an effort to minimize the risk of issuer default or bankruptcy, the
Developing Capital Markets Focus Fund, High Current Income Fund, International
Equity Focus Fund and Capital Focus Fund each will diversify its holdings among
many issuers. However, there can be no assurance that diversification will
protect a Fund from widespread defaults brought about by a sustained economic
downturn.
High yield securities frequently have call or redemption features that
would permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividend to
shareholders.
High yield securities tend to be more volatile than higher-rated
fixed-income securities, so that adverse economic events may have a greater
impact on their prices and yields than on higher-rated fixed-income securities.
Zero coupon bonds and bonds which pay interest and/or principal in additional
bonds rather than in cash are especially volatile. Like higher-rated
fixed-income securities, junk bonds are generally purchased and sold through
dealers who make a market in such securities for their own accounts. However,
there are fewer dealers in this market, which may be less liquid than the market
for higher-rated fixed-income securities, even under normal economic conditions.
Also, there may be significant disparities in the prices quoted for such bonds
by various dealers. Adverse economic conditions or investor perceptions (whether
or not based on economic fundamentals) may impair the liquidity of this market,
and may cause the prices the Developing Capital Markets Focus Fund, High Current
Income Fund, International Equity Focus Fund and Capital Focus Fund receive for
their junk bonds to be reduced, or a Fund may experience difficulty in
liquidating a portion of its portfolio when necessary to meet the Fund's
liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. Under such conditions,
judgement may play a greater role in valuing certain of each Fund's portfolio
securities than in the case of securities trading in a more liquid market.
It is expected that a significant portion of the high yield securities
acquired by the Capital Focus Fund will be purchase upon issuance, which may
involve special risks because the securities so acquired are new issues. In such
instances the Capital Focus Fund may be a substantial purchaser of the issue and
therefore have the opportunity to participate in structuring the terms of the
offering. Although this may enable the Capital Focus Fund to seek to protect
itself against certain of such risks, the considerations discussed herein would
nevertheless remain applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of junk bonds,
particularly in a thinly traded market. Factors adversely affecting the market
value of such securities are likely to affect adversely the net asset value of
the Developing Capital Markets Focus Fund, High Current Income Fund, Capital
Focus Fund and International Equity Focus Fund. In addition, each Fund may incur
additional expenses to the extent that it is required to seek recovery upon a
default on a portfolio holding or to participate in the restructuring of the
obligation.
Sovereign Debt. The junk bonds in which the Developing Capital Markets
Focus Fund, High Current Income Fund, Capital Focus Fund and International
Equity Focus Fund may invest include junk bonds issued by sovereign entities.
Investment in such sovereign debt involves a high degree of risk. The
governmental entity that controls the repayment of sovereign debt may not be
able or willing to repay the principal and/or interest when
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due in accordance with the terms of such debt. A governmental entity's
willingness or ability to repay principal and interest due in a timely manner
may be affected by, among other factors, its cash flow situation, the extent of
its foreign reserves, the availability of sufficient foreign exchange on the
date a payment is due, the relative size of the debt service burden to the
economy as a whole, the governmental entity's policy towards the International
Monetary Fund and the political constraints to which a governmental entity may
be subject. Governmental entities may also be dependent on expected
disbursements from foreign governments, multilateral agencies and others abroad
to reduce principal and interest arrearages on their debt. The commitment on the
part of these governments, agencies and others to make such disbursements may be
conditioned on a governmental entity's implementation of economic reforms and/or
economic performance and the timely service of such debtor's obligations.
Failure to implement such reforms, achieve such levels of economic performance
or repay principal or interest when due may result in the cancellation of such
third parties' commitments to lend funds to the governmental entity, which may
further impair such debtor's ability or willingness to timely service its debts.
Consequently, governmental entities may default on their sovereign debt.
Holders of sovereign debt, including the Developing Capital Markets Focus
Fund, High Current Income Fund, Capital Focus Fund and International Equity
Focus Fund, may be requested to participate in the rescheduling of such debt and
to extend further loans to governmental entities. In the event of a default by a
governmental entity, there may be few or no effective legal remedies available
to a Fund and there can be no assurance a Fund will be able to collect on
defaulted sovereign debt in whole or in part.
INSURANCE LAW RESTRICTIONS
In order for shares of the Company's Funds to remain eligible investments
for the Separate Accounts, it may be necessary, from time to time, for a Fund to
limit its investments in certain types of securities in accordance with the
insurance laws or regulations of the various states in which the Contracts are
sold.
The New York insurance law requires that investments of each Fund be made
with the degree of care of an "ordinarily prudent person." The Investment
Adviser believes that compliance with this standard will not have any negative
impact on the performance of any of the Funds.
OTHER CONSIDERATIONS
The Investment Adviser will use its best efforts to assure that each Fund
of the Company complies with certain investment limitations of the Internal
Revenue Service to assure favorable income tax treatment for the Contracts. It
is not expected that such investment limitations will materially affect the
ability of any Fund to achieve its investment objective.
DIRECTORS
The Directors of the Company consist of six individuals, five of whom are
not "interested persons" of the Company as defined in the Investment Company Act
of 1940. The Directors of the Company are responsible for the overall
supervision of the operations of the Company and perform the various duties
imposed on the directors of the investment companies by the Investment Company
Act of 1940. The Board of Directors elects officers of the Company annually.
The Directors of the Company and their principal employment are as follows:
ARTHUR ZEIKEL(1) -- Chairman of the Investment Adviser and its affiliate,
Fund Asset Management, L.P. ("FAM"); Chairman and Director of Princeton
Services, Inc. ("Princeton Services"); and Executive Vice President of ML&Co.
JOE GRILLS -- Member of the Committee on Investment of Employee Benefit
Assets of the Financial Executives Institute ("CIEBA"); Member of CIEBA's
Executive Committee; and Member of the Investment Advisory Committee of the
State of New York Common Retirement Fund and the Howard Hughes Medical
Institute; Director, Duke Management Company, LaSalle Street Fund and Kimco
Realty Corporation.
- ---------------
(1) Interested person, as defined in the Investment Company Act of 1940, of the
Company.
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WALTER MINTZ -- Special Limited Partner of Cumberland Partners (investment
partnership).
ROBERT S. SALOMON, JR. -- Principal of STI Management (investment adviser).
MELVIN R. SEIDEN -- Director of Silbanc Properties, Ltd. (real estate,
consulting and investments).
STEPHEN R. SWENSRUD -- Chairman Fernwood Advisors (investment adviser);
Principal, Fernwood Associates (financial consultants)
INVESTMENT ADVISER
Merrill Lynch Asset Management L.P. ("MLAM"), an indirect wholly owned
subsidiary of Merrill Lynch & Co., Inc., is the investment adviser (the
"Investment Adviser") for the Fund. The general partner of the Investment
Adviser is Princeton Services, Inc., a wholly owned subsidiary of Merrill Lynch
& Co., Inc. The principal address of the Investment Adviser is 800 Scudders Mill
Road, Plainsboro, New Jersey 08536 (mailing address: Box 9011, Princeton, New
Jersey 08543-9011). The Asset Management Group of Merrill Lynch & Co., Inc.
(which includes MLAM) presently acts as the investment adviser to more than 100
registered investment companies. The Investment Adviser also offers portfolio
management to individual and institutional accounts. As of March 1998, the Asset
Management Group had a total of $488 billion in investment company and other
portfolio assets under management. This amount includes assets managed for
certain affiliates of the Investment Adviser.
While the Investment Adviser is at all times subject to the direction of
the Board of Directors of the Company, the Investment Advisory Agreements
provide that the Investment Adviser, subject to review by the Board of
Directors, is responsible for the actual management of the Funds and has
responsibility for making decisions to buy, sell or hold any particular
security. The Investment Adviser provides the portfolio managers for the Funds,
who consider information from various sources, make the necessary investment
decisions and effect transactions accordingly. The Investment Adviser is also
obligated to perform certain administrative and management services for the
Company (certain of which it may delegate to third parties) and is obligated to
provide all the office space, facilities, equipment and personnel necessary to
perform its duties under the Agreements. The Investment Adviser has access to
the full range of the securities and economic research facilities of Merrill
Lynch.
During the Company's fiscal year ended December 31, 1997, the advisory fees
expense incurred by the Company totaled $30,733,366 of which $107,029 related to
the Reserve Assets Fund (representing .50% of its average net assets),
$2,226,345 related to the Prime Bond Fund (representing .42% of its average net
assets), $2,277,140 related to the High Current Income Fund (representing .47%
of its average net assets), $3,629,013 related to the Quality Equity Fund
(representing .44% of its average net assets), $3,466,085 related to the Special
Value Focus Fund (representing .75% of its average net assets), $415,327 related
to the Index 500 Fund (representing .30% of its average net assets) of which
$79,567 was voluntarily waived by MLAM, $241,712 related to the Natural
Resources Focus Fund (representing .65% of its average net assets), $1,102,076
related to the American Balanced Fund (representing .55% of its average net
assets), $1,549,078 related to the Domestic Money Market Fund (representing .50%
of its average net assets), $5,860,619 related to the Global Strategy Focus Fund
(representing .65% of its average net assets), $3,489,377 related to the Basic
Value Focus Fund (representing .60% of its average net assets), $483,479 related
to the Global Bond Focus Fund (representing .60% of its average net assets),
$813,756 related to the Global Utility Focus Fund (representing .60% of its
average net assets), $3,089,994 related to the International Equity Focus Fund
(representing .75% of its average net assets), $1,306,661 related to the
Developing Capital Markets Focus Fund (representing 1.00% of its average net
assets) of which $217,067 was voluntarily waived by MLAM, $675,675 related to
the Government Bond Fund (representing .50% of its average net assets) of which
$78,164 was voluntarily waived by MLAM.
During the Company's fiscal year ended December 31, 1997, the total
operating expenses attributable to the Class A Shares of the Company's Funds
(including the advisory fees paid to the Investment Adviser), before any fee
waiver or reimbursement of a portion of such expenses, expressed as a percentage
of each Fund's average net assets, were as follows: .62% of the Reserve Assets
Fund's average net assets, .47% of the Prime Bond Fund's average net assets,
.54% of the High Current Income Fund's average net assets, .48% of the Quality
Equity Fund's average net assets, .80% of the Special Value Focus Fund's average
net assets, .40% of the Index 500 Fund's average net assets, .81% of the Natural
Resources Focus Fund's average net assets, .60% of the American
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Balanced Fund's average net assets, .54% of the Domestic Money Market Fund's
average net assets, .73% of the Global Strategy Focus Fund's average net assets,
.65% of the Basic Value Focus Fund's average net assets, .73% of the Global Bond
Focus Fund's average net assets, .67% of the Global Utility Focus Fund's average
net assets, .90% of the International Equity Focus Fund's average net assets,
1.42% of the Developing Capital Markets Focus Fund's average net assets, .57% of
the Government Bond Fund's average net assets.
The Investment Adviser has entered into a sub-advisory agreement (the
"Sub-Advisory Agreement") with MLAM U.K., an indirect wholly owned subsidiary of
ML & Co., and an affiliate of the Investment Adviser, pursuant to which the
Investment Adviser pays MLAM U.K. a fee for providing investment advisory
services to the Investment Adviser with respect to the Funds in an amount to be
determined from time to time by the Investment Adviser and MLAM U.K. but in no
event in excess of the amount that the Investment Adviser actually receives for
providing services to the Funds pursuant to the Investment Advisory Agreement.
The Investment Adviser and Merrill Lynch Life Agency, Inc. ("MLLA") have
entered into agreements which limit the operating expenses, exclusive of any
distribution fees imposed on shares of Class B Common Stock, paid by each Fund
in a given year to 1.25% of its average daily net assets (the "Reimbursement
Agreements"). The Reimbursement Agreement provides that any such expenses in
excess of 1.25% of average daily net assets will be reimbursed to the Fund by
the Investment Adviser which, in turn, will be reimbursed by MLLA.
The Investment Adviser has entered into administrative services agreements
with certain Insurance Companies, including MLLIC and ML of New York, pursuant
to which the Investment Adviser compensates such companies for administrative
responsibilities relating to the Company which are performed by such Insurance
Companies.
CODE OF ETHICS
The Board of Directors of the Company has adopted a Code of Ethics pursuant
to Rule 17j-1 under the Act which incorporates the Code of Ethics of the
Investment Adviser (together, the "Codes"). The Codes significantly restrict the
personal investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are designed
to identify any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Investment Adviser include a ban on acquiring any securities in a "hot" initial
public offering and a prohibition from profiting on short-term trading in
securities. In addition, no employee may purchase or sell any security which at
the time is being purchased or sold (as the case may be), or to the knowledge of
the employee is being considered for purchase or sale, by any fund advised by
the Investment Adviser. Furthermore, the Codes provide for trading "blackout
periods" which prohibit trading by investment personnel of the Company within
periods of trading by the Company in the same (or equivalent) security (15 or 30
days depending upon the transaction).
PORTFOLIO MANAGERS
The following is information with respect to the Portfolio Managers for
each of the Company's Funds.
Thomas R. Robinson has served as the Portfolio Manager of the American
Balanced Fund, Global Strategy Focus Fund and Quality Equity Fund since November
1995, and is primarily responsible for each such Fund's day-to-day management.
He has served as a First Vice President of MLAM since 1997 and as a Senior
Portfolio Manager of MLAM from November 1995 to 1997. From 1989 to 1995, he
served as Manager of International Strategy for Merrill Lynch & Co. Global
Securities Research & Economics Group.
Kevin Rendino has served as the Basic Value Focus Fund's Portfolio Manager
since July 1993, and is primarily responsible for the Fund's day-to-day
management. He has served as First Vice President of MLAM since 1997; Vice
President from December 1993 to 1997; Senior Research Analyst from 1990 to 1992;
Corporate Analyst from 1988 to 1990.
Daniel V. Szemis has served as the Portfolio Manager of the Special Value
Focus Fund (formerly, the Equity Growth Fund) since May 1997 and became the
Co-Portfolio Manager in January 1998. He and R. Elise
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Baum are primarily responsible for the day-to-day management of the Special
Value Focus Fund. Mr. Szemis has served as First Vice President of MLAM since
1997 and Vice President of MLAM from 1996 to 1997. From 1990 to 1996, Mr. Szemis
was a portfolio manager with Prudential Mutual Fund Investment Management
Advisors.
Walter Rogers has served as the Global Utility Focus Fund's Portfolio
Manager since July 1993, and is primarily responsible for the Fund's day-to-day
management. He has served as First Vice President of MLAM since 1997; Vice
President from 1987 to 1997.
Clive D. Lang has served as the International Equity Focus Fund's Portfolio
Manager since April 1998, and is primarily responsible for the Fund's day-to-day
management. Mr. Lang has been associated with MLAM U.K. and has served as a
Senior Quantitative Analyst for the Fund since 1996, and was prior to that the
Chief Investment Officer of Panagora Asset Management Limited.
Robert M. Shearer has served as the Natural Resources Focus Fund's
Portfolio Manager since December 1997, and is primarily responsible for the
Fund's day-to-day management. Mr. Shearer has served as First Vice President of
MLAM since January 1998 and was an Associate Portfolio Manager of the Fund from
September 1997 to December 1997. From 1996 to 1997 he was a Vice President and
an Assistant Portfolio Manager at David L. Babson and Company, Incorporated.
From 1993 to 1996 he was a Vice President/Sector Manager at Concert Capital
Management. From 1988 to 1993 he was the Senior Energy Analyst at Fiduciary
Trust Company International.
Jay Harbeck has served as the Prime Bond Fund's and the Government Bond
Fund's Portfolio Manager since July 1992 and May 1994 respectively. Mr. Harbeck
and Co-Portfolio Manager Christopher G. Ayoub are primarily responsible for each
such Fund's day-to-day management. Mr. Harbeck has served as First Vice
President of MLAM since 1997 and Vice President of MLAM from 1986 to 1997.
Jacqueline Rogers has served as the Portfolio Manager of the Domestic Money
Market Fund and the Reserve Assets Fund since October 1996, and is primarily
responsible for each such Fund's day-to-day management. She has served as Vice
President of MLAM since January 1986.
Paolo H. Valle has served as the Global Bond Focus Fund's Portfolio Manager
since January 1998, and is primarily responsible for the Fund's day-to-day
management. Mr. Valle has served as First Vice President of MLAM since 1997;
Senior Portfolio Manager since 1992; Vice President from 1992 to 1997.
Grace Pineda has served as the Developing Capital Markets Focus Fund's
Portfolio Manager since May 1994, and is primarily responsible for the Fund's
day-to-day management. She has served as FirstVice President of MLAM since 1997
and Vice President from 1989 to 1997.
Eric Mitofsky has served as the Index 500 Fund's Portfolio Manager since
the Fund commenced operations in December 1996. He has served as a Vice
President of MLAM since 1992, and was an employee of Merrill Lynch's Equity
Trading Group from 1983 to 1992.
R. Elise Baum has served as the Co-Portfolio Manager of the Special Value
Focus Fund (formerly, the Equity Growth Fund) since January 1998. She and Daniel
V. Szemis are primarily responsible for the day-to-day management of the Fund.
She has served as Director of MLAM since 1997; Vice President from 1995 to 1997;
Senior Fund Analyst from 1994 to 1995; Fund Analyst from 1993 to 1994; and
Consultant from 1992 to 1993.
Kurt Schansinger is the Senior Portfolio Manager of the Capital Focus Fund
and is primarily responsible for the day-to-day management of the Fund. He has
served as First Vice President of MLAM since 1997 and Vice President of MLAM
from January 1996 to 1997. Prior to MLAM, he spent 12 years with Oppenheimer
Capital, where he rose to Senior Vice President with various portfolio
management, research and administrative responsibilities.
Walter Cuje is the Associate Portfolio Manager of the Capital Focus Fund.
Mr. Cuje has been an Associate Portfolio Manager of MLAM since October 1993;
Director and First Vice President since 1997; Vice President from July 1991 to
1997.
Lawrence R. Fuller is the Portfolio Manager of the Global Growth Focus
Fund. Mr. Fuller has been a Vice President of the Investment Adviser since 1992
and is responsible for the day-to-day management of the Fund's investment
portfolio.
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Christopher G. Ayoub has served as the Co-Portfolio Manager of the Prime
Bond Fund and the Government Bond Fund since April 1998. He and Jay Harbeck are
primarily responsible for each such Fund's day-to-day management. Mr. Ayoub has
served as First Vice President of MLAM since 1998 and as Vice President of MLAM
from 1985 to 1997.
Robert F. Murray has served as the Portfolio Manager of the High Current
Income Fund since April 1998, and is primarily responsible for the Fund's
day-to-day management. He has served as Vice President of MLAM since 1993 and
employee of MLAM since 1989.
PORTFOLIO TRANSACTIONS AND BROKERAGE
None of the Company's Funds has any obligation to deal with any dealer or
group of dealers in the execution of transactions in portfolio securities.
Subject to policy established by the Board of Directors of the Company, the
Investment Adviser is primarily responsible for the Company's portfolio
decisions and the placing of the Company's portfolio transactions. In placing
orders, it is the policy of each Fund to obtain the most favorable net results,
taking into account various factors, including price, dealer spread or
commission, if any, size of the transactions and difficulty of execution. While
the Investment Adviser generally seeks reasonably competitive spreads or
commissions, the Company will not necessarily be paying the lowest spread or
commission available.
Under the Investment Company Act of 1940, persons affiliated with the
Company are prohibited from dealing with the Company as a principal in the
purchase and sale of the Company's portfolio securities unless an exemptive
order allowing such transactions is obtained from the Securities and Exchange
Commission. Affiliated persons of the Company may serve as its broker in
over-the-counter transactions conducted on an agency basis. The Securities and
Exchange Commission has issued an order permitting the Company to conduct
certain principal transactions with respect to the Domestic Money Market and
Reserve Assets Funds with Merrill Lynch Government Securities Inc. and Merrill
Lynch Money Markets Inc. in U.S. Government and Government agency securities,
and certain other money market securities, subject to certain terms and
conditions. During the fiscal year ended December 31, 1997, the Company engaged
in 15 transactions pursuant to such order involving approximately $49.2 million
of securities. For the year ended December 31, 1997, the Company paid brokerage
commissions of $8,344,021, of which $302,843 was paid to Merrill Lynch.
PURCHASE OF SHARES
The Company continuously offers shares in each of its Funds to the
Insurance Companies at prices equal to the respective per share net asset value
of the Funds. Merrill Lynch Funds Distributor, Inc., a wholly owned subsidiary
of the Investment Adviser, acts as the distributor of the shares. Net Asset
Value is determined in the manner set forth below under "Additional
Information -- Determination of Net Asset Value."
The Company and the Distributor reserve the right to suspend the sale of
shares of each Fund in response to conditions in the securities markets or
otherwise.
REDEMPTION OF SHARES
The Company is required to redeem all full and fractional shares of the
Funds for cash. The redemption price is the net asset value per share next
determined after the initial receipt of proper notice of redemption.
DIVIDENDS, DISTRIBUTIONS AND TAXES
It is the Company's intention to distribute substantially all of the net
investment income, if any, of each Fund. For dividend purposes, net investment
income of each Fund, other than the Company's Domestic Money Market and Reserve
Assets Funds, will consist of all payments of dividends or interest received by
such Fund less the estimated expenses of such Fund (including fees payable to
the Investment Adviser). Net investment income of the Domestic Money Market and
Reserve Assets Funds (from the time of the immediate preceding determination
thereof) consists of (i) interest accrued and/or discount earned (including both
original issue and market discount), (ii) plus or minus all realized and
unrealized gains (other than realized long-term capital gains) and losses on its
portfolio securities, (iii) less the estimated expenses of the respective Fund
(including the
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fees payable to the Investment Adviser) applicable to that dividend period.
Dividends on the Domestic Money Market and Reserve Assets Funds are declared
daily and reinvested monthly in additional full and fractional shares of such
Fund. Dividends from net investment income of the Global Bond Focus, Government
Bond, High Current Income and Prime Bond Funds are declared and reinvested
monthly in additional full and fractional shares of the respective Funds at net
asset value. Dividends from net investment income of the Global Utility Focus
Fund are declared and reinvested quarterly in additional full and fractional
shares of the Fund. Dividends from net investment income of the American
Balanced, Basic Value Focus, Capital Focus, Developing Capital Markets Focus,
Special Value Focus, Global Strategy Focus, Global Growth Focus, Index 500,
International Equity Focus, National Resources Focus and Quality Equity Funds
are declared and reinvested at least annually in additional full and fractional
shares of the respective Funds.
All net realized long-term or short-term capital gains of the Company, if
any, other than short-term capital gains of the Domestic Money Market and
Reserve Assets Funds, are declared and distributed annually after the close of
the Company's fiscal year to the shareholders of the Fund or Funds to which such
gains are attributable. Short-term capital gains are taxable as ordinary income.
TAX TREATMENT OF THE COMPANY
Each Fund intends to continue to qualify as a regulated investment company
under certain provisions of the Internal Revenue Code. Under such provisions, a
Fund will not be subject to federal income tax on such part of its net ordinary
income and net realized capital gains which it distributes to shareholders.
If a Fund earns original issue discount income in a taxable year which is
not represented by correlative cash income, or if a Fund receives property
rather than cash in payment of interest, shareholders will be allocated income
greater than the amount of cash distributed to them. In addition, the Fund may
have to dispose of securities and use the proceeds thereof to make distributions
in amounts necessary to satisfy its distribution requirements under the Code.
TAX TREATMENT OF INSURANCE COMPANIES AS SHAREHOLDERS
Dividends paid by the Company from its ordinary income and distributions of
the Company's net realized capital gains are includable in the respective
Insurance Company's gross income. Distributions of the Company's net realized
long-term capital gains retain their character as long-term capital gains in the
hands of the Insurance Companies if certain requirements are met. The tax
treatment of such dividends and distributions depends on the respective
Insurance Company's tax status. To the extent that income of the Company
represents dividends on common or preferred stock, rather than interest income,
its distributions to the Insurance Companies will be eligible for the present
70% dividends received deduction applicable in the case of a life insurance
company as provided in the Code. See the Prospectus for the Contracts for a
description of the respective Insurance Company's tax status and the charges
which may be made to cover any taxes attributable to the Separate Account. Not
later than 60 days after the end of each calendar year, the Company will send to
the Insurance Companies a written notice required by the Code designating the
amount and character of any distributions made during such year.
PERFORMANCE DATA
From time to time the average annual total return and yield of one or more
of the Company's Funds for various specified time periods may be included in
advertisements or information furnished by the Insurance Companies to present or
prospective Contract owners. Average annual total return and yield are computed
in accordance with formulas specified by the Securities and Exchange Commission.
In connection with its reorganization on December 6, 1996, the Global Bond Focus
Fund (i) acquired substantially all of the assets and assumed substantially all
the liabilities of the International Bond Fund, a separate Fund of the Company,
(ii) implemented a change in its investment objective and policies from seeking
high current income from a global portfolio of fixed income securities,
including non-investment grade securities, to seeking a high total
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investment return by investing in a global portfolio of investment grade fixed
income securities and (iii) changed its name from the World Income Focus Fund to
its current name. For the period from the commencement of the World Income Focus
Fund's operations through its reorganization on December 6, 1996, the portfolio
of the Fund included debt securities rated below investment grade (i.e., junk
bonds). On December 6, 1996, the Government Bond Fund (i) implemented a change
in its investment objective so that the Fund may invest in any debt securities
issued or guaranteed by the U.S. Government, its agencies or instrumentalities
without regard to remaining maturity and (ii) changed its name from the
Intermediate Government Bond Fund to its current name. For the period from the
commencement of the Fund's operations through December 6, 1996, the portfolio of
the Intermediate Government Bond Fund consisted primarily of intermediate-term
debt securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities with a maximum maturity not to exceed fifteen years. As a
result of the foregoing changes in the investment objective of each of the
Global Bond Focus Fund and the Government Bond Fund, the performance information
set forth herein and in the Statement of Additional Information for the fiscal
year ended December 31, 1996 may not be indicative of such Fund's future
performance.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield to maturity of each security earned during the
period by (b) the average daily number of shares outstanding during the period
that were entitled to receive dividends multiplied by the offering price per
share on the last day of the period. The yield for the 30-day period ending
December 31, 1997 was 6.05% for the Prime Bond Fund, 8.73% for the High Current
Income Fund, 6.11% for the Global Bond Focus Fund and 5.52% for the Government
Bond Fund.
Total return and yield figures are based on the Fund's historical
performance and are not intended to indicate future performance. The Fund's
total return and yield will vary depending on market conditions, the securities
comprising the Fund's portfolio, the Fund's operating expenses and the amount of
realized and unrealized net capital gains or losses during the period. The value
of an investment in the Fund will fluctuate and an investor's shares, when
redeemed, may be worth more or less than their original cost. The yield and
total return quotations may be of limited use for comparative purposes because
they do not reflect charges imposed at the Separate Account level which, if
included, would decrease the yield.
On occasion, one or more of the Company's Funds may compare its performance
to that of the S&P 500 Index, the Value Line Composite Index, the Dow Jones
Industrial Average, or performance data published by Lipper Analytical Services,
Inc., or Variable Annuity Research Data Service or contained in publications
such as Morningstar Publications, Inc., Chase Investment Performance Digest,
Money Magazine, U.S. News & World Report, Business Week, Financial Services
Weekly, Kiplinger Personal Finances, CDA Investment Technology, Inc., Forbes
Magazine, Fortune Magazine, Wall Street Journal, USA Today, Barrons, Strategic
Insight, Donaghues, Investors Business Daily and Ibbotson Associates. As with
other performance data, performance comparisons should not be considered
indicative of the Fund's relative performance for any future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of each class of shares of each Fund is determined once
daily by the Investment Adviser immediately after the declaration of dividends,
if any, and is determined as of fifteen minutes following the close of trading
(generally 4:00 p.m., New York time) on each day the New York Stock Exchange
("NYSE") is open for business. The NYSE is open on business days other than
national holidays and Good Friday. The net asset value per share of each class
of shares of a Fund other than the Domestic Money Market and Reserve Assets
Funds is computed by dividing the sum of the value of the securities plus any
cash or other assets (including interest and dividends accrued) held by such
Fund and attributable to such class minus all liabilities (including
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accrued expenses) attributable to such class by the total number of shares of
such class outstanding of that Fund at such time, rounded to the nearest cent.
Expenses, including the investment advisory fees payable to the Investment
Adviser, are accrued daily. Since the net investment income of the Domestic
Money Market and Reserve Assets Funds (including realized and unrealized gains
and losses on their portfolio securities) are declared as a dividend each time
the net income of the Funds are determined (see "Dividends, Distributions and
Taxes"), the net asset value per share of the Funds normally remains at $1.00
per share immediately after each such determination and dividend declaration.
Except with respect to securities held by the Domestic Money Market and
Reserve Assets Funds having a remaining maturity of 60 days or less, securities
held by each Fund will be valued as follows: Portfolio securities that are
traded on stock exchanges are valued at the last sale price (regular way) as of
the close of business on the day the securities are being valued, or, lacking
any sales, at the last available bid price for long positions and at the last
available ask price for short positions. Long positions in securities traded in
the over-the-counter ("OTC") market are valued at the last available bid price
in the OTC market prior to the time of valuation, provided however that the
Index 500 Fund will value its portfolio holdings which trade on the NASDAQ
national market system at the last sale price prior to the time of valuation.
Short positions in securities traded in the OTC market are valued at the last
available ask price in the OTC market prior to the time of valuation. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the OTC market. When a
Fund writes an option, the amount of the premium received is recorded on the
books as an asset and an equivalent liability. The amount of the liability is
subsequently valued to reflect the current market value of the option written,
based upon the last sale price in the case of exchange-traded options or, in the
case of options traded in the OTC market, the last asked price. Options
purchased are valued at their last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last bid price.
Futures contracts are valued at settlement price at the close of the applicable
exchange. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Company. Any assets or liabilities
initially expressed in terms of non-U.S. dollar currencies are translated into
U.S. dollars at the prevailing market rates as quoted by one or more banks or
dealers on the day of valuation. Securities held by the Domestic Money Market
and Reserve Assets Funds with a remaining maturity of 60 days or less are valued
on an amortized cost basis, unless particular circumstances dictate otherwise.
The Company has used pricing services, including Merrill Lynch Securities
Pricing(SM) Service ("MLSPS"), to value securities held by the High Current
Income and Prime Bond Funds and to value bonds held by other of the Company's
Funds. The Board of Directors of the Company has examined the methods used by
the pricing services in estimating the value of securities held by the Funds and
believes that such methods will reasonably and fairly approximate the price at
which those securities may be sold and result in a good faith determination of
the fair value of such securities; however, there is no assurance that
securities can be sold at the prices at which they are valued. During the fiscal
year ended December 31, 1997, American Balanced Fund, Global Strategy Focus
Fund, Global Utility Focus Fund, High Current Income Fund, Government Bond Fund,
Prime Bond Fund and Global Bond Focus Fund paid MLSPS $248, $239, $43, $7,008,
$1,676, $8,877 and $116, respectively.
ORGANIZATION OF THE COMPANY
The Company was incorporated on October 16, 1981, and operations of its
Reserve Assets Fund commenced on November 12, 1981. Operations of the Prime
Bond, High Current Income, Quality Equity and Special Value Focus Funds
commenced on April 20, 1982. The Natural Resources Focus Fund and the American
Balanced Fund commenced operations on June 1, 1988 and June 1, 1988,
respectively. The Domestic Money Market Fund and the Global Strategy Focus Fund
commenced operations on February 20 and February 28, 1992, respectively. The
Basic Value Focus, Global Bond Focus, Global Utility Focus and International
Equity Focus Funds commenced operations on July 1, 1993. The Developing Capital
Markets Focus Fund and Government Bond Fund commenced operations on May 2, 1994.
The Index 500 Fund commenced operations on December 13, 1996. The Global Growth
Focus Fund and the Capital Focus Fund are expected to commence operations on or
about June 5, 1998. The authorized capital stock of the Company consists of
3,600,000,000 shares of Class A Common Stock, par value $0.10 per share, and
3,600,000,000 shares of Class B Common Stock, par value $0.10 per share. The
shares of Class A and Class B Common Stock are each divided into eighteen
classes designated
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Merrill Lynch American Balanced Fund Common Stock, Merrill Lynch Basic Value
Focus Fund Common Stock, Merrill Lynch Capital Focus Fund Common Stock, Merrill
Lynch Developing Capital Markets Focus Fund Common Stock, Merrill Lynch Domestic
Money Market Fund Common Stock, Merrill Lynch Special Value Focus Fund Common
Stock, Merrill Lynch Global Bond Focus Fund Common Stock, Merrill Lynch Global
Strategy Focus Fund Common Stock, Merrill Lynch Global Utility Focus Fund Common
Stock, Merrill Lynch Global Growth Focus Fund Common Stock, Merrill Lynch
Government Bond Fund Common Stock, Merrill Lynch High Current Income Fund Common
Stock, Merrill Lynch Index 500 Common Stock, Merrill Lynch International Equity
Focus Fund Common Stock, Merrill Lynch Natural Resources Focus Fund Common
Stock, Merrill Lynch Prime Bond Fund Common Stock, Merrill Lynch Quality Equity
Fund Common Stock and Merrill Lynch Reserve Assets Fund Common Stock,
respectively. The Company may, from time to time, at the sole discretion of its
Board of Directors and without the need to obtain the approval of its
shareholders or of Contract owners, offer and sell shares of one or more of such
classes. Each class consists of 100,000,000 Class A shares and 100,000,000 Class
B shares except for Domestic Money Market Fund Common Stock which consists of
1,300,000,000 Class A shares and 1,300,000,000 Class B shares, Reserve Assets
Fund Common Stock which consists of 500,000,000 Class A shares and 500,000,000
Class B shares and Global Bond Focus Fund Common Stock and Global Strategy Focus
Fund Common Stock, each of which consists of 200,000,000 Class A shares and
200,000,000 Class B shares. All shares of Common Stock have equal voting rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. Pursuant to the Investment Company Act of
1940 and the rules and regulations thereunder, certain matters approved by a
vote of all shareholders of the Company may not be binding on a class whose
shareholders have not approved such matter. Each issued and outstanding share of
a class is entitled to one vote and to participate equally in dividends and
distributions declared with respect to such class and in net assets of such
class upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities. The shares of each class, when issued, will be fully
paid and nonassessable, have no preference, preemptive, conversion, exchange or
similar rights, and will be freely transferable. Holders of shares of any class
are entitled to redeem their shares as set forth under "Redemption of Shares."
Shares do not have cumulative voting rights and the holders of more than 50% of
the shares of the Company voting for the election of directors can elect all of
the directors of the Company if they choose to do so and in such event the
holders of the remaining shares would not be able to elect any directors. The
Company does not intend to hold meetings of shareholders unless under the
Investment Company Act of 1940 shareholders are required to act on any of the
following matters: (i) election of directors; (ii) approval of an investment
advisory agreement; (iii) approval of a distribution agreement; and (iv)
ratification of the selection of independent accountants.
Family Life purchased $1,000 worth of shares of each of the Natural
Resources Focus Fund and the American Balanced Fund on April 29, 1988 and
$1,999,000 worth of shares of each such Fund on May 27, 1988. Family Life also
provided the initial capitalization for each of the Company's other Funds other
than the Funds named below for which MLLIC provided the initial capitalization.
MLLIC purchased $100 worth of shares of each of the Domestic Money Market and
Global Strategy Focus Funds on February 6, 1992, $2,000,000 worth of shares of
the Domestic Money Market Fund on February 20, 1992, $2,000,000 worth of shares
of the Global Strategy Focus Fund on February 28, 1992 and $100 worth of shares
of each of the Basic Value Focus, Global Bond Focus, Global Utility Focus and
International Equity Focus Funds on June 28, 1993. MLLIC purchased, on July 1,
1993, $8,000,000 worth of shares of each of the Global Bond Focus Fund and
International Equity Focus Fund and $2,000,000 worth of shares of each of the
Basic Value Focus Fund and the Global Utility Focus Fund. MLLIC purchased, on
May 2, 1994, $8,000,000 worth of shares of the Developing Capital Markets Focus
Fund and, on May 16, 1994, $2,000,000 worth of shares of the Government Bond
Fund. On December 13, 1996, MLLIC purchased $10,000,000 worth of shares of the
Index 500 Fund. On April 16, 1998, MLLIC purchased $1,000 worth of shares of the
Global Growth Focus Fund and $1,000 worth of shares of the Capital Focus Fund.
In connection with a reorganization on December 6, 1996 conducted by the
Company with respect to certain of its Funds, the Company, with the approval of
the affected shareholders of the Funds, caused (i) Global Bond Focus Fund (a) to
acquire substantially all of the assets and assume substantially all the
liabilities of the International Bond Fund, a separate Fund of the Company, (b)
to implement a change in its investment objective and policies from seeking high
current income from a global portfolio of fixed income securities, including
non-investment grade securities, to seeking a high total investment return by
investing in a global portfolio of investment grade fixed income securities and
(c) to change its name from the World Income Focus Fund to its current name;
(ii) the Government Bond Fund (x) to implement a change in its investment
objective
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so that the Fund may invest in any debt securities issued or guaranteed by the
U.S. Government, its agencies or instrumentalities without regard to remaining
maturity and (y) to change its name from the Intermediate Government Bond Fund
to its current name; and (iii) the Global Strategy Focus Fund to acquire
substantially all of the assets and assume substantially all the liabilities of
the Flexible Strategy Fund, a separate Fund of the Company.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
been selected as the independent auditors of the Company. The selection of
independent auditors is subject to annual ratification by the Company's
shareholders.
CUSTODIAN
The Bank of New York ("BONY"), 110 Washington Street, New York, New York
10286, acts as Custodian of the Company's assets, except that Brown Brothers
Harriman & Co., 40 Water Street, Boston, Massachusetts 02109, acts as Custodian
for assets of the Company's Developing Capital Markets Focus Fund.
TRANSFER AND DIVIDEND DISBURSING AGENT
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), which is a wholly
owned subsidiary of Merrill Lynch & Co., Inc., acts as the Company's Transfer
Agent and is responsible for the issuance, transfer and redemption of shares and
the opening and maintenance of shareholder accounts. MLFDS will receive an
annual fee of $5,000 per Fund and will be entitled to reimbursement of
out-of-pocket expenses.
LEGAL COUNSEL
Rogers & Wells LLP, New York, New York, is counsel for the Company.
REPORTS TO SHAREHOLDERS
The fiscal year of the Company ends on December 31 of each year. The
Company will send to its shareholders at least semi-annually reports showing the
Funds' portfolio securities and other information. An annual report containing
financial statements, audited by independent auditors, will be sent to
shareholders each year.
ADDITIONAL INFORMATION
This Prospectus does not contain all of the information included in the
Registration Statement filed with the Securities and Exchange Commission under
the Securities Act of 1933 and the Investment Company Act of 1940, with respect
to the securities offered hereby, certain portions of which have been omitted
pursuant to the rules and regulations of the Securities and Exchange Commission.
The Statement of Additional Information, dated April 17, 1998, which forms
a part of the Registration Statement, is incorporated by reference into this
Prospectus. The Statement of Additional Information may be obtained without
charge as provided on the cover page of this Prospectus. The Registration
Statement, including the exhibits filed therewith, may be examined at the office
of the Securities and Exchange Commission in Washington, D.C.
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate
years. These systems may not be able to distinguish the Year 2000 from the Year
1900 (commonly known as the "Year 2000 Problem"). Like other investment
companies and financial and business organizations, the Company could be
adversely affected if the computer systems used by the Investment Adviser or
other Company service providers do not properly address this problem prior to
January 1, 2000. The Investment Adviser has established a dedicated group to
analyze these issues and to implement any systems modifications necessary to
prepare for the Year 2000. Currently, the Investment Adviser does not anticipate
that the transition to the 21st century will have any material impact on its
ability to continue to service the Company at current levels. In addition, the
Investment
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Adviser has sought assurances from the Company's other service providers that
they are taking all necessary steps to ensure that their computer systems will
accurately reflect the Year 2000, and the Investment Adviser will continue to
monitor the situation. At this time, however, no assurance can be given that the
Company's other service providers have anticipated every step necessary to avoid
any adverse effect on the Company attributable to the Year 2000 Problem.
A-17
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ANNEX A
DESCRIPTION OF TEMPORARY INVESTMENTS AND CORPORATE BOND RATINGS
U.S. GOVERNMENT SECURITIES
The Domestic Money Market Fund, Reserve Assets Fund, Capital Focus Fund and
the Government Bond Fund (and, for temporary or defensive purposes, each other
Fund) may invest in the various types of marketable securities issued by or
guaranteed as to principal and interest by the U.S. Government and supported by
the full faith and credit of the U.S. Treasury. U.S. Treasury obligations differ
mainly in the length of their maturity. Treasury bills, the most frequently
issued marketable government security, have a maturity of up to one year and are
issued on a discount basis.
GOVERNMENT AGENCY SECURITIES
The Domestic Money Market Fund, Reserve Assets Fund, Capital Focus Fund and
the Government Bond Fund (and, for temporary or defensive purposes, each other
Fund) may invest in government agency securities, which are debt securities
issued by government sponsored enterprises, federal agencies and international
institutions. Such securities are not direct obligations of the Treasury but
involve government sponsorship or guarantees by government agencies or
enterprises. The Funds may invest in all types of government agency securities
currently outstanding or to be issued in the future.
DEPOSITARY INSTITUTIONS MONEY INSTRUMENTS
The Domestic Money Market Fund, Reserve Assets Fund and Capital Focus Fund
(and, for temporary or defensive purposes, each other Fund) may invest in
depositary institutions money instruments, such as certificates of deposit,
including variable rate certificates of deposit, bankers' acceptances, time
deposits and bank notes. Certificates of deposit are generally short-term,
interest-bearing negotiable certificates issued by commercial banks, savings
banks or savings and loan associations against funds deposited in the issuing
institution. Variable rate certificates of deposit are certificates of deposit
on which the interest rate is periodically adjusted prior to their stated
maturity, usually at 30, 90 or 180 day intervals ("coupon dates"), based upon a
specified market rate. As a result of these adjustments, the interest rate on
these obligations may be increased or decreased periodically. Often, dealers
selling variable rate certificates of deposit to the Funds agree to repurchase
such instruments, at the Funds' option, at par on the coupon dates. The dealers'
obligations to repurchase these instruments are subject to conditions imposed by
the various dealers; such conditions typically are the continued credit standing
of the issuer and the existence of reasonably orderly market conditions. The
Funds are also able to sell variable rate certificates of deposit in the
secondary market. Variable rate certificates of deposit normally carry a higher
interest rate than comparable fixed rate certificates of deposit because
variable rate certificates of deposit generally have a longer stated maturity
than comparable fixed rate certificates of deposit. As a matter of policy, the
Domestic Money Market Fund will invest only in these types of instruments issued
by U.S. issuers.
A bankers' acceptance is a time draft drawn on a commercial bank by a
borrower usually in connection with an international commercial transaction (to
finance the import, export, transfer or storage of goods). The borrower is
liable for payment as well as the bank, which unconditionally guarantees to pay
the draft at its face amount on the maturity date. Most acceptances have
maturities of six months or less and are traded in secondary markets prior to
maturity.
The Reserve Assets Fund and Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund, Developing Capital Markets Focus Fund and the Quality Equity Fund)
may invest in certificates of deposit and bankers' acceptances issued by foreign
branches or subsidiaries of U.S. banks ("Eurodollar" obligations) or U.S.
branches or subsidiaries of foreign banks ("Yankeedollar" obligations). The Fund
may invest only in Eurodollar obligations which by their terms are general
obligations of the U.S. parent bank and meet the other criteria discussed below.
Yankeedollar obligations in which the Fund may invest must be issued by U.S.
branches or subsidiaries of foreign banks which are subject to state or federal
banking regulations in the U.S. and by their terms must be general obligations
of the foreign parent. In addition, the Fund will limit its investments in
Yankeedollar obligations to obligations issued by banking institutions with more
than $1 billion in assets.
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The Reserve Assets Fund and Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund, Developing Capital Markets Focus Fund and the Quality Equity Fund)
may also invest in U.S. dollar-denominated obligations of foreign depository
institutions and their foreign branches and subsidiaries, such as certificates
of deposit, bankers' acceptances, time deposits and deposit notes. The
obligations of such foreign branches and subsidiaries may be the general
obligation of the parent bank or may be limited to the issuing branch or
subsidiary by the terms of the specific obligation or by government regulation.
Such investments will only be made if determined to be of comparable quality to
other investments permissible for the Reserve Assets Fund. The Reserve Assets
Fund will not invest more than 25% of its total assets (taken at market value at
the time of each investment) in these obligations.
Except as otherwise provided above with respect to investment in
Yankeedollar and other foreign bank obligations no Fund may invest in any bank
money instrument issued by a commercial bank or a savings and loan association
unless the bank or association is organized and operating in the United States,
has total assets of at least $1 billion and its deposits are insured by the
Federal Deposit Insurance Corporation (the "FDIC"); provided that this
limitation shall not prohibit the investment of up to 10% of the total assets of
a Fund (taken at market value at the time of each investment) in certificates of
deposit issued by banks and savings and loan associations with assets of less
than $1 billion if the principal amount of each such certificate of deposit is
fully insured by the FDIC.
SHORT-TERM DEBT INSTRUMENTS
The Domestic Money Market Fund, Reserve Assets Fund and Capital Focus Fund
(and, for temporary or defensive purposes, each other Fund) may invest in
commercial paper (including variable amount master demand notes and insurance
company funding agreements), which refers to short-term, unsecured promissory
notes issued by corporations, partnerships, trusts and other entities to finance
short-term credit needs and by trusts issuing asset-backed commercial paper.
Commercial paper is usually sold on a discount basis and has a maturity at the
time of issuance not exceeding nine months. Variable amount master demand notes
are demand obligations that permit the investment of fluctuating amounts at
varying market rates of interest pursuant to arrangements between the issuer and
a commercial bank acting as agent for the payees of such notes, whereby both
parties have the right to vary the amount of the outstanding indebtedness on the
notes. Because variable amount master notes are direct lending arrangements
between the lender and borrower, it is not generally contemplated that such
instruments will be traded and there is no secondary market for the notes.
Typically, agreements relating to such notes provide that the lender may not
sell or otherwise transfer the note without the borrower's consent. Such notes
provide that the interest rate on the amount outstanding is adjusted
periodically, typically on a daily basis, in accordance with a stated short-term
interest rate benchmark. Because the interest rate of a variable amount master
note is adjusted no less often than every 60 days and since repayment of the
note may be demanded at any time, the Investment Adviser values such a note in
accordance with the amortized cost basis described under "Determination of Net
Asset Value" in the Statement of Additional Information.
The Domestic Money Market Fund and Reserve Assets Fund may also invest in
nonconvertible debt securities issued by entities or asset-backed nonconvertible
debt securities issued by trusts (e.g., bonds and debentures) with no more than
397 days (13 months) remaining to maturity at date of settlement. Short-term
debt securities with a remaining maturity of less than one year tend to become
extremely liquid and are traded as money market securities. For a discussion of
the ratings requirements of the Funds' portfolio securities, see "Portfolio
Restrictions" in the Prospectuses to the Domestic Money Market Fund and Reserve
Assets Fund.
The Reserve Assets Fund and the Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund and Developing Capital Markets Focus Fund) may also invest in U.S.
dollar-denominated commercial paper and other short-term obligations issued by
foreign entities. Such investments are subject to quality standards similar to
those applicable to investments in comparable obligations of domestic issuers.
Investments in foreign entities in general involve the same risks as those
described in the Statement of Additional Information in connection with
investments in Eurodollar, Yankeedollar and foreign bank obligations.
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REPURCHASE AGREEMENTS
Repurchase Agreements; Purchase and Sale Contracts. Each Fund may invest
in securities pursuant to repurchase agreements or purchase and sale contracts.
Under a repurchase agreement, the seller agrees, upon entering into the contract
with the Fund, to repurchase a security (typically a security issued or
guaranteed by the U.S. government) at a mutually agreed upon time and price,
thereby determining the yield during the term of the agreement. This results in
a fixed yield for the Fund insulated from fluctuations in the market value of
the underlying security during such period, although, to the extent the
repurchase agreement is not denominated in U.S. dollars, the Fund's return may
be affected by currency fluctuations. Repurchase agreements may be entered into
only with a member bank of the Federal Reserve System, a primary dealer in U.S.
government securities or an affiliate thereof. A purchase and sale contract is
similar to a repurchase agreement, but purchase and sale contracts, unlike
repurchase agreements, allocate interest on the underlying security to the
purchaser during the term of the agreement and generally do not require the
seller to provide additional securities in the event of a decline in the market
value of the purchased security during the term of the agreement. If the seller
were to default on its obligation to repurchase a security under a repurchase
agreement or purchase and sale contract and the market value of the underlying
security at such time was less than the Fund had paid to the seller, the Fund
would realize a loss. Repurchase agreements maturing in more than seven days
will be considered "illiquid securities." The Domestic Money Markets and Reserve
Assets Funds will not enter into repurchase agreements maturing in more than 30
days.
Reverse Repurchase Agreements. The Domestic Money Market and Reserve
Assets Funds may enter into reverse repurchase agreements, which involve the
sale of money market securities held by the Funds, with an agreement to
repurchase the securities at an agreed upon price, date, and interest payment.
The Funds will use the proceeds of the reverse repurchase agreements to purchase
other money market securities either maturing, or under an agreement to resell,
at a date simultaneous with or prior to the expiration of the reverse repurchase
agreement. The Funds will utilize reverse repurchase agreements when the
interest income to be earned from the investment of the proceeds of the
transaction is greater than the interest expense of the reverse repurchase
transaction. A separate account of the applicable Fund will be established with
the Custodian consisting of cash or liquid securities having a market value at
all times at least equal in value to the proceeds received on any sale subject
to repurchase plus accrued interest.
DESCRIPTION OF CORPORATE BOND RATINGS
Moody's Investors Service, Inc. ("Moody's"):
Aaa -- Bonds which are 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." Interest payments are protected by a large or
by an exceptionally stable margin and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of
such issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there may
be other elements present which make the long-term risks appear somewhat
larger than in Aaa securities.
A -- Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium-grade obligations.
Factors giving security to principal and interest are considered adequate
but elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa -- Bonds which are rated Baa are considered 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 length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba -- Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate
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and thereby not well safeguarded both during good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of a
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any period of time may be
small.
Caa -- Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca -- Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have
other market shortcomings.
C -- Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Standard & Poor's Ratings Services ("Standard & Poor's"):
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, and in the majority
of instances they differ from AAA issues only in small degree.
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 obligations. 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.
NR -- Not rated by the indicated rating agency.
Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by
the addition of a plus or minus sign to show relative standing within the
major rating categories.
Annex A-4
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ANNEX B
DESCRIPTION OF DERIVATIVE INSTRUMENTS
Certain Funds of the Company are authorized to use derivative instruments,
including indexed and inverse securities, options, and futures, and to purchase
and sell foreign exchange, as described below. Such instruments are referred to
collectively herein as "Strategic Instruments."
INDEXED AND INVERSE SECURITIES
The Domestic Money Market Fund, the Global Bond Focus Fund, the Global
Strategy Focus Fund, the Global Utility Focus Fund, the Government Bond Fund,
the Index 500 Fund, the International Equity Focus Fund, the Natural Resources
Focus Fund, the Prime Bond Fund, the Developing Capital Markets Focus Fund, the
Global Growth Focus Fund, and the Reserve Assets Fund may invest in securities
the potential return of which is based on the change in particular measurements
of value or rate (an "index"). As an illustration, a Fund may invest in a debt
security that pays interest and returns principal based on the change in the
value of an interest rate index (such as the prime rate or federal funds rate),
a securities index (such as the Standard & Poor's 500 Composite Index (the "S&P
500") or a more narrowly-focused index such as the AMEX Oil & Gas Index) or a
basket of securities, or based on the relative changes of two indices. In
addition, the Developing Capital Markets Focus Fund, the Global Strategy Focus
Fund, the International Equity Focus Fund and the Natural Resources Focus Fund
may invest in securities the potential return of which is based inversely on the
change in an index. For example, these Funds may invest in securities that pay a
higher rate of interest when a particular index decreases and pay a lower rate
of interest (or do not fully return principal) when the value of the index
increases. If the Fund invests in such securities, it may be subject to reduced
or eliminated interest payments or loss of principal in the event of an adverse
movement in the relevant index or indices.
Certain indexed and inverse securities may have the effect of providing
investment leverage because the rate of interest or amount of principal payable
increases or decreases at a rate that is a multiple of the changes in the
relevant index. As a consequence, the market value of such securities may be
substantially more volatile than the market values of other debt securities. The
Company believes that indexed and inverse securities may provide portfolio
management flexibility that permits Funds to seek enhanced returns, hedge other
portfolio positions or vary the degree of portfolio leverage with greater
efficiency than would otherwise be possible under certain market conditions.
OPTIONS ON SECURITIES AND SECURITIES INDICES
Purchasing Options. The Developing Capital Markets Focus Fund, the Global
Bond Focus Fund, the Global Strategy Focus Fund, the Global Utility Focus Fund,
the Index 500 Fund, the International Equity Focus Fund, the Global Growth Focus
Fund, and the Natural Resources Focus Fund are each authorized to purchase put
options on securities held in its portfolio or securities indices the
performance of which is substantially correlated with securities held in its
portfolio. When a Fund purchases a put option, in consideration for an upfront
payment (the "option premium") the Fund acquires a right to sell to another
party specified securities owned by the Fund at a specified price (the "exercise
price") on or before a specified date (the "expiration date"), in the case of an
option on securities, or to receive from another party a payment based on the
amount a specified securities index declines below a specified level on or
before the expiration date, in the case of an option on a securities index. The
purchase of a put option limits the Fund's risk of loss in the event of a
decline in the market value of the portfolio holdings underlying the put option
prior to the option's expiration date. If the market value of the portfolio
holdings associated with the put option increases rather than decreases,
however, the Fund will lose the option premium and will consequently realize a
lower return on the portfolio holdings than would have been realized without the
purchase of the put.
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Index 500 Fund, the International Equity Focus
Fund, the Global Growth Focus Fund and the Natural Resources Focus Fund are each
authorized to purchase call options on securities it intends to purchase or
securities indices the performance of which are substantially correlated with
the performance of the types of securities it intends to purchase. When a Fund
purchases a call option, in consideration for the option premium the Fund
acquires a right to purchase from another party specified securities at the
exercise price on or before the expiration date, in the case of an option on
securities, or to receive from another party a payment based on the
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amount a specified securities index increases beyond a specified level on or
before the expiration date, in the case of an option on a securities index. The
purchase of a call option may protect the Fund from having to pay more for a
security as a consequence of increases in the market value for the security
during a period when the Fund is contemplating its purchase, in the case of an
option on a security, or attempting to identify specific securities in which to
invest in a market the Fund believes to be attractive, in the case of an option
on an index (an "anticipatory hedge"). In the event the Fund determines not to
purchase a security underlying a call option, however, the Fund may lose the
entire option premium.
Each Fund is also authorized to purchase put or call options in connection
with closing out put or call options it has previously sold.
Writing Options. The American Balanced Fund, the Basic Value Focus Fund,
the Developing Capital Markets Focus Fund, the Special Value Focus Fund, the
Global Bond Focus Fund, the Global Strategy Focus Fund, the Global Utility Focus
Fund, the Index 500 Fund, the International Equity Focus Fund, the Natural
Resources Focus Fund, the Global Growth Focus Fund, the Capital Focus Fund and
the Quality Equity Fund are each authorized to write (i.e., sell) call options
on securities held in its portfolio or securities indices the performance of
which is substantially correlated with securities held in its portfolio. When a
Fund writes a call option, in return for an option premium the Fund gives
another party the right to buy specified securities owned by the Fund at the
exercise price on or before the expiration date, in the case of an option on
securities, or agrees to pay to another party an amount based on any gain in a
specified securities index beyond a specified level on or before the expiration
date, in the case of an option on a securities index. The Fund may write call
options to earn income, through the receipt of option premiums. In the event the
party to which the Fund has written an option fails to exercise its rights under
the option because the value of the underlying securities is less than the
exercise price, the Fund will partially offset any decline in the value of the
underlying securities through the receipt of the option premium. By writing a
call option, however, the Fund limits its ability to sell the underlying
securities, and gives up the opportunity to profit from any increase in the
value of the underlying securities beyond the exercise price, while the option
remains outstanding.
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the Index 500 Fund,
the International Equity Focus Fund, the Global Growth Focus Fund and the
Natural Resources Focus Fund each may also write put options on securities or
securities indices. When the Fund writes a put option, in return for an option
premium the Fund gives another party the right to sell to the Fund a specified
security at the exercise price on or before the expiration date, in the case of
an option on a security, or agrees to pay to another party an amount based on
any decline in a specified securities index below a specified level on or before
the expiration date, in the case of an option on a securities index. The Fund
may write put options to earn income, through the receipt of option premiums. In
the event the party to which the Fund has written an option fails to exercise
its rights under the option because the value of the underlying securities is
greater than the exercise price, the Fund will profit by the amount of the
option premium. By writing a put option, however, the Fund will be obligated to
purchase the underlying security at a price that may be higher than the market
value of the security at the time of exercise as long as the put option is
outstanding, in the case of an option on a security, or make a cash payment
reflecting any decline in the index, in the case of an option on an index.
Accordingly, when the Fund writes a put option it is exposed to a risk of loss
in the event the value of the underlying securities falls below the exercise
price, which loss potentially may substantially exceed the amount of option
premium received by the Fund for writing the put option. The Fund will write a
put option on a security or a securities index only if the Fund would be willing
to purchase the security at the exercise price for investment purposes (in the
case of an option on a security) or is writing the put in connection with
trading strategies involving combinations of options -- for example, the sale
and purchase of options with identical expiration dates on the same security or
index but different exercise prices (a technique called a "spread").
Each Fund is also authorized to sell call or put options in connection with
closing out call or put options it has previously purchased.
Other than with respect to closing transactions, a Fund will only write
call or put options that are "covered." A call or put option will be considered
covered if the Fund has segregated assets with respect to such option in the
manner described in "Risk Factors in Options, Futures, and Currency Instruments"
below. A call option will also be considered covered if a Fund owns the
securities it would be required to deliver upon exercise of the
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<PAGE> 107
option (or, in the case of option on a securities index, securities which are
substantially correlated with the performance of such index) or owns a call
option, warrant or convertible instrument which is immediately exercisable for,
or convertible into, such security.
Types of Options. A Fund may engage in transactions in options on
securities or securities indices on exchanges and in the over-the-counter
("OTC") markets. In general, exchange-traded options have standardized exercise
prices and expiration dates and require the parties to post margin against their
obligations, and the performance of the parties' obligations in connection with
such options is guaranteed by the exchange or a related clearing corporation.
OTC options have more flexible terms negotiated between the buyer and the
seller, but generally do not require the parties to post margin and are subject
to greater risk of counterparty default. See "Additional Risk Factors of OTC
Transactions" below.
FUTURES
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the Index 500 Fund,
the International Equity Focus Fund, the Global Growth Focus Fund and the
Natural Resources Focus Fund may each engage in transactions in futures and
options thereon. Futures are standardized, exchange-traded contracts which
obligate a purchaser to take delivery, and a seller to make delivery, of a
specific amount of a commodity at a specified future date at a specified price.
No price is paid upon entering into a futures contract. Rather, upon purchasing
or selling a futures contract the Fund is required to deposit collateral
("margin") equal to a percentage (generally less than 10%) of the contract
value. Each day thereafter until the futures position is closed, the Fund will
pay additional margin representing any loss experienced as a result of the
futures position the prior day or be entitled to a payment representing any
profit experienced as a result of the futures position the prior day.
The sale of a futures contract limits a Fund's risk of loss through a
decline in the market value of portfolio holdings correlated with the futures
contract prior to the futures contract's expiration date. In the event the
market value of the portfolio holdings correlated with the futures contract
increases rather than decreases, however, the Fund will realize a loss on the
futures position and a lower return on the portfolio holdings than would have
been realized without the purchase of the futures contract.
The purchase of a futures contract may protect a Fund from having to pay
more for securities as a consequence of increases in the market value for such
securities during a period when the Fund was attempting to identify specific
securities in which to invest in a market the Fund believes to be attractive. In
the event that such securities decline in value or the Fund determines not to
complete an anticipatory hedge transaction relating to a futures contract,
however, the Fund may realize a loss relating to the futures position.
A Fund will limit transactions in futures and options on futures to
financial futures contracts (i.e., contracts for which the underlying commodity
is a currency or securities or interest rate index) purchased or sold for
hedging purposes (including anticipatory hedges). Each Fund will further limit
transactions in futures and options on futures to the extent necessary to
prevent the Fund from being deemed a "commodity pool" under regulations of the
Commodity Futures Trading Commission.
FOREIGN EXCHANGE TRANSACTIONS
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the International
Equity Focus Fund, the Natural Resources Focus Fund, the Global Growth Focus
Fund, the Capital Focus Fund and the Quality Equity Fund may engage in spot and
forward foreign exchange transactions and currency swaps, purchase and sell
options on currencies and purchase and sell currency futures and related options
thereon (collectively, "Currency Instruments") for purposes of hedging against
the decline in the value of currencies in which its portfolio holdings are
denominated against the US dollar.
Forward foreign exchange transactions are OTC contracts to purchase or sell
a specified amount of a specified currency or multinational currency unit at a
price and future date set at the time of the contract. Spot foreign exchange
transactions are similar but require current, rather than future, settlement. A
Fund will enter into foreign exchange transactions only for purposes of hedging
either a specific transaction or a portfolio position. A Fund may enter into a
foreign exchange transaction for purposes of hedging a specific transaction by,
for
Annex B-3
<PAGE> 108
example, purchasing a currency needed to settle a security transaction or
selling a currency in which the Fund has received or anticipates receiving a
dividend or distribution. A Fund may enter into a foreign exchange transaction
for purposes of hedging a portfolio position by selling forward a currency in
which a portfolio position of the Fund is denominated or by purchasing a
currency in which the Fund anticipates acquiring a portfolio position in the
near future. A Fund may also hedge portfolio positions through currency swaps,
which are transactions in which one currency is simultaneously bought for a
second currency on a spot basis and sold for the second currency on a forward
basis.
The Funds authorized to engage in Currency Instrument transactions may also
hedge against the decline in the value of a currency against the US dollar
through use of currency futures or options thereon. Currency futures are similar
to forward foreign exchange transactions except that futures are standardized
exchange-traded contracts. See "Futures" above.
The Funds authorized to engage in Currency Instrument transactions may also
hedge against the decline in the value of a currency against the US dollar
through the use of currency options. Currency options are similar to options on
securities, but in consideration for an option premium the writer of a currency
option is obligated to sell (in the case of a call option) or purchase (in the
case of a put option) a specified amount of a specified currency on or before
the expiration date for a specified amount of another currency. The Fund may
engage in transactions in options on currencies either on exchanges or OTC
markets. See "Types of Options" above and "Additional Risk Factors of OTC
Transactions" below.
No Fund will speculate in Currency Instruments. Accordingly, a Fund will
not hedge a currency in excess of the aggregate market value of the securities
which it owns (including receivables for unsettled securities sales), or has
committed to or anticipates purchasing, which are denominated in such currency.
A Fund may, however, hedge a currency by entering into a transaction in a
Currency Instrument denominated in a currency other than the currency being
hedged (a "cross-hedge"). The Fund will only enter into a cross-hedge if the
Investment Adviser believes that (i) there is a demonstrable high correlation
between the currency in which the cross-hedge is denominated and the currency
being hedged, and (ii) executing a cross-hedge through the currency in which the
cross-hedge is denominated will be significantly more cost-effective or provide
substantially greater liquidity than executing a similar hedging transaction by
means of the currency being hedged.
Risk Factors in Hedging Foreign Currency Risks. While a Fund's use of
Currency Instruments to effect hedging strategies is intended to reduce the
volatility of the net asset value of the Fund's shares, the net asset value of
the Fund's shares will fluctuate. Moreover, although Currency Instruments will
be used with the intention of hedging against adverse currency movements,
transactions in Currency Instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective. To the extent that a Fund hedges against
anticipated currency movements which do not occur, the Fund may realize losses,
and decrease its total return, as the result of its hedging transactions.
Furthermore, a Fund will only engage in hedging activities from time to time and
may not be engaging in hedging activities when movements in currency exchange
rates occur. It may not be possible for a Fund to hedge against currency
exchange rate movements, even if correctly anticipated, in the event that (i)
the currency exchange rate movement is so generally anticipated that the Fund is
not able to enter into a hedging transaction at an effective price, or (ii) the
currency exchange rate movement relates to a market with respect to which
Currency Instruments are not available (such as certain developing markets) and
it is not possible to engage in effective foreign currency hedging.
RISK FACTORS IN OPTIONS, FUTURES, AND CURRENCY INSTRUMENTS
Use of Strategic Instruments for hedging purposes involves the risk of
imperfect correlation in movements in the value of the Strategic Instruments and
the value of the instruments being hedged. If the value of the Strategic
Instruments moves more or less than the value of the hedged instruments a Fund
will experience a gain or loss which will not be completely offset by movements
in the value of the hedged instruments.
Each Fund intends to enter into transactions involving Strategic
Instruments only if there appears to be a liquid secondary market for such
instruments or, in the case of illiquid instruments traded in OTC transactions,
such instruments satisfy the criteria set forth below under "Additional Risk
Factors of OTC Transactions." However, there can be no assurance that, at any
specific time, either a liquid secondary market will exist for a
Annex B-4
<PAGE> 109
Strategic Instrument or the Fund will otherwise be able to sell such instrument
at an acceptable price. It may therefore not be possible to close a position in
a Strategic Instrument without incurring substantial losses, if at all.
Certain transactions in Strategic Instruments (e.g., forward foreign
exchange transactions, futures transactions, sales of put options) may expose a
Fund to potential losses which exceed the amount originally invested by the Fund
in such instruments. When a Fund engages in such a transaction, the Fund will
deposit in a segregated account at its custodian liquid securities with a value
at least equal to the Fund's exposure, on a mark-to-market basis, to the
transaction (as calculated pursuant to requirements of the Securities and
Exchange Commission). Such segregation will ensure that the Fund has assets
available to satisfy its obligations with respect to the transaction, but will
not limit the Fund's exposure to loss.
ADDITIONAL RISK FACTORS OF OTC TRANSACTIONS; LIMITATIONS ON THE USE OF OTC
STRATEGIC INSTRUMENTS
Certain Strategic Instruments traded in OTC markets, including indexed
securities and OTC options, may be substantially less liquid than other
instruments in which a Fund may invest. The absence of liquidity may make it
difficult or impossible for the Fund to sell such instruments promptly at an
acceptable price. The absence of liquidity may also make it more difficult for
the Fund to ascertain a market value for such instruments. A Fund will therefore
acquire illiquid OTC instruments (i) if the agreement pursuant to which the
instrument is purchased contains a formula price at which the instrument may be
terminated or sold, or (ii) for which the Investment Adviser anticipates the
Fund can receive on each business day at least two independent bids or offers,
unless a quotation from only one dealer is available, in which case that
dealer's quotation may be used.
The staff of the Securities and Exchange Commission has taken the position
that purchased OTC options and the assets underlying written OTC options are
illiquid securities. Each Fund has therefore adopted an investment policy
pursuant to which it will not purchase or sell OTC options (including OTC
options on futures contracts) if, as a result of such transactions, the sum of
the market value of OTC options currently outstanding which are held by the
Fund, the market value of the securities underlying OTC call options currently
outstanding which have been sold by the Fund and margin deposits on the Fund's
outstanding OTC options exceeds 15% of the total assets of the Fund, taken at
market value, together with all other assets of the Fund which are deemed to be
illiquid or are otherwise not readily marketable. However, if an OTC option is
sold by the Fund to a dealer in U.S. government securities recognized as a
"primary dealer" by the Federal Reserve Bank of New York and the Fund has the
unconditional contractual right to repurchase such OTC option at a predetermined
price, then the Fund will treat as illiquid such amount of the underlying
securities as is equal to the repurchase price less the amount by which the
option is "in-the-money" (i.e., current market value of the underlying security
minus the option's exercise price).
Because Strategic Instruments traded in OTC markets are not guaranteed by
an exchange or clearing corporation and generally do not require payment of
margin to the extent that a Fund has unrealized gains in such instruments or has
deposited collateral with its counterparty, the Fund is at risk that its
counterparty will become bankrupt or otherwise fail to honor its obligations. A
Fund will attempt to minimize the risk that a counterparty will become bankrupt
or otherwise fail to honor its obligations by engaging in transactions in
Strategic Instruments traded in OTC markets only with financial institutions
which have substantial capital or which have provided the Fund with a
third-party guaranty or other credit enhancement.
ADDITIONAL LIMITATIONS ON THE USE OF STRATEGIC INSTRUMENTS
No Fund may use any Strategic Instrument to gain exposure to an asset or
class of assets that it would be prohibited by its investment restrictions from
purchasing directly, except that the Natural Resources Focus Fund may acquire
securities indexed to a precious metal or other natural resource index.
Annex B-5
<PAGE> 110
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH DOMESTIC MONEY MARKET FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Domestic Money Market Fund (the "Domestic Money Market Fund")
is a diversified fund whose objectives are the preservation of capital,
liquidity and achieving the highest possible current income consistent with the
foregoing objectives by investing in short-term domestic money market
securities. The Domestic Money Market Fund is a separate fund of the Merrill
Lynch Variable Series Funds, Inc. (the "Company"), an open-ended management
investment company that has a wide range of investment objectives among its
eighteen separate funds (hereinafter referred to as the "Funds" or individually
as a "Fund"). Two separate classes of common stock ("Common Stock"), Class A
Common Stock and Class B Common Stock, are issued for each Fund. The Company is
offering shares of its Class B Common Stock for the Domestic Money Market Fund
pursuant to this Prospectus. Each Fund's Class B Common Stock will be subject to
a distribution fee at an annual rate of 0.15% of the Fund's average daily net
assets attributable to the Class B Common Stock. This Prospectus consists of
this four page document and the attached Appendix. For more information on the
Domestic Money Market Fund's investment objectives and policies, please see page
3 of this document and the Appendix.
-------------------------
THE DOMESTIC MONEY MARKET FUND ATTEMPTS TO MAINTAIN A STABLE NET ASSET
VALUE OF $1.00 PER SHARE, BUT THERE CAN BE NO ASSURANCE THAT IT WILL BE ABLE TO
DO SO. AN INVESTMENT IN THE DOMESTIC MONEY MARKET FUND IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Yield Information.................. 3
Investment Objectives and
Policies........................ 3
Portfolio Restrictions............. 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 111
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 112
YIELD INFORMATION
Set forth below is yield information for the Class A Shares of the Domestic
Money Market Fund for the seven-day period ended December 31, 1997, computed to
include realized and unrealized gains and losses and also computed to exclude
such gains and losses, and information as to the compounded annualized yield,
excluding gains and losses, for the same periods. The yield quotations may be of
limited use for comparative purposes because they do not reflect charges imposed
at the separate account level which, if included, would decrease the yield.
Because no shares of Class B Common Stock were in issue as of or prior to
December 31, 1997, the yield information below relates to the Class A Common
Stock only. The following yield information should not be considered indicative
of the results that the Fund's Class B Common Stock would have achieved had the
Class B Common Stock been outstanding during the period shown above because the
Class B Common Stock will be subject to a distribution fee, to which the Class A
Common Stock was not subject, at an annual rate of 0.15% of the Fund's average
daily net assets attributable to Class B Common Stock.
<TABLE>
<S> <C>
Annualized Yield:
Including gains and losses................................ 5.33%
Excluding gains and losses................................ 5.33%
Compounded Annualized Yield................................. 5.47%
Average maturity of portfolio at end of period.............. 72 Days
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the Domestic Money Market Fund are to preserve
shareholder capital, to maintain liquidity and to achieve the highest possible
current income consistent with the foregoing objectives by investing in
short-term domestic money market securities. There can be no assurance that the
Domestic Money Market Fund will achieve its investment objectives.
The Domestic Money Market Fund will invest in short-term U.S. Government
securities, U.S. Government agency securities, domestic depository institution
money instruments (including certificates of deposit, bankers' acceptances, time
deposits and bank notes), short-term debt securities (such as commercial paper),
variable amount master demand notes and insurance company funding agreements,
repurchase and reverse repurchase agreements of U.S. issuers and other money
market instruments. As a matter of fundamental policy, which may be changed only
with the approval of a majority of the Domestic Money Market Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "Act" or the "Investment Company Act"), the Domestic Money Market Fund may
not purchase securities of foreign issuers (including Eurodollar or Yankeedollar
bank obligations). U.S. Government securities may be purchased on a forward
commitment basis. The types of money market securities in which the Domestic
Money Market Fund may invest are described more fully in Annex A to the Appendix
to this Prospectus. The Domestic Money Market Fund will be subject to portfolio
maturity, quality and diversification restrictions discussed below.
In addition, the Domestic Money Market Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities the potential return of which is based on the
change in particular measurements of value or rate, (i.e. indexed securities). A
further discussion of the investments described in this paragraph and the risks
associated with such investments is set forth in the Appendix to this
Prospectus, including Annex B of the Appendix to this Prospectus, which includes
a discussion of certain portfolio strategies relating to indexed securities.
PORTFOLIO RESTRICTIONS
For purposes of the investment policy of the Domestic Money Market Fund,
the Company defines short-term money market securities as securities having a
maturity of no more than 762 days (25 months) in the case of U.S. Government and
agency securities and no more than 397 days (13 months) in the case of all other
securities. Management of the Company expects that substantially all the assets
of the Domestic Money Market Fund will be invested in securities maturing in
less than one year, but at times some portion may have maturities of up to 25
months. For these purposes, the maturity of a variable rate security is deemed
to be the next coupon
3
<PAGE> 113
date on which the interest rate is adjusted. The dollar-weighted average
maturity of this Fund's portfolio assets will not exceed 90 days.
The Domestic Money Market Fund's investments in short-term debt and
depository institution money instruments will be rated, or will be issued by
issuers who have been rated, in one of the two highest rating categories for
short-term debt obligations by a nationally recognized statistical rating
organization (an "NRSRO") or, if not rated, will be of comparable quality as
determined by the Directors of the Company. The Domestic Money Market Fund's
investments in corporate bonds and debentures (which must have maturities at the
date of purchase of 397 days (13 months) or less) will be in issuers which have
received from an NRSRO a rating, with respect to a class of short-term debt
obligations that is comparable in priority and security with the investment, in
one of the two highest rating categories for short-term obligations or, if not
rated, are of comparable quality as determined by the Directors of the Company.
Currently, there are six NRSROs: Duff & Phelps Inc., Fitch Investors Services,
Inc., IBCA Limited and its affiliate IBCA Inc., Moody's Investor's Service,
Inc., Standard & Poor's Ratings Group and Thomson BankWatch.
A regulation of the Commission limits investments by the Domestic Money
Market Fund in securities issued by any one issuer (other than the U.S.
Government, its agencies or instrumentalities) ordinarily to not more than 5% of
its total assets, or in the event that such securities do not have the highest
rating, not more than 1% of its total assets. In addition, this regulation
requires that not more than 5% of the Fund's total assets be invested in
securities that have a rating lower than the highest rating.
4
<PAGE> 114
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH RESERVE ASSETS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Reserve Assets Fund (the "Reserve Assets Fund") is a
diversified fund whose objectives are the preservation of capital, liquidity and
achieving the highest possible current income consistent with the foregoing
objectives by investing in short-term money market securities. The Reserve
Assets Fund is a separate fund of the Merrill Lynch Variable Series Funds, Inc.
(the "Company"), an open-ended management investment company that has a wide
range of investment objectives among its eighteen separate funds (hereinafter
referred to as the "Funds" or individually as a "Fund"). Two separate classes of
common stock ("Common Stock"), Class A Common Stock and Class B Common Stock,
are issued for each Fund. The Company is offering shares of its Class B Common
Stock for the Reserve Assets Fund pursuant to this Prospectus. Each Fund's Class
B Common Stock will be subject to a distribution fee at an annual rate of 0.15%
of the Fund's average daily net assets attributable to the Class B Common Stock.
This Prospectus consists of this four page document and the attached Appendix.
For more information on the Reserve Assets Fund's investment objectives and
policies, please see page 3 of this document and the Appendix.
THE RESERVE ASSET FUND ATTEMPTS TO MAINTAIN A STABLE NET ASSET VALUE OF
$1.00 PER SHARE, BUT THERE CAN BE NO ASSURANCE THAT IT WILL BE ABLE TO DO SO. AN
INVESTMENT IN THE RESERVE ASSET FUND IS NEITHER INSURED NOR GUARANTEED BY THE
U.S. GOVERNMENT.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Yield Information.................. 3
Investment Objectives and
Policies........................ 3
Portfolio Restrictions............. 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Adviser................... A-8
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 115
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 116
YIELD INFORMATION
Set forth below is yield information for the Class A Shares of the Reserve
Assets Fund for the seven-day period ended December 31, 1997, computed to
include and exclude realized and unrealized gains and losses and also computed
to exclude such gains and losses, and information as to the compounded
annualized yield, excluding gains and losses, for the same periods. The yield
quotations may be of limited use for comparative purposes because they do not
reflect charges imposed at the separate account level which, if included, would
decrease the yield. Because no shares of Class B Common Stock were in issue as
of or prior to December 31, 1997, the yield information below relates to the
Class A Common Stock only. The following yield information should not be
considered indicative of the results that the Fund's Class B Common Stock would
have achieved had the Class B Common Stock been outstanding during the period
shown above because the Class B Common Stock will be subject to a distribution
fee, to which the Class A Common Stock was not subject, at an annual rate of
0.15% of the Fund's average daily net assets attributable to Class B Common
Stock.
<TABLE>
<S> <C>
Annualized Yield:
Including gains and losses................................ 5.23%
Excluding gains and losses................................ 5.20%
Compounded Annualized Yield................................. 5.34%
Average maturity of portfolio at end of period.............. 70 Days
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the Reserve Assets Fund are to preserve
shareholder capital, to maintain liquidity and to achieve the highest possible
current income consistent with the foregoing objectives by investing in
short-term money market securities. There can be no assurance that the Reserve
Assets Fund will achieve its investment objectives.
The Reserve Assets Fund will invest in short-term U.S. Government
securities, U.S. Government agency securities, depository institution money
instruments (including certificates of deposit, bankers' acceptances, time
deposits and bank notes), short-term debt securities (such as commercial paper),
variable amount master demand notes and insurance company funding agreements,
securities of foreign issuers (including Eurodollar, Yankeedollar and foreign
bank obligations) and repurchase and reverse repurchase agreements. U.S.
Government securities may be purchased on a forward commitment basis. The types
of money market securities in which the Reserve Assets Fund may invest are
described more fully in Annex A to the Appendix to this Prospectus. The Reserve
Assets Fund will be subject to the portfolio maturity, quality and
diversification restrictions discussed below.
In addition, the Reserve Assets Fund may purchase certain securities that
are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The
Reserve Assets Fund may also invest in securities of foreign issuers and in
securities the potential return of which is based on the change in particular
measurements of value or rate (i.e. indexed securities). A further discussion of
the investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus, which includes a discussion of certain
portfolio strategies relating to indexed securities.
PORTFOLIO RESTRICTIONS
For purposes of the investment policy of the Reserve Assets Fund, the
Company defines short-term money market securities as securities having a
maturity of no more than 762 days (25 months) in the case of U.S. Government and
agency securities and no more than 397 days (13 months) in the case of all other
securities. Management of the Company expects that substantially all the assets
of the Reserve Assets Fund will be invested in securities maturing in less than
one year, but at times some portion may have maturities of up to 25 months. For
these purposes, the maturity of a variable rate security is deemed to be the
next coupon date on which the interest rate is adjusted. The dollar-weighted
average maturity of this Fund's portfolio assets will not exceed 90 days.
3
<PAGE> 117
The Reserve Asset Fund's investments in short-term debt and depository
institution money instruments will be rated, or will be issued by issuers who
have been rated, in one of the two highest rating categories for short-term debt
obligations by a nationally recognized statistical rating organization (an
"NRSRO") or, if not rated, will be of comparable quality as determined by the
Directors of the Company. The Reserve Assets Fund's investments in corporate
bonds and debentures (which must have maturities at the date of purchase of 397
days (13 months) or less) will be in issuers which have received from an NRSRO a
rating, with respect to a class of short-term debt obligations that is
comparable in priority and security with the investment, in one of the two
highest rating categories for short-term obligations or, if not rated, are of
comparable quality as determined by the Directors of the Company. Currently,
there are six NRSROs: Duff & Phelps Inc., Fitch Investors Services, Inc., IBCA
Limited and its affiliate IBCA Inc., Moody's Investors Service, Inc., Standard &
Poor's Ratings Group and Thomson BankWatch.
A regulation of the Commission limits investments by the Reserve Assets
Fund in securities issued by any one issuer (other than the U.S. Government, its
agencies or instrumentalities) ordinarily to not more than 5% of its total
assets, or in the event that such securities do not have the highest rating, not
more than 1% of its total assets. In addition, this regulation requires that not
more than 5% of the Reserve Assets Fund's total assets be invested in securities
that have a rating lower than the highest rating.
4
<PAGE> 118
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH PRIME BOND FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Prime Bond Fund (the "Prime Bond Fund") is a diversified fund
whose objectives are as high a level of current income as is consistent with
prudent investment management, and as a secondary objective, capital
appreciation when consistent with the foregoing objective, by investing
primarily in long-term corporate bonds rated A or better by either Moody's
Investors Service, Inc. ("Moody's") or Standard & Poor's Ratings Group
("Standard & Poor's"). The Prime Bond Fund is a separate fund of the Merrill
Lynch Variable Series Funds, Inc. (the "Company"), an open-ended management
investment company that has a wide range of investment objectives among its
eighteen separate funds (hereinafter referred to as the "Funds" or individually
as a "Fund"). Two separate classes of common stock ("Common Stock"), Class A
Common Stock and Class B Common Stock, are issued for each Fund. The Company is
offering shares of its Class B Common Stock for the Prime Bond Fund pursuant to
this Prospectus. Each Fund's Class B Common Stock will be subject to a
distribution fee at an annual rate of 0.15% of the Fund's average daily net
assets attributable to the Class B Common Stock. This Prospectus consists of
this three page document and the attached Appendix. For more information on the
Prime Bond Fund's investment objectives and policies, please see page 3 of this
document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 119
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 120
INVESTMENT OBJECTIVES AND POLICIES
The principal investment objective of the Prime Bond Fund is to provide
shareholders with as high a level of current income as is consistent with the
investment policies of the Fund and with prudent investment management. As a
secondary objective, the Prime Bond Fund seeks capital appreciation when
consistent with its principal objective. There can be no assurance that the
Prime Bond Fund will achieve its investment objectives.
The Prime Bond Fund invests primarily in securities rated in the top three
rating categories of either Standard & Poor's (AAA, AA and A) or Moody's (Aaa,
Aa and A). Additional information regarding various bond ratings is set forth in
Annex A to the Appendix to this Prospectus. The financial risk of this Fund
should be minimized by the credit quality of the bonds in which it will invest,
but the long maturities that typically provide the best yield will subject the
Fund to possible substantial price changes resulting from market yield
fluctuations. The market prices of fixed-income securities such as those
purchased by the Prime Bond Fund are affected by changes in interest rates
generally. As interest rates rise, the market value of fixed-income securities
will fall, adversely affecting the net asset value of the Fund. The Fund should
be considered a long-term investment and a vehicle for diversification, and not
as a balanced investment program. The Fund may not be appropriate as the
exclusive investment to fund a variable annuity or variable life insurance
contract ("Contract") for all Contract owners.
Fund management strategy will attempt to mitigate adverse price changes and
optimize favorable price changes through active trading that shifts the maturity
and/or quality structure of the Fund within the overall investment guidelines.
The Prime Bond Fund's investments will vary from time to time depending upon the
judgment of management as to prevailing conditions in the economy and the
securities markets and the prospects for interest rate changes among different
categories of fixed-income securities. The Prime Bond Fund anticipates that
under normal circumstances more than 90% of the assets of the Fund will be
invested in fixed-income securities, including convertible and non-convertible
debt securities and preferred stock. The Prime Bond Fund does not intend to
invest in common stock, rights or other equity securities. Under unusual market
or economic conditions, the Prime Bond Fund for defensive or other purposes may
invest up to 100% of its assets in U.S. Government or Government agency
securities, money market or other fixed-income securities deemed by the
Investment Adviser to be consistent with the objectives of the Fund, or the Fund
may hold its assets in cash.
In addition, the Prime Bond Fund may purchase certain securities that are
not registered under the Securities Act of 1933, as amended and which therefore
may be subject to restrictions on their transfer or resale. The Fund may also
invest in securities of foreign issuers and may invest in securities the
potential return of which is based on the change in particular measurements of
value or rate (i.e. indexed securities). A further discussion of the investments
described in this paragraph and the risks associated with such investments is
set forth in the Appendix to this Prospectus, including Annex B of the Appendix
to this Prospectus, which includes a discussion of certain portfolio strategies
relating to indexed securities.
3
<PAGE> 121
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH HIGH CURRENT INCOME FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch High Current Income Fund (the "High Current Income Fund") is
a diversified fund whose objectives are as high a level of current income as is
consistent with its investment policies and prudent investment management, and
as a secondary objective, capital appreciation when consistent with the
foregoing objective. The Fund invests principally in fixed-income securities
that are rated in the lower rating categories of the established rating services
or in unrated securities of comparable quality. The High Current Income Fund is
a separate fund of the Merrill Lynch Variable Series Funds, Inc. (the
"Company"), an open-ended management investment company that has a wide range of
investment objectives among its eighteen separate funds (hereinafter referred to
as the "Funds" or individually as a "Fund"). Two separate classes of common
stock ("Common Stock"), Class A Common Stock and Class B Common Stock, are
issued for each Fund. The Company is offering shares of its Class B Common Stock
for the High Current Income Fund pursuant to this Prospectus. Each Fund's Class
B Common Stock will be subject to a distribution fee at an annual rate of 0.15%
of the Fund's average daily net assets attributable to the Class B Common Stock.
This Prospectus consists of this four page document and the attached Appendix.
For more information on the High Current Income Fund's investment objectives and
policies, please see page 3 of this document and this Appendix.
THE HIGH CURRENT INCOME FUND INVESTS OR MAY INVEST IN HIGH YIELD BONDS
(COMMONLY KNOWN AS "JUNK BONDS"), WHICH INVOLVE SPECIAL RISKS. SEE "INVESTMENT
OBJECTIVES AND POLICIES OF THE FUNDS -- RISKS OF HIGH YIELD SECURITIES" IN THE
APPENDIX TO THIS PROSPECTUS.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 122
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 123
INVESTMENT OBJECTIVES AND POLICIES
The primary investment objective of the High Current Income Fund is to
obtain the highest level of current income that is consistent with the
investment policies of the Fund and with prudent investment management. As a
secondary objective, the High Current Income Fund seeks capital appreciation
when consistent with its primary objective. There can be no assurance that the
High Current Income Fund will achieve its investment objectives.
The High Current Income Fund seeks high current income by investing
principally in fixed-income securities that are rated in the lower rating
categories of the established rating services (Baa or lower by Moody's Investors
Service Inc. ("Moody's") and BBB or lower by Standard & Poor's Ratings Group
("Standard & Poor's"), or in unrated securities of comparable quality.
Securities rated below Baa by Moody's and below BBB by Standard & Poor's are
commonly known as "junk bonds." Additional information regarding various bond
ratings is set forth in Annex A to the Appendix to this Prospectus. The market
price of fixed-income securities such as those purchased by the Fund is affected
by changes in interest rates generally. As interest rates rise, the market value
of fixed-income securities will fall, adversely affecting the net asset value of
the Fund.
Although they can be expected to provide higher yields, lower-rated
securities such as those purchased by the High Current Income Fund may be
subject to greater market fluctuations and risks of loss of income and principal
than lower-yielding, higher-rated fixed-income securities. Such securities are
generally issued by corporations that are not as financially secure or as
creditworthy as issuers of higher-rated securities. There is, accordingly, a
greater risk that the issuers of higher-yielding securities will not be able to
pay principal and interest on such securities, especially during periods of
adverse economic conditions. Investment in such high-yield securities entails
relatively greater risk of loss of income or principal. The Fund should be
considered a long-term investment and a vehicle for diversification, and not as
a balanced investment program. The Fund may not be appropriate as the exclusive
investment to fund a variable annuity or variable life insurance contract
("Contract") for all Contract owners. See "Investment Objectives and Policies of
the Funds -- Risks of High Yield Securities" in the Appendix to this Prospectus.
Selection and supervision by the management of the Company regarding
investments in lower-rated fixed-income securities involves continuous analysis
of individual issuers, general business conditions and other factors that may be
too time consuming or too costly for the average investor. The furnishing of
these services does not, of course, guarantee successful results. The analysis
of issuers may include, among other things, historic and current financial
condition, current and anticipated cash flow and borrowing requirements, value
of assets in relation to historical cost, strength of management, responsiveness
to business conditions, credit standing, and current and anticipated results of
operations. Analysis of general business conditions and other factors may
include anticipated changes in economic activity and interest rates, the
availability of new investment opportunities, and the economic outlook for
specific industries. While Merrill Lynch Asset Management, L.P. (the "Investment
Adviser") considers as one factor in its credit analysis the ratings assigned by
the rating services, the Investment Adviser performs its own independent credit
analysis of issuers and consequently, the High Current Income Fund may invest,
without limit, in unrated securities if such securities offer, in the opinion of
the Investment Adviser, a relatively high yield without undue risk. As a result,
the High Current Income Fund's ability to achieve its investment objective may
depend to a greater extent on the Investment Adviser's own credit analysis than
the Funds which invest in higher-rated securities. Although the High Current
Income Fund will invest primarily in lower-rated securities, it will not invest
in securities rated Ca or lower by Moody's and CC or lower by Standard & Poor's
unless the Investment Adviser believes that the financial condition of the
issuer or the protection afforded to the particular securities is stronger than
would otherwise be indicated by such low ratings. However, securities purchased
by the High Current Income Fund may subsequently be downgraded. Such securities
may continue to be held and will be sold only if, in the judgment of the
Investment Adviser, it is advantageous to do so.
When changing economic conditions and other factors cause the yield
difference between lower-rated and higher-rated securities to narrow, the High
Current Income Fund may purchase higher-rated securities if the Investment
Adviser believes that the risk of loss of income and principal may be
substantially reduced with only a relatively small reduction in yield.
The securities in the High Current Income Fund will be varied from time to
time depending upon the judgment of management as to prevailing conditions in
the economy and the securities markets and the prospects for interest rate
changes among different categories of fixed-income securities. It is anticipated
that under normal
3
<PAGE> 124
circumstances more than 90% of the High Current Income Fund's assets will be
invested in fixed-income securities, including convertible and non-convertible
debt securities and preferred stock. Although it is expected that, in general,
the Fund will not invest in common stocks, rights or other equity securities, it
will acquire or hold such securities (if consistent with the objectives of the
Fund) when such securities are acquired in unit offerings with fixed-income
securities or in connection with an actual or proposed conversion or exchange of
fixed-income securities. In addition, under unusual market or economic
conditions, the High Current Income Fund for defensive purposes may invest up to
100% of its assets in U.S. Government or Government agency securities, money
market securities or other fixed-income securities deemed by the Investment
Adviser to be consistent with a defensive posture, or may hold its assets in
cash. The yield on such securities may be lower than the yield on lower-rated
fixed-income securities.
The table below shows the average monthly dollar-weighted market value, by
Standard & Poor's rating category, of securities held by the High Current Income
Fund during the fiscal year ended December 31, 1997.
<TABLE>
<CAPTION>
% MARKET
VALUE
% NET CORPORATE
RATING* ASSETS BONDS
------- ------- ----------
<S> <C> <C>
BBB......................................................... 2.1% 2.5%
BB.......................................................... 28.0 32.0
B........................................................... 51.2 58.1
CCC......................................................... 2.7 3.0
NR**........................................................ 3.8 4.4
-----
100.0%
=====
</TABLE>
- ---------------
* A description of corporate bond ratings of Standard & Poor's is set forth in
Annex A of the Appendix to this Prospectus.
** Bonds that are not rated by Standard & Poor's. Such bonds may be rated by
nationally recognized statistical rating organizations other than Standard &
Poor's, or may not be rated by any other organizations.
In addition, the High Current Income Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities of foreign issuers, and may from time to time
enter into standby commitment agreements. A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus.
4
<PAGE> 125
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH QUALITY EQUITY FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Quality Equity Fund (the "Quality Equity Fund") is a
diversified fund whose objective is the highest total investment return
consistent with prudent risk. The Quality Equity Fund uses a fully managed
investment policy utilizing equity securities, primarily common stocks of
large-capitalization companies, as well as investment grade debt and convertible
securities. The Quality Equity Fund is a separate fund of the Merrill Lynch
Variable Series Funds, Inc. (the "Company"), an open-ended management investment
company that has a wide range of investment objectives among its eighteen
separate funds (hereinafter referred to as the "Funds" or individually as a
"Fund"). Two separate classes of common stock ("Common Stock"), Class A Common
Stock and Class B Common Stock, are issued for each Fund. The Company is
offering shares of its Class B Common Stock for the Quality Equity Fund pursuant
to this Prospectus. Each Fund's Class B Common Stock will be subject to a
distribution fee at an annual rate of 0.15% of the Fund's average daily net
assets attributable to the Class B Common Stock. This Prospectus consists of
this three page document and the attached Appendix. For more information on the
Quality Equity Fund's investment objective and policies, please see page 3 of
this document, and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 126
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 127
INVESTMENT OBJECTIVE AND POLICIES
The Quality Equity Fund seeks to achieve the highest total investment
return, or the aggregate of income and capital value changes, consistent with
prudent risk. To do this, management will shift the emphasis among investment
alternatives for capital growth, capital stability and income as market trends
change. This "fully managed" investment policy distinguishes the Quality Equity
Fund from investment companies which seek either capital growth or income. The
Quality Equity Fund's investment philosophy is based on management's belief that
the structure of the United States economy and its securities markets will
undergo continuous change. The flexibility of the Fund is designed to reduce
overall exposure to risk by achieving below-average volatility in a falling
market and above-average volatility in a rising market. There can be no
assurance that the Quality Equity Fund will achieve its investment objective.
The Fund may employ a variety of instruments and techniques to hedge against
market and currency risk. See Annex B to the Appendix to this Prospectus.
The Quality Equity Fund's fully managed investment approach will make use
of equity, debt and convertible securities. The majority of the Fund's equity
portfolio will be in the common stocks of large-capitalization, "quality"
companies. For this purpose, "large capitalization" companies are considered to
be those companies with market capitalizations in excess of $500 million.
Management of the Company believes that a quality company is one which conforms
closely to the following criteria: good financial resources, strong balance
sheet, satisfactory rate of return on capital, good industry position and
superior management skills. The earnings of quality companies generally tend to
grow consistently. Whenever market or financial conditions warrant, the Quality
Equity Fund may, in order to reduce risk and achieve the highest total
investment return, invest in non-convertible, long-term debt securities,
including "deep discount" corporate debt securities of investment grade or
issues of fixed-income convertible securities which give the owner the option of
a later exchange for common stock. Management expects that over longer periods
the larger portion of the Quality Equity Fund's portfolio will consist of equity
securities. The Fund should be considered a long-term investment and a vehicle
for diversification, and not as a balanced investment program. The Fund may not
be appropriate as the exclusive investment to fund a variable annuity or
variable life insurance contract ("Contract") for all Contract owners. During
defensive periods, the Fund may invest in U.S. Government and Government agency
securities, money market securities or other fixed-income securities deemed by
the Merrill Lynch Asset Management L.P. (the "Investment Adviser") to be
consistent with a defensive posture, or cash.
OTHER INVESTMENTS AND RISKS
In addition, the Quality Equity Fund may purchase certain securities that
are not registered under the Securities Act of 1933, as amended and which may
therefore be subject to restrictions on their transfer or resale. The Fund may
also invest in securities of foreign issuers, may from time-to-time be invested
in non-dollar-denominated securities of foreign issuers, and is authorized to
write (i.e., sell) call options on securities held in its portfolio or
securities indices the performance of which is substantially correlated with
securities held in its portfolio. Changes in foreign currency exchange rates may
affect the value of securities in the portfolio and the unrealized appreciation
or depreciation of investments insofar as United States investors are concerned.
Furthermore, the Quality Equity Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments.
The Quality Equity Fund may engage in transactions, such as currency swaps
and purchasing and selling options on currencies, for purposes of hedging
against the decline in the value of currencies in which its portfolio holdings
are denominated against the US dollar. Although such instruments will be used
with the intention of hedging against adverse currency movements, transactions
in such instruments involve the risk that anticipated currency movements will
not be accurately predicted and that the Fund's hedging strategies will be
ineffective and may cause the Fund to realize losses.
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to options and foreign exchange
transactions.
3
<PAGE> 128
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH SPECIAL VALUE FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Special Value Focus Fund, formerly the Merrill Lynch Equity
Growth Fund (the "Special Value Focus Fund"), is a diversified fund whose
objective is long-term capital growth by investing primarily in common shares of
small companies and of emerging growth companies regardless of size. The Special
Value Focus Fund is a separate fund of the Merrill Lynch Variable Series Funds,
Inc. (the "Company"), an open-ended management investment company that has a
wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class B Common Stock for the Special Value Focus Fund pursuant to this
Prospectus. Each Fund's Class B Common Stock will be subject to a distribution
fee at an annual rate of 0.15% of the Fund's average daily net assets
attributable to the Class B Common Stock. This Prospectus consists of this four
page document and the attached Appendix. For more information on the Special
Value Focus Fund's investment objectives and policies, please see page 3 of this
document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 2
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 129
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
SPECIAL VALUE
FOCUS FUND
(CLASS B)#
FOR THE PERIOD
OCTOBER 23, 1997+ TO
DECEMBER 31, 1997
Increase (Decrease) in Net Asset Value: ---------------------
<S> <C>
Per Share Operating Performance:
Net asset value, beginning of period........................ $ 31.23
-------
Investment loss -- net...................................... (.01)
Realized and unrealized loss on investments -- net.......... (3.48)
-------
Total from investment operations............................ (3.49)
-------
Net asset value, end of period.............................. $ 27.74
=======
Total Investment return:**
Based on net asset value per share.......................... (11.18%)++
=======
Ratios to Average Net Assets:
Expenses.................................................... .96%*
=======
Investment loss -- net...................................... (.24%)*
=======
Supplemental Data:
Net assets, end of period (in thousands).................... $ 248
=======
Portfolio turnover.......................................... 147.06%
=======
Average commission rate paid................................ $ .0555
=======
</TABLE>
- ---------------
* Annualized
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations
++ Aggregate total investment return
# Based on average shares outstanding
2
<PAGE> 130
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Special Value Focus Fund is to seek
long-term growth of capital by investing in a diversified portfolio of
securities, primarily common stocks, of relatively small companies that
management of the Company believes have special investment value, and of
emerging growth companies regardless of size. There can be no assurance that the
Special Value Focus Fund will achieve its investment objective. Companies are
selected by management on the basis of their long-term potential for expanding
their size and profitability or for gaining increased market recognition for
their securities. Current income is not a factor in the selection of securities.
The Special Value Focus Fund is intended to provide an opportunity for owners
("Contract Owners") of variable annuity contracts and/or variable life insurance
contracts ("Contracts") who are not ordinarily in a position to perform the
specialized type of research or analysis of small and emerging growth companies.
Management seeks to identify those small emerging growth companies that can
show significant and sustained increases in earnings over an extended period of
time and are in sound financial condition. Management believes that, while these
companies present above-average risks, properly selected companies of this type
also have the potential to increase their earnings at a rate substantially in
excess of the general growth of the economy. The Special Value Focus Fund
attempts to achieve its objective by focusing on the long-range view of a
company's prospects through a fundamental analysis of its management, financial
structure, product development, marketing ability and other relevant factors.
Full development of these companies frequently takes time and, for this reason,
the Special Value Focus Fund should not be considered as a long-term investment
and not as a vehicle for seeking short-term profits. The Fund should be
considered a long-term investment and a vehicle for diversification, and not as
a balanced investment program.
Small companies. Management seeks small companies that offer special
investment value in terms of their product or service, research capability, or
other unique attributes, and are relatively undervalued in the marketplace when
compared with similar, but larger, enterprises. The definition of "small
companies" will change over time in response to market conditions; for the Fund,
"small companies" typically have capitalization, at the time of initial purchase
by the Fund, in the same range as companies in the Russell 2000 stock index, a
widely known small cap investment benchmark. Small companies are generally
little known to most individual investors, although some may be dominant in
their respective industries. Underlying this strategy is management's belief
that relatively small companies will continue to have the opportunity to develop
into significant business enterprises. Some such companies may be in a
relatively early stage of development; others may manufacture a new product or
perform a new service. Such companies may not be counted upon to develop into
major industrial companies, but management believes that eventual recognition of
their special value characteristics by the investment community can provide
above-average long-term growth to the portfolio.
Emerging growth companies. In selecting investments for the Special Value
Focus Fund, management also seeks emerging growth companies that either occupy a
dominant position in an emerging industry or subindustry or have a significant
and growing market share in a large, fragmented industry. Management believes
that capable and flexible management is one of the most important criteria of
emerging growth companies and that such companies should employ sound financial
and accounting policies and also demonstrate effective research, successful
product development and marketing, efficient service and pricing flexibility.
Emphasis is given to companies with rapid historical growth rates, above-average
returns on equity and strong current balance sheets, all of which should enable
the company to finance its continued growth. Management of the Company also
analyzes and weighs relevant factors beyond the company itself, such as the
level of competition in the industry, the extent of governmental regulation, the
nature of labor conditions and other related matters.
The Special Value Focus Fund emphasizes investments in companies that do
most of their business in the United States and therefore are free of the
currency exchange problems, foreign tax considerations and potential political
and economic upheavals that many multinational corporations face. Moreover, the
size and kinds of markets that they serve make these companies less susceptible
than larger companies to intervention from the federal government by means of
price controls, regulations or litigation.
While the process of selection and continuous supervision by management
does not, of course, guarantee successful investment results, it does provide
ingredients not available to the average individual due to the time and cost
involved. Careful initial selection is particularly important in this area as
many new enterprises have promise but lack certain of the ingredients necessary
to prosper.
3
<PAGE> 131
It should be apparent that an investment in a fund such as the Special
Value Focus Fund involves greater risk than is customarily associated with more
established companies. The securities of smaller or emerging growth companies
may be subject to more abrupt or erratic market movements than larger, more
established companies or the market average in general. These companies may have
limited product lines, markets or financial resources, or they may be dependent
upon a limited management group. Because of these factors, management of the
Company believes that shares in the Special Value Focus Fund are suitable for
Contract Owners who are in a financial position to assume above-average
investment risk in search of above-average long-term reward. As indicated, the
Special Value Focus Fund is designed for Contract Owners whose investment
objective is growth rather than income. It is definitely not intended for
exclusive funding of Contracts but is designed for Contract Owners who are
prepared to experience above-average fluctuations in net asset value.
The securities in which the Special Value Focus Fund invests will often be
traded only in the over-the-counter market or on a regional securities exchange
and may not be traded every day or in the volume typical of trading on a
national securities exchange. As a result, the disposition by the Fund of
portfolio securities to meet redemptions or otherwise may require the Fund to
sell these securities at a discount from market prices or during periods when in
management's judgment such disposition is not desirable or to make many small
sales over a lengthy period of time.
The investment emphasis of the Special Value Focus Fund is on equities,
primarily common stock and, to a lesser extent, securities convertible into
common stocks and rights to subscribe for common stock, and the Fund will
maintain at least 80% of its net assets invested in equity securities of small
or emerging growth companies except during defensive periods. The Special Value
Focus Fund reserves the right as a defensive measure and to provide for
redemptions to hold other types of securities, including non-convertible
preferred stocks and debt securities, U.S. Government and Government agency
securities, money market securities or other fixed-income securities deemed by
the Investment Adviser to be consistent with a defensive posture, or cash, in
such proportions as, in the opinion of management, prevailing market or economic
conditions warrant.
In addition, the Special Value Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities of foreign issuers and is authorized to write
(i.e., sell) call options on securities held in its portfolio or securities
indices the performance of which is substantially correlated with securities
held in its portfolio. A further discussion of the investments described in this
paragraph and the risks associated with such investments is set forth in the
Appendix to this Prospectus, including Annex B of the Appendix to this
Prospectus, which includes a discussion of certain portfolio strategies relating
to options.
4
<PAGE> 132
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH NATURAL RESOURCES FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Natural Resources Focus Fund (the "Natural Resources Focus
Fund") is a non-diversified fund whose objectives are achieving long-term growth
of capital and protection of the purchasing power of shareholder's capital by
investing primarily in equity securities of domestic and foreign companies with
substantial natural resource assets. The Natural Resources Focus Fund is a
separate fund of the Merrill Lynch Variable Series Funds, Inc. (the "Company"),
an open-ended management investment company that has a wide range of investment
objectives among its eighteen separate funds (hereinafter referred to as the
"Funds" or individually as a "Fund"). Two separate classes of common stock
("Common Stock"), Class A Common Stock and Class B Common Stock, are issued for
each Fund. The Company is offering shares of its Class B Common Stock for the
Natural Resources Focus Fund pursuant to this Prospectus. Each Fund's Class B
Common Stock will be subject to a distribution fee at an annual rate of 0.15% of
the Fund's average daily net assets attributable to the Class B Common Stock.
This Prospectus consists of this four page document and the attached Appendix.
For more information on the Natural Resources Focus Fund's investment objectives
and policies, please see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 133
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 134
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the Natural Resources Focus Fund are to
achieve long-term growth of capital and to protect the purchasing power of
shareholders' capital by investing primarily in a portfolio of equity securities
(e.g., common stocks and securities convertible into common stocks) of domestic
and foreign companies with substantial natural resource assets. This investment
objective is a fundamental policy and may not be changed without a vote of the
majority of outstanding shares of the Natural Resources Focus Fund. The Natural
Resources Focus Fund also may invest in debt, preferred or convertible
securities, the value of which is related to the market value of some natural
resource asset ("asset-based securities"). Management of the Company will seek
to identify companies or asset-based securities it believes are attractively
priced relative to the intrinsic value of the underlying natural resource assets
or are especially well positioned to benefit during particular portions of
inflationary cycles. The Fund should be considered a long-term investment and a
vehicle for diversification, and not as a balanced investment program. The Fund
may not be appropriate as the exclusive investment to fund a variable annuity or
variable life insurance contract ("Contract") for all Contract owners. There can
be no assurance that the Natural Resources Focus Fund will achieve its
investment objectives.
IN SEEKING TO PROTECT THE PURCHASING POWER OF SHAREHOLDERS' CAPITAL, THE
NATURAL RESOURCES FOCUS FUND HAS RESERVED THE RIGHT, WHEN MANAGEMENT OF THE
COMPANY ANTICIPATES SIGNIFICANT ECONOMIC, POLITICAL OR FINANCIAL INSTABILITY,
SUCH AS HIGH INFLATIONARY PRESSURES OR UPHEAVAL IN THE FOREIGN CURRENCY EXCHANGE
MARKETS, TO INVEST A MAJORITY OF ITS ASSETS IN COMPANIES THAT EXPLORE FOR,
EXTRACT, PROCESS OR DEAL IN GOLD OR IN ASSET-BASED SECURITIES INDEXED TO THE
VALUE OF GOLD BULLION. Such a switch in investment strategies could require the
Fund to liquidate portfolio securities and incur transaction costs. The Company
has been advised by counsel that it is uncertain under the current federal tax
law whether the Fund may concentrate its investments in gold and gold-related
securities without adversely affecting the federal tax status of the Contracts.
Accordingly, management of the Company has determined that the Natural Resources
Focus Fund will not concentrate its investments in such securities until counsel
has advised the Company that such uncertainty has been resolved favorably.
Management attempts to achieve the investment objectives of the Natural
Resources Focus Fund by seeking to identify securities of companies which, in
its opinion, are undervalued relative to the value of natural resource holdings
of such companies in light of current and anticipated economic or financial
conditions. Natural resource assets are materials derived from natural sources
which have economic value. Management will consider a company to have
substantial natural resource assets when, in its opinion, the company's holdings
of the assets are of such magnitude, when compared to the capitalization,
revenues or operating profits of the company, that changes in the economic value
of the assets are expected to affect the market price of the equity securities
of such company. Generally, a company has substantial natural resource assets
when at least 50% of the non-current assets, capitalization, gross revenues or
operating profits of the company in the most recent or current fiscal year are
involved in or result from directly or indirectly through subsidiaries,
exploring, mining, refining, processing, fabricating, dealing in or owning
natural resource assets. Examples of natural resource assets include precious
metals (e.g., gold, silver and platinum), ferrous and nonferrous metals (e.g.,
iron, steel, aluminum and copper), strategic metals (e.g., uranium and
titanium), hydrocarbons (e.g., coal, oil and natural gas), timber land,
undeveloped real property and agricultural commodities. The Fund presently does
not intend to invest directly in natural resource assets or contracts related
thereto.
Management of the Company believes that, based upon past performance, the
securities of specific companies that hold different types of substantial
natural resource assets may move relatively independently of one another during
different stages of inflationary cycles due to different degrees of demand for,
or market values of, their respective natural resource holdings during
particular portions of such inflationary cycles. The Fund's fully managed
investment approach enables it to switch its emphasis among various industry
groups depending upon management's outlook with respect to prevailing trends and
developments.
The Natural Resources Focus Fund at all times, except during defensive
periods, will maintain at least 65% of its total assets invested in companies
with substantial natural resource assets or in asset-based securities. Current
income from dividends and interest will not be a primary consideration in
selecting securities. The Fund reserves the right as a temporary defensive
measure and to provide for redemptions, to hold short-term
3
<PAGE> 135
U.S. Government and Government agency securities, money market securities or
other fixed-income securities deemed by the Investment Adviser to be consistent
with a defensive posture, or cash, in such proportions as, in the opinion of
management, prevailing market or economic conditions warrant.
As indicated above, under certain circumstances, the Natural Resources
Focus Fund has reserved the right to invest a majority of its assets in
gold-related companies or securities. Based on historic experience, during
periods of economic or financial instability, the securities of such companies
may be subject to extreme price fluctuations, reflecting the high volatility of
gold prices during such periods. In addition, the instability of gold prices may
result in volatile earnings of gold-related companies which, in turn, may affect
adversely the financial condition of such companies. Gold mining companies also
are subject to the risks generally associated with mining operations.
The major producers of gold include the Republic of South Africa, Russia,
the United States, Australia, Canada, the People's Republic of China and the
Philippines. Sales of gold by Russia and the People's Republic of China are
largely unpredictable and often relate to political and economic considerations
rather than to market forces. Economic, social and political developments within
Russia, the People's Republic of China and the Republic of South Africa may
affect significantly gold production in those countries.
OTHER INVESTMENTS AND RISKS
In addition, the Natural Resources Focus Fund may purchase certain
securities that are not registered under the Securities Act of 1933, as amended
and which therefore may be subject to restrictions on their transfer or resale.
The Fund may also engage in transactions for purpose of hedging against the
decline in the value of currencies in which its portfolio holdings are
denominated against the US dollar. The Fund is also authorized to write (i.e.,
sell) and purchase call and put options on securities held in its portfolio, on
securities indices the performance of which is substantially correlated with
securities held in its portfolio or on securities it intends to purchase, may
engage in transactions in futures, and may invest in securities the potential
return of which is based on the change in particular measurements of value or
rate (i.e., indexed and inverse securities).
The Natural Resources Focus Fund may also invest in securities of foreign
issuers and may concentrate its investments in one or more countries.
Investments in foreign securities, particularly those of non-governmental
issuers, involve considerations and risks which are not ordinarily associated
with investing in domestic issuers. These considerations and risks include
changes in currency rates, currency exchange control regulations, the
possibility of expropriation, confiscatory taxation, high rates of inflation,
the unavailability of financial information or the difficulty of interpreting
financial information prepared under foreign accounting standards, less
liquidity and more volatility in foreign securities markets, the impact of
political, social or diplomatic developments, and the difficulty of assessing
economic trends in foreign countries. In addition, net investment income earned
by the Fund on a foreign security may be subject to withholding and other taxes
imposed by foreign governments which will reduce the Fund's net investment
income. The Natural Resources Focus Fund may also from time to time be
substantially invested in non-dollar-denominated securities of foreign issuers.
Changes in foreign currency exchange rates may affect the value of securities in
the portfolio and the unrealized appreciation or depreciation of investments
insofar as United States investors are concerned. Furthermore, the Fund's return
on investments in non-dollar-denominated securities may be reduced or enhanced
as a result of changes in foreign currency rates during the period in which the
Fund holds such investments. See "Other Portfolio Strategies -- Foreign
Securities" in the Appendix to this Prospectus for special considerations
concerning investments in foreign securities.
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed and inverse securities,
options, futures and foreign exchange transactions.
4
<PAGE> 136
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH AMERICAN BALANCED FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch American Balanced Fund (the "American Balanced Fund") is a
diversified fund whose objective is a level of current income and a degree of
stability or principal not normally available from an investment solely in
equity securities and the opportunity for capital appreciation greater than is
normally available from an investment solely in debt securities by investing in
a balanced portfolio of fixed-income and equity securities. The American
Balanced Fund is a separate fund of the Merrill Lynch Variable Series Funds,
Inc. (the "Company"), an open-ended management investment company that has a
wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class B Common Stock for the American Balanced Fund pursuant to this
Prospectus. Each Fund's Class B Common Stock will be subject to a distribution
fee at an annual rate of 0.15% of the Fund's average daily net assets
attributable to the Class B Common Stock. This Prospectus consists of this three
page document and the attached Appendix. For more information on the American
Balanced Fund's investment objective and policies, please see page 3 of this
document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 137
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 138
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the American Balanced Fund is to seek a level
of current income and a degree of stability of principal not normally available
from an investment solely in equity securities and the opportunity for capital
appreciation greater than is normally available from an investment solely in
debt securities by investing in a balanced portfolio of fixed income and equity
securities. This investment objective is a fundamental policy and may not be
changed without a vote of the majority of the outstanding shares of the American
Balanced Fund. The American Balanced Fund will seek current income by investing
a portion of its assets in a portfolio of intermediate to long-term debt,
convertible debt, non-convertible and convertible term preferred stock and money
market securities. The American Balanced Fund will seek capital appreciation
primarily by investing a portion of its assets in equity securities, including
perpetual preferred and convertible perpetual preferred stock. At all times the
Fund will maintain at least 25% of its net assets in senior fixed income
securities. As a non-fundamental policy, the Fund is not permitted to invest in
securities of foreign issuers. There can be no assurance that the American
Balanced Fund will achieve its investment objective.
The Fund will normally limit its allocation of assets to equity securities
to no more than 65% of its net assets. To the extent its equity position exceeds
this limitation, because of changes in the value of portfolio securities or
otherwise, the Fund will seek to reduce its equity position to less than 65% of
net assets by selling such securities at such times and in such amounts as
management of the Company deems appropriate in light of market conditions and
other pertinent factors. See "Dividends, Distributions and Taxes -- Tax
Treatment of the Company" in the Appendix to this Prospectus.
The American Balanced Fund will generally emphasize investment in common
stocks of larger-capitalization issuers and in investment-grade debt
obligations. The Fund may also seek to enhance the return on its common stock
portfolio by writing covered call options listed on United States securities
exchanges. Under unusual market or economic conditions, the Fund for defensive
purposes may invest up to 100% of its assets in short-term U.S. Government or
Government agency securities, money market securities or other fixed-income
securities deemed by the Investment Adviser to be consistent with a defensive
posture, or cash.
In addition, the American Balanced Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Fund
is authorized to write (i.e., sell) call options on securities held in its
portfolio or securities indices the performance of which is substantially
correlated with securities held in its portfolio. A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus, which includes a discussion of certain
portfolio strategies relating to options.
3
<PAGE> 139
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GLOBAL STRATEGY FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Global Strategy Focus Fund (the "Global Strategy Focus Fund")
is a non-diversified fund whose objective is high total investment return by
investing primarily in a portfolio of equity and fixed income securities of U.S.
and foreign issuers. The Global Strategy Focus Fund is a separate fund of the
Merrill Lynch Variable Series Funds, Inc. (the "Company"), an open-ended
management investment company that has a wide range of investment objectives
among its eighteen separate funds (hereinafter referred to as the "Funds" or
individually as a "Fund"). Two separate classes of common stock ("Common
Stock"), Class A Common Stock and Class B Common Stock, are issued for each
Fund. The Company is offering shares of its Class B Common Stock for the Global
Strategy Focus Fund pursuant to this Prospectus. Each Fund's Class B Common
Stock will be subject to a distribution fee at an annual rate of 0.15% of the
Fund's average daily net assets attributable to the Class B Common Stock. This
Prospectus consists of this four page document and the attached Appendix. For
more information on the Global Strategy Focus Fund's investment objective and
policies, please see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 140
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 141
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Global Strategy Focus Fund is to seek high
total investment return by investing primarily in a portfolio of equity and
fixed income securities, including convertible securities, of U.S. and foreign
issuers. Total investment return consists of interest, dividends, discount
accruals and capital changes, including changes in the value of non-dollar
denominated securities and other assets and liabilities resulting from currency
fluctuations. There can be no assurance that the Global Strategy Focus Fund will
achieve its investment objective. Investing on an international basis involves
special considerations. See "Other Investments and Risks" below.
The Global Strategy Focus Fund seeks to achieve its objective by investing
primarily in the securities of issuers located in the United States, Canada,
Western Europe, the Far East and Latin America. There are no prescribed limits
on the geographical allocation of the Fund among these regions. Such allocation
will be made primarily on the basis of the anticipated total return from
investments in the securities of issuers wherever located, considering such
factors as the condition and growth potential of the various economies and
securities markets and the issuers domiciled therein, anticipated movements in
interest rates in the various capital markets and in the value of foreign
currencies relative to the U.S. dollar, tax considerations and economic, social,
financial, national and political factors which may affect the climate for
investing within such securities markets. When, in the judgment of Merrill Lynch
Asset Management L.P. (the "Investment Adviser"), economic or market conditions
warrant, the Fund reserves the right to concentrate its investments in one or
more capital markets, including the United States. The Fund should be considered
a long-term investment and a vehicle for diversification, and not as a balanced
investment program. The Fund may not be appropriate as the exclusive investment
to fund a variable annuity or variable life insurance contract ("Contract") for
all Contract owners.
The corporate debt securities, including convertible debt securities, in
which the Fund may invest will be rated BBB or better by Standard and Poor's
Ratings Group ("Standard & Poor's") or Baa or better by Moody's Investors
Service, Inc. ("Moody's") or, in the opinion of the Investment Adviser, of
comparable quality. The Fund may also invest in debt obligations issued or
guaranteed by sovereign governments, political subdivisions thereof (including
states, provinces and municipalities) or their agencies or instrumentalities or
issued or guaranteed by international organizations designated or supported by
governmental entities to promote economic reconstruction or development
("supranational entities") such as the International Bank for Reconstruction and
Development (the "World Bank") and the European Coal and Steel Community.
Investments in securities of supranational entities are subject to the risk that
member governments will fail to make required capital contributions and that a
supranational entity will thus be unable to meet its obligations.
When market or financial conditions warrant, the Global Strategy Focus Fund
may invest as a temporary defensive measure up to 100% of its assets in U.S.
Government or Government agency securities, money market securities or other
fixed income securities deemed by the Investment Adviser to be consistent with a
defensive posture, or may hold its assets in cash.
The Global Strategy Focus Fund may use derivatives in connection with
certain trading strategies. See Annex B of the Appendix to this Prospectus.
OTHER INVESTMENTS AND RISKS
In addition, the Global Strategy Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Global
Strategy Focus Fund may also invest in securities of foreign issuers and may
concentrate its investments in one or more countries. Investments in foreign
securities, particularly those of non-governmental issuers, involve
considerations and risks that are not ordinarily associated with investing in
domestic issuers. These considerations and risks include changes in currency
rates, currency exchange control regulations, the possibility of expropriation,
confiscatory taxation, high rates of inflation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of political, social or diplomatic
developments, and the difficulty of assessing economic trends in foreign
countries. In addition, net investment income earned by the Fund on a foreign
security may be subject to withholding and other taxes imposed by foreign
governments, which will reduce the Fund's net investment income. The Fund may
also from time to time
3
<PAGE> 142
be substantially invested in non-dollar-denominated securities of foreign
issuers. Changes in foreign currency exchange rates may affect the value of
securities in the portfolio and the unrealized appreciation or depreciation of
investments insofar as United States investors are concerned. Furthermore, the
Fund's return on investments in non-dollar-denominated securities may be reduced
or enhanced as a result of changes in foreign currency rates during the period
in which the Fund holds such investments. For additional information concerning
the risks of investing in foreign securities, see "Other Portfolio
Strategies -- Foreign Securities" in the Appendix to this Prospectus.
The Global Strategy Focus Fund may engage in transactions, such as currency
swaps and purchasing and selling options on currencies, for purposes of hedging
against the decline in the value of currencies in which its portfolio holdings
are denominated against the U.S. dollar. The Fund is also authorized to purchase
and to write (i.e., sell) call and put options on securities held in its
portfolio, securities indices the performance of which is substantially
correlated with securities held in its portfolio or on securities it intends to
purchase and to purchase put options on securities held in its portfolio and may
also invest in futures and in securities the potential return of which is based
on the change in particular measurements of value of rate (i.e. indexed and
inverse securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed and inverse securities,
options, futures and foreign exchange transactions.
4
<PAGE> 143
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH BASIC VALUE FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Basic Value Focus Fund (the "Basic Value Focus Fund") is a
diversified fund whose objectives are capital appreciation and, secondarily,
income by investing in securities, primarily equities, that management of the
Fund believes are undervalued and therefore represent basic investment value.
The Basic Value Focus Fund is a separate fund of the Merrill Lynch Variable
Series Funds, Inc. (the "Company"), an open-ended management investment company
that has a wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class B Common Stock for the Basic Value Focus Fund pursuant to this
Prospectus. Each Fund's Class B Common Stock will be subject to a distribution
fee at an annual rate of 0.15% of the Fund's average daily net assets
attributable to the Class B Common Stock. This Prospectus consists of this four
page document and the attached Appendix. For more information on the Basic Value
Focus Fund's investment objectives and policies, please see page 4 of this
document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objectives and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 144
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 145
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
BASIC VALUE
FOCUS FUND
(CLASS B)
FOR THE PERIOD
NOVEMBER 3, 1997+ TO
DECEMBER 31, 1997
--------------------
<S> <C>
Increase (Decrease) in Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period........................ $15.89
------
Investment income -- net.................................... .01
Realized and unrealized loss on investments -- net.......... (.06)
------
Total from investment operations............................ (.05)
------
Net asset value, end of period.............................. $15.84
======
Total Investment return:**
Based on net asset value per share.......................... (0.31%)++
======
Ratios to Average Net Assets:
Expenses.................................................... .82%*
======
Investment income -- net.................................... 1.27%*
======
Supplemental Data:
Net assets, end of period (in thousands).................... $ 348
======
Portfolio turnover.......................................... 95.52%
======
Average commission rate paid................................ $.0562
======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Aggregate total investment return.
3
<PAGE> 146
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the Basic Value Focus Fund are to seek capital
appreciation and, secondarily, income by investing in securities, primarily
equities, that management of the Fund believes are undervalued and therefore
represent basic investment value. There can be no assurance that the Basic Value
Focus Fund will achieve its investment objectives. The Fund seeks special
opportunities in securities that are selling at a discount, either from book
value or historical price-earnings ratios, or seem capable of recovering from
temporarily out of favor considerations. Particular emphasis is placed on
securities that provide an above-average dividend return and sell at a
below-average price-earnings ratio. The Fund should be considered a long-term
investment and a vehicle for diversification, and not as a balanced investment
program. The Fund may not be appropriate as the exclusive investment to fund a
variable annuity or variable life insurance contract ("Contract") for all
Contract owners.
The investment policy of the Basic Value Focus Fund is based on the belief
that the pricing mechanism of the securities market lacks total efficiency and
has a tendency to inflate prices of securities in favorable market climates and
depress prices of securities in unfavorable climates. Based on this premise,
management believes that favorable changes in market prices are more likely to
begin when securities are out of favor, earnings are depressed, price-earnings
ratios are relatively low, investment expectations are limited, and there is no
real general interest in the particular security or industry involved. On the
other hand, management believes that negative developments are more likely to
occur when investment expectations are generally high, stock prices are
advancing or have advanced rapidly, price-earnings ratios have been inflated,
and the industry or issue continues to gain new investment acceptance on an
accelerated basis. In other words, management believes that market prices of
securities with relatively high price-earnings ratios are more susceptible to
unexpected adverse developments while securities with relatively low
price-earnings ratios are more favorably positioned to benefit from favorable,
but generally unanticipated, events. This investment policy departs from
traditional philosophy. Management of the Fund believes that the market risk
involved in this policy is moderated somewhat by an emphasis on securities with
above-average dividend returns.
The current institutionally-dominated market tends to ignore, to some
extent, the numerous secondary issues whose market capitalizations are below
those of the relatively few larger size growth companies. It is expected that
the Basic Value Focus Fund's portfolio generally will have significant
representation in this secondary segment of the market. The basic orientation of
the Fund's investment policies is such that at times a large portion of its
common stock holdings may carry less than favorable research ratings from
research analysts.
Investment emphasis is on equities, primarily common stock and, to a lesser
extent, securities convertible into common stocks. The Basic Value Focus Fund
also may invest in preferred stocks and non-convertible debt securities rated
investment grade and utilize covered call options with respect to portfolio
securities as described in Annex B to the Appendix of this Prospectus. The Fund
reserves the right as a defensive measure to hold other types of securities,
including U.S. Government and Government agency securities, money market
securities or other fixed-income securities deemed by the Investment Adviser to
be consistent with a defensive posture, or cash, in such proportions as, in the
opinion of management, prevailing market or economic conditions warrant. The
Fund may invest up to 10% of its total assets, taken at market value at the time
of acquisition, in the securities of foreign issuers.
In addition, the Basic Value Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Fund
is also authorized to write (i.e., sell) call options on securities held in its
portfolio or securities indices the performance of which is substantially
correlated with securities held in its portfolio. A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus, which includes a discussion of certain
portfolio strategies relating to options.
4
<PAGE> 147
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GLOBAL BOND FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Global Bond Focus Fund, formerly, the Merrill Lynch World
Income Focus Fund, (the "Global Bond Focus Fund") is a non-diversified fund
whose objective is high total investment return by investing in a global
portfolio of fixed income securities denominated in various currencies,
including multinational currency units. The Global Bond Focus Fund is a separate
fund of the Merrill Lynch Variable Series Funds, Inc. (the "Company"), an
open-ended management investment company that has a wide range of investment
objectives among its eighteen separate funds (hereinafter referred to as the
"Funds" or individually as a "Fund"). Two separate classes of common stock
("Common Stock"), Class A Common Stock and Class B Common Stock for the Global
Bond Focus are issued for each Fund. The Company is offering shares of its Class
B Common Stock pursuant to this Prospectus. Each Fund's Class B Common Stock
will be subject to a distribution fee at an annual rate of 0.15% of the Fund's
average daily net assets attributable to the Class B Common Stock. This
Prospectus consists of this four page document and the attached Appendix. For
more information on the Global Bond Focus Fund's investment objective and
policies, please see page 2 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 2
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 148
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Global Bond Focus Fund is to seek to
provide shareholders a high total investment return by investing in a global
portfolio of fixed income securities denominated in various currencies,
including multi-national currency units. The Fund will, under normal conditions,
invest at least 90% of its total assets in such fixed income securities. In
pursuing its investment objective, the Global Bond Focus Fund will allocate its
investments among different types of fixed income securities denominated in
various currencies based upon Merrill Lynch Asset Management L.P.'s (the
"Investment Adviser") analysis of the yield, maturity, potential appreciation
and currency considerations affecting such securities. There can be no assurance
that the Global Bond Focus Fund will achieve its investment objective. Investing
on an international basis involves special considerations. See "Other
Investments and Risks" below. The Fund should be considered a long-term
investment and a vehicle for diversification, and not as a balanced investment
program. The Fund may not be appropriate as the exclusive investment to fund a
variable annuity or variable life insurance contract ("Contract") for all
Contract owners.
The Global Bond Focus Fund may invest in United States and foreign
government and corporate fixed income securities that have a credit rating of A
or better by Standard & Poor's Rating Group ("Standard & Poor's") or by Moody's
Investors Service, Inc. ("Moody's") or commercial paper rated A-1 by Standard &
Poor's or Prime-1 by Moody's or obligations that the Investment Adviser has
determined to be of similar creditworthiness. The Fund may purchase fixed income
securities issued by United States or foreign corporations or financial
institutions, including debt securities of all types and maturities, convertible
securities and preferred stocks. The Fund also may purchase securities issued or
guaranteed by United States or foreign governments (including foreign states,
provinces and municipalities) or their agencies and instrumentalities
("governmental entities") or issued or guaranteed by international organizations
designated or supported by multiple governmental entities to promote economic
reconstruction or development ("supranational entities").
International Investing. The Global Bond Focus Fund may invest in fixed
income securities denominated in any currency or multinational currency unit. An
illustration of a multinational currency unit is the European Currency Unit
("ECU"), which is a "basket" consisting of specified amounts of the currencies
of certain of the twelve member states of the European Community, a Western
European economic cooperative association including France, Germany, the
Netherlands and the United Kingdom. The specific amounts of currencies
comprising the ECU may be adjusted by the Council of Ministers of the European
Community to reflect changes in relative values of the underlying currencies.
The Investment Adviser does not believe that such adjustments will adversely
affect holders of ECU-denominated obligations or the marketability of such
securities. European supranational entities (described further below), in
particular, issue ECU-denominated obligations. The Fund may invest in securities
denominated in the currency of one nation although issued by a governmental
entity, corporation or financial institution of another nation. For example, the
Fund may invest in a British pound sterling-denominated obligation issued by a
United States corporation. Such investments involve credit risks associated with
the issuer and currency risks associated with the currency in which the
obligation is denominated. See "Other Investments and Risks" below.
It is anticipated that under current conditions the Global Bond Focus Fund
will invest primarily in marketable securities denominated in the currencies of
the United States, Canada, Western European nations, New Zealand and Australia,
as well as in ECUs. Further, it is anticipated that such securities will be
issued primarily by entities located in such countries and by supranational
entities. Under normal conditions, the Fund's investments will be denominated in
at least three currencies or multinational currency units. Under certain adverse
conditions, the Fund may restrict the financial markets or currencies in which
its assets will be invested. The Fund presently intends to invest its assets
solely in the United States financial markets or United States
dollar-denominated obligations only for temporary defensive purposes.
The obligations of foreign governmental entities have various kinds of
government support and include obligations issued or guaranteed by foreign
governmental entities with taxing power. These obligations may or may not be
supported by the full faith and credit of a foreign government. The Global Bond
Focus Fund will invest in foreign government securities of issuers considered
stable by the Investment Adviser. While investments in foreign government debt
securities may involve special risks, the Investment Adviser does not believe
that the credit risk inherent in the obligations of stable foreign governments
is significantly greater than that of
2
<PAGE> 149
U.S. Government securities. See "Other Portfolio Strategies -- Foreign
Securities" in the Appendix to this Prospectus.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the "World Bank"), the European Steel and Coal Community, the Asian
Development Bank and the Inter -- American Development Bank. The government
members, or "stockholders," usually make initial capital contributions to the
supranational entity and in many cases are committed to make additional capital
contributions if the supranational entity is unable to repay its borrowings.
Allocation of Investments. In seeking to meet its investment objective,
high current income will be only one of the factors that the Investment Adviser
will consider in selecting portfolio securities for the Global Bond Focus Fund.
As a general matter, in evaluating investments for the Fund, the Investment
Adviser will consider, among other factors, the relative levels of interest
rates prevailing in various countries, the potential appreciation of such
investments in their denominated currencies and, for debt instruments not
denominated in US dollars, the potential movement in the value of such
currencies compared to the US dollar. Additionally, the Fund, in seeking capital
appreciation, may invest in relatively low yielding instruments in expectation
of favorable currency fluctuations or interest rate movements, thereby
potentially reducing the Fund's current yield. In seeking income, the Fund may
invest in short term instruments with relatively high yields (as compared to
other debt securities) meeting the Fund's investment criteria, notwithstanding
that the Fund may not anticipate that such instruments will experience
substantial capital appreciation.
The average maturity of the Global Bond Focus Fund's portfolio securities
will vary based upon the Investment Adviser's assessment of economic and market
conditions. As with all fixed income securities, changes in market yields will
affect the Fund's asset value as the prices of portfolio securities generally
increase when interest rates decline and decrease when interest rates rise.
Prices of longer-term securities generally fluctuate more in response to
interest rate changes than do shorter-term securities. The Global Bond Focus
Fund does not expect the average maturity of its portfolio to exceed ten years.
OTHER INVESTMENTS AND RISKS
In addition, the Global Bond Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may invest in securities of foreign issuers. Investments in foreign securities,
particularly those of non-governmental issuers, involve considerations and risks
that are not ordinarily associated with investing in domestic issuers. These
considerations and risks include changes in currency rates, currency exchange
control regulations, the possibility of expropriation, confiscatory taxation,
high rates of inflation, the unavailability of financial information or the
difficulty of interpreting financial information prepared under foreign
accounting standards, less liquidity and more volatility in foreign securities
markets, the impact of political, social or diplomatic developments, and the
difficulty of assessing economic trends in foreign countries. In addition, net
investment income earned by the Fund on a foreign security may be subject to
withholding and other taxes imposed by foreign governments, which will reduce
the Fund's net investment income. The Global Bond Focus Fund may also from time
to time be substantially invested in non-dollar-denominated securities of
foreign issuers. The value of the Global Bond Focus Fund's holdings denominated
in currencies other than the US dollar and the unrealized appreciation or
depreciation of those investments insofar as United States investors are
concerned will be affected by changes in the value of such currencies relative
to the US dollar. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. Such currency fluctuations may have a substantial impact on the
value of the Fund's holdings. The Fund may engage in transactions, such as
currency swaps and purchasing and selling options on currencies, for purposes of
hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the US dollar. Although such instruments will
be used with the intention of hedging against adverse currency movements,
transactions in such instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective and may cause the Fund to realize losses. The
Global Bond Focus Fund may also invest in debt securities issued by foreign
governments. See
3
<PAGE> 150
"Other Portfolio Strategies -- Foreign Securities" in the Appendix and Annex B
of the Appendix to this Prospectus.
The Global Bond Focus Fund is also authorized to write (i.e., sell) and to
purchase call and put options on securities held in its portfolio or securities
indices the performance of which is substantially correlated with securities
held in its portfolio, may engage in transactions in futures and may invest in
securities the potential return of which is based on the change in particular
measurements of value or rate (i.e., indexed securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed securities, options and
futures.
4
<PAGE> 151
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GLOBAL UTILITY FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Global Utility Focus Fund, (the "Global Utility Focus Fund")
is a diversified fund whose objective is capital appreciation and current income
through investment of at least 65% of its total assets in equity and debt
securities issued by domestic and foreign companies which are, in the opinion of
the Investment Adviser (defined below), primarily engaged in the ownership or
operation of facilities used to generate, transmit or distribute electricity,
telecommunications, gas or water. The Global Utility Focus Fund is a separate
fund of the Merrill Lynch Variable Series Funds, Inc. (the "Company"), an
open-ended management investment company that has a wide range of investment
objectives among its eighteen separate funds (hereinafter referred to as the
"Funds" or individually as a "Fund"). Two separate classes of common stock
("Common Stock"), Class A Common Stock and Class B Common Stock, are issued for
each Fund. The Company is offering shares of its Class B Common Stock for the
Global Utility Focus Fund pursuant to this Prospectus. Each Fund's Class B
Common Stock will be subject to a distribution fee at an annual rate of 0.15% of
the Fund's average daily net assets attributable to the Class B Common Stock.
This Prospectus consists of this seven page document and the attached Appendix.
For more information on the Global Utility Focus Fund's investment objective and
policies, please see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 152
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 153
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Global Utility Focus Fund is to seek both
capital appreciation and current income through investment of at least 65% of
its total assets in equity and debt securities issued by domestic and foreign
companies which are, in the opinion of Merrill Lynch Asset Management, L.P. (the
"Investment Adviser"), primarily engaged in the ownership or operation of
facilities used to generate, transmit or distribute electricity,
telecommunications, gas or water. There can be no assurance that the Global
Utility Focus Fund will achieve its investment objective. The Fund may employ a
variety of instruments and techniques to enhance income and to hedge against
market and currency risk, as described in Annex B to the Appendix to this
Prospectus. Investing on an international basis involves special considerations.
See "Other Investments and Risks" below. The Fund should be considered a
long-term investment and a vehicle for diversification, and not as a balanced
investment program. The Fund may not be appropriate as the exclusive investment
to fund a variable annuity or variable life insurance contract ("Contract") for
all Contract owners.
The Global Utility Focus Fund at all times, except during temporary
defensive periods, will maintain at least 65% of its total assets invested in
equity and debt securities issued by domestic and foreign companies in the
utilities industries. The Fund reserves the right to hold, as a temporary
defensive measure or as a reserve for redemptions, short-term U.S. Government
securities, money market securities, including repurchase agreements, or cash in
such proportions as, in the opinion of the Investment Adviser, prevailing market
or economic conditions warrant. Except during temporary defensive periods, such
securities or cash will not exceed 20% of its total assets. Under normal
circumstances, the Fund will invest at least 65% of its total assets in issuers
domiciled in at least three countries, one of which may be the United States,
although the Investment Adviser expects the Fund's portfolio to be more
geographically diversified. Under normal conditions, it is anticipated that the
percentage of assets invested in U.S. securities will be higher than that
invested in securities of any other single country. It is possible that at times
the Fund may have 65% or more of its total assets invested in foreign
securities.
The Global Utility Focus Fund will invest in common stocks (including
preferred or debt securities convertible into common stocks), preferred stocks
and debt securities. The relative weightings among common stocks, debt
securities and preferred stocks will vary from time to time based upon the
Investment Adviser's judgment of the extent to which investments in each
category will contribute to meeting the Fund's investment objective. Fixed
income securities in which the Fund will invest generally will be limited to
those rated investment grade, that is, rated in one of the four highest rating
categories by Standard & Poor's Ratings Group ("Standard & Poor's") or Moody's
Investors Service, Inc. ("Moody's") (i.e., securities rated at least BBB by
Standard & Poor's or Baa by Moody's), or deemed to be of equivalent quality in
the judgment of the Investment Adviser. Securities rated Baa by Moody's are
described by it as having speculative characteristics and, according to Standard
& Poor's, fixed income securities rated BBB normally exhibit adequate protection
parameters, although adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal.
The Fund's commercial paper investments at the time of purchase will be rated
"A-1" or "A-2" by Standard & Poor's or "Prime-1" or "Prime-2" by Moody's or, if
not rated, will be of comparable quality as determined by the Investment
Adviser. The Fund may also invest up to 5% of its total assets at the time of
purchase in fixed income securities having a minimum rating no lower than Caa by
Moody's or CCC by Standard & Poor's. The Fund may, but need not, dispose of any
security if it is subsequently downgraded. For a description of ratings of debt
securities, see Annex A to the Appendix to this Prospectus.
A change in prevailing interest rates is likely to affect the Fund's net
asset value because prices of debt and equity securities of utility companies
tend to increase when interest rates decline and decrease when interest rates
rise.
Utility Industries -- Description and Risks. Under normal circumstances,
the Global Utility Focus Fund will invest at least 65% of its total assets in
common stocks (including preferred or debt securities convertible into common
stocks), debt securities and preferred stocks of domestic and/or foreign
companies in the utility industries. To meet its objective of current income,
the Fund may invest in domestic utility companies that pay higher than average
dividends, but have a lesser potential for capital appreciation. The average
dividend yields of common stocks issued by domestic utility companies
historically have significantly exceeded those of industrial companies' common
stocks, while the prices of domestic utility stocks have tended to be less
volatile than stocks of industrial companies. The Investment Adviser believes
that the average dividend yields of common stocks
3
<PAGE> 154
issued by foreign utility companies have also historically exceeded those of
foreign industrial companies' common stocks. To pursue its objective of capital
appreciation, the Fund may invest in foreign utility companies that pay lower
than average dividends, but have a greater potential for capital appreciation.
The utility companies in which the Fund will invest include companies that
are, in the opinion of the Investment Adviser, primarily engaged in the
ownership or operation of facilities used to generate, transmit or distribute
electricity, telecommunications, gas or water.
Investments in utility industries bear certain risks, including difficulty
in obtaining an adequate return on invested capital, difficulty in financing
large construction programs during an inflationary period, restrictions on
operations and increased cost and delays attributable to environmental
considerations and regulation, difficulty in raising capital in adequate amounts
on reasonable terms in periods of high inflation and unsettled capital markets,
technological innovations which may render existing plants, equipment or
products obsolete, the potential impact of natural or man-made disasters,
increased costs and reduced availability of certain types of fuel, occasionally
reduced availability and high costs of natural gas for resale, the effects of
energy conservation, the effects of a national energy policy and lengthy delays
and greatly increased costs and other problems associated with design,
construction, licensing, regulation and operation of nuclear facilities for
electric generation, including, among other considerations, the problems
associated with the use of radioactive materials and the disposal of radioactive
wastes. There are substantial differences between the regulatory practices and
policies of various jurisdictions, and any given regulatory agency may make
major shifts in policy from time to time. There is no assurance that regulatory
authorities will, in the future, grant rate increases or that such increases
will be adequate to permit the payment of dividends on common stocks.
Additionally, existing and possible future regulatory legislation may make it
even more difficult for these utilities to obtain adequate relief. Certain of
the issuers of securities in the portfolio may own or operate nuclear generating
facilities. Governmental authorities may from time to time review existing
policies, and impose additional requirements governing the licensing,
construction and operation of nuclear power plants.
Utility companies in the United States and in foreign countries are
generally subject to regulation. In the United States, most utility companies
are regulated by state and/or federal authorities. Such regulation is intended
to ensure appropriate standards of service and adequate capacity to meet public
demand. Generally, prices are also regulated in the United States and in foreign
countries with the intention of protecting the public while ensuring that the
rate of return earned by utility companies is sufficient to allow them to
attract capital in order to grow and continue to provide appropriate services.
There can be no assurance that such pricing policies or rates of return will
continue in the future. The nature of regulation of the utility industries is
evolving both in the United States and in foreign countries. Changes in
regulation in the United States increasingly allow utility companies to provide
services and products outside their traditional geographic areas and lines of
business, creating new areas of competition within the industries. In some
instances, utility companies are operating on an unregulated basis. Because of
trends toward deregulation and the evolution of independent power producers as
well as new entrants to the field of telecommunications, non-regulated providers
of utility services have become a significant part of their respective
industries. The Investment Adviser believes that the emergence of competition
and deregulation will result in certain utility companies being able to earn
more than their traditional regulated rates of return, while others may be
forced to defend their core businesses from increased competition and may be
less profitable. The Investment Adviser seeks to take advantage of favorable
investment opportunities that are expected to arise from these structural
changes. Of course, there can be no assurance that favorable developments will
occur in the future.
Foreign utility companies are also subject to regulation, although such
regulations may or may not be comparable to that in the United States. Foreign
utility companies may be more heavily regulated by their respective governments
than utilities in the United States and, as in the U.S., generally are required
to seek government approval for rate increases. In addition, many foreign
utilities use fuels that cause more pollution than those used in the United
States, which may require such utilities to invest in pollution control
equipment to meet any proposed pollution restrictions. Foreign regulatory
systems vary from country to country and may evolve in ways different from
regulation in the United States.
The principal sectors of the global utility industries are discussed below.
Electric. The electric utility industry consists of companies that are
engaged principally in the generation, transmission and sale of electric energy,
although many also provide other energy-related services. Domestic
4
<PAGE> 155
electric utility companies, in general, recently have been favorably affected by
lower fuel and financing costs and the full or near completion of major
construction programs. In addition, certain of these companies generate cash
flows in excess of current operating expenses and construction expenditures,
permitting some degree of diversification into unregulated businesses. Some
electric utilities have also taken advantage of the right to sell power outside
of their traditional geographic areas. Electric utility companies have
historically been subject to the risks associated with increases in fuel and
other operating costs, high interest costs on borrowings needed for capital
construction programs, costs associated with compliance with environmental and
safety regulations and changes in the regulatory climate. As interest rates have
declined, many utilities have refinanced high cost debt and in doing so have
improved their fixed charges coverage. Regulators, however, have lowered allowed
rates of return as interest rates have declined and thereby caused the benefits
of the rate declines to be shared wholly or in part with customers.
In the United States, the construction and operation of nuclear power
facilities is subject to increased scrutiny by, and evolving regulations of, the
Nuclear Regulatory Commission and state agencies having comparable jurisdiction.
Increased scrutiny might result in higher operating costs and higher capital
expenditures, with the risk that the regulators may disallow inclusion of these
costs in rate authorizations or the risk that a company may not be permitted to
operate or complete construction of a facility. In addition, operators of
nuclear power plants may be subject to significant costs for disposal of nuclear
fuel and for decommissioning of such plants.
In October 1993, Standard & Poor's stiffened its debt-ratings formula for
the electric utility industry, stating that the industry is in long-term
decline. In addition, Moody's stated that it expected a drop in the next three
years in its average credit ratings for the industry. Reasons set forth for
these outlooks included slowing demand and increasing cost pressures as a result
of competition from rival providers.
Telecommunications. The telephone industry is large and highly
concentrated. Companies that distribute telephone services and provide access to
the telephone networks comprise the greatest portion of this segment. Telephone
companies in the United States are still experiencing the effects of the breakup
of American Telephone & Telegraph Company, which occurred in 1984. Since 1984,
companies engaged in telephone communication services have expanded their
non-regulated activities into other businesses, including cellular telephone
services, data processing, equipment retailing, computer software and hardware
services, and financial services. This expansion has provided significant
opportunities for certain telephone companies to increase their earnings and
dividends at faster rates than had been allowed in traditional regulated
businesses. Increasing competition, technological innovations and other
structural changes, however, could adversely affect the profitability of such
utilities. Technological breakthroughs and the merger of telecommunications with
video and entertainment is now associated with the expansion of the role of
cable companies as providers of utility services in the telecommunications
industry and the competitive response of traditional telephone companies. Given
mergers and certain marketing tests currently underway, it is likely that both
traditional telephone companies and cable companies will soon provide a greatly
expanded range of utility services, including two-way video and informational
services.
Gas. Gas transmission companies and gas distribution companies are also
undergoing significant changes. In the United States, interstate transmission
companies are regulated by the Federal Energy Regulatory Commission, which is
reducing its regulation of the industry. Many companies have diversified into
oil and gas exploration and development, making returns more sensitive to energy
prices. In the recent decades, gas utility companies have been adversely
affected by disruptions in the oil industry and have also been affected by
increased concentration and competition.
Water. Water supply utilities are companies that collect, purify,
distribute and sell water. In the United States and around the world, the
industry is highly fragmented because most of the supplies are owned by local
authorities. Companies in this industry are generally mature and are
experiencing little or no per capita volume growth.
Investment Outside the Utility Industries. The Global Utility Focus Fund
is permitted to invest up to 35% of its assets in securities of issuers that are
outside the utility industries. Such investments may include common stocks, debt
securities or preferred stocks and will be selected to meet the Fund's
investment objective of both capital appreciation and current income. These
securities may be issued by either U.S. or non-U.S. companies. Some of these
issuers may be in industries related to utility industries and, therefore, may
be subject to similar
5
<PAGE> 156
risks. Securities that are issued by foreign companies or are denominated in
foreign currencies are subject to certain risks. See "Other Investments and
Risks" below.
The Global Utility Focus Fund is also permitted to invest in securities
issued or guaranteed by the U.S. Government, its agencies or instrumentalities
and in securities issued or guaranteed by foreign governments. Foreign
government securities are typically denominated in foreign currencies and are
subject to the currency fluctuation and other risks of foreign securities
investments. The foreign government securities in which the Fund intends to
invest generally will consist of obligations supported by national, state or
local governments or similar political subdivisions. Foreign government
securities also include debt obligations of supranational entities, including
international organizations designated or supported by governmental entities to
promote economic reconstruction or development and international banking
institutions and related government agencies. Examples include the International
Bank for Reconstruction and Development (the "World Bank"), the European
Investment Bank, the Asian Development Bank and the Inter-American Development
Bank.
Foreign government securities also include debt securities of
"quasi-governmental agencies" and debt securities denominated in multinational
currency units. An example of a multinational currency unit is the European
Currency Unit. A European Currency Unit represents specified amounts of the
currencies of certain of the twelve member states of the European Economic
Community. Debt securities of quasi-governmental agencies are issued by entities
owned by either a national or local government or are obligations of a political
unit that is not backed by the national government's full faith and credit and
general taxing powers. Foreign government securities will not be considered
government securities for purposes of determining the Fund's compliance with
diversification and concentration policies.
OTHER INVESTMENTS AND RISKS
In addition, the Global Utility Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Global
Utility Focus Fund may also invest in securities of foreign issuers. Investments
in foreign securities, particularly those of non-governmental issuers, involve
considerations and risks that are not ordinarily associated with investing in
domestic issuers. These considerations and risks include changes in currency
rates, currency exchange control regulations, the possibility of expropriation,
confiscatory taxation, high rates of inflation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of political, social or diplomatic
developments, and the difficulty of assessing economic trends in foreign
countries. In addition, net investment income earned by the Fund on a foreign
security may be subject to withholding and other taxes imposed by foreign
governments which will reduce the Fund's net investment income. The Global
Utility Focus Fund may from time to time be substantially invested in
non-dollar-denominated securities of foreign issuers. Changes in the foreign
currency exchange rates may affect the value of securities in the portfolio and
the unrealized appreciation or depreciation of investments insofar as United
States investors are concerned. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. The Global Utility Focus Fund may also engage in transactions, such
as currency swaps and purchasing and selling options on currencies, for purposes
of hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the US dollar. Although such instruments will
be used with the intention of hedging against adverse currency movements,
transactions in such instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective and may cause the Fund to realize losses. See
"Other Portfolio Strategies -- Foreign Securities" in the Appendix to this
Prospectus.
The Global Utility Focus Fund may from time to time enter into standby
commitment agreements, engage in transactions in futures, invest in securities
the potential return of which is based on the change in particular measurements
of value or rate (i.e. indexed securities), and, is authorized to write (i.e.,
sell) call and put options and purchase put options on securities held in its
portfolio or securities indices the performance of which is substantially
correlated with securities held in its portfolio.
6
<PAGE> 157
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed securities, options, futures
and foreign exchange transactions.
7
<PAGE> 158
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH INTERNATIONAL EQUITY FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch International Equity Focus Fund, (the "International Equity
Focus Fund") is a diversified fund whose objectives are capital appreciation
and, secondarily, income, through investment in securities, principally
equities, of issuers in countries other than the United States. The
International Equity Focus Fund is a separate fund of the Merrill Lynch Variable
Series Funds, Inc. (the "Company"), an open-ended management investment company
that has a wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class B Common Stock for the International Equity Focus Fund pursuant to
this Prospectus. Each Fund's Class B Common Stock will be subject to a
distribution fee at an annual rate of 0.15% of the Fund's average daily net
assets attributable to the Class B Common Stock. This Prospectus consists of
this four page document and the attached Appendix. For more information on the
International Equity Focus Fund's investment objectives and policies, please see
page 2 of this document and the Appendix.
THE INTERNATIONAL EQUITY FOCUS FUND MAY INVEST IN HIGH YIELD -- HIGH RISK
SECURITIES (INCLUDING "JUNK BONDS"), WHICH INVOLVE SPECIAL RISKS. SEE
"INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS -- RISKS OF HIGH YIELD
SECURITIES" IN THE APPENDIX TO THIS PROSPECTUS.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and
Policies........................ 2
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 159
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the International Equity Focus Fund are to
seek capital appreciation and, secondarily, income by investing in a diversified
portfolio of equity securities of issuers located in countries other than the
United States. Under normal conditions, at least 65% of the Fund's net assets
will be invested in such equity securities and at least 65% of the Fund's total
assets will be invested in the securities of issuers from at least three
different foreign countries. The investment objective of the Fund is a
fundamental policy and may not be changed without approval of a majority of the
Fund's outstanding shares. There can be no assurance that the International
Equity Focus Fund will achieve its investment objectives. The Fund may employ a
variety of investments and techniques to hedge against market and currency risk.
See Annex B of the Appendix to this Prospectus. Investing on an international
basis involves special considerations. Investing in smaller capital markets
entails the risk of significant volatility in the Fund's security prices. The
Fund is designed for investors seeking to complement their U.S. holdings through
foreign investments. The Fund should be considered a long-term investment and a
vehicle for diversification, and not as a balanced investment program. The Fund
may not be appropriate as the exclusive investment to fund a variable annuity or
variable life insurance contract ("Contract") for all Contract owners.
The International Equity Focus Fund will invest in an international
portfolio of securities of foreign companies located throughout the world. While
there are no prescribed limits on the geographic allocation of the Fund's
investments, management of the Fund anticipates that a substantial portion of
its assets will be invested in the developed countries of Europe and the Far
East. For the reasons stated below, management of the Fund will give special
attention to investment opportunities in the developing countries of the world,
including, but not limited to Latin America, the Far East and Eastern Europe. It
is anticipated that a significant portion of the Fund's assets may be invested
in such developing countries.
The allocation of the International Equity Focus Fund's assets among the
various foreign securities markets will be determined by Merrill Lynch Asset
Management, L.P. (the "Investment Adviser") based primarily on its assessment of
the relative condition and growth potential of the various economies and
securities markets, currency and taxation considerations and other pertinent
financial, social, national and political factors. Within such allocations, the
Investment Adviser will seek to identify equity investments in each market that
are expected to provide a total return that equals or exceeds the return of such
market as a whole.
A significant portion of the International Equity Focus Fund's assets may
be invested in developing countries. This allocation of the Fund's assets
reflects the belief that attractive investment opportunities may result from an
evolving long-term international trend favoring more market-oriented economies,
a trend that may especially benefit certain developing countries with smaller
capital markets. This trend may be facilitated by local or international
political, economic or financial developments that could benefit the capital
markets of such countries. Certain such countries, particularly so-called
"emerging" countries (such as Malaysia, Mexico and Thailand), which may be in
the process of developing more market-oriented economies, may experience
relatively high rates of economic growth. Because of the general illiquidity of
the capital markets in certain developing countries, the Fund may invest in a
relatively small number of leading or relatively actively traded companies in
the capital markets of such a country in the expectation that the investment
experience of the securities of such companies will substantially represent the
investment experience of that country's capital markets as a whole.
While the International Equity Focus Fund will primarily emphasize
investments in common stock, the Fund may also invest in preferred stocks,
convertible debt securities and other instruments the return on which is linked
to the performance of a common stock or a basket or index of common stocks
(collectively, "equity securities"). The Fund may also invest in non-equity
securities, including debt securities, cash or cash equivalents denominated in
US dollars or foreign currencies and short-term securities, including money
market instruments. Under certain adverse investment conditions, for defensive
purposes, the Fund may restrict the markets in which its assets will be invested
and may increase the proportion of assets invested in short-term obligations of
U.S. issuers. Investments made for defensive purposes will be maintained only
during periods in which the Investment Adviser determines that economic or
financial conditions are adverse for holding or being fully invested in equity
securities of foreign issuers.
The International Equity Focus Fund also may invest up to 35% of its net
assets in longer-term, non-convertible debt securities emphasizing debt
securities which offer the opportunity for capital appreciation.
2
<PAGE> 160
Capital appreciation in debt securities may arise as a result of a favorable
change in relative foreign exchange rates, in relative interest rate levels, or
in the creditworthiness of issuers. In accordance with its investment objective,
the Fund will not seek to benefit from anticipated short-term fluctuations in
currency exchange rates. The Fund may, from time to time, invest in debt
securities with relatively high yields (as compared to other debt securities
meeting the Fund's investment criteria), notwithstanding that the Fund may not
anticipate that such securities will experience substantial capital
appreciation. Such income can be used, however, to offset the operating expenses
of the Fund.
The International Equity Focus Fund may invest in debt securities issued or
guaranteed by foreign governments (including foreign states, provinces and
municipalities) or their agencies and instrumentalities ("governmental
entities"), issued or guaranteed by international organizations designated or
supported by multiple foreign governmental entities (which are not obligations
of foreign governments) to promote economic reconstruction or development
("supranational entities"), or issued by foreign corporations or financial
institutions.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the "World Bank"), the European Steel and Coal Community, the Asian
Development Bank and the Inter-American Development Bank. The governmental
members, or "stockholders," usually make initial capital contributions to the
supranational entity and in many cases are committed to make additional capital
contributions if the supranational entity is unable to repay its borrowings.
OTHER INVESTMENTS AND RISKS
In addition, the International Equity Focus Fund may purchase certain
securities that are not registered under the Securities Act of 1933, as amended
and which therefore may be subject to restrictions on their transfer or resale.
The International Equity Focus Fund has established no rating criteria for
the debt securities in which it may invest, and such securities may not be rated
at all for creditworthiness. Securities rated in the medium to lower rating
categories of nationally recognized statistical rating organizations and unrated
securities of comparable quality are predominantly speculative with respect to
the capacity to pay interest and repay principal in accordance with the terms of
the security and generally involve a greater volatility of price than securities
in higher rating categories. In purchasing such securities, the Fund will rely
on the Investment Adviser's judgment, analysis and experience in evaluating the
creditworthiness of an issuer of such securities. The Investment Adviser will
take into consideration, among other things, the issuer's financial resources,
its sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters. The Fund does not
intend to purchase debt securities that are in default or that the Investment
Adviser believes will be in default. See "Risks of High Yield Securities" in the
Appendix to this Prospectus.
The Fund may invest in securities of foreign issuers. Investments in
foreign securities, particularly those of non-governmental issuers, involve
considerations and risks that are not ordinarily associated with investing in
domestic issuers. These considerations and risks include changes in currency
rates, currency exchange control regulations, the possibility of expropriation,
confiscatory taxation, high rates of inflation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of political, social or diplomatic
developments, and the difficulty of assessing economic trends in foreign
countries. In addition, net investment income earned by the Fund on a foreign
security may be subject to withholding and other taxes imposed by foreign
governments, which will reduce the Fund's net investment income. The Fund may
from time to time be substantially invested in non-dollar-denominated securities
of foreign issuers. Changes in foreign currency exchange rates may affect the
value of securities in the portfolio and the unrealized appreciation or
depreciation of investments insofar as United States investors are concerned.
Furthermore, the Fund's return on investments in non-dollar-denominated
securities may be reduced or enhanced as a result of changes in foreign currency
rates during the period in which the Fund holds such investments. See "Other
Portfolio Strategies -- Foreign Securities" in the Appendix to this Prospectus.
3
<PAGE> 161
The International Equity Focus Fund may engage in transactions, such as
currency swaps and purchasing and selling options on currencies, for purposes of
hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the US dollar. Although such instruments will
be used with the intention of hedging against adverse currency movements,
transactions in such instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the International Equity
Focus Fund's hedging strategies will be ineffective and may cause the Fund to
realize losses.
The International Equity Focus Fund may also invest a significant portion
of its assets in securities of foreign issuers in smaller capital markets.
Foreign investments involve risks that are often heightened for investments in
smaller capital markets. There may be less publicly available information about
an issuer in a smaller capital market than would be available about a United
States company, and it may not be subject to accounting, auditing and financial
reporting standards and requirements comparable to those of United States
companies. Furthermore, smaller capital markets have substantially less volume
than United States markets so securities in many smaller capital markets are
less liquid and their prices may be more volatile than securities of comparable
United States companies. As a result, traditional investment measurements, such
as price/earnings ratios, as used in the United States, may not be applicable in
certain capital markets. See "Other Portfolio Strategies -- Foreign Securities"
in the Appendix to this Prospectus.
The International Equity Focus Fund is also authorized to write (i.e.,
sell) and purchase call and put options on securities held in its portfolio or
securities indices the performance of which is substantially correlated with
securities held in its portfolio, engage in transactions in futures and options
thereon, and may invest in securities the potential return of which is based on
the change in particular measurements of value or rate (i.e. indexed and inverse
securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed and inverse securities,
options, futures and foreign exchange transactions.
4
<PAGE> 162
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH DEVELOPING CAPITAL MARKETS FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Developing Capital Markets Focus Fund, (the "Developing
Capital Markets Focus Fund") is a non-diversified fund whose objective is
long-term capital appreciation by investing in securities, principally equities,
of issuers in countries having smaller capital markets. The Developing Capital
Markets Focus Fund is a separate fund of the Merrill Lynch Variable Series
Funds, Inc. (the "Company"), an open-ended management investment company that
has a wide range of investment objectives among its eighteen separate funds
(hereinafter referred to as the "Funds" or individually as a "Fund"). Two
separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund. The Company is offering shares
of its Class B Common Stock for the Developing Capital Markets Focus Fund
pursuant to this Prospectus. Each Fund's Class B Common Stock will be subject to
a distribution fee at an annual rate of 0.15% of the Fund's average daily net
assets attributable to the Class B Common Stock. This Prospectus consists of
this six page document and the attached Appendix. For more information on the
Developing Capital Markets Focus Fund's investment objective and policies,
please see page 4 of this document and the Appendix.
THE DEVELOPING CAPITAL MARKETS FOCUS FUND INVESTS OR MAY INVEST IN HIGH
YIELD BONDS (COMMONLY KNOWN AS "JUNK BONDS"), WHICH INVOLVE SPECIAL RISKS. SEE
"INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS -- RISKS OF HIGH YIELD
SECURITIES" IN THE APPENDIX TO THIS PROSPECTUS.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights............... 3
Investment Objective and
Policies........................ 4
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 163
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 164
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1997 are included in the Statement of Additional Information.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements. Further information about
the performance of the Fund is contained in the Fund's most recent annual report
to shareholders, which may be obtained, without charge, by calling or by writing
the Company at the telephone number or address on the front cover of this
Prospectus.
<TABLE>
<CAPTION>
DEVELOPING CAPITAL
MARKETS FOCUS FUND
(CLASS B)
FOR THE PERIOD
NOVEMBER 3, 1997+ TO
DECEMBER 31, 1997
--------------------
<S> <C>
Increase (Decrease) in Net Asset Value:
Per Share Operating Performance:
Net asset value, beginning of period........................ $ 9.30
------
Investment income -- net.................................... .01
Realized and unrealized loss on investments and foreign
currency transactions -- net.............................. (.09)
------
Total from investment operations............................ (.08)
------
Net asset value, end of period.............................. $ 9.22
======
Total Investment return:**
Based on net asset value per share.......................... (0.86)%++
======
Ratios to Average Net Assets:
Expenses, net of reimbursement.............................. 1.39%*
======
Expenses.................................................... 1.58%*
======
Investment income -- net.................................... 1.16%*
======
Supplemental Data:
Net assets, end of period (in thousands).................... $ 32
======
Portfolio turnover.......................................... 93.62%
======
Average commission rate paid#............................... $.0015
======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Aggregate total investment return.
# The "Average Commission Rate Paid" includes commissions paid in foreign
currencies, which have been converted into US dollars using the prevailing
exchange rate on the date of the transaction. Such conversions may
significantly affect the rate shown.
3
<PAGE> 165
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Developing Capital Markets Focus Fund is to
seek long-term capital appreciation by investing in securities, principally
equities, of issuers in countries having smaller capital markets. Under normal
conditions, at least 65% of the Fund's net assets will be invested in such
equity securities. The investment objective of the Fund is a fundamental policy
and may not be changed without approval of a majority of the Fund's outstanding
shares. There can be no assurance that the Fund will achieve its investment
objective. The Developing Capital Markets Focus Fund may employ a variety of
investments and techniques to hedge against market and currency risk. See Annex
B to the Appendix to this Prospectus. Investing on an international basis
involves special considerations. Investing in smaller capital markets entails
the risk of significant volatility in the Fund's security prices. See "Other
Investments and Risks" below. The Fund should be considered a long-term
investment and a vehicle for diversification, and not as a balanced investment
program. The Fund may not be appropriate as the exclusive investment to fund a
variable annuity or variable life insurance contract ("Contract") for all
Contract owners.
For purposes of its investment objective, the Developing Capital Markets
Focus Fund considers countries having smaller capital markets to be all
countries other than the four countries having the largest equity market
capitalizations. Currently, these four countries are Japan, the United Kingdom,
the United States and Germany. At December 31, 1997, those countries' equity
market capitalizations totalled approximately 75% of the world's equity market
capitalization according to data provided by Morgan Stanley Capital
International. The Fund will at all times, except during defensive periods,
maintain investments in at least three countries having smaller capital markets.
The Developing Capital Markets Focus Fund seeks to benefit from economic
and other developments in smaller capital markets. The investment objective of
the Fund reflects the belief that investment opportunities may result from an
evolving long-term international trend favoring more market-oriented economies,
a trend that may especially benefit certain countries having smaller capital
markets. This trend may be facilitated by local or international political,
economic or financial developments that could benefit the capital markets of
such countries. Certain such countries, particularly so-called "emerging"
countries (such as Malaysia, Mexico and Thailand) which may be in the process of
developing more market-oriented economies, may experience relatively high rates
of economic growth. Other countries (such as France, the Netherlands and Spain),
although having relatively mature smaller capital markets, may also be in a
position to benefit from local or international developments encouraging greater
market orientation and diminishing governmental intervention in economic
affairs.
Many investors, particularly individuals, lack the information, capability
or inclination to invest in countries having smaller capital markets. It also
may not be permissible for such investors to invest directly in certain such
markets. Unlike many intermediary investment vehicles, such as closed-end
investment companies that invest in a single country, the Fund intends to
diversify investment risk among the capital markets of a number of countries.
The Fund will not necessarily seek to diversify investments on a geographical
basis or on the basis of the level of economic development of any particular
country.
In its investment decision-making, Merrill Lynch Asset Management, L.P.
(the "Investment Adviser") will emphasize the allocation of assets among certain
countries' capital markets, rather than the selection of particular industries
or issuers. Because of the general illiquidity of the capital markets in some
countries, the Fund may invest in a relatively small number of leading or
actively traded companies in a country's capital markets in the expectation that
the investment experience of the securities of such companies will substantially
represent the investment experience of the country's capital markets as a whole.
The Developing Capital Markets Focus Fund also may invest in debt
securities of issuers in countries having smaller capital markets. Capital
appreciation in debt securities may arise as a result of a favorable change in
relative foreign exchange rates, in relative interest rate levels, or in the
creditworthiness of issuers. In accordance with its investment objective, the
Fund will not seek to benefit from anticipated short-term fluctuations in
currency exchange rates. The Fund may, from time to time, invest in debt
securities with relatively high yields (as compared to other debt securities
meeting the Fund's investment criteria), notwithstanding that the Fund may not
anticipate that such securities will experience substantial capital
appreciation. See "Other Investments and Risks" below. Such income can be used,
however, to offset the operating expenses of the Fund.
4
<PAGE> 166
The Developing Capital Markets Focus Fund may invest in debt securities
issued or guaranteed by foreign governments (including foreign states, provinces
and municipalities) or their agencies and instrumentalities ("governmental
entities"), issued or guaranteed by international organizations designated or
supported by multiple foreign governmental entities (which are not obligations
of foreign governments) to promote economic reconstruction or development
("supranational entities"), or issued by foreign corporations or financial
institutions.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the "World Bank"), the European Steel and Coal Community, the Asian
Development Bank and the Inter-American Development Bank. The governmental
members, or "stockholders," usually make initial capital contributions to the
supranational entity and in many cases are committed to make additional capital
contributions if the supranational entity is unable to repay its borrowings.
For purposes of the Developing Capital Markets Focus Fund's investment
objective, an issuer ordinarily will be considered to be located in the country
where the primary trading market of its securities is located. The Fund,
however, may consider a company to be located in countries having smaller
capital markets, without reference to its domicile or to the primary trading
market of its securities, when at least 50% of its non-current assets,
capitalization, gross revenues or profits in any one of the two most recent
fiscal years represents (directly or indirectly through subsidiaries) assets or
activities located in such countries. The Fund also may consider closed-end
investment companies to be located in the country or countries in which they
primarily make their portfolio investments.
The Developing Capital Markets Focus Fund may invest a significant portion
of its assets in securities of foreign issuers in smaller capital markets.
Foreign investments involve risks, which are often heightened for investments in
smaller capital markets, including fluctuations in foreign exchange rates,
future political and economic developments, different legal systems and the
existence or possible imposition of exchange controls or other foreign or United
States governmental laws or restrictions applicable to such investments. With
respect to certain countries, there may be the possibility of expropriation of
assets, confiscatory taxation, high rates of inflation, political or social
instability or diplomatic developments which could affect investment in those
countries. In addition, certain foreign investments may be subject to foreign
withholding taxes. See "Other Investments and Risks" below.
There may be less publicly available information about an issuer in a
smaller capital market than would be available about a United States company,
and it may not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those of United States companies. As a
result, traditional investment measurements, such as price/earnings ratios, as
used in the United States, may not be applicable in certain capital markets.
Furthermore, smaller capital markets have substantially less volume than United
States markets so securities in many smaller capital markets are less liquid and
their prices may be more volatile than securities of comparable United States
companies. See "Other Portfolio Strategies -- Foreign Securities" in the
Appendix to this Prospectus.
OTHER INVESTMENTS AND RISKS
In addition, the Fund may purchase certain securities that are not
registered under the Securities Act of 1933, as amended and which therefore may
be subject to restrictions on their transfer or resale.
The Developing Capital Markets Focus Fund has established no rating
criteria for the debt securities in which it may invest, and such securities may
not be rated at all for creditworthiness. Securities rated in the medium to
lower rating categories of nationally recognized statistical rating
organizations and unrated securities of comparable quality are predominantly
speculative with respect to the capacity to pay interest and repay principal in
accordance with the terms of the security and generally involve a greater
volatility of price than securities in higher rating categories. In purchasing
such securities, the Fund will rely on the Investment Adviser's judgment,
analysis and experience in evaluating the creditworthiness of an issuer of such
securities. The Investment Adviser will take into consideration, among other
things, the issuer's financial resources, its sensitivity to economic conditions
and trends, its operating history, the quality of the issuer's management and
regulatory
5
<PAGE> 167
matters. The Fund does not intend to purchase debt securities that are in
default or which the Investment Adviser believes will be in default. See "Risks
of High Yield Securities" in the Appendix to this Prospectus.
The Developing Capital Markets Focus Fund invests in securities of foreign
issuers. Investments in foreign securities, particularly those of
non-governmental issuers, involve considerations and risks that are not
ordinarily associated with investing in domestic issuers. These considerations
and risks include changes in currency rates, currency exchange control
regulations, the possibility of expropriation, confiscatory taxation, high rates
of inflation, the unavailability of financial information or the difficulty of
interpreting financial information prepared under foreign accounting standards,
less liquidity and more volatility in foreign securities markets, the impact of
political, social or diplomatic developments, and the difficulty of assessing
economic trends in foreign countries. In addition, net investment income earned
by the Fund on a foreign security may be subject to withholding and other taxes
imposed by foreign governments, which will reduce the Fund's net investment
income. The Fund may from time to time be substantially invested in
non-dollar-denominated securities of foreign issuers. Changes in foreign
currency exchange rates may affect the value of securities in the portfolio and
the unrealized appreciation or depreciation of investments insofar as United
States investors are concerned. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. See "Other Portfolio Strategies -- Foreign Securities" in the
Appendix to this Prospectus.
The Developing Capital Markets Focus Fund may engage in transactions, such
as currency swaps and purchasing and selling options on currencies, for purposes
of hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the US dollar. Although such instruments will
be used with the intention of hedging against adverse currency movements,
transactions in such instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective and may cause the Fund to realize losses.
The Developing Capital Markets Focus Fund may from time to time enter into
standby commitment agreements and is authorized to write (i.e., sell) and
purchase call and put options on securities held in its portfolio or securities
indices the performance of which is substantially correlated with securities
held in its portfolio, may engage in transactions in futures and may invest in
securities the potential return of which is based on the change in particular
measurements of value or rate (i.e., indexed and inverse securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed and inverse securities,
options, futures and foreign exchange transactions.
6
<PAGE> 168
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GOVERNMENT BOND FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Government Bond Fund, formerly, Merrill Lynch Intermediate
Government Bond Fund (the "Government Bond Fund") is a diversified fund whose
objective is the highest possible current income consistent with the protection
of capital afforded by investing in debt securities issued or guaranteed by the
United States Government, its agencies or instrumentalities. The Government Bond
Fund is a separate fund of the Merrill Lynch Variable Series Funds, Inc. (the
"Company"), an open-ended management investment company that has a wide range of
investment objectives among its eighteen separate funds (hereinafter referred to
as the "Funds" or individually as a "Fund"). Two separate classes of common
stock ("Common Stock"), Class A Common Stock and Class B Common Stock, are
issued for each Fund. The Company is offering shares of its Class B Common Stock
for the Government Bond Fund pursuant to this Prospectus. Each Fund's Class B
Common Stock will be subject to a distribution fee at an annual rate of 0.15% of
the Fund's average daily net assets attributable to the Class B Common Stock.
This Prospectus consists of this three page document and the attached Appendix.
For more information on the Government Bond Fund's investment objective and
policies, please see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 169
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 170
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Government Bond Fund is to seek the highest
possible current income consistent with the protection of capital afforded by
investing in debt securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities. Under normal circumstances, all or substantially
all of the Fund's assets will be invested in such securities. Depending on
market conditions, an average maturity of six to fifteen years is anticipated.
When, in the opinion of management, prevailing market or economic conditions
warrant, a portion of the Fund may be invested in money market securities or a
liquid asset fund to effectively utilize cash reserves. There can be no
assurance that the Government Bond Fund will achieve its investment objective.
Certain of the securities in which the Government Bond Fund invests are
supported by the full faith and credit of the U.S. Government, such as U.S.
Treasury obligations. Other of the securities in which the Fund invests are not
supported by the full faith and credit of the U.S. Government but are issued by
U.S. Government agencies, instrumentalities or government-sponsored enterprises.
Such securities are generally supported only by the credit of the agency,
instrumentality or enterprise issuing the security and are generally considered
to have a low principal risk. However, because of the longer-term maturities of
the securities in which the Fund will invest, interest rate fluctuations may
adversely affect the market value of such securities. As interest rates rise,
the value of fixed-income securities will fall, adversely affecting the net
asset value of the Fund. The Fund should be considered a long-term investment
and a vehicle for diversification, and not as a balanced investment program. The
Fund may not be appropriate as the exclusive investment to fund a variable
annuity or variable life insurance contract ("Contract") for all Contract
owners.
The U.S. Treasury Department has enacted regulations prescribing
diversification standards to be met by investment company portfolios to which
the investment base for any variable annuity policy has been allocated as a
condition to such policies being treated as variable annuity contracts under the
Internal Revenue Code of 1986, as amended. The regulations limit the percentage
of the total assets of any investment company portfolio which may be invested in
securities of any five or fewer issuers, including a requirement that no more
than 55% of a portfolio's total assets be invested in the securities of any one
issuer. Direct obligations of the U.S. Treasury are not excepted from the
diversification requirements. Each government agency or instrumentality issuing,
guaranteeing or insuring securities will be treated as a separate issuer for
purposes of the diversification standards.
In addition, the Government Bond Fund may purchase certain securities that
are not registered under the Securities Act of 1933, as amended and which
therefore may be subject to restrictions on their transfer or resale. The Fund
may also invest in securities the potential return of which is based on the
change in particular measurements of value or rate (i.e., indexed securities). A
further discussion of the investments described in this paragraph and the risks
associated with such investments is set forth in the Appendix to this
Prospectus, including Annex B of the Appendix to this Prospectus, which includes
a discussion of certain portfolio strategies relating to indexed securities.
3
<PAGE> 171
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH INDEX 500 FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Index 500 Fund (the "Index 500 Fund") is a non-diversified
fund whose objective is investment results that, before expenses, correspond to
the aggregate price and yield performance of the Standard & Poor's 500 Composite
Stock Price Index (the "S&P 500 Index"). The Index 500 Fund is a separate fund
of the Merrill Lynch Variable Series Funds, Inc. (the "Company"), an open-ended
management investment company that has a wide range of investment objectives
among its eighteen separate funds (hereinafter referred to as the "Funds" or
individually as a "Fund"). Two separate classes of common stock ("Common
Stock"), Class A Common Stock and Class B Common Stock, are issued for each
Fund. The Company is offering shares of its Class B Common Stock for the Index
500 Fund pursuant to this Prospectus. Each Fund's Class B Common Stock will be
subject to a distribution fee at an annual rate of 0.15% of the Fund's average
daily net assets attributable to the Class B Common Stock. This Prospectus
consists of this four page document and the attached Appendix. For more
information on the Index 500 Fund's investment objective and policies, please
see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 172
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 173
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Index 500 Fund is to seek to provide
investment results that, before expenses, correspond to the aggregate price and
yield performance of the S&P 500 Index. There can be no assurance that the Fund
will achieve its investment objective. The Fund should be considered a long-term
investment and a vehicle for diversification, and not as a balanced investment
program. The Fund may not be appropriate as the exclusive investment to fund a
variable annuity or variable life insurance contract ("Contract") for all
Contract owners.
The S&P 500 Index is a market-weighted index composed of 500 common stocks
issued by companies in a wide range of businesses and which collectively
represent a substantial portion of all common stocks publicly traded in the U.S.
The composition of the S&P 500 Index is determined by Standard & Poor's Rating
Group ("Standard & Poor's"), a division of the McGraw-Hill Companies, Inc.
Standard & Poor's criteria for selecting common stocks to include in the S&P 500
Index is based on factors such as market capitalization, trading activity and
the adequacy of representation of particular industries, and favors U.S.-traded
stocks of large companies that are among the most dominant in their industries.
The S&P 500 Index is generally considered broadly representative of the
performance of large-capitalization publicly traded common stocks in the U.S.
The inclusion of a stock in the S&P 500 Index does not imply that Standard &
Poor's believes the stock to be an attractive investment.
The Index 500 Fund will not attempt to buy or sell securities based on
Merrill Lynch Asset Management, L.P.'s (the "Investment Adviser") economic,
financial or market analysis, but will instead employ a "passive" approach that
attempts to remain invested at all times in a portfolio of assets the
performance of which is expected to be strongly correlated with that of the S&P
500 Index. The Index 500 Fund may invest in all 500 stocks in the S&P 500 Index
in approximately the same proportions as their weightings in the S&P 500 Index,
or may invest in a statistically selected sample of the 500 stocks which
comprise the S&P 500 Index designed, based on market capitalizations, industry
weightings and financial attributes, to have aggregate investment
characteristics similar to those of the S&P 500 Index as a whole. The Index 500
Fund may also (i) purchase common stocks not included in the S&P 500 Index as a
proxy for certain common stocks included in the S&P 500 Index when the
Investment Adviser believes it is an efficient means of replicating the
performance of that index to do so, and (ii) invest in options and future
contracts linked to the performance of the S&P 500 Index or of common stocks
represented in the index.
Under normal circumstances, it is expected that the Index 500 Fund will
invest at least 90% (65% if the Index 500 Fund's assets are below $20 million)
of its assets in common stocks represented in the S&P 500 Index and related
options and futures contracts. The Index 500 Fund may invest a substantial
portion of its assets in options and futures contracts in order to gain market
exposure efficiently in the event of subscriptions, to maintain liquidity in the
event of redemptions and to minimize trading costs. The Index 500 Fund may also
invest in short-term fixed income instruments as cash reserves. The Index 500
Fund will not invest in short-term fixed income instruments, options or futures
contracts for the purpose of implementing a defensive market strategy by
lowering the Fund's exposure to common stocks to protect against a potential
stock market decline, but instead will attempt to remain fully invested without
regard to the Investment Adviser's market analysis. The Fund may, however, hold
short-term fixed income instruments for temporary cash management purposes.
The foregoing investment techniques are expected to be an effective means
of substantially duplicating the aggregate price and yield performance of the
S&P 500 Index at such times when the Index 500 Fund is not fully invested in all
500 stocks in the S&P 500 Index in approximately the same proportions as their
weightings in that index. To the extent the Index 500 Fund utilizes the
foregoing investment techniques, the Fund may not track the S&P 500 Index with
the same degree of accuracy as the Fund would if it were fully invested in all
500 stocks in the S&P 500 Index in approximately the same proportions as their
weightings in that index. However, the principal advantage of the foregoing
investment techniques is to provide an efficient means to invest in the universe
of stocks of the S&P 500 Index. The Fund is expected to provide broad
diversification, and will seek to operate at low costs due to its "passive"
approach to portfolio management and anticipated low portfolio turnover rate.
In addition, the Index 500 Fund may purchase certain securities that are
not registered under the Securities Act of 1933, as amended and which therefore
may be subject to restrictions on their transfer or resale. The Index 500 Fund
may also invest in securities of foreign issuers to the extent such issuers are
included in the S&P 500
3
<PAGE> 174
Index. See "Other Portfolio Strategies -- Foreign Securities" in the Appendix to
this Prospectus. The Fund is also authorized to write (i.e., sell) and purchase
call and put options on securities held in its portfolio or securities indices
the performance of which is substantially correlated with securities held in its
portfolio and may engage in transactions in futures and may invest in securities
the potential return of which is based on the change in particular measurements
of value or rate (i.e., indexed securities). A further discussion of the
investments described in this paragraph and the risks associated with such
investments is set forth in the Appendix to this Prospectus, including Annex B
of the Appendix to this Prospectus which includes a discussion of certain
portfolio strategies relating to indexed securities, options and futures.
4
<PAGE> 175
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH GLOBAL GROWTH FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Global Growth Focus Fund, (the "Global Growth Focus Fund") is
a diversified fund whose objective is long-term growth of capital. The Global
Growth Focus Fund will seek to achieve its investment objective by investing in
a diversified portfolio of equity securities of issuers located in various
foreign countries and the United States, placing particular emphasis on
companies that have exhibited above-average growth rates in earnings. The Global
Growth Focus Fund should be considered a long-term investment and a vehicle for
diversification and not as a balanced investment program. The Global Growth
Focus Fund is a separate fund of the Merrill Lynch Variable Series Funds, Inc.
(the "Company"), an open-ended management investment company that has a wide
range of investment objectives among its eighteen separate funds (hereinafter
referred to as the "Funds" or individually as a "Fund"). Two separate classes of
common stock ("Common Stock"), Class A Common Stock and Class B Common Stock,
are issued for each Fund. The Company is offering shares of its Class B Common
Stock for the Global Growth Focus Fund pursuant to this Prospectus. Each Fund's
Class B Common Stock will be subject to a distribution fee at an annual rate of
0.15% of the Fund's average daily net assets attributable to the Class B Common
Stock. This Prospectus consists of this four page document and the attached
Appendix. THE GLOBAL GROWTH FOCUS FUND IS EXPECTED TO COMMENCE OPERATIONS IN
JUNE 1998. For more information on the Global Growth Focus Fund's investment
objective and policies, please see page 3 of this document and the Appendix.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 3
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 176
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
2
<PAGE> 177
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Global Growth Focus Fund is to seek
long-term growth of capital. The Global Growth Focus Fund will seek to achieve
its investment objective by investing in a diversified portfolio of equity
securities of issuers located in various foreign countries and the United
States, placing particular emphasis on companies that have exhibited
above-average growth rates in earnings. The Fund may be appropriate only for
long-term investors who can assume the risk of loss of principal, and do not
seek current income. There can be no assurance that the Global Growth Focus Fund
will achieve its investment objective. The Global Growth Focus Fund may employ a
variety of techniques, including derivative investments, in connection with
certain trading strategies, including to hedge against market and currency risk,
to enhance total return or to gain exposure to equity markets. See Annex B of
the Appendix to this Prospectus. Investments on an international basis in
foreign securities markets involve risks and special considerations not
typically associated with investments in securities of United States issuers.
See "Other Investments and Risks" below. The Fund should be considered a
long-term investment and a vehicle for diversification, and not as a balanced
investment program.
Issuers may achieve above-average growth rates in earnings from a variety
of factors including, but not limited to, above-average growth rates in sales,
profit margin improvement, proprietary or niche products or services, leading
market shares, and underlying strong industry growth. Management of the Fund
believes that companies which possess above-average earnings growth frequently
provide the prospect of above-average stock market returns, although such
companies tend to have higher relative stock market valuations. Emphasis also
will be given to companies having medium to large stock market capitalizations
($2 billion or more). Investment in companies with lower market capitalizations,
especially those under $1 billion, may involve special risks including limited
product lines, market or financial resources or a limited management group. In
addition, many smaller company stocks trade less frequently and in smaller
volume, and may be subject to more abrupt or erratic price movements or may be
more sensitive to market fluctuations, than stocks of larger companies.
The Global Growth Focus Fund will emphasize investments in equity
securities, primarily common stock, and, to a lesser extent, securities
convertible into common stock, preferred stock, rights to subscribe for common
stock and other investments the return on which is determined by the performance
of a common stock or a basket or index of common stocks. Under normal market
conditions, at least 65% of the Fund's total assets will be invested in equity
securities of issuers from at least three different countries. The Fund reserves
the right, as a defensive measure and to provide for redemptions, to hold other
types of securities, including non-convertible preferred stocks and debt
securities rated investment grade by a nationally recognized statistical rating
organization, U.S. Government and money market securities, including repurchase
agreements, or cash, in such proportions, including up to 100%, as in the
opinion of Merrill Lynch Asset Management L.P. (the "Investment Adviser")
prevailing market or economic conditions warrant.
OTHER INVESTMENTS AND RISKS
In addition, the Global Growth Focus Fund may purchase certain securities
that are not registered under the Securities Act of 1933, as amended, and which
therefore may be subject to restrictions on their transfer or resale.
Because a substantial portion of the Fund's assets may be invested in
securities of non-U.S. issuers, an investor in the Fund should be aware of
certain risk factors and special considerations relating to international
investing, which may involve risks that are not typically associated with
investments in the securities of U.S. issuers. Investing on an international
basis involves certain risks not involved in domestic investments, including
fluctuations in foreign exchange rates, future political and economic
developments, different legal systems and the possible imposition of exchange
controls or other foreign governmental laws or restrictions. Securities prices
in different countries are subject to different economic, financial, political
and social factors. Since the Fund invests heavily in securities denominated or
quoted in currencies other than the U.S. dollar, changes in foreign currency
exchange rates will affect the value of securities in the Fund and the
unrealized appreciation or depreciation of investments. Currencies of certain
countries may be volatile and therefore may affect the value of securities
denominated in such currencies. In addition, with respect to certain foreign
countries, there is the possibility of expropriation of assets, confiscatory
taxation, difficulty in obtaining or enforcing a court judgment, economic,
political or social instability or diplomatic developments that could affect
investments in those countries. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross domestic product, rates of inflation, capital reinvestment,
3
<PAGE> 178
resources, self-sufficiency and balance of payments position. Certain foreign
investments also may be subject to foreign withholding taxes, These risks often
are heightened for investments in smaller, emerging capital markets. For
additional information concerning the risks of investing in foreign securities.
See "Other Portfolio Strategies -- Foreign Securities" in the Appendix to this
Prospectus.
The Global Growth Focus Fund may also engage in transactions, such as
currency swaps and purchasing and selling options on currencies, for purposes of
hedging against the decline in the value of currencies in which its portfolio
holdings are denominated against the U.S. dollar. The Fund is also authorized to
write (i.e., sell) and purchase both call and put options on securities held in
its portfolio, securities indices the performance of which is substantially
correlated with securities held in its portfolio or on securities it intends to
purchase and may also invest in futures and in securities the potential return
of which is based on the change in particular measurements of value or rate
(i.e., indexed securities).
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix to this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to indexed securities, options, futures
and foreign exchange transactions.
4
<PAGE> 179
PROSPECTUS
APRIL 17, 1998
MERRILL LYNCH CAPITAL FOCUS FUND
of Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
-------------------------
Merrill Lynch Capital Focus Fund (the "Capital Focus Fund") is a
diversified fund whose objective is the highest total investment return
consistent with prudent risk. The Capital Focus Fund will seek to achieve its
investment objective through a fully managed investment policy utilizing equity,
debt (including money market) and convertible securities. The Capital Focus Fund
is a separate fund of the Merrill Lynch Variable Series Funds, Inc. (the
"Company"), an open-ended management investment company that has a wide range of
investment objectives among its eighteen separate funds (hereinafter referred to
as the "Funds" or individually as a "Fund"). Two separate classes of common
stock ("Common Stock"), Class A Common Stock and Class B Common Stock, are
issued for each Fund. The Company is offering shares of its Class B Common Stock
for the Capital Focus Fund pursuant to this Prospectus. Each Fund's Class B
Common Stock will be subject to a distribution fee at an annual rate of 0.15% of
the Fund's average daily net assets attributable to the Class B Common Stock.
THE CAPITAL FOCUS FUND IS EXPECTED TO COMMENCE OPERATIONS IN JUNE 1998. This
Prospectus consists of this four page document and the attached Appendix. For
more information on the Capital Focus Fund's investment objective and policies,
please see page 2 of this document and the Appendix.
THE CAPITAL FOCUS FUND INVESTS OR MAY INVEST IN HIGH YIELD BONDS (COMMONLY
KNOWN AS "JUNK BONDS"), WHICH INVOLVE SPECIAL RISKS. SEE "INVESTMENT OBJECTIVES
AND POLICIES OF THE FUNDS--RISKS OF HIGH YIELD SECURITIES" IN THE APPENDIX TO
THIS PROSPECTUS.
-------------------------
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.
-------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE
COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") IN A STATEMENT OF
ADDITIONAL INFORMATION, DATED APRIL 17, 1998, AND IS AVAILABLE ON REQUEST AND
WITHOUT CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE
NUMBER SET FORTH ABOVE. THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV)
THAT CONTAINS THE STATEMENT OF ADDITIONAL INFORMATION, MATERIAL INCORPORATED BY
REFERENCE AND OTHER INFORMATION ABOUT THE FUND. THE STATEMENT OF ADDITIONAL
INFORMATION IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and
Policies........................ 2
Appendix
The Insurance Companies............ A-1
Investment Objectives and Policies
of the Funds.................... A-1
Directors.......................... A-8
Investment Adviser................. A-8
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Portfolio Transactions and
Brokerage.......................... A-11
Purchase of Shares................... A-11
Redemption of Shares................. A-12
Dividends, Distributions and Taxes... A-12
Performance Data..................... A-13
Distribution Plan.................... A-14
Additional Information............... A-15
</TABLE>
-------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE COMPANY OR BY THE DISTRIBUTOR IN ANY
STATE IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
<PAGE> 180
INVESTMENT OBJECTIVE AND POLICIES
The Capital Focus Fund's investment objective is to achieve the highest
total investment return consistent with prudent risk. To do this, management of
the Fund shifts the emphasis among equity, debt (including money market) and
convertible securities. This flexible, total investment return approach is
called a "fully managed" investment policy. It distinguishes the Capital Focus
Fund from other investment companies, which often seek either capital growth or
current income. This approach permits management of the Fund to vary investment
policy based on its evaluation of changes in economic and market trends. Total
investment return is the aggregate of income and capital value changes.
Consistent with this policy, the Capital Focus Fund's portfolio may, at any
given time, be invested substantially in equity securities, corporate bonds or
money market securities. It is the expectation of management that, over longer
periods, a major portion of the Fund's portfolio will consist of equity
securities of larger market capitalization, quality companies. There can be no
assurance that the Fund will achieve its investment objective. The Capital Focus
Fund may employ a variety of investments and techniques to hedge against market
and currency risk. See Annex B to the Appendix to this Prospectus.
The Capital Focus Fund's investment philosophy is based on the belief that,
as in the past, the structure of the United States' economy and the economies
and securities markets of other countries will undergo continuous change. Thus,
the fully managed approach puts maximum emphasis on investment flexibility. The
two principal features of the Fund's management approach are flexibility and
concentration in "quality" companies.
Flexibility. The Capital Focus Fund's fully managed investment approach
makes use of equity, debt (including money market) and convertible securities.
Freedom to move among these different types of securities as prevailing trends
change is the keystone of the Fund's investment policy.
Concentration in "Quality" Companies. The earnings of quality companies
generally tend to grow consistently. Their internal strengths -- good financial
resources, a strong balance sheet, satisfactory rate of return on capital, a
good industry position and superior management skills -- give the Fund
confidence that these companies consistently will perform at high levels. The
Fund considers quality companies to be those that conform most closely to these
characteristics. Most of the Fund's equity portfolio is in the common stocks of
these quality companies.
Sometimes, to reduce risk and to achieve the highest total investment
return, the Capital Focus Fund may invest in other securities:
-- Non-convertible, long-term debt securities, including "deep discount"
corporate debt securities, mortgage-backed securities issued or guaranteed by
governmental entities or private issuers, and debt securities issued or
guaranteed by governments, their agencies and instrumentalities. Such debt
securities generally will be "investment grade." However, the Fund has
established no rating criteria for the debt securities in which it may invest,
and the Fund may invest in securities that are rated below Baa by Moody's
Investors Service, Inc. ("Moody's") or below BBB by Standard & Poor's Ratings
Services ("S&P") or which, in the judgment of Merrill Lynch Asset Management,
L.P. (the "Investment Adviser") possess similar credit characteristics. Such
securities, sometimes referred to as "high yield/high risk securities" or "junk
bonds", are predominantly speculative with respect to the capacity to pay
interest and repay principal in accordance with the terms of the security and
generally involve a greater volatility of price than securities in higher rating
categories. See "Other Investment and Risks" below and "Risks of High Yield
Securities" in the Appendix to this Prospectus. The Fund does not intend to
purchase debt securities that are in default or which the Investment Adviser
believes will be in default. The Fund does not intend to invest in excess of 35%
of its total assets in securities that are rated below Baa by Moody's or below
BBB by S&P or that the Investment Adviser believes have characteristics similar
to those securities.
-- Convertible securities, i.e., fixed income issues that give the owner
the option of a later exchange for common stock. Convertible securities entitle
the holder to receive interest payments paid on corporate debt securities or the
dividend preference on a preferred stock until such time as the convertible
security matures or is redeemed or until the holder elects to exercise the
conversion privilege. The value of convertible securities is influenced by both
the yield of nonconvertible securities of comparable issuers and by the value of
the underlying common stock. The value of a convertible security viewed without
regard to its conversion feature (i.e., strictly on the basis of its yield) is
sometimes referred to as its "investment value." To the extent interest rates
change, the investment value of the convertible security typically will
fluctuate. However, at the same time, the value of the
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convertible security will be influenced by its "conversion value," which is the
market value of the underlying common stock that would be obtained if the
convertible security were converted. Conversion value fluctuates directly with
the price of the underlying common stock. If, because of a low price for the
common stock, the conversion value is substantially below the investment value
of the convertible security, the price of the convertible security will be
governed principally by its investment value.
-- Cash or money-market securities to produce interest income during
periods of defensive investment.
The Investment Adviser expects that over longer periods a larger portion of
the Fund's portfolio will consist of equity securities. However, the flexible
fully managed investment approach enables the Fund to switch its emphasis to
debt and convertible securities if, in the opinion of the Investment Adviser,
prevailing market or economic conditions warrant. The Investment Adviser will
determine the emphasis among equity and debt securities, including convertible
securities, based on its evaluation as to the types of securities presently
providing the opportunity for the highest total investment return consistent
with prudent risk.
OTHER INVESTMENTS AND RISKS
In addition, the Capital Focus Fund may purchase securities that are not
registered under the Securities Act of 1933, as amended, and which therefore may
be subject to restrictions on their transfer or resale.
The Capital Focus Fund may invest up to 25% of its total assets in
securities of foreign issuers. Investments in securities of foreign issuers
involve certain risks, including fluctuations in foreign exchange rates, future
political and economic developments, and the possible imposition of exchange
controls or other foreign governmental laws or restrictions. In addition,
foreign companies may not be subject to accounting, auditing and financial
reporting standards and requirements comparable to those of U.S. companies. The
foreign markets also have different clearance and settlement procedures, and in
certain markets there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Delays in settlement could result in temporary periods when
assets of the Fund are uninvested and no return is earned thereon. The inability
of the Fund to make intended security purchases due to settlement problems could
cause the Fund to miss attractive investment opportunities. Inability to dispose
of a portfolio security due to settlement problems could result either in losses
to the Fund due to subsequent declines in the value of such portfolio security
or, if the Fund has entered into a contract to sell the security, could result
in possible liability to the purchaser. To the extent such investments are
subject to withholding or other taxes or to regulations relating to repatriation
of assets, the Fund's distributable income will be reduced. The prices of
securities in different countries may be subject to different economic,
financial, political and social factors.
The Capital Focus Fund may from time to time be invested in
non-dollar-denominated securities of foreign issuers. Changes in foreign
currency exchange rates may affect the value of securities in the portfolio and
the unrealized appreciation or depreciation of investments insofar as United
States investors are concerned. Furthermore, the Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. See "Other Portfolio Strategies -- Foreign Securities" in the
Appendix to this Prospectus.
The Capital Focus Fund has established no rating criteria for the debt
securities in which it may invest, and such securities may not be rated at all
for creditworthiness. Securities rated in the medium to lower rating categories
of nationally recognized statistical rating organizations and unrated securities
of comparable quality are predominantly speculative with respect to the capacity
to pay interest and repay principal in accordance with the terms of the security
and generally involve a greater volatility of price than securities in higher
rating categories. In purchasing such securities, the Fund will rely on the
Investment Adviser's judgment, analysis and experience in evaluating the
creditworthiness of an issuer of such securities. The Investment Adviser will
take into consideration, among other things, the issuer's financial resources,
its sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters. The Fund does not
intend to purchase debt securities that are in default or that the Investment
Adviser believes will be in default. See "Risks of High Yield Securities" in the
Appendix to this Prospectus.
Among the risks to which an investment in the Capital Focus Fund is subject
are interest rate risk and credit risk. Interest rate risk is the risk that the
portion of the Fund's net asset value attributable to the Fund's fixed-income
securities may fall when interest rates rise and rise when interest rates fall.
In general, fixed-income
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securities with longer maturities will be subject to greater volatility
resulting from interest rate fluctuations than will fixed-income securities with
shorter maturities. Credit risk is the risk that an issuer of fixed-income
securities that the Fund owns will not make timely payments of interest or
repayments of principal from the issuer. Credit risk is generally greater in
lower-rated securities.
The Capital Focus Fund may invest in the securities of smaller or emerging
growth companies. The securities of smaller or emerging growth companies may be
subject to more abrupt or erratic market movements than larger, more established
companies or the market average in general. These companies may have limited
product lines, markets or financial resources, or they may be dependent on a
limited management group.
The Capital Focus Fund may engage in transactions, such as currency swaps
and purchasing and selling options on currencies, for purposes of hedging
against the decline in the value of currencies in which its portfolio holdings
are denominated against the US dollar. Although such instruments will be used
with the intention of hedging against adverse currency movements, transactions
in such instruments involve the risk that anticipated currency movements will
not be accurately predicted and that the Fund's hedging strategies will be
ineffective and may cause the Fund to realize losses.
The Capital Focus Fund may from time to time write (i.e. sell) covered call
options on its portfolio securities.
A further discussion of the foregoing investments and the risks associated
with such investments is set forth in the Appendix of this Prospectus, including
Annex B of the Appendix to this Prospectus, which includes a discussion of
certain portfolio strategies relating to options and foreign exchange
transactions.
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APPENDIX
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
This Appendix constitutes part of the Prospectus for the Class B Shares of
Merrill Lynch Domestic Money Market Fund, Merrill Lynch Reserve Assets Fund,
Merrill Lynch Prime Bond Fund, Merrill Lynch High Current Income Fund, Merrill
Lynch Quality Equity Fund, Merrill Lynch Special Value Focus Fund, Merrill Lynch
Natural Resources Focus Fund, Merrill Lynch American Balanced Fund, Merrill
Lynch Global Strategy Focus Fund, Merrill Lynch Basic Value Focus Fund, Merrill
Lynch Global Bond Focus Fund, Merrill Lynch Global Utility Focus Fund, Merrill
Lynch International Equity Focus Fund, Merrill Lynch Developing Capital Markets
Focus Fund, Merrill Lynch Government Bond Fund, Merrill Lynch Global Growth
Focus Fund, Merrill Lynch Capital Focus Fund and Merrill Lynch Index 500 Fund
(hereinafter referred to as the "Funds" or individually as a "Fund").
TABLE OF CONTENTS
<TABLE>
<S> <C>
THE INSURANCE COMPANIES..................................... A-1
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS............. A-1
DIRECTORS................................................... A-8
INVESTMENT ADVISER.......................................... A-8
PORTFOLIO TRANSACTIONS AND BROKERAGE........................ A-11
PURCHASE OF SHARES.......................................... A-11
REDEMPTION OF SHARES........................................ A-12
DIVIDENDS, DISTRIBUTIONS AND TAXES.......................... A-12
PERFORMANCE DATA............................................ A-13
DISTRIBUTION PLAN........................................... A-14
ADDITIONAL INFORMATION...................................... A-15
ANNEX A -- DESCRIPTION OF TEMPORARY INVESTMENTS AND
CORPORATE BOND RATINGS.......................... Annex A-1
ANNEX B -- DESCRIPTION OF DERIVATIVE INSTRUMENTS........... Annex B-1
</TABLE>
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APPENDIX
THE INSURANCE COMPANIES
Shares of the Funds currently are sold to separate accounts ("Separate
Accounts") of Merrill Lynch Life Insurance Company ("MLLIC") and ML Life
Insurance Company of New York ("ML of New York"), as well as other insurance
companies not affiliated with MLLIC or ML of New York (together with MLLIC and
ML of New York, "Insurance Companies") to fund certain variable life insurance
contracts and/or variable annuities (together, "Contracts") issued by such
companies. The rights of the Insurance Companies as shareholders should be
distinguished from the rights of a Contract owner, which are set forth in the
Contract. A Contract owner has no interest in the shares of a Fund, but only in
the Contract. A Contract is described in the prospectus for that Contract. That
prospectus describes the relationship between increases or decreases in the net
asset value of shares of a Fund, and any distributions on such shares, and the
benefits provided under a Contract. The prospectus for the Contracts also
describes various fees payable to the Insurance Companies and charges to the
Separate Accounts made by the Insurance Companies with respect to the Contracts.
Since shares of the Funds will be sold only to the Insurance Companies for the
Separate Accounts, the terms "shareholder" and "shareholders" in this Prospectus
refer to the Insurance Companies. MLLIC and ML of New York are wholly owned
subsidiaries of ML&Co., as is the Investment Adviser.
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS
INVESTMENT OBJECTIVES
Each Fund of the Company has its own investment objective, which it pursues
through separate investment policies as described in the Fund's Prospectus (of
which this Appendix is a part). The differences in objectives and policies among
the Funds can be expected to affect the return of each Fund and the degree of
market and financial risk to which each Fund is subject. Each Fund is classified
as "diversified," as defined in the Investment Company Act of 1940, as amended
(the "Investment Company Act" or the "Act") except for the Developing Capital
Markets Focus Fund, the Global Bond Focus Fund, the Global Strategy Focus Fund,
the Index 500 Fund, and the Natural Resources Focus Fund, each of which is
classified as "non-diversified." The investment objectives and classification of
each Fund may not be changed without the approval of the holders of a majority
of the outstanding shares of each Fund affected.
Fixed Income Security Ratings. No Fund other than the Developing Capital
Markets Focus Fund, the High Current Income Fund, the Capital Focus Fund and the
International Equity Focus Fund invests in fixed-income securities rated below
investment grade (i.e., securities rated Ba or below by Moody's Investors
Service, Inc. ("Moody's") or BB or below by Standard & Poor's Ratings Group
("Standard & Poor's") at the time of investment). However, securities purchased
by a Fund may subsequently be downgraded. Such securities may continue to be
held and will be sold only if, in the judgment of the Investment Adviser, it is
advantageous to do so. Securities in the lowest category of investment grade
debt securities may have speculative characteristics, which may lead to weakened
capacity to pay interest and principal during periods of adverse economic
conditions. See Annex A of this Appendix for a fuller description of corporate
bond ratings.
NON-DIVERSIFIED FUNDS
The Developing Capital Markets Focus, Global Bond Focus, Global Strategy
Focus, Index 500, and Natural Resources Focus Funds are classified as
non-diversified investment companies under the Investment Company Act. However,
each Fund will have to limit its investments to the extent required by the
diversification requirements applicable to regulated investment companies under
the Internal Revenue Code of 1986, as amended (the "Code" or the "Internal
Revenue Code"). To qualify as a regulated investment company, a Fund, at the
close of each fiscal quarter, may not have more than 25% of its total assets
invested in the securities (except obligations of the U.S. Government, its
agencies or instrumentalities) of any one issuer and with respect to 50% of its
assets, (i) may not have more than 5% of its total assets invested in the
securities of any one issuer and (ii) may not own more than 10% of the
outstanding voting securities of any one issuer.
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INVESTMENT RESTRICTIONS
The Company has adopted a number of restrictions and policies relating to
the investment of its assets and its activities which are fundamental policies
and may not be changed without the approval of the holders of the Company's
outstanding voting securities (including a majority of the shares of each Fund).
Investors are referred to the Statement of Additional Information for a complete
description of such restrictions and policies.
OTHER PORTFOLIO STRATEGIES
Restricted Securities. Each of the Funds is subject to limitations on the
amount of illiquid securities it may purchase; however, each Fund may purchase
without regard to that limitation certain securities that are not registered
under the Securities Act of 1933, as amended (the "Securities Act"), including
(a) commercial paper exempt from registration under Section 4(2) of the
Securities Act, and (b) securities that can be offered and sold to "qualified
institutional buyers" under Rule 144A under the Securities Act, provided that
the Company's Board of Directors continuously determines, based on the trading
markets for the specific Rule 144A security, that it is liquid. The Board of
Directors may adopt guidelines and delegate to the Investment Adviser the daily
function of determining and monitoring liquidity of restricted securities. The
Board has determined that securities sold under Rule 144A that are freely
tradeable in their primary market offshore should be deemed liquid. The Board,
however, will retain sufficient oversight and be ultimately responsible for the
determinations.
Since it is not possible to predict with assurance exactly how the market
for restricted securities sold and offered under Rule 144A will develop, the
Board of Directors will carefully monitor the Funds' investments in these
securities, focusing on such factors, among others, as valuation, liquidity and
availability of information. This investment practice could have the effect of
increasing the level of illiquidity in a Fund to the extent that qualified
institutional buyers become for a time uninterested in purchasing these
restricted securities.
Foreign Securities. The Basic Value Focus, Developing Capital Markets
Focus, Special Value Focus, Global Strategy Focus, Global Bond Focus, Global
Utility Focus, High Current Income, International Equity Focus, Natural
Resources Focus, Prime Bond, Quality Equity, Global Growth Focus, Capital Focus
and Reserve Assets Funds may invest in securities of foreign issuers. The Index
500 Fund may also invest in securities of foreign issuers to the extent such
issuers are included in the Standard & Poor's 500 Composite Stock Price Index
(the "S&P Index"). Investments in foreign securities, particularly those of
non-governmental issuers, involve considerations and risks which are not
ordinarily associated with investing in domestic issuers. These considerations
and risks include changes in currency rates, currency exchange control
regulations, the possibility of expropriation, the unavailability of financial
information or the difficulty of interpreting financial information prepared
under foreign accounting standards, less liquidity and more volatility in
foreign securities markets, the impact of economic, political, social or
diplomatic developments, and the difficulty of assessing economic trends in
foreign countries. Foreign legal systems may differ from the U.S. legal system,
and if it should become necessary, a Fund could encounter greater difficulties
in invoking legal processes abroad than would be the case in the United States.
Transaction costs in foreign securities may be higher. The operating expense
ratio of a Fund investing in foreign securities can be expected to be higher
than that of an investment company investing exclusively in United States
securities because the expenses of the Fund, such as custodial costs, are
higher. In addition, net investment income earned by a Fund on a foreign
security may be subject to withholding and other taxes imposed by foreign
governments which will reduce a Fund's net investment income. The Investment
Adviser will consider these and other factors before investing in foreign
securities, and will not make such investments unless, in its opinion, such
investments will meet the standards and objectives of a particular Fund. No Fund
that may invest in foreign securities, other than the Natural Resources Focus
and Global Strategy Focus Funds, will concentrate its investments in any
particular country. The Developing Capital Markets Focus, Global Bond Focus,
Global Strategy Focus, Global Utility Focus, International Equity Focus, Global
Growth Focus and Natural Resources Focus Funds may from time to time be
substantially invested in non-dollar-denominated securities of foreign issuers.
For a Fund that invests in foreign securities denominated or quoted in
currencies other than the United States dollar, changes in foreign currency
exchange rates may directly affect the value of securities in the portfolio and
the unrealized appreciation or depreciation of investments insofar as United
States investors are concerned, and a Fund's return on investments in
non-dollar-denominated securities may be reduced or enhanced as a result of
changes in foreign currency rates during the period in which the Fund holds such
investments. Foreign currency exchange rates are determined by forces of supply
and demand in the foreign exchange markets. These forces are, in turn, affected
by international balance of payments and other
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economic and financial conditions, government intervention, speculation and
other factors. With respect to certain countries, there may be the possibility
of expropriation of assets, confiscatory taxation, high rates of inflation,
political or social instability or diplomatic developments which could affect
investment in those countries. Each Fund of the Company other than the
Developing Capital Markets Focus, Global Bond Focus, Global Strategy Focus,
Global Utility Focus, International Equity Focus, Natural Resources Focus,
Global Growth Focus, Capital Focus and Quality Equity Funds will purchase only
securities issued in dollar denominations.
The securities markets of many countries at times in the past have moved
relatively independently of one another due to different economic, financial,
political and social factors. When such lack of correlation, or negative
correlation, in movements of these securities markets occurs, it may reduce risk
for a Fund's portfolio as a whole. This negative correlation also may offset
unrealized gains a Fund has derived from movements in a particular market. To
the extent the various markets move independently, total portfolio volatility is
reduced when the various markets are combined into a single portfolio. Of
course, movements in the various securities markets may be offset by changes in
foreign currency exchange rates. Exchange rates frequently move independently of
securities markets in a particular country. As a result, gains in a particular
securities market may be affected by changes in exchange rates.
Each of the International Equity Focus Fund and Developing Capital Markets
Focus Fund may invest a significant portion of its assets in securities of
foreign issuers in smaller capital markets, while each of the other Funds which
is permitted to invest in foreign securities may from time to time invest in
securities of such foreign issuers. Foreign investments involve risks, including
fluctuations in foreign exchange rates, future political and economic
developments, different legal systems, the existence or possible imposition of
exchange controls, or other foreign or United States governmental laws or
restrictions, that are often heightened for investments in smaller capital
markets.
There may be less publicly available information about an issuer in a
foreign market, particularly one in a smaller capital market, than would be
available about a United States company, and it may not be subject to
accounting, auditing and financial reporting standards and requirements
comparable to those of United States companies. As a result, traditional
investment measurements, such as price/earnings ratios, as used in the United
States, may not be applicable in certain capital markets.
Smaller capital markets, while often growing in trading volume, have
substantially less volume than United States markets, and securities in many
smaller capital markets are less liquid and their prices may be more volatile
than securities of comparable United States companies. Brokerage commissions,
custodial services, and other costs relating to investment in smaller capital
markets are generally more expensive than in the United States. Such markets
have different clearance and settlement procedures, and in certain markets there
have been times when settlements have been unable to keep pace with the volume
of securities transactions, making it difficult to conduct such transactions.
Further, satisfactory custodial services for investment securities may not be
available in some countries having smaller capital markets, which may result in
a Fund which invests in these markets incurring additional costs and delays in
transporting and custodying such securities outside such countries. Delays in
settlement could result in temporary periods when assets of such a Fund are
uninvested and no return is earned thereon. The inability of a Fund to make
intended security purchases due to settlement problems could cause the Fund to
miss attractive investment opportunities. Inability to dispose of a portfolio
security due to settlement problems could result either in losses to the Fund
due to subsequent declines in value of the portfolio security or, if the Fund
has entered into a contract to sell the security, could result in possible
liability to the purchaser. There is generally less government supervision and
regulation of exchanges, brokers and issuers in countries having smaller capital
markets than there is in the United States.
As a result, management of a Fund that invests in foreign securities may
determine that, notwithstanding otherwise favorable investment criteria, it may
not be practicable or appropriate to invest in a particular country. A Fund may
invest in countries in which foreign investors, including management of the
Fund, have had no or limited prior experience.
Certain of the Funds may invest in debt securities issued by foreign
governments. Investments in foreign government debt securities, particularly
those of emerging market country governments, involve special risks. Certain
emerging market countries have historically experienced, and may continue to
experience, high rates of inflation, high interest rates, exchange rate
fluctuations, large amounts of external debt, balance of payments and
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trade difficulties and extreme poverty and unemployment. The issuer or
governmental authority that controls the repayment of an emerging market
country's debt may not be able or willing to repay the principal and/or interest
when due in accordance with the terms of such debt. A debtor's willingness or
ability to repay principal and interest due in a timely manner may be affected
by, among other factors, its cash flow situation, and, in the case of a
government debtor, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole and the political constraints
to which a government debtor may be subject. Government debtors may default on
their debt and may also be dependent on expected disbursements from foreign
governments, multilateral agencies and others abroad to reduce principal and
interest arrearages on their debt. Holders of government debt, including the
Fund, may be requested to participate in the rescheduling of such debt and to
extend further loans to government debtors.
As a result of the foregoing, a government obligor may default on its
obligations. If such an event occurs, a Fund may have limited legal recourse
against the issuer and/or guarantor. Remedies must, in some cases, be pursued in
the courts of the defaulting party itself, and the ability of the holder of
foreign government debt securities to obtain recourse may be subject to the
political climate in the relevant country. Government obligors in developing and
emerging market countries are among the world's largest debtors to commercial
banks, other governments, international financial organizations and other
financial institutions. Some issuers of the government debt securities in which
a Fund may invest have in the past experienced substantial difficulties in
servicing their external debt obligations, which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements.
The Global Utility Focus Fund, International Equity Focus Fund, Developing
Capital Markets Focus Fund, Capital Focus Fund and the Global Growth Focus Fund
may invest in the securities of foreign issuers in the form of American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") or other
securities convertible into securities of foreign issuers. These securities may
not necessarily be denominated in the same currency as the securities into which
they may be converted. ADRs are receipts typically issued by an American bank or
trust company which evidence ownership of underlying securities issued by a
foreign corporation. EDRs are receipts issued in Europe which evidence a similar
ownership arrangement. Generally, ADRs, which are issued in registered form, are
designated for use in the United States securities markets, and EDRs, which are
issued in bearer form, are designed for use in European securities markets. The
Funds may invest in ADRs and EDRs through both sponsored and unsponsored
arrangements. In a sponsored ADR or EDR arrangement, the foreign issuer assumes
the obligation to pay some or all of the depository's transaction fees, whereas
in an unsponsored arrangement the foreign issuer assumes no obligations and the
depository's transaction fees are paid by the ADR or EDR holders. Foreign
issuers in respect of whose securities unsponsored ADRs or EDRs have been issued
are not necessarily obligated to disclose material information in the markets in
which the unsponsored ADRs or EDRs are traded and, therefore, there may not be a
correlation between such information and the market value of such securities.
The Developing Capital Markets Focus and International Equity Focus Funds
intend to invest in securities of foreign issuers in smaller capital markets.
Some countries with smaller capital markets prohibit or impose substantial
restrictions on investments in their capital markets, particularly their equity
markets, by foreign entities such as the Fund. As illustrations, certain
countries require governmental approval prior to investments by foreign persons,
or limit the amount of investment by foreign persons in a particular company, or
limit the investment by foreign persons to only a specific class of securities
of a company which may have less advantageous terms than securities of the
company available for purchase by nationals.
A number of countries, such as South Korea, Taiwan and Thailand, have
authorized the formation of closed-end investment companies to facilitate
indirect foreign investment in their capital markets. In accordance with the
Investment Company Act, the Developing Capital Markets Focus, Global Growth
Focus and International Equity Focus Funds each may invest up to 10% of its
total assets in securities of such closed-end investment companies. This
restriction on investments in securities of closed-end investment companies may
limit opportunities for the Fund to invest indirectly in certain smaller capital
markets. Shares of certain closed-end investment companies may at times be
acquired only at market prices representing premiums to their net asset values.
If a Fund acquires shares in closed-end investment companies, shareholders would
bear both their proportionate share of expenses in the Fund (including
management and advisory fees) and, indirectly, the
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expenses of such closed-end investment companies. A Fund also may seek, at its
own cost, to create its own investment entities under the laws of certain
countries.
In some countries, banks or other financial institutions may constitute a
substantial number of the leading companies or the companies with the most
actively traded securities. Also, the Investment Company Act restricts a Fund's
investments in any equity security of an issuer which, in its most recent fiscal
year, derived more than 15% of its revenues from "securities related
activities," as defined by the rules thereunder. These provisions may also
restrict a Fund's investments in certain foreign banks and other financial
institutions.
Rules adopted under the Investment Company Act permit the Funds to maintain
their foreign securities and cash in the custody of certain eligible non-U.S.
banks and securities depositories. Certain banks in foreign countries may not be
eligible sub-custodians for the Funds, in which event the Funds may be precluded
from purchasing securities in certain foreign countries in which they otherwise
would invest or the Funds may incur additional costs and delays in providing
transportation and custody services for such securities outside of such
countries. The Funds may encounter difficulties in effecting on a timely basis
portfolio transactions with respect to any securities of issuers held outside
their countries. Other banks that are eligible foreign sub-custodians may be
recently organized or otherwise lack extensive operating experience. In
addition, in certain countries there may be legal restrictions or limitations on
the ability of the Funds to recover assets held in custody by foreign sub-
custodians in the event of the bankruptcy of the sub-custodian.
Lending of Portfolio Securities. Each Fund of the Company may from time to
time lend securities (but not in excess of 20%, or in the case of the Global
Growth Focus Fund 33 1/3%) of its total assets from its portfolio to brokers,
dealers and financial institutions and receive collateral in cash or securities
issued or guaranteed by the U.S. Government which, while the loan is
outstanding, will be maintained at all times in an amount equal to at least 100%
of the current market value of the loaned securities plus accrued interest. Such
cash collateral will be invested in short-term securities, the income from which
will increase the return to the Fund.
Forward Commitments. Each of the Funds may purchase securities on a
when-issued basis, and they may purchase or sell such securities for delayed
delivery. These transactions occur when securities are purchased or sold by a
Fund with payment and delivery taking place in the future to secure what is
considered an advantageous yield and price to the Fund at the time of entering
into the transaction. The value of the security on the delivery date may be more
or less than its purchase price. A Fund entering into such transactions will
maintain a segregated account with its custodian of cash or liquid securities in
an aggregate amount equal to the amount of its commitments in connection with
such delayed delivery and purchase transactions.
Standby Commitment Agreements. The Developing Capital Markets Focus, Global
Utility Focus, Global Growth Focus and High Current Income Funds may from time
to time enter into standby commitment agreements. Such agreements commit the
respective Fund, for a stated period of time, to purchase a stated amount of a
fixed income security which may be issued and sold to the Fund at the option of
the issuer. The price and coupon of the security is fixed at the time of the
commitment. At the time of entering into the agreement the Fund is paid a
commitment fee which is typically approximately 0.5% of the aggregate purchase
price of the security which the Fund has committed to purchase. The Fund will at
all times maintain a segregated account with its custodian of cash or liquid
securities in an amount equal to the purchase price of the securities underlying
the commitment. There can be no assurance that the securities subject to a
standby commitment will be issued, and the value of the security, if issued, on
the delivery date may be more or less than its purchase price.
Portfolio Strategies Involving Indexed and Inverse Securities, Options,
Futures and Foreign Exchange Transactions. Certain Funds may use derivative
instruments, including indexed and inverse securities, options and futures and
purchase and sell foreign exchange. Transactions involving such instruments
expose these Funds to certain risks. Each Fund's use of these instruments and
the associated risks are described in detail in Annex B of the Appendix attached
to this Prospectus.
RISKS OF HIGH YIELD SECURITIES
The Developing Capital Markets Focus Fund, High Current Income Fund,
International Equity Focus Fund and Capital Focus Fund may invest a substantial
portion of their assets in high yield, high risk securities or junk bonds, which
are regarded as being predominantly speculative as to the issuer's ability to
make payments of principal and interest. Investment in such securities involves
substantial risk. Issuers of junk bonds may be highly
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leveraged and may not have available to them more traditional methods of
financing. Therefore, the risks associated with acquiring the securities of such
issuers generally are greater than is the case with higher-rated securities. For
example, during an economic downturn or a sustained period of rising interest
rates, issuers of high yield securities may be more likely to experience
financial stress, especially if such issuers are highly leveraged. During
recessionary periods, such issuers may not have sufficient revenues to meet
their interest payment obligations. The issuer's ability to service its debt
obligations also may be adversely affected by specific issuer developments, or
the issuer's inability to meet specific projected business forecasts, or the
unavailability of additional financing. The risk of loss due to default by the
issuer is significantly greater for the holders of junk bonds because such
securities may be unsecured and may be subordinated to other creditors of the
issuer. While the high yield securities in which the Developing Capital Markets
Focus Fund, High Current Income Fund, International Equity Focus Fund and
Capital Focus Fund may invest normally do not include securities which, at the
time of investment, are in default or the issuers of which are in bankruptcy,
there can be no assurance that such events will not occur after a Fund purchases
a particular security, in which case a Fund may experience losses and incur
costs.
In an effort to minimize the risk of issuer default or bankruptcy, the
Developing Capital Markets Focus Fund, High Current Income Fund, International
Equity Focus Fund and Capital Focus Fund each will diversify its holdings among
many issuers. However, there can be no assurance that diversification will
protect a Fund from widespread defaults brought about by a sustained economic
downturn.
High yield securities frequently have call or redemption features that
would permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividend to
shareholders.
High yield securities tend to be more volatile than higher-rated
fixed-income securities, so that adverse economic events may have a greater
impact on their prices and yields than on higher-rated fixed-income securities.
Zero coupon bonds and bonds which pay interest and/or principal in additional
bonds rather than in cash are especially volatile. Like higher-rated
fixed-income securities, junk bonds are generally purchased and sold through
dealers who make a market in such securities for their own accounts. However,
there are fewer dealers in this market, which may be less liquid than the market
for higher-rated fixed-income securities, even under normal economic conditions.
Also, there may be significant disparities in the prices quoted for such bonds
by various dealers. Adverse economic conditions or investor perceptions (whether
or not based on economic fundamentals) may impair the liquidity of this market,
and may cause the prices the Developing Capital Markets Focus Fund, High Current
Income Fund, International Equity Focus Fund and Capital Focus Fund receive for
their junk bonds to be reduced, or a Fund may experience difficulty in
liquidating a portion of its portfolio when necessary to meet the Fund's
liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. Under such conditions,
judgement may play a greater role in valuing certain of each Fund's portfolio
securities than in the case of securities trading in a more liquid market.
It is expected that a significant portion of the high yield securities
acquired by the Capital Focus Fund will be purchase upon issuance, which may
involve special risks because the securities so acquired are new issues. In such
instances the Capital Focus Fund may be a substantial purchaser of the issue and
therefore have the opportunity to participate in structuring the terms of the
offering. Although this may enable the Capital Focus Fund to seek to protect
itself against certain of such risks, the considerations discussed herein would
nevertheless remain applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of junk bonds,
particularly in a thinly traded market. Factors adversely affecting the market
value of such securities are likely to affect adversely the net asset value of
the Developing Capital Markets Focus Fund, High Current Income Fund, Capital
Focus Fund and International Equity Focus Fund. In addition, each Fund may incur
additional expenses to the extent that it is required to seek recovery upon a
default on a portfolio holding or to participate in the restructuring of the
obligation.
Sovereign Debt. The junk bonds in which the Developing Capital Markets
Focus Fund, High Current Income Fund, Capital Focus Fund and International
Equity Focus Fund may invest include junk bonds issued by sovereign entities.
Investment in such sovereign debt involves a high degree of risk. The
governmental entity that controls the repayment of sovereign debt may not be
able or willing to repay the principal and/or interest when
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due in accordance with the terms of such debt. A governmental entity's
willingness or ability to repay principal and interest due in a timely manner
may be affected by, among other factors, its cash flow situation, the extent of
its foreign reserves, the availability of sufficient foreign exchange on the
date a payment is due, the relative size of the debt service burden to the
economy as a whole, the governmental entity's policy towards the International
Monetary Fund and the political constraints to which a governmental entity may
be subject. Governmental entities may also be dependent on expected
disbursements from foreign governments, multilateral agencies and others abroad
to reduce principal and interest arrearages on their debt. The commitment on the
part of these governments, agencies and others to make such disbursements may be
conditioned on a governmental entity's implementation of economic reforms and/or
economic performance and the timely service of such debtor's obligations.
Failure to implement such reforms, achieve such levels of economic performance
or repay principal or interest when due may result in the cancellation of such
third parties' commitments to lend funds to the governmental entity, which may
further impair such debtor's ability or willingness to timely service its debts.
Consequently, governmental entities may default on their sovereign debt.
Holders of sovereign debt, including the Developing Capital Markets Focus
Fund, High Current Income Fund, Capital Focus Fund and International Equity
Focus Fund, may be requested to participate in the rescheduling of such debt and
to extend further loans to governmental entities. In the event of a default by a
governmental entity, there may be few or no effective legal remedies available
to a Fund and there can be no assurance a Fund will be able to collect on
defaulted sovereign debt in whole or in part.
INSURANCE LAW RESTRICTIONS
In order for shares of the Company's Funds to remain eligible investments
for the Separate Accounts, it may be necessary, from time to time, for a Fund to
limit its investments in certain types of securities in accordance with the
insurance laws or regulations of the various states in which the Contracts are
sold.
The New York insurance law requires that investments of each Fund be made
with the degree of care of an "ordinarily prudent person." The Investment
Adviser believes that compliance with this standard will not have any negative
impact on the performance of any of the Funds.
OTHER CONSIDERATIONS
The Investment Adviser will use its best efforts to assure that each Fund
of the Company complies with certain investment limitations of the Internal
Revenue Service to assure favorable income tax treatment for the Contracts. It
is not expected that such investment limitations will materially affect the
ability of any Fund to achieve its investment objective.
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DIRECTORS
The Directors of the Company consist of six individuals, five of whom are
not "interested persons" of the Company as defined in the Investment Company Act
of 1940. The Directors of the Company are responsible for the overall
supervision of the operations of the Company and perform the various duties
imposed on the directors of the investment companies by the Investment Company
Act of 1940. The Board of Directors elects officers of the Company annually.
The Directors of the Company and their principal employment are as follows:
ARTHUR ZEIKEL(1) -- Chairman of the Investment Adviser and its affiliate,
Fund Asset Management, L.P. ("FAM"); Chairman and Director of Princeton
Services, Inc. ("Princeton Services"); and Executive Vice President of ML&Co.
JOE GRILLS -- Member of the Committee on Investment of Employee Benefit
Assets of the Financial Executives Institute ("CIEBA"); Member of CIEBA's
Executive Committee; and Member of the Investment Advisory Committee of the
State of New York Common Retirement Fund and the Howard Hughes Medical
Institute; Director, Duke Management Company, LaSalle Street Fund and Kimco
Realty Corporation.
WALTER MINTZ -- Special Limited Partner of Cumberland Partners (investment
partnership).
ROBERT S. SALOMON, JR. -- Principal of STI Management (investment adviser).
MELVIN R. SEIDEN -- Director of Silbanc Properties, Ltd. (real estate,
consulting and investments).
STEPHEN R. SWENSRUD -- Chairman Fernwood Advisors (investment adviser);
Principal, Fernwood Associates (financial consultants)
INVESTMENT ADVISER
Merrill Lynch Asset Management L.P. ("MLAM"), an indirect wholly owned
subsidiary of Merrill Lynch & Co., Inc., is the investment adviser (the
"Investment Adviser") for the Fund. The general partner of the Investment
Adviser is Princeton Services, Inc., a wholly owned subsidiary of Merrill Lynch
& Co., Inc. The principal address of the Investment Adviser is 800 Scudders Mill
Road, Plainsboro, New Jersey 08536 (mailing address: Box 9011, Princeton, New
Jersey 08543-9011). The Asset Management Group of Merrill Lynch & Co., Inc.
(which includes MLAM) presently acts as the investment adviser to more than 100
registered investment companies. The Investment Adviser also offers portfolio
management to individual and institutional accounts. As of March 1998, the Asset
Management Group had a total of $488 billion in investment company and other
portfolio assets under management. This amount includes assets managed for
certain affiliates of the Investment Adviser.
While the Investment Adviser is at all times subject to the direction of
the Board of Directors of the Company, the Investment Advisory Agreements
provide that the Investment Adviser, subject to review by the Board of
Directors, is responsible for the actual management of the Funds and has
responsibility for making decisions to buy, sell or hold any particular
security. The Investment Adviser provides the portfolio managers for the Funds,
who consider information from various sources, make the necessary investment
decisions and effect transactions accordingly. The Investment Adviser is also
obligated to perform certain administrative and management services for the
Company (certain of which it may delegate to third parties) and is obligated to
provide all the office space, facilities, equipment and personnel necessary to
perform its duties under the Agreements. The Investment Adviser has access to
the full range of the securities and economic research facilities of Merrill
Lynch.
During the Company's fiscal year ended December 31, 1997, the advisory fees
expense incurred by the Company totaled $30,733,366 of which $107,029 related to
the Reserve Assets Fund (representing .50% of its average net assets),
$2,226,345 related to the Prime Bond Fund (representing .42% of its average net
assets), $2,277,140 related to the High Current Income Fund (representing .47%
of its average net assets), $3,629,013 related to the Quality Equity Fund
(representing .44% of its average net assets), $3,466,085 related to the Special
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(1) Interested person, as defined in the Investment Company Act of 1940, of the
Company.
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Value Focus Fund (representing .75% of its average net assets), $415,327 related
to the Index 500 Fund (representing .30% of its average net assets) of which
$79,567 was voluntarily waived by MLAM, $241,712 related to the Natural
Resources Focus Fund (representing .65% of its average net assets), $1,102,076
related to the American Balanced Fund (representing .55% of its average net
assets), $1,549,078 related to the Domestic Money Market Fund (representing .50%
of its average net assets), $5,860,619 related to the Global Strategy Focus Fund
(representing .65% of its average net assets), $3,489,377 related to the Basic
Value Focus Fund (representing .60% of its average net assets), $483,479 related
to the Global Bond Focus Fund (representing .60% of its average net assets),
$813,756 related to the Global Utility Focus Fund (representing .60% of its
average net assets), $3,089,994 related to the International Equity Focus Fund
(representing .75% of its average net assets), $1,306,661 related to the
Developing Capital Markets Focus Fund (representing 1.00% of its average net
assets) of which $217,067 was voluntarily waived by MLAM, $675,675 related to
the Government Bond Focus Fund (representing .50% of its average net assets) of
which $78,164 was voluntarily waived by MLAM.
During the Company's fiscal year ended December 31, 1997, the total
operating expenses attributable to the Class B Shares of the Company's Funds
(including the advisory fees paid to the Investment Adviser), before any fee
waiver or reimbursement of a portion of such expenses, expressed as a percentage
of each Fund's average net assets, were as follows: 0.96% of the Special Value
Focus Fund's average net assets, 0.82% of the Basic Value Focus Fund's average
net assets, and 1.58% of the Developing Capital Markets Focus Fund's average net
assets.
The Investment Adviser has entered into a sub-advisory agreement (the
"Sub-Advisory Agreement") with MLAM U.K., an indirect wholly owned subsidiary of
ML & Co., and an affiliate of the Investment Adviser, pursuant to which the
Investment Adviser pays MLAM U.K. a fee for providing investment advisory
services to the Investment Adviser with respect to the Funds in an amount to be
determined from time to time by the Investment Adviser and MLAM U.K. but in no
event in excess of the amount that the Investment Adviser actually receives for
providing services to the Funds pursuant to the Investment Advisory Agreement.
The Investment Adviser and Merrill Lynch Life Agency, Inc. ("MLLA") have
entered into agreements which limit the operating expenses, exclusive of any
distribution fees imposed on shares of Class B Common Stock, paid by each Fund
in a given year to 1.25% of its average daily net assets (the "Reimbursement
Agreements"). The Reimbursement Agreement provides that any such expenses in
excess of 1.25% of average daily net assets will be reimbursed to the Fund by
the Investment Adviser which, in turn, will be reimbursed by MLLA.
The Investment Adviser has entered into administrative services agreements
with certain Insurance Companies, including MLLIC and ML of New York, pursuant
to which the Investment Adviser compensates such companies for administrative
responsibilities relating to the Company which are performed by such Insurance
Companies.
CODE OF ETHICS
The Board of Directors of the Company has adopted a Code of Ethics pursuant
to Rule 17j-1 under the Act which incorporates the Code of Ethics of the
Investment Adviser (together, the "Codes"). The Codes significantly restrict the
personal investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are designed
to identify any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Investment Adviser include a ban on acquiring any securities in a "hot" initial
public offering and a prohibition from profiting on short-term trading in
securities. In addition, no employee may purchase or sell any security which at
the time is being purchased or sold (as the case may be), or to the knowledge of
the employee is being considered for purchase or sale, by any fund advised by
the Investment Adviser. Furthermore, the Codes provide for trading "blackout
periods" which prohibit trading by investment personnel of the Company within
periods of trading by the Company in the same (or equivalent) security (15 or 30
days depending upon the transaction).
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PORTFOLIO MANAGERS
The following is information with respect to the Portfolio Managers for
each of the Company's Funds.
Thomas R. Robinson has served as the Portfolio Manager of the American
Balanced Fund, Global Strategy Focus Fund and Quality Equity Fund since November
1995, and is primarily responsible for each such Fund's day-to-day management.
He has served as a First Vice President of MLAM since 1997 and as a Senior
Portfolio Manager of MLAM from November 1995 to 1997. From 1989 to 1995, he
served as Manager of International Strategy for Merrill Lynch & Co. Global
Securities Research & Economics Group.
Kevin Rendino has served as the Basic Value Focus Fund's Portfolio Manager
since July 1993, and is primarily responsible for the Fund's day-to-day
management. He has served as First Vice President of MLAM since 1997; Vice
President from 1993 to 1997; Senior Research Analyst from 1990 to 1992;
Corporate Analyst from 1988 to 1990.
Daniel V. Szemis has served as the Portfolio Manager of the Special Value
Focus Fund (formerly, the Equity Growth Fund) since May 1997 and became the
Co-Portfolio Manager in January 1998. He and R. Elise Baum are primarily
responsible for the day-to-day management of the Special Value Focus Fund. Mr.
Szemis has served as First Vice President of MLAM since 1997 and Vice President
of MLAM from 1996 to 1997. From 1990 to 1996, Mr. Szemis was a portfolio manager
with Prudential Mutual Fund Investment Management Advisors.
Walter Rogers has served as the Global Utility Focus Fund's Portfolio
Manager since July 1993, and is primarily responsible for the Fund's day-to-day
management. He has served as First Vice President of MLAM since 1997; Vice
President from 1987 to 1997.
Clive D. Lang has served as the International Equity Focus Fund's Portfolio
Manager since April 1998, and is primarily responsible for the Fund's day-to-day
management. Mr. Lang has been associated with MLAM U.K. and has served as a
Senior Quantitative Analyst for the Fund since 1996, and was prior to that the
Chief Investment Officer of Panagora Asset Management Limited.
Robert M. Shearer has served as the Natural Resources Focus Fund's
Portfolio Manager since December 1997, and is primarily responsible for the
Fund's day-to-day management. Mr. Shearer has served as First Vice President of
MLAM since January 1998 and was an Associate Portfolio Manager of the Fund from
September 1997 to December 1997. From 1996 to 1997 he was a Vice President and
an Assistant Portfolio Manager at David L. Babson and Company, Incorporated.
From 1993 to 1996 he was a Vice President/Sector Manager at Concert Capital
Management. From 1988 to 1993 he was the Senior Energy Analyst at Fiduciary
Trust Company International.
Jay Harbeck has served as the Prime Bond Fund's and the Government Bond
Fund's Portfolio Manager since July 1992 and May 1994 respectively. Mr. Harbeck
and Co-Portfolio Manager Christopher G. Ayoub are primarily responsible for each
such Fund's day-to-day management. Mr. Harbeck has served as First Vice
President of MLAM since 1997 and Vice President of MLAM from 1986 to 1997.
Jacqueline Rogers has served as the Portfolio Manager of the Domestic Money
Market Fund and the Reserve Assets Fund since October 1996, and is primarily
responsible for each such Fund's day-to-day management. She has served as Vice
President of MLAM since January 1986.
Paolo H. Valle has served as the Global Bond Focus Fund's Portfolio Manager
since January 1998, and is primarily responsible for the Fund's day-to-day
management. Mr. Valle has served as First Vice President of MLAM since 1997;
Senior Portfolio Manager since 1992; Vice President from 1992 to 1997.
Grace Pineda has served as the Developing Capital Markets Focus Fund's
Portfolio Manager since May 1994, and is primarily responsible for the Fund's
day-to-day management. She has served as First Vice President of MLAM since 1997
and Vice President from 1989 to 1997.
Eric Mitofsky has served as the Index 500 Fund's Portfolio Manager since
the Fund commenced operations in December 1996. He has served as a Vice
President of MLAM since 1992, and was an employee of Merrill Lynch's Equity
Trading Group from 1983 to 1992.
R. Elise Baum has served as the Co-Portfolio Manager of the Special Value
Focus Fund (formerly, the Equity Growth Fund) since January 1998. She and Daniel
V. Szemis and primarily responsible for the day-to-
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day management of the Fund. She has served as Director of MLAM since 1997; Vice
President from 1995 to 1997; Senior Fund Analyst from 1994 to 1995; Fund Analyst
from 1993 to 1994; and Consultant from 1992 to 1993.
Kurt Schansinger is the Senior Portfolio Manager of the Capital Focus Fund
and is primarily responsible for the day-to-day management of the Fund. He has
served as First Vice President of MLAM since 1997 and Vice President of MLAM
from January 1996 to 1997. Prior to MLAM, he spent 12 years with Oppenheimer
Capital, where he rose to Senior Vice President with various portfolio
management, research and administrative responsibilities.
Walter Cuje is the Associate Portfolio Manager of the Capital Focus Fund.
Mr. Cuje has been an Associate Portfolio Manager of MLAM since October 1993;
Director and First Vice President since 1997; Vice President from July 1991 to
1997.
Lawrence R. Fuller is the Portfolio Manager of the Global Growth Focus
Fund. Mr. Fuller has been a Vice President of the Investment Adviser since 1992
and is responsible for the day-to-day management of the Fund's investment
portfolio.
Christopher G. Ayoub has served as the Co-Portfolio Manager of the Prime
Bond Fund and the Government Bond Fund since April 1998. He and Jay Harbeck are
primarily responsible for each such Fund's day-to-day management. Mr. Ayoub has
served as First Vice President of MLAM since 1998 and as Vice President of MLAM
from 1985 to 1997.
Robert F. Murray has served as the Portfolio Manager of the High Current
Income Fund since April 1998, and is primarily responsible for the Fund's
day-to-day management. He has served as Vice President of MLAM since 1993 and
employee of MLAM since 1989.
PORTFOLIO TRANSACTIONS AND BROKERAGE
None of the Company's Funds has any obligation to deal with any dealer or
group of dealers in the execution of transactions in portfolio securities.
Subject to policy established by the Board of Directors of the Company, the
Investment Adviser is primarily responsible for the Company's portfolio
decisions and the placing of the Company's portfolio transactions. In placing
orders, it is the policy of each Fund to obtain the most favorable net results,
taking into account various factors, including price, dealer spread or
commission, if any, size of the transactions and difficulty of execution. While
the Investment Adviser generally seeks reasonably competitive spreads or
commissions, the Company will not necessarily be paying the lowest spread or
commission available.
Under the Investment Company Act of 1940, persons affiliated with the
Company are prohibited from dealing with the Company as a principal in the
purchase and sale of the Company's portfolio securities unless an exemptive
order allowing such transactions is obtained from the Securities and Exchange
Commission. Affiliated persons of the Company may serve as its broker in
over-the-counter transactions conducted on an agency basis. The Securities and
Exchange Commission has issued an order permitting the Company to conduct
certain principal transactions with respect to the Domestic Money Market and
Reserve Assets Funds with Merrill Lynch Government Securities Inc. and Merrill
Lynch Money Markets Inc. in U.S. Government and Government agency securities,
and certain other money market securities, subject to certain terms and
conditions. During the fiscal year ended December 31, 1997, the Company engaged
in 15 transactions pursuant to such order involving approximately $49.2 million
of securities. For the year ended December 31, 1997, the Company paid brokerage
commissions of $8,344,021, of which $302,843 was paid to Merrill Lynch.
PURCHASE OF SHARES
The Company continuously offers shares of Class B Common Stock of the Basic
Value Focus Fund, Developing Capital Markets Focus Fund and the Special Value
Focus Fund to the Insurance Companies at prices equal to the respective per
share net asset value of the Funds. Merrill Lynch Funds Distributor, Inc. (the
"Distributor"), a wholly owned subsidiary of the Investment Adviser, acts as the
distributor of the shares.
The Company will offer shares of Class B Stock in each of its other Funds
to the Insurance Companies at the per share price of the Class A Common Stock of
the corresponding Fund until such time as a share of Class B Common Stock is
purchased, and thereafter, the Company will continuously offer shares of Class B
Common Stock at prices equal to the respective per share net asset value of the
Class B Common Stock of the
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Funds. The Distributor acts as the distributor of the shares. Net asset value is
determined in the manner set forth below under "Additional
Information -- Determination of Net Asset Value."
The Company and the Distributor reserve the right to suspend the sale of
shares of each Fund in response to conditions in the securities markets or
otherwise.
REDEMPTION OF SHARES
The Company is required to redeem all full and fractional shares of the
Funds for cash. The redemption price is the net asset value per share next
determined after the initial receipt of proper notice of redemption.
DIVIDENDS, DISTRIBUTIONS AND TAXES
It is the Company's intention to distribute substantially all of the net
investment income, if any, of each Fund. For dividend purposes, net investment
income of each Fund, other than the Company's Domestic Money Market and Reserve
Assets Funds, will consist of all payments of dividends or interest received by
such Fund less the estimated expenses of such Fund (including fees payable to
the Investment Adviser). Net investment income of the Domestic Money Market and
Reserve Assets Funds (from the time of the immediate preceding determination
thereof) consists of (i) interest accrued and/or discount earned (including both
original issue and market discount), (ii) plus or minus all realized and
unrealized gains (other than realized long-term capital gains) and losses on its
portfolio securities, (iii) less the estimated expenses of the respective Fund
(including the fees payable to the Investment Adviser) applicable to that
dividend period. Dividends on the Domestic Money Market and Reserve Assets Funds
are declared daily and reinvested monthly in additional full and fractional
shares of such Fund. Dividends from net investment income of the Global Bond
Focus, Government Bond, High Current Income and Prime Bond Funds are declared
and reinvested monthly in additional full and fractional shares of the
respective Funds at net asset value. Dividends from net investment income of the
Global Utility Focus Fund are declared and reinvested quarterly in additional
full and fractional shares of the Fund. Dividends from net investment income of
the American Balanced, Basic Value Focus, Capital Focus, Developing Capital
Markets Focus, Special Value Focus, Global Strategy Focus, Global Growth Focus,
Index 500, International Equity Focus, National Resources Focus and Quality
Equity Funds are declared and reinvested at least annually in additional full
and fractional shares of the respective Funds.
All net realized long-term or short-term capital gains of the Company, if
any, other than short-term capital gains of the Domestic Money Market and
Reserve Assets Funds, are declared and distributed annually after the close of
the Company's fiscal year to the shareholders of the Fund or Funds to which such
gains are attributable. Short-term capital gains are taxable as ordinary income.
TAX TREATMENT OF THE COMPANY
Each Fund intends to continue to qualify as a regulated investment company
under certain provisions of the Internal Revenue Code. Under such provisions, a
Fund will not be subject to federal income tax on such part of its net ordinary
income and net realized capital gains which it distributes to shareholders.
If a Fund earns original issue discount income in a taxable year which is
not represented by correlative cash income, or if a Fund receives property
rather than cash in payment of interest, shareholders will be allocated income
greater than the amount of cash distributed to them. In addition, the Fund may
have to dispose of securities and use the proceeds thereof to make distributions
in amounts necessary to satisfy its distribution requirements under the Code.
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TAX TREATMENT OF INSURANCE COMPANIES AS SHAREHOLDERS
Dividends paid by the Company from its ordinary income and distributions of
the Company's net realized capital gains are includable in the respective
Insurance Company's gross income. Distributions of the Company's net realized
long-term capital gains retain their character as long-term capital gains in the
hands of the Insurance Companies if certain requirements are met. The tax
treatment of such dividends and distributions depends on the respective
Insurance Company's tax status. To the extent that income of the Company
represents dividends on common or preferred stock, rather than interest income,
its distributions to the Insurance Companies will be eligible for the present
70% dividends received deduction applicable in the case of a life insurance
company as provided in the Code. See the Prospectus for the Contracts for a
description of the respective Insurance Company's tax status and the charges
which may be made to cover any taxes attributable to the Separate Account. Not
later than 60 days after the end of each calendar year, the Company will send to
the Insurance Companies a written notice required by the Code designating the
amount and character of any distributions made during such year.
PERFORMANCE DATA
From time to time the average annual total return and yield of one or more
of the Company's Funds for various specified time periods may be included in
advertisements or information furnished by the Insurance Companies to present or
prospective Contract owners. Average annual total return and yield are computed
in accordance with formulas specified by the Securities and Exchange Commission.
In connection with its reorganization on December 6, 1996, the Global Bond Focus
Fund (i) acquired substantially all of the assets and assumed substantially all
the liabilities of the International Bond Fund, a separate Fund of the Company,
(ii) implemented a change in its investment objective and policies from seeking
high current income from a global portfolio of fixed income securities,
including non-investment grade securities, to seeking a high total investment
return by investing in a global portfolio of investment grade fixed income
securities and (iii) changed its name from the World Income Focus Fund to its
current name. For the period from the commencement of the World Income Focus
Fund's operations through its reorganization on December 6, 1996, the portfolio
of the Fund included debt securities rated below investment grade (i.e., junk
bonds). On December 6, 1996, the Government Bond Fund (i) implemented a change
in its investment objective so that the Fund may invest in any debt securities
issued or guaranteed by the U.S. Government, its agencies or instrumentalities
without regard to remaining maturity and (ii) changed its name from the
Intermediate Government Bond Fund to its current name. For the period from the
commencement of the Fund's operations through December 6, 1996, the portfolio of
the Intermediate Government Bond Fund consisted primarily of intermediate-term
debt securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities with a maximum maturity not to exceed fifteen years. As a
result of the foregoing changes in the investment objective of each of the
Global Bond Focus Fund and the Government Bond Fund, the performance information
set forth herein and in the Statement of Additional Information for the fiscal
year ended December 31, 1996 may not be indicative of such Fund's future
performance.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield to maturity of each security earned during the
period by (b) the average daily number of shares outstanding during the period
that were entitled to receive dividends multiplied by the offering price per
share on the last day of the period. Because no shares of Class B Common Stock
of the Prime Bond Fund, the High Current Income Fund, the Global Bond Focus Fund
and the Government Bond Fund were in issue prior to December 31, 1997, the yield
information below relates to Class A Common Stock only. The yield for the 30-day
period ending December 31, 1997 was 6.05% for the Prime Bond Fund, 8.73% for the
High Current Income Fund, 6.11% for the Global Bond Focus Fund and 5.52% for the
Government Bond Fund.
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Total return and yield figures are based on the Fund's historical
performance and are not intended to indicate future performance. The Fund's
total return and yield will vary depending on market conditions, the securities
comprising the Fund's portfolio, the Fund's operating expenses and the amount of
realized and unrealized net capital gains or losses during the period. The value
of an investment in the Fund will fluctuate and an investor's shares, when
redeemed, may be worth more or less than their original cost. The yield and
total return quotations may be of limited use for comparative purposes because
they do not reflect charges imposed at the Separate Account level which, if
included, would decrease the yield.
On occasion, one or more of the Company's Funds may compare its performance
to that of the S&P 500 Index, the Value Line Composite Index, the Dow Jones
Industrial Average, or performance data published by Lipper Analytical Services,
Inc., or Variable Annuity Research Data Service or contained in publications
such as Morningstar Publications, Inc., Chase Investment Performance Digest,
Money Magazine, U.S. News & World Report, Business Week, Financial Services
Weekly, Kiplinger Personal Finances, CDA Investment Technology, Inc., Forbes
Magazine, Fortune Magazine, Wall Street Journal, USA Today, Barrons, Strategic
Insight, Donaghues, Investors Business Daily and Ibbotson Associates. As with
other performance data, performance comparisons should not be considered
indicative of the Fund's relative performance for any future period.
DISTRIBUTION PLAN
The Funds have adopted a Distribution Plan (the "Plan") with regards to the
Class B Common Stock of each Fund, pursuant to Rule 12b-1 under the Investment
Company Act. The Plan permits the Company to pay to each Insurance Company that
enters into an agreement with the Company to provide distribution related
services to Contract owners, a fee, at the end of each month, of up to 0.15% of
the net asset value of the Class B Common Stock of each Fund held by such
Insurance Company. Such services include, but are not limited to, (a) the
printing and mailing of Fund prospectuses, statements of additional information,
any supplements thereto and shareholder reports for existing and prospective
Contract owners, (b) services relating to the development, preparation, printing
and mailing of Company advertisements, sales literature and other promotional
materials describing and/or relating to the Company and including materials
intended for use within the Insurance Company, (c) holding seminars and sales
meetings designed to promote the distribution of the Class B Shares of the
Funds, (d) obtaining information and providing explanations to Contract owners
regarding the investment objectives and policies and other information about the
Company and its Funds, including the performance of the Funds, (e) training
sales personnel regarding the Company and the Funds, (f) compensating sales
personnel in connection with the allocation of cash values and premiums of the
Separate Accounts of the Insurance Company, (g) providing personal services
and/or maintenance of the Separate Accounts with respect to Class B Shares of
the Funds attributable to such accounts, and (h) financing any other activity
that the Company's Board of Directors determines is primarily intended to result
in the sale of Class B Shares.
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ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of each class of shares of each Fund is determined once
daily by the Investment Adviser immediately after the declaration of dividends,
if any, and is determined as of fifteen minutes following the close of trading
(generally 4:00 p.m., New York time) on each day the New York Stock Exchange
("NYSE") is open for business. The NYSE is open on business days other than
national holidays and Good Friday. The net asset value per share of each class
of shares of a Fund other than the Domestic Money Market and Reserve Assets
Funds is computed by dividing the sum of the value of the securities plus any
cash or other assets (including interest and dividends accrued) held by such
Fund and attributable to such class minus all liabilities (including accrued
expenses) attributable to such class by the total number of shares of such class
outstanding of that Fund at such time, rounded to the nearest cent. Expenses,
including the investment advisory fees payable to the Investment Adviser, are
accrued daily. Since the net investment income of the Domestic Money Market and
Reserve Assets Funds (including realized and unrealized gains and losses on
their portfolio securities) are declared as a dividend each time the net income
of the Funds are determined (see "Dividends, Distributions and Taxes"), the net
asset value per share of the Funds normally remains at $1.00 per share
immediately after each such determination and dividend declaration.
Except with respect to securities held by the Domestic Money Market and
Reserve Assets Funds having a remaining maturity of 60 days or less, securities
held by each Fund will be valued as follows: Portfolio securities that are
traded on stock exchanges are valued at the last sale price (regular way) as of
the close of business on the day the securities are being valued, or, lacking
any sales, at the last available bid price for long positions and at the last
available ask price for short positions. Long positions in securities traded in
the over-the-counter ("OTC") market are valued at the last available bid price
in the OTC market prior to the time of valuation, provided however that the
Index 500 Fund will value its portfolio holdings which trade on the NASDAQ
national market system at the last sale price prior to the time of valuation.
Short positions in securities traded in the OTC market are valued at the last
available ask price in the OTC market prior to the time of valuation. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the OTC market. When a
Fund writes an option, the amount of the premium received is recorded on the
books as an asset and an equivalent liability. The amount of the liability is
subsequently valued to reflect the current market value of the option written,
based upon the last sale price in the case of exchange-traded options or, in the
case of options traded in the OTC market, the last asked price. Options
purchased are valued at their last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last bid price.
Futures contracts are valued at settlement price at the close of the applicable
exchange. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Company. Any assets or liabilities
initially expressed in terms of non-U.S. dollar currencies are translated into
U.S. dollars at the prevailing market rates as quoted by one or more banks or
dealers on the day of valuation. Securities held by the Domestic Money Market
and Reserve Assets Funds with a remaining maturity of 60 days or less are valued
on an amortized cost basis, unless particular circumstances dictate otherwise.
The Company has used pricing services, including Merrill Lynch Securities
PricingSM Service ("MLSPS"), to value securities held by the High Current Income
and Prime Bond Funds and to value bonds held by other of the Company's Funds.
The Board of Directors of the Company has examined the methods used by the
pricing services in estimating the value of securities held by the Funds and
believes that such methods will reasonably and fairly approximate the price at
which those securities may be sold and result in a good faith determination of
the fair value of such securities; however, there is no assurance that
securities can be sold at the prices at which they are valued. During the fiscal
year ended December 31, 1997, American Balanced Fund, Global Strategy Focus
Fund, Global Utility Focus Fund, High Current Income Fund, Government Bond Fund,
Prime Bond Fund and Global Bond Focus Fund paid MLSPS $248, $239, $43, $7,008,
$1,676, $8,877 and $116, respectively.
ORGANIZATION OF THE COMPANY
The Company was incorporated on October 16, 1981, and operations of its
Reserve Assets Fund commenced on November 12, 1981. Operations of the Prime
Bond, High Current Income, Quality Equity and Special Value
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<PAGE> 199
Focus Funds commenced on April 20, 1982. The Natural Resources Focus Fund and
the American Balanced Fund commenced operations on June 1, 1988 and June 1,
1988, respectively. The Domestic Money Market Fund and the Global Strategy Focus
Fund commenced operations on February 20 and February 28, 1992, respectively.
The Basic Value Focus, Global Bond Focus, Global Utility Focus and International
Equity Focus Funds commenced operations on July 1, 1993. The Developing Capital
Markets Focus Fund and Government Bond Fund commenced operations on May 2, 1994.
The Index 500 Fund commenced operations on December 13, 1996. The Global Growth
Focus Fund and the Capital Focus Fund are expected to commence operations on or
about June 5, 1998. The authorized capital stock of the Company consists of
3,600,000,000 shares of Class A Common Stock, par value $0.10 per share, and
3,600,000,000 shares of Class B Common Stock, par value $0.10 per share. The
shares of Class A and Class B Common Stock are each divided into eighteen
classes designated Merrill Lynch American Balanced Fund Common Stock, Merrill
Lynch Basic Value Focus Fund Common Stock, Merrill Lynch Capital Focus Fund
Common Stock, Merrill Lynch Developing Capital Markets Focus Fund Common Stock,
Merrill Lynch Domestic Money Market Fund Common Stock, Merrill Lynch Special
Value Focus Fund Common Stock, Merrill Lynch Global Bond Focus Fund Common
Stock, Merrill Lynch Global Strategy Focus Fund Common Stock, Merrill Lynch
Global Utility Focus Fund Common Stock, Merrill Lynch Global Growth Focus Fund
Common Stock, Merrill Lynch Government Bond Fund Common Stock, Merrill Lynch
High Current Income Fund Common Stock, Merrill Lynch Index 500 Common Stock,
Merrill Lynch International Equity Focus Fund Common Stock, Merrill Lynch
Natural Resources Focus Fund Common Stock, Merrill Lynch Prime Bond Fund Common
Stock, Merrill Lynch Quality Equity Fund Common Stock and Merrill Lynch Reserve
Assets Fund Common Stock, respectively. The Company may, from time to time, at
the sole discretion of its Board of Directors and without the need to obtain the
approval of its shareholders or of Contract owners, offer and sell shares of one
or more of such classes. Each class consists of 100,000,000 Class A shares and
100,000,000 Class B shares except for Domestic Money Market Fund Common Stock
which consists of 1,300,000,000 Class A shares and 1,300,000,000 Class B shares,
Reserve Assets Fund Common Stock which consists of 500,000,000 Class A shares
and 500,000,000 Class B shares and Global Bond Focus Fund Common Stock and
Global Strategy Focus Fund Common Stock, each of which consists of 200,000,000
Class A shares and 200,000,000 Class B shares. All shares of Common Stock have
equal voting rights, except that only shares of the respective classes are
entitled to vote on matters concerning only that class. Pursuant to the
Investment Company Act of 1940 and the rules and regulations thereunder, certain
matters approved by a vote of all shareholders of the Company may not be binding
on a class whose shareholders have not approved such matter. Each issued and
outstanding share of a class is entitled to one vote and to participate equally
in dividends and distributions declared with respect to such class and in net
assets of such class upon liquidation or dissolution remaining after
satisfaction of outstanding liabilities. The shares of each class, when issued,
will be fully paid and nonassessable, have no preference, preemptive,
conversion, exchange or similar rights, and will be freely transferable. Holders
of shares of any class are entitled to redeem their shares as set forth under
"Redemption of Shares." Shares do not have cumulative voting rights and the
holders of more than 50% of the shares of the Company voting for the election of
directors can elect all of the directors of the Company if they choose to do so
and in such event the holders of the remaining shares would not be able to elect
any directors. The Company does not intend to hold meetings of shareholders
unless under the Investment Company Act of 1940 shareholders are required to act
on any of the following matters: (i) election of directors; (ii) approval of an
investment advisory agreement; (iii) approval of a distribution agreement; and
(iv) ratification of the selection of independent accountants.
Family Life purchased $1,000 worth of shares of each of the Natural
Resources Focus Fund and the American Balanced Fund on April 29, 1988 and
$1,999,000 worth of shares of each such Fund on May 27, 1988. Family Life also
provided the initial capitalization for each of the Company's other Funds other
than the Funds named below for which MLLIC provided the initial capitalization.
MLLIC purchased $100 worth of shares of each of the Domestic Money Market and
Global Strategy Focus Funds on February 6, 1992, $2,000,000 worth of shares of
the Domestic Money Market Fund on February 20, 1992, $2,000,000 worth of shares
of the Global Strategy Focus Fund on February 28, 1992 and $100 worth of shares
of each of the Basic Value Focus, Global Bond Focus, Global Utility Focus and
International Equity Focus Funds on June 28, 1993. MLLIC purchased, on July 1,
1993, $8,000,000 worth of shares of each of the Global Bond Focus Fund and
International Equity Focus Fund and $2,000,000 worth of shares of each of the
Basic Value Focus Fund and the Global Utility Focus Fund. MLLIC purchased, on
May 2, 1994, $8,000,000 worth of shares of the Developing Capital Markets Focus
Fund and, on May 16, 1994, $2,000,000 worth of shares of the Government Bond
Fund. On December 13, 1996,
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<PAGE> 200
MLLIC purchased $10,000,000 worth of shares of the Index 500 Fund. On April 16,
1998, MLLIC purchased $1,000 worth of shares of the Global Growth Focus Fund and
$1,000 worth of shares of the Capital Focus Fund.
In connection with a reorganization on December 6, 1996 conducted by the
Company with respect to certain of its Funds, the Company, with the approval of
the affected shareholders of the Funds, caused (i) Global Bond Focus Fund (a) to
acquire substantially all of the assets and assume substantially all the
liabilities of the International Bond Fund, a separate Fund of the Company, (b)
to implement a change in its investment objective and policies from seeking high
current income from a global portfolio of fixed income securities, including
non-investment grade securities, to seeking a high total investment return by
investing in a global portfolio of investment grade fixed income securities and
(c) to change its name from the World Income Focus Fund to its current name;
(ii) the Government Bond Fund (x) to implement a change in its investment
objective so that the Fund may invest in any debt securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities without
regard to remaining maturity and (y) to change its name from the Intermediate
Government Bond Fund to its current name; and (iii) the Global Strategy Focus
Fund to acquire substantially all of the assets and assume substantially all the
liabilities of the Flexible Strategy Fund, a separate Fund of the Company.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
been selected as the independent auditors of the Company. The selection of
independent auditors is subject to annual ratification by the Company's
shareholders.
CUSTODIAN
The Bank of New York ("BONY"), 110 Washington Street, New York, New York
10286, acts as Custodian of the Company's assets, except that Brown Brothers
Harriman & Co., 40 Water Street, Boston, Massachusetts 02109, acts as Custodian
for assets of the Company's Developing Capital Markets Focus Fund.
TRANSFER AND DIVIDEND DISBURSING AGENT
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), which is a wholly
owned subsidiary of Merrill Lynch & Co., Inc., acts as the Company's Transfer
Agent and is responsible for the issuance, transfer and redemption of shares and
the opening and maintenance of shareholder accounts. MLFDS will receive an
annual fee of $5,000 per Fund and will be entitled to reimbursement of
out-of-pocket expenses.
LEGAL COUNSEL
Rogers & Wells LLP, New York, New York, is counsel for the Company.
REPORTS TO SHAREHOLDERS
The fiscal year of the Company ends on December 31 of each year. The
Company will send to its shareholders at least semi-annually reports showing the
Funds' portfolio securities and other information. An annual report containing
financial statements, audited by independent auditors, will be sent to
shareholders each year.
ADDITIONAL INFORMATION
This Prospectus does not contain all of the information included in the
Registration Statement filed with the Securities and Exchange Commission under
the Securities Act of 1933 and the Investment Company Act of 1940, with respect
to the securities offered hereby, certain portions of which have been omitted
pursuant to the rules and regulations of the Securities and Exchange Commission.
The Statement of Additional Information, dated April 17, 1998, which forms
a part of the Registration Statement, is incorporated by reference into this
Prospectus. The Statement of Additional Information may be obtained without
charge as provided on the cover page of this Prospectus. The Registration
Statement, including the exhibits filed therewith, may be examined at the office
of the Securities and Exchange Commission in Washington, D.C.
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<PAGE> 201
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate
years. These systems may not be able to distinguish the Year 2000 from the Year
1900 (commonly known as the "Year 2000 Problem"). Like other investment
companies and financial and business organizations, the Company could be
adversely affected if the computer systems used by the Investment Adviser or
other Company service providers do not properly address this problem prior to
January 1, 2000. The Investment Adviser has established a dedicated group to
analyze these issues and to implement any systems modifications necessary to
prepare for the Year 2000. Currently, the Investment Adviser does not anticipate
that the transition to the 21st century will have any material impact on its
ability to continue to service the Company at current levels. In addition, the
Investment Adviser has sought assurances from the Company's other service
providers that they are taking all necessary steps to ensure that their computer
systems will accurately reflect the Year 2000, and the Investment Adviser will
continue to monitor the situation. At this time, however, no assurance can be
given that the Company's other service providers have anticipated every step
necessary to avoid any adverse effect on the Company attributable to the Year
2000 Problem.
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<PAGE> 202
ANNEX A
DESCRIPTION OF TEMPORARY INVESTMENTS AND CORPORATE BOND RATINGS
U.S. GOVERNMENT SECURITIES
The Domestic Money Market Fund, Reserve Assets Fund, Capital Focus Fund and
the Government Bond Fund (and, for temporary or defensive purposes, each other
Fund) may invest in the various types of marketable securities issued by or
guaranteed as to principal and interest by the U.S. Government and supported by
the full faith and credit of the U.S. Treasury. U.S. Treasury obligations differ
mainly in the length of their maturity. Treasury bills, the most frequently
issued marketable government security, have a maturity of up to one year and are
issued on a discount basis.
GOVERNMENT AGENCY SECURITIES
The Domestic Money Market Fund, Reserve Assets Fund, Capital Focus Fund and
the Government Bond Fund (and, for temporary or defensive purposes, each other
Fund) may invest in government agency securities, which are debt securities
issued by government sponsored enterprises, federal agencies and international
institutions. Such securities are not direct obligations of the Treasury but
involve government sponsorship or guarantees by government agencies or
enterprises. The Funds may invest in all types of government agency securities
currently outstanding or to be issued in the future.
DEPOSITARY INSTITUTIONS MONEY INSTRUMENTS
The Domestic Money Market Fund, Reserve Assets Fund and Capital Focus Fund
(and, for temporary or defensive purposes, each other Fund) may invest in
depositary institutions money instruments, such as certificates of deposit,
including variable rate certificates of deposit, bankers' acceptances, time
deposits and bank notes. Certificates of deposit are generally short-term,
interest-bearing negotiable certificates issued by commercial banks, savings
banks or savings and loan associations against funds deposited in the issuing
institution. Variable rate certificates of deposit are certificates of deposit
on which the interest rate is periodically adjusted prior to their stated
maturity, usually at 30, 90 or 180 day intervals ("coupon dates"), based upon a
specified market rate. As a result of these adjustments, the interest rate on
these obligations may be increased or decreased periodically. Often, dealers
selling variable rate certificates of deposit to the Funds agree to repurchase
such instruments, at the Funds' option, at par on the coupon dates. The dealers'
obligations to repurchase these instruments are subject to conditions imposed by
the various dealers; such conditions typically are the continued credit standing
of the issuer and the existence of reasonably orderly market conditions. The
Funds are also able to sell variable rate certificates of deposit in the
secondary market. Variable rate certificates of deposit normally carry a higher
interest rate than comparable fixed rate certificates of deposit because
variable rate certificates of deposit generally have a longer stated maturity
than comparable fixed rate certificates of deposit. As a matter of policy, the
Domestic Money Market Fund will invest only in these types of instruments issued
by U.S. issuers.
A bankers' acceptance is a time draft drawn on a commercial bank by a
borrower usually in connection with an international commercial transaction (to
finance the import, export, transfer or storage of goods). The borrower is
liable for payment as well as the bank, which unconditionally guarantees to pay
the draft at its face amount on the maturity date. Most acceptances have
maturities of six months or less and are traded in secondary markets prior to
maturity.
The Reserve Assets Fund and Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund, Developing Capital Markets Focus Fund and the Quality Equity Fund)
may invest in certificates of deposit and bankers' acceptances issued by foreign
branches or subsidiaries of U.S. banks ("Eurodollar" obligations) or U.S.
branches or subsidiaries of foreign banks ("Yankeedollar" obligations). The Fund
may invest only in Eurodollar obligations which by their terms are general
obligations of the U.S. parent bank and meet the other criteria discussed below.
Yankeedollar obligations in which the Fund may invest must be issued by U.S.
branches or subsidiaries of foreign banks which are subject to state or federal
banking regulations in the U.S. and by their terms must be general obligations
of the foreign parent. In addition, the Fund will limit its investments in
Yankeedollar obligations to obligations issued by banking institutions with more
than $1 billion in assets.
Annex A-1
<PAGE> 203
The Reserve Assets Fund and Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund, Developing Capital Markets Focus Fund and the Quality Equity Fund)
may also invest in U.S. dollar-denominated obligations of foreign depository
institutions and their foreign branches and subsidiaries, such as certificates
of deposit, bankers' acceptances, time deposits and deposit notes. The
obligations of such foreign branches and subsidiaries may be the general
obligation of the parent bank or may be limited to the issuing branch or
subsidiary by the terms of the specific obligation or by government regulation.
Such investments will only be made if determined to be of comparable quality to
other investments permissible for the Reserve Assets Fund. The Reserve Assets
Fund will not invest more than 25% of its total assets (taken at market value at
the time of each investment) in these obligations.
Except as otherwise provided above with respect to investment in
Yankeedollar and other foreign bank obligations no Fund may invest in any bank
money instrument issued by a commercial bank or a savings and loan association
unless the bank or association is organized and operating in the United States,
has total assets of at least $1 billion and its deposits are insured by the
Federal Deposit Insurance Corporation (the "FDIC"); provided that this
limitation shall not prohibit the investment of up to 10% of the total assets of
a Fund (taken at market value at the time of each investment) in certificates of
deposit issued by banks and savings and loan associations with assets of less
than $1 billion if the principal amount of each such certificate of deposit is
fully insured by the FDIC.
SHORT-TERM DEBT INSTRUMENTS
The Domestic Money Market Fund, Reserve Assets Fund and Capital Focus Fund
(and, for temporary or defensive purposes, each other Fund) may invest in
commercial paper (including variable amount master demand notes and insurance
company funding agreements), which refers to short-term, unsecured promissory
notes issued by corporations, partnerships, trusts and other entities to finance
short-term credit needs and by trusts issuing asset-backed commercial paper.
Commercial paper is usually sold on a discount basis and has a maturity at the
time of issuance not exceeding nine months. Variable amount master demand notes
are demand obligations that permit the investment of fluctuating amounts at
varying market rates of interest pursuant to arrangements between the issuer and
a commercial bank acting as agent for the payees of such notes, whereby both
parties have the right to vary the amount of the outstanding indebtedness on the
notes. Because variable amount master notes are direct lending arrangements
between the lender and borrower, it is not generally contemplated that such
instruments will be traded and there is no secondary market for the notes.
Typically, agreements relating to such notes provide that the lender may not
sell or otherwise transfer the note without the borrower's consent. Such notes
provide that the interest rate on the amount outstanding is adjusted
periodically, typically on a daily basis, in accordance with a stated short-term
interest rate benchmark. Because the interest rate of a variable amount master
note is adjusted no less often than every 60 days and since repayment of the
note may be demanded at any time, the Investment Adviser values such a note in
accordance with the amortized cost basis described under "Determination of Net
Asset Value" in the Statement of Additional Information.
The Domestic Money Market Fund and Reserve Assets Fund may also invest in
nonconvertible debt securities issued by entities or asset-backed nonconvertible
debt securities issued by trusts (e.g., bonds and debentures) with no more than
397 days (13 months) remaining to maturity at date of settlement. Short-term
debt securities with a remaining maturity of less than one year tend to become
extremely liquid and are traded as money market securities. For a discussion of
the ratings requirements of the Funds' portfolio securities, see "Portfolio
Restrictions" in the Prospectuses to the Domestic Money Market Fund and Reserve
Assets Fund.
The Reserve Assets Fund and Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund and Developing Capital Markets Focus Fund) may also invest in U.S.
dollar-denominated commercial paper and other short-term obligations issued by
foreign entities. Such investments are subject to quality standards similar to
those applicable to investments in comparable obligations of domestic issuers.
Investments in foreign entities in general involve the same risks as those
described in the Statement of Additional Information in connection with
investments in Eurodollar, Yankeedollar and foreign bank obligations.
Annex A-2
<PAGE> 204
REPURCHASE AGREEMENTS
Repurchase Agreements; Purchase and Sale Contracts. Each Fund may invest
in securities pursuant to repurchase agreements or purchase and sale contracts.
Under a repurchase agreement, the seller agrees, upon entering into the contract
with the Fund, to repurchase a security (typically a security issued or
guaranteed by the U.S. government) at a mutually agreed upon time and price,
thereby determining the yield during the term of the agreement. This results in
a fixed yield for the Fund insulated from fluctuations in the market value of
the underlying security during such period, although, to the extent the
repurchase agreement is not denominated in U.S. dollars, the Fund's return may
be affected by currency fluctuations. Repurchase agreements may be entered into
only with a member bank of the Federal Reserve System, a primary dealer in U.S.
government securities or an affiliate thereof. A purchase and sale contract is
similar to a repurchase agreement, but purchase and sale contracts, unlike
repurchase agreements, allocate interest on the underlying security to the
purchaser during the term of the agreement and generally do not require the
seller to provide additional securities in the event of a decline in the market
value of the purchased security during the term of the agreement. If the seller
were to default on its obligation to repurchase a security under a repurchase
agreement or purchase and sale contract and the market value of the underlying
security at such time was less than the Fund had paid to the seller, the Fund
would realize a loss. Repurchase agreements maturing in more than seven days
will be considered "illiquid securities." The Domestic Money Markets and Reserve
Assets Funds will not enter into repurchase agreements maturing in more than 30
days.
Reverse Repurchase Agreements. The Domestic Money Market and Reserve
Assets Funds may enter into reverse repurchase agreements, which involve the
sale of money market securities held by the Funds, with an agreement to
repurchase the securities at an agreed upon price, date, and interest payment.
The Funds will use the proceeds of the reverse repurchase agreements to purchase
other money market securities either maturing, or under an agreement to resell,
at a date simultaneous with or prior to the expiration of the reverse repurchase
agreement. The Funds will utilize reverse repurchase agreements when the
interest income to be earned from the investment of the proceeds of the
transaction is greater than the interest expense of the reverse repurchase
transaction. A separate account of the applicable Fund will be established with
the Custodian consisting of cash or liquid securities having a market value at
all times at least equal in value to the proceeds received on any sale subject
to repurchase plus accrued interest.
DESCRIPTION OF CORPORATE BOND RATINGS
Moody's Investors Service, Inc. ("Moody's"):
Aaa -- Bonds which are 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." Interest payments are protected by a large or
by an exceptionally stable margin and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of
such issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there may
be other elements present which make the long-term risks appear somewhat
larger than in Aaa securities.
A -- Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium-grade obligations.
Factors giving security to principal and interest are considered adequate
but elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa -- Bonds which are rated Baa are considered 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 length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba -- Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate
Annex A-3
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and thereby not well safeguarded both during good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of a
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any period of time may be
small.
Caa -- Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca -- Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have
other market shortcomings.
C -- Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Standard & Poor's Ratings Services ("Standard & Poor's"):
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, and in the majority
of instances they differ from AAA issues only in small degree.
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 obligations. 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.
NR -- Not rated by the indicated rating agency.
Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Annex A-4
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ANNEX B
DESCRIPTION OF DERIVATIVE INSTRUMENTS
Certain Funds of the Company are authorized to use derivative instruments,
including indexed and inverse securities, options, and futures, and to purchase
and sell foreign exchange, as described below. Such instruments are referred to
collectively herein as "Strategic Instruments."
INDEXED AND INVERSE SECURITIES
The Domestic Money Market Fund, the Global Bond Focus Fund, the Global
Strategy Focus Fund, the Global Utility Focus Fund, the Government Bond Fund,
the Index 500 Fund, the International Equity Focus Fund, the Natural Resources
Focus Fund, the Prime Bond Fund, the Developing Capital Markets Focus Fund, the
Global Growth Focus Fund and the Reserve Assets Fund may invest in securities
the potential return of which is based on the change in particular measurements
of value or rate (an "index"). As an illustration, a Fund may invest in a debt
security that pays interest and returns principal based on the change in the
value of an interest rate index (such as the prime rate or federal funds rate),
a securities index (such as the Standard & Poor's 500 Composite Index (the "S&P
500") or a more narrowly-focused index such as the AMEX Oil & Gas Index) or a
basket of securities, or based on the relative changes of two indices. In
addition, the Developing Capital Markets Focus Fund, the Global Strategy Focus
Fund, the International Equity Focus Fund and the Natural Resources Focus Fund
may invest in securities the potential return of which is based inversely on the
change in an index. For example, these Funds may invest in securities that pay a
higher rate of interest when a particular index decreases and pay a lower rate
of interest (or do not fully return principal) when the value of the index
increases. If the Fund invests in such securities, it may be subject to reduced
or eliminated interest payments or loss of principal in the event of an adverse
movement in the relevant index or indices.
Certain indexed and inverse securities may have the effect of providing
investment leverage because the rate of interest or amount of principal payable
increases or decreases at a rate that is a multiple of the changes in the
relevant index. As a consequence, the market value of such securities may be
substantially more volatile than the market values of other debt securities. The
Company believes that indexed and inverse securities may provide portfolio
management flexibility that permits Funds to seek enhanced returns, hedge other
portfolio positions or vary the degree of portfolio leverage with greater
efficiency than would otherwise be possible under certain market conditions.
OPTIONS ON SECURITIES AND SECURITIES INDICES
Purchasing Options. The Developing Capital Markets Focus Fund, the Global
Bond Focus Fund, the Global Strategy Focus Fund, the Global Utility Focus Fund,
the Index 500 Fund, the International Equity Focus Fund, the Global Growth Focus
Fund, and the Natural Resources Focus Fund are each authorized to purchase put
options on securities held in its portfolio or securities indices the
performance of which is substantially correlated with securities held in its
portfolio. When a Fund purchases a put option, in consideration for an upfront
payment (the "option premium") the Fund acquires a right to sell to another
party specified securities owned by the Fund at a specified price (the "exercise
price") on or before a specified date (the "expiration date"), in the case of an
option on securities, or to receive from another party a payment based on the
amount a specified securities index declines below a specified level on or
before the expiration date, in the case of an option on a securities index. The
purchase of a put option limits the Fund's risk of loss in the event of a
decline in the market value of the portfolio holdings underlying the put option
prior to the option's expiration date. If the market value of the portfolio
holdings associated with the put option increases rather than decreases,
however, the Fund will lose the option premium and will consequently realize a
lower return on the portfolio holdings than would have been realized without the
purchase of the put.
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Index 500 Fund, the International Equity Focus
Fund, the Global Growth Focus Fund and the Natural Resources Focus Fund are each
authorized to purchase call options on securities it intends to purchase or
securities indices the performance of which are substantially correlated with
the performance of the types of securities it intends to purchase. When a Fund
purchases a call option, in consideration for the option premium the Fund
acquires a right to purchase from another party specified securities at the
exercise price on or before the expiration date, in the case of an option on
securities, or to receive from another party a payment based on the
Annex B-1
<PAGE> 207
amount a specified securities index increases beyond a specified level on or
before the expiration date, in the case of an option on a securities index. The
purchase of a call option may protect the Fund from having to pay more for a
security as a consequence of increases in the market value for the security
during a period when the Fund is contemplating its purchase, in the case of an
option on a security, or attempting to identify specific securities in which to
invest in a market the Fund believes to be attractive, in the case of an option
on an index (an "anticipatory hedge"). In the event the Fund determines not to
purchase a security underlying a call option, however, the Fund may lose the
entire option premium.
Each Fund is also authorized to purchase put or call options in connection
with closing out put or call options it has previously sold.
Writing Options. The American Balanced Fund, the Basic Value Focus Fund,
the Developing Capital Markets Focus Fund, the Special Value Focus Fund, the
Global Bond Focus Fund, the Global Strategy Focus Fund, the Global Utility Focus
Fund, the Index 500 Fund, the International Equity Focus Fund, the Natural
Resources Focus Fund, the Global Growth Focus Fund, the Capital Focus Fund and
the Quality Equity Fund are each authorized to write (i.e., sell) call options
on securities held in its portfolio or securities indices the performance of
which is substantially correlated with securities held in its portfolio. When a
Fund writes a call option, in return for an option premium the Fund gives
another party the right to buy specified securities owned by the Fund at the
exercise price on or before the expiration date, in the case of an option on
securities, or agrees to pay to another party an amount based on any gain in a
specified securities index beyond a specified level on or before the expiration
date, in the case of an option on a securities index. The Fund may write call
options to earn income, through the receipt of option premiums. In the event the
party to which the Fund has written an option fails to exercise its rights under
the option because the value of the underlying securities is less than the
exercise price, the Fund will partially offset any decline in the value of the
underlying securities through the receipt of the option premium. By writing a
call option, however, the Fund limits its ability to sell the underlying
securities, and gives up the opportunity to profit from any increase in the
value of the underlying securities beyond the exercise price, while the option
remains outstanding.
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the Index 500 Fund,
the International Equity Focus Fund, the Global Growth Focus Fund and the
Natural Resources Focus Fund each may also write put options on securities or
securities indices. When the Fund writes a put option, in return for an option
premium the Fund gives another party the right to sell to the Fund a specified
security at the exercise price on or before the expiration date, in the case of
an option on a security, or agrees to pay to another party an amount based on
any decline in a specified securities index below a specified level on or before
the expiration date, in the case of an option on a securities index. The Fund
may write put options to earn income, through the receipt of option premiums. In
the event the party to which the Fund has written an option fails to exercise
its rights under the option because the value of the underlying securities is
greater than the exercise price, the Fund will profit by the amount of the
option premium. By writing a put option, however, the Fund will be obligated to
purchase the underlying security at a price that may be higher than the market
value of the security at the time of exercise as long as the put option is
outstanding, in the case of an option on a security, or make a cash payment
reflecting any decline in the index, in the case of an option on an index.
Accordingly, when the Fund writes a put option it is exposed to a risk of loss
in the event the value of the underlying securities falls below the exercise
price, which loss potentially may substantially exceed the amount of option
premium received by the Fund for writing the put option. The Fund will write a
put option on a security or a securities index only if the Fund would be willing
to purchase the security at the exercise price for investment purposes (in the
case of an option on a security) or is writing the put in connection with
trading strategies involving combinations of options -- for example, the sale
and purchase of options with identical expiration dates on the same security or
index but different exercise prices (a technique called a "spread").
Each Fund is also authorized to sell call or put options in connection with
closing out call or put options it has previously purchased.
Other than with respect to closing transactions, a Fund will only write
call or put options that are "covered." A call or put option will be considered
covered if the Fund has segregated assets with respect to such option in the
manner described in "Risk Factors in Options, Futures, and Currency Instruments"
below. A call option will also be considered covered if a Fund owns the
securities it would be required to deliver upon exercise of the
Annex B-2
<PAGE> 208
option (or, in the case of option on a securities index, securities which are
substantially correlated with the performance of such index) or owns a call
option, warrant or convertible instrument which is immediately exercisable for,
or convertible into, such security.
Types of Options. A Fund may engage in transactions in options on
securities or securities indices on exchanges and in the over-the-counter
("OTC") markets. In general, exchange-traded options have standardized exercise
prices and expiration dates and require the parties to post margin against their
obligations, and the performance of the parties' obligations in connection with
such options is guaranteed by the exchange or a related clearing corporation.
OTC options have more flexible terms negotiated between the buyer and the
seller, but generally do not require the parties to post margin and are subject
to greater risk of counterparty default. See "Additional Risk Factors of OTC
Transactions" below.
FUTURES
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the Index 500 Fund,
the International Equity Focus Fund, the Global Growth Focus Fund and the
Natural Resources Focus Fund may each engage in transactions in futures and
options thereon. Futures are standardized, exchange-traded contracts which
obligate a purchaser to take delivery, and a seller to make delivery, of a
specific amount of a commodity at a specified future date at a specified price.
No price is paid upon entering into a futures contract. Rather, upon purchasing
or selling a futures contract the Fund is required to deposit collateral
("margin") equal to a percentage (generally less than 10%) of the contract
value. Each day thereafter until the futures position is closed, the Fund will
pay additional margin representing any loss experienced as a result of the
futures position the prior day or be entitled to a payment representing any
profit experienced as a result of the futures position the prior day.
The sale of a futures contract limits a Fund's risk of loss through a
decline in the market value of portfolio holdings correlated with the futures
contract prior to the futures contract's expiration date. In the event the
market value of the portfolio holdings correlated with the futures contract
increases rather than decreases, however, the Fund will realize a loss on the
futures position and a lower return on the portfolio holdings than would have
been realized without the purchase of the futures contract.
The purchase of a futures contract may protect a Fund from having to pay
more for securities as a consequence of increases in the market value for such
securities during a period when the Fund was attempting to identify specific
securities in which to invest in a market the Fund believes to be attractive. In
the event that such securities decline in value or the Fund determines not to
complete an anticipatory hedge transaction relating to a futures contract,
however, the Fund may realize a loss relating to the futures position.
A Fund will limit transactions in futures and options on futures to
financial futures contracts (i.e., contracts for which the underlying commodity
is a currency or securities or interest rate index) purchased or sold for
hedging purposes (including anticipatory hedges). Each Fund will further limit
transactions in futures and options on futures to the extent necessary to
prevent the Fund from being deemed a "commodity pool" under regulations of the
Commodity Futures Trading Commission.
FOREIGN EXCHANGE TRANSACTIONS
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the International
Equity Focus Fund, the Natural Resources Focus Fund, the Global Growth Focus
Fund, the Capital Focus Fund and the Quality Equity Fund may engage in spot and
forward foreign exchange transactions and currency swaps, purchase and sell
options on currencies and purchase and sell currency futures and related options
thereon (collectively, "Currency Instruments") for purposes of hedging against
the decline in the value of currencies in which its portfolio holdings are
denominated against the US dollar.
Forward foreign exchange transactions are OTC contracts to purchase or sell
a specified amount of a specified currency or multinational currency unit at a
price and future date set at the time of the contract. Spot foreign exchange
transactions are similar but require current, rather than future, settlement. A
Fund will enter into foreign exchange transactions only for purposes of hedging
either a specific transaction or a portfolio position. A Fund may enter into a
foreign exchange transaction for purposes of hedging a specific transaction by,
for
Annex B-3
<PAGE> 209
example, purchasing a currency needed to settle a security transaction or
selling a currency in which the Fund has received or anticipates receiving a
dividend or distribution. A Fund may enter into a foreign exchange transaction
for purposes of hedging a portfolio position by selling forward a currency in
which a portfolio position of the Fund is denominated or by purchasing a
currency in which the Fund anticipates acquiring a portfolio position in the
near future. A Fund may also hedge portfolio positions through currency swaps,
which are transactions in which one currency is simultaneously bought for a
second currency on a spot basis and sold for the second currency on a forward
basis.
The Funds authorized to engage in Currency Instrument transactions may also
hedge against the decline in the value of a currency against the US dollar
through use of currency futures or options thereon. Currency futures are similar
to forward foreign exchange transactions except that futures are standardized
exchange-traded contracts. See "Futures" above.
The Funds authorized to engage in Currency Instrument transactions may also
hedge against the decline in the value of a currency against the US dollar
through the use of currency options. Currency options are similar to options on
securities, but in consideration for an option premium the writer of a currency
option is obligated to sell (in the case of a call option) or purchase (in the
case of a put option) a specified amount of a specified currency on or before
the expiration date for a specified amount of another currency. The Fund may
engage in transactions in options on currencies either on exchanges or OTC
markets. See "Types of Options" above and "Additional Risk Factors of OTC
Transactions" below.
No Fund will speculate in Currency Instruments. Accordingly, a Fund will
not hedge a currency in excess of the aggregate market value of the securities
which it owns (including receivables for unsettled securities sales), or has
committed to or anticipates purchasing, which are denominated in such currency.
A Fund may, however, hedge a currency by entering into a transaction in a
Currency Instrument denominated in a currency other than the currency being
hedged (a "cross-hedge"). The Fund will only enter into a cross-hedge if the
Investment Adviser believes that (i) there is a demonstrable high correlation
between the currency in which the cross-hedge is denominated and the currency
being hedged, and (ii) executing a cross-hedge through the currency in which the
cross-hedge is denominated will be significantly more cost-effective or provide
substantially greater liquidity than executing a similar hedging transaction by
means of the currency being hedged.
Risk Factors in Hedging Foreign Currency Risks. While a Fund's use of
Currency Instruments to effect hedging strategies is intended to reduce the
volatility of the net asset value of the Fund's shares, the net asset value of
the Fund's shares will fluctuate. Moreover, although Currency Instruments will
be used with the intention of hedging against adverse currency movements,
transactions in Currency Instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective. To the extent that a Fund hedges against
anticipated currency movements which do not occur, the Fund may realize losses,
and decrease its total return, as the result of its hedging transactions.
Furthermore, a Fund will only engage in hedging activities from time to time and
may not be engaging in hedging activities when movements in currency exchange
rates occur. It may not be possible for a Fund to hedge against currency
exchange rate movements, even if correctly anticipated, in the event that (i)
the currency exchange rate movement is so generally anticipated that the Fund is
not able to enter into a hedging transaction at an effective price, or (ii) the
currency exchange rate movement relates to a market with respect to which
Currency Instruments are not available (such as certain developing markets) and
it is not possible to engage in effective foreign currency hedging.
RISK FACTORS IN OPTIONS, FUTURES, AND CURRENCY INSTRUMENTS
Use of Strategic Instruments for hedging purposes involves the risk of
imperfect correlation in movements in the value of the Strategic Instruments and
the value of the instruments being hedged. If the value of the Strategic
Instruments moves more or less than the value of the hedged instruments a Fund
will experience a gain or loss which will not be completely offset by movements
in the value of the hedged instruments.
Each Fund intends to enter into transactions involving Strategic
Instruments only if there appears to be a liquid secondary market for such
instruments or, in the case of illiquid instruments traded in OTC transactions,
such instruments satisfy the criteria set forth below under "Additional Risk
Factors of OTC Transactions." However, there can be no assurance that, at any
specific time, either a liquid secondary market will exist for a
Annex B-4
<PAGE> 210
Strategic Instrument or the Fund will otherwise be able to sell such instrument
at an acceptable price. It may therefore not be possible to close a position in
a Strategic Instrument without incurring substantial losses, if at all.
Certain transactions in Strategic Instruments (e.g., forward foreign
exchange transactions, futures transactions, sales of put options) may expose a
Fund to potential losses which exceed the amount originally invested by the Fund
in such instruments. When a Fund engages in such a transaction, the Fund will
deposit in a segregated account at its custodian liquid securities with a value
at least equal to the Fund's exposure, on a mark-to-market basis, to the
transaction (as calculated pursuant to requirements of the Securities and
Exchange Commission). Such segregation will ensure that the Fund has assets
available to satisfy its obligations with respect to the transaction, but will
not limit the Fund's exposure to loss.
ADDITIONAL RISK FACTORS OF OTC TRANSACTIONS; LIMITATIONS ON THE USE OF OTC
STRATEGIC INSTRUMENTS
Certain Strategic Instruments traded in OTC markets, including indexed
securities and OTC options, may be substantially less liquid than other
instruments in which a Fund may invest. The absence of liquidity may make it
difficult or impossible for the Fund to sell such instruments promptly at an
acceptable price. The absence of liquidity may also make it more difficult for
the Fund to ascertain a market value for such instruments. A Fund will therefore
acquire illiquid OTC instruments (i) if the agreement pursuant to which the
instrument is purchased contains a formula price at which the instrument may be
terminated or sold, or (ii) for which the Investment Adviser anticipates the
Fund can receive on each business day at least two independent bids or offers,
unless a quotation from only one dealer is available, in which case that
dealer's quotation may be used.
The staff of the Securities and Exchange Commission has taken the position
that purchased OTC options and the assets underlying written OTC options are
illiquid securities. Each Fund has therefore adopted an investment policy
pursuant to which it will not purchase or sell OTC options (including OTC
options on futures contracts) if, as a result of such transactions, the sum of
the market value of OTC options currently outstanding which are held by the
Fund, the market value of the securities underlying OTC call options currently
outstanding which have been sold by the Fund and margin deposits on the Fund's
outstanding OTC options exceeds 15% of the total assets of the Fund, taken at
market value, together with all other assets of the Fund which are deemed to be
illiquid or are otherwise not readily marketable. However, if an OTC option is
sold by the Fund to a dealer in U.S. government securities recognized as a
"primary dealer" by the Federal Reserve Bank of New York and the Fund has the
unconditional contractual right to repurchase such OTC option at a predetermined
price, then the Fund will treat as illiquid such amount of the underlying
securities as is equal to the repurchase price less the amount by which the
option is "in-the-money" (i.e., current market value of the underlying security
minus the option's exercise price).
Because Strategic Instruments traded in OTC markets are not guaranteed by
an exchange or clearing corporation and generally do not require payment of
margin to the extent that a Fund has unrealized gains in such instruments or has
deposited collateral with its counterparty, the Fund is at risk that its
counterparty will become bankrupt or otherwise fail to honor its obligations. A
Fund will attempt to minimize the risk that a counterparty will become bankrupt
or otherwise fail to honor its obligations by engaging in transactions in
Strategic Instruments traded in OTC markets only with financial institutions
which have substantial capital or which have provided the Fund with a
third-party guaranty or other credit enhancement.
ADDITIONAL LIMITATIONS ON THE USE OF STRATEGIC INSTRUMENTS
No Fund may use any Strategic Instrument to gain exposure to an asset or
class of assets that it would be prohibited by its investment restrictions from
purchasing directly, except that the Natural Resources Focus Fund may acquire
securities indexed to a precious metal or other natural resource index.
Annex B-5
<PAGE> 211
APRIL 17, 1998
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 - PHONE NO. (609) 282-2800
------------------------
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company which has a wide range of investment objectives
among its eighteen separate funds (hereinafter referred to as the "Funds" or
individually as a "Fund"): Merrill Lynch Domestic Money Market Fund, Merrill
Lynch Reserve Assets Fund, Merrill Lynch Prime Bond Fund, Merrill Lynch High
Current Income Fund, Merrill Lynch Quality Equity Fund, Merrill Lynch Special
Value Focus Fund, Merrill Lynch Natural Resources Focus Fund, Merrill Lynch
American Balanced Fund, Merrill Lynch Global Strategy Focus Fund, Merrill Lynch
Basic Value Focus Fund, Merrill Lynch Global Bond Focus Fund, Merrill Lynch
Global Utility Focus Fund, Merrill Lynch International Equity Focus Fund,
Merrill Lynch Developing Capital Markets Focus Fund, Merrill Lynch Government
Bond Fund, Merrill Lynch Index 500 Fund, Merrill Lynch Global Growth Focus Fund,
Merrill Lynch Capital Focus Fund. Two separate classes of common stock ("Common
Stock"), Class A Common Stock and Class B Common Stock, are issued for each
Fund.
The shares of the Funds are sold to separate accounts ("Separate Accounts")
of certain insurance companies (the "Insurance Companies") including Merrill
Lynch Life Insurance Company ("MLLIC") and ML Life Insurance Company of New York
("ML of New York") to fund benefits under variable annuity contracts (the
"Variable Annuity Contracts") and/or variable life insurance contracts (together
with the Variable Annuity Contracts, the "Contracts") issued by such companies.
The Insurance Companies will redeem shares to the extent necessary to provide
benefits under the respective Contracts or for such other purposes as may be
consistent with the respective Contracts. MLLIC and ML of New York are wholly
owned subsidiaries of Merrill Lynch & Co., Inc., as is the Company's investment
adviser, Merrill Lynch Asset Management, L.P. (the "Investment Adviser").
------------------------
THIS STATEMENT OF ADDITIONAL INFORMATION OF THE COMPANY IS NOT A PROSPECTUS AND
SHOULD BE READ IN CONJUNCTION WITH THE PROSPECTUS OF THE COMPANY (THE
"PROSPECTUS") DATED APRIL 17, 1998 WHICH HAS BEEN FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION AND WHICH IS AVAILABLE UPON REQUEST AND WITHOUT CHARGE BY
CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE NUMBER SET FORTH
ABOVE.
------------------------
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE> 212
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and Policies.......................... 3
Investment Restrictions..................................... 3
Management of the Company................................... 13
Investment Advisory Arrangements............................ 16
Determination of Net Asset Value............................ 18
Portfolio Transactions and Brokerage........................ 19
Redemption of Shares........................................ 21
Dividends, Distributions and Taxes.......................... 21
Distribution Arrangements................................... 22
Performance Data............................................ 22
Additional Information...................................... 25
Independent Auditors' Report................................ 27
Statement of Assets and Liabilities -- Capital Focus Fund... 28
Statement of Assets and Liabilities -- Global Growth Focus
Fund...................................................... 29
Independent Auditors' Report................................ 30
Audited Financial Statements................................ 31
</TABLE>
2
<PAGE> 213
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives and certain investment policies of the Funds are
as follows: The Domestic Money Market Fund seeks preservation of capital,
liquidity and the highest possible current income consistent with the foregoing
objectives by investing in short-term domestic money market securities. The
Reserve Assets Fund seeks the preservation of capital, liquidity and the highest
possible current income consistent with the foregoing objectives by investing in
short-term money market securities. The Prime Bond Fund seeks to attain as high
a level of current income as is consistent with prudent investment management,
and as a secondary objective, capital appreciation when consistent with the
foregoing objective, by investing primarily in long-term corporate bonds rated A
or better by either Moody's Investors Service, Inc. ("Moody's") or Standard &
Poor's Rating Group ("Standard & Poor's"). The High Current Income Fund seeks to
attain as high a level of current income as is consistent with its investment
policies and prudent investment management, and as a secondary objective,
capital appreciation when consistent with the foregoing objective; the Fund
invests principally in fixed-income securities which are rated in the lower
rating categories of the established rating services or in unrated securities of
comparable quality. The Quality Equity Fund seeks to attain the highest total
investment return consistent with prudent risk; the Fund uses a fully managed
investment policy utilizing equity securities, primarily common stocks of
large-capitalization companies, as well as investment grade debt and convertible
securities. The Special Value Focus Fund seeks to attain long-term capital
growth by investing primarily in common shares, of small companies and of
emerging growth companies regardless of size. The Natural Resources Focus Fund
seeks to attain long-term growth of capital and the protection of the purchasing
power of shareholders' capital by investing primarily in equity securities of
domestic and foreign companies with substantial natural resource assets. The
American Balanced Fund seeks a level of current income and a degree of stability
of principal not normally available from an investment solely in equity
securities and the opportunity for capital appreciation greater than normally
available from an investment solely in debt securities by investing in a
balanced portfolio of fixed income and equity securities. The Global Strategy
Focus Fund seeks high total investment return by investing primarily in a
portfolio of equity and fixed income securities of U.S. and foreign issuers. The
Basic Value Focus Fund seeks to attain capital appreciation and, secondarily,
income by investing in securities, primarily equities, that management of the
Fund believes are undervalued and therefore represent basic investment value.
The Global Bond Focus Fund seeks to attain high total investment return by
investing in a global portfolio of fixed income securities denominated in
various currencies, including multinational currency units. The Global Utility
Focus Fund seeks to attain capital appreciation and current income through
investment of at least 65% of its total assets in equity and debt securities
issued by domestic and foreign companies which are, in the opinion of the
Investment Adviser, primarily engaged in the ownership or operation of
facilities used to generate, transmit or distribute electricity,
telecommunications, gas or water. The International Equity Focus Fund seeks to
attain capital appreciation and, secondarily, income, through investment in
securities, principally equities, of issuers in countries other than the United
States. The Developing Capital Markets Focus Fund seeks long-term capital
appreciation through investment in securities, principally equities, of issuers
in countries having smaller capital markets. The Government Bond Fund seeks the
highest possible current income consistent with the protection of capital
afforded by investing in debt securities issued or guaranteed by the United
States Government, its agencies or instrumentalities. The Index 500 Fund seeks
to provide investment results that, before expenses, correspond to the aggregate
price and yield performance of Standard & Poor's 500 Composite Stock Price Index
(the "S&P 500 Index"). The Global Growth Focus Fund seeks long-term growth of
capital by investing in a diversified portfolio of equity securities of issuers
located in various foreign countries and the United States with a particular
emphasis on companies that have exhibited above-average growth rates in
earnings. The Capital Focus Fund seeks to achieve the highest total investment
return consistent with prudent risk through a fully managed investment policy
utilizing equity, debt (including money market) and convertible securities.
Investors are referred to "Investment Objectives and Policies" in each
Fund's Prospectus for a more complete discussion of the investment objectives
and policies of the Company.
INVESTMENT RESTRICTIONS
The Company has adopted the following fundamental and non-fundamental
restrictions and policies relating to the investment of the assets of the Funds
and their activities. The fundamental policies set forth below may not be
changed without the approval of the holders of a majority of the outstanding
voting shares of each Fund affected (which for this purpose and under the
Investment Company Act of 1940 means the lesser of (i) 67% of
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the shares represented at a meeting at which more than 50% of the outstanding
shares of the affected Fund are represented or (ii) more than 50% of the
outstanding shares of the affected Fund).
RESTRICTIONS APPLICABLE TO THE DOMESTIC MONEY MARKET FUND
The Domestic Money Market Fund may not purchase any security other than
money market and other securities described under "Investment Objectives and
Policies" in the Domestic Money Market Fund's Prospectus. In addition, the
Domestic Money Market Fund may not purchase securities of foreign issuers
(including Eurodollar and Yankeedollar obligations). In addition, the Domestic
Money Market Fund may not:
(1) invest more than 10% of its total assets (taken at market value
at the time of each investment) in the securities (other than U.S.
Government or government agency securities) of any one issuer (including
repurchase agreements with any one bank) except that up to 25% of the value
of the Fund's total assets may be invested without regard to such 10%
limitation.
(2) alone, or together with any other Fund or Funds, make
investments for the purpose of exercising control or management.
(3) purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization.
(4) purchase or sell interests in oil, gas or other mineral
exploration or development programs, commodities, commodity contracts or
real estate, except that the Fund may invest in securities secured by real
estate or interests therein or securities issued by companies which invest
in real estate or interest therein.
(5) purchase any securities on margin except that the Company may
obtain such short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities.
(6) make short sales of securities or maintain a short position or
write, purchase or sell puts, calls, straddles, spreads or combination
thereof.
(7) make loans to other persons; provided that the Fund may purchase
money market securities or enter into repurchase agreements; lend
securities owned or held by it pursuant to (8) below; and provided further
that for purposes of this restriction the acquisition of a portion of an
issue of publicly distributed bonds, debentures or other corporate debt
securities or of government obligations, short-term commercial paper,
certificates of deposit and bankers' acceptances shall not be deemed the
making of a loan.
(8) lend its portfolio securities in excess of 20% of its total
assets, taken at market value at the time of the loan, provided that such
loans are made according to the guidelines set forth below and the
guidelines of the Securities and Exchange Commission and the Company's
Board of Directors, including maintaining collateral from the borrower
equal at all times to the current market value of the securities loaned.
(9) borrow amounts in excess of 20% of its total assets, taken at
market value, and then only from banks as a temporary measure for
extraordinary or emergency purposes. The borrowing provisions shall not
apply to reverse repurchase agreements. Usually only "leveraged" investment
companies may borrow in excess of 5% of their assets; however, the Fund
will not borrow to increase income but only to meet redemption requests
which might otherwise require untimely dispositions of portfolio
securities. The Fund will not purchase securities while borrowings are
outstanding.
(10) mortgage, pledge, hypothecate or in any manner transfer (except
as provided in (8) above), as security for indebtedness, any securities
owned or held by the Fund except as may be necessary in connection with
borrowings mentioned in (9) above, and then such mortgaging, pledging or
hypothecating may not exceed 25% of the Fund's total assets, taken at
market value at the time thereof. Although the Fund has the authority to
mortgage, pledge or hypothecate more than 10% of its total assets under
this investment restriction (10), as a matter of operating policy, the Fund
will not mortgage, pledge or hypothecate in excess of 10% of total net
assets.
(11) act as an underwriter of securities, except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933 in selling
portfolio securities.
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(12) purchase, either alone or together with any other Fund or Funds,
more than 10% of the outstanding securities of an issuer except that such
restriction does not apply to U.S. Government or government agency
securities, bank money instruments or repurchase agreements.
(13) invest in securities (except for repurchase agreements or
variable amount master notes) with legal or contractual restrictions on
resale or for which no readily available market exists or in securities of
issuers (other than issuers of government agency securities) having a
record, together with predecessors, of less than three years of continuous
operation if, regarding all such securities, more than 10% of its total
assets (taken at market value) would be invested in such securities.
(14) enter into repurchase agreements if, as a result thereof, more
than 10% of the Fund's total assets (taken at market value at the time of
each investment) would be subject to repurchase agreements maturing in more
than seven days.
(15) enter into reverse repurchase agreements if, as a result
thereof, the Fund's obligations with respect to reverse repurchase
agreements would exceed one-third of the Fund's net assets (defined to be
total assets, taken at market value, less liabilities other than reverse
repurchase agreements).
(16) invest more than 25% of its total assets (taken at market value
at the time of each investment) in the securities of issuers in any
particular industry (other than U.S. Government securities, government
agency securities or bank money instruments).
RESTRICTIONS APPLICABLE TO THE RESERVE ASSETS FUND
The Reserve Assets Fund may not purchase any security other than money
market and other securities described under "Investment Objectives and Policies"
in the Prospectus for the Reserve Assets Fund. In addition, the Reserve Assets
Fund may not:
(1) invest more than 10% of its total assets (taken at market value
at the time of each investment) in the securities (other than U.S.
Government or government agency securities) of any one issuer (including
repurchase agreements with any one bank) except that up to 25% of the value
of the Fund's total assets may be invested without regard to such 10%
limitation.
(2) alone, or together with any other Fund or Funds, make
investments for the purpose of exercising control or management.
(3) purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization.
(4) purchase or sell interests in oil, gas or other mineral
exploration or development programs, commodities, commodity contracts or
real estate, except that the Fund may invest in securities secured by real
estate or interests therein or securities issued by companies which invest
in real estate or interest therein.
(5) purchase any securities on margin except that the Company may
obtain such short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities.
(6) make short sales of securities or maintain a short position or
write, purchase or sell puts, calls, straddles, spreads or combinations
thereof.
(7) make loans to other persons; provided that the Fund may purchase
money market securities or enter into repurchase agreements; lend
securities owned or held by it pursuant to (8) below; and provided further
that for purposes of this restriction the acquisition of a portion of an
issue of publicly-distributed bonds, debentures or other corporate debt
securities or of government obligations, short-term commercial paper,
certificates of deposit and bankers' acceptances shall not be deemed the
making of a loan.
(8) lend its portfolio securities in excess of 20% of its total
assets, taken at market value at the time of the loan, provided that such
loans are made according to the guidelines set forth below and the
guidelines of the Securities and Exchange Commission and the Company's
Board of Directors, including maintaining collateral from the borrower
equal at all times to the current market value of the securities loaned.
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(9) borrow amounts in excess of 20% of its total assets, taken at
market value and then only from banks as a temporary measure for
extraordinary or emergency purposes. The borrowing provisions shall not
apply to reverse repurchase agreements. Usually only "leveraged" investment
companies may borrow in excess of 5% of their assets; however, the Fund
will not borrow to increase income but only to meet redemption requests
which might otherwise require untimely dispositions of portfolio
securities. The Fund will not purchase securities while borrowings are
outstanding.
(10) mortgage, pledge, hypothecate or in any manner transfer (except
as provided in (8) above), as security for indebtedness, any securities
owned or held by the Fund except as may be necessary in connection with
borrowings mentioned in (9) above, and then such mortgaging, pledging or
hypothecating may not exceed 25% of the Fund's total assets, taken at
market value at the time thereof. As a matter of operating policy, the Fund
will not mortgage, pledge or hypothecate in excess of 10% of total net
assets.
(11) act as an underwriter of securities, except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933 in selling
portfolio securities.
(12) purchase, either alone or together with any other Fund or Funds,
more than 10% of the outstanding securities of an issuer except that such
restriction does not apply to U.S. Government or government agency
securities, bank money instruments or repurchase agreements.
(13) invest in securities (except for repurchase agreements or
variable amount master notes) with legal or contractual restrictions on
resale or for which no readily available market exists or in securities of
issuers (other than issuers of government agency securities) having a
record, together with predecessors, of less than three years of continuous
operation if, regarding all such securities, more than 5% of its total
assets (taken at market value) would be invested in such securities.
(14) enter into repurchase agreements if, as a result thereof, more
than 10% of the Fund's total assets (taken at market value at the time of
each investment) would be subject to repurchase agreements maturing in more
than seven days.
(15) enter into reverse repurchase agreements if, as a result
thereof, the Fund's obligations with respect to reverse repurchase
agreements would exceed one-third of the Fund's net assets (defined to be
total assets, taken at market value, less liabilities other than reverse
repurchase agreements).
(16) invest more than 25% of its total assets (taken at market
value at the time of each investment) in the securities of issuers in any
particular industry (other than U.S. Government securities, government
agency securities or bank money instruments).
RESTRICTIONS APPLICABLE TO EACH OF THE FUNDS (EXCEPT THE DOMESTIC MONEY MARKET
FUND AND THE RESERVE ASSETS FUND)
Under the fundamental investment restrictions, each of the Funds (unless
noted otherwise below) may not:
1. Make any investment inconsistent with the Fund's classification as
a diversified company under the Investment Company Act.(1)
2. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).(2)
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(1) The Developing Capital Markets Focus, Global Bond Focus, Global Strategy
Focus, Index 500, and Natural Resource Focus Funds are classified as
non-diversified investment companies under the Investment Company Act, and
therefore this restriction is not applicable to those Funds.
(2) For purposes of this restriction, states, municipalities and their political
subdivisions are not considered to be part of any industry, and utilities
will be divided according to their services; for example, gas, gas
transmission, electricity, telecommunications and water each will be
considered a separate industry for purposes of this restriction. In
addition, this restriction will not restrict (i) the Global Utility Focus
Fund, under normal circumstances, from investing 65% or more of its total
assets in equity and debt securities issued by domestic and foreign
companies in the utilities industries (i.e., electricity,
telecommunications, gas or water), and (ii) the Natural Resources Focus Fund
from investing greater than 25% of its assets in gold- related companies.
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3. Make investments for the purpose of exercising control or
management.(3)
4. Purchase or sell real estate, except that the Fund may invest in
securities directly or indirectly secured by real estate or interests
therein or issued by companies which invest in real estate or interests
therein.
5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Prospectus and Statement
of Additional Information, as they may be amended from time to time.
6. Issue senior securities to the extent such issuance would violate
applicable law.
7. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) the Fund may borrow up
to an additional 5% of its total assets for temporary purposes, (iii) the
Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (iv) the Fund
may purchase securities on margin to the extent permitted by applicable
law.
The Fund may not pledge its assets other than to secure such borrowings or,
to the extent permitted by the Fund's investment policies as set forth in
the Prospectus and Statement of Additional Information, as they may be
amended from time to time, in connection with hedging transactions, short
sales, when-issued and forward commitment transactions and similar
investment strategies.
8. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933
in selling portfolio securities.
9. Purchase or sell commodities or contracts on commodities, except
to the extent the Fund may do so in accordance with applicable law and the
Prospectus and Statement of Additional Information, as they may be amended
from time to time, and without registering as a commodity pool operator
under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, each of the Funds
(unless noted otherwise below) may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law. As a matter of
policy, however, the Fund will not purchase shares of any registered
open-end investment company or registered unit investment trust, in
reliance on Section 12(d)(1)(F) or (G) (the "fund of funds" provisions) of
the Investment Company Act, at any time its shares are owned by another
investment company that is part of the same group of investment companies
as the Fund.
b. Engage in short sales of securities or maintain a short position
except to the extent permitted by applicable law. The Fund does not
currently intend to engage in short sales or maintain a short position,
except for short sales "against the box."(4)
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(3) In the case of the Global Growth Focus Fund, investments in wholly-owned
investment entities created under the laws of certain countries will not be
deemed to be the making of investments for the purpose of exercising control
or management.
(4) The Global Bond Focus, Global Strategy Focus, International Equity Focus,
Global Growth Focus and Natural Resources Focus Funds may maintain short
positions in forward currency contracts, options, futures contracts and
options on futures contracts.
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c. Invest in securities which cannot be readily resold because of
legal or contractual restrictions or which cannot otherwise be marketed,
redeemed or put to the issuer or a third party, if at the time of
acquisition more than 15% of its total assets would be invested in such
securities. This restriction shall not apply to securities which mature
within seven days or securities which the Board of Directors has otherwise
determined to be liquid pursuant to applicable law. Securities purchased in
accordance with Rule 144A under the Securities Act and determined to be
liquid by the Board of Directors of the Company are not subject to the
limitations set forth in this investment restriction.
d. Invest in warrants if, at the time of acquisition, its investments
in warrants, valued at the lower of cost or market value, would exceed 5%
of the Fund's total assets; included within such limitation, but not to
exceed 2% of the Fund's total assets, are warrants which are not listed on
the New York Stock Exchange or American Stock Exchange or a major foreign
exchange. For purposes of this restriction, warrants acquired by the Fund
in units or attached to securities may be deemed to be without value.(5)
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, except to
the extent permitted under applicable law. This restriction shall not apply
to mortgage-backed securities, asset-backed securities or obligations
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities.(6)
f. Purchase or retain the securities of any issuer, if those
individual officers and directors of the Company, the officers and general
partner of the Investment Adviser, the directors of such general partner or
the officers and directors of any subsidiary thereof each owning
beneficially more than one-half of one percent of the securities of such
issuer own in the aggregate more than 5% of the securities of such
issuer.(7)
g. Invest in real estate limited partnership interests or interests
in oil, gas or other mineral leases, or exploration or development
programs, except that the Fund may invest in securities issued by companies
that engage in oil, gas or other mineral exploration or development
activities.(8)
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
i. Notwithstanding fundamental investment restriction number 7 above,
borrow amounts in excess of 5% (20% in the case of the Developing Capital
Markets Focus and Global Bond Focus Funds 10% in the case of the Global
Strategy Focus, Government Bond, International Equity Focus and Natural
Resources Focus Funds, and 33 1/3% in the case of the Global Growth Focus
Fund) of the total assets of the Fund, taken at market value, and then only
from banks as a temporary measure for extraordinary or emergency purposes
such as the redemption of Fund shares.(9)
j. Pledge greater than 10% (20% in the case of the Developing Capital
Markets Focus Fund) of its total assets, taken at market value at the time
of the pledge. For the purpose of this restriction, collateral arrangements
with respect to (i) transactions in options, foreign currency contracts,
futures contracts and
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(5) This restriction is not applicable to the Global Growth Focus Fund and the
Capital Focus Fund.
(6) This restriction is not applicable to the Global Growth Focus Fund and the
Capital Focus Fund.
(7) This restriction is not applicable to the Global Growth Focus Fund and the
Capital Focus Fund.
(8) This restriction is not applicable to the Global Growth Focus Fund and the
Capital Focus Fund.
(9) In addition, the American Balanced, Basic Value Focus, Developing Capital
Markets Focus, Special Value Focus, Global Strategy Focus, High Current
Income, Natural Resources Focus, Prime Bond and Quality Equity Funds will
not purchase securities while borrowings are outstanding, except, in the
case of the Developing Capital Markets Focus Fund, (a) to honor prior
commitments or (b) to exercise subscription rights where outstanding
borrowings have been obtained exclusively for settlements of other
securities transactions. The Global Bond Focus, Global Utility Focus,
International Equity Focus and Global Growth Focus Funds will not purchase
securities while borrowings in excess of 5% of its total assets are
outstanding.
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options on futures contracts and (ii) initial and variation margin are not
deemed to be a pledge of assets.(10)
k. Lend its portfolio securities in excess of 20% of its total assets
(33 1/3% in the case of the Global Growth Focus Fund), taken at market
value at the time of the loan, provided however that the Quality Equity
Fund may only make loans to New York Stock Exchange Member firms, other
brokerage firms having net capital of at least $10 million and financial
institutions, such as registered investment companies, banks and insurance
companies, having at least $10 million in capital and surplus.
l. In the case of the Global Utility Focus Fund only, invest less
than 65% of its total assets in equity and debt securities issued by
domestic and foreign companies in the utilities industries, except during
temporary defensive periods.
m. In the case of each of the American Balanced Fund, the Basic Value
Focus Fund, the Special Value Focus Fund, the High Current Income Fund, the
Prime Bond Fund and the Quality Equity Fund, invest in the securities of
foreign issuers except that each such Fund (except the American Balanced
Fund) may invest in securities of foreign issuers if at the time of
acquisition no more than 10% (25% in the case of the Quality Equity Fund)
of its total assets, taken at market value at the time of the investment,
would be invested in such securities. Consistent with the general policy of
the Securities and Exchange Commission, the nationality or domicile of an
issuer for determination of foreign issuer status may be (i) the country
under whose laws the issuer is organized, (ii) the country in which the
issuer's securities are principally traded, or (iii) a country in which the
issuer derives a significant proportion (at least 50%) of its revenues or
profits from goods produced or sold, investments made, or services
performed in the country, or in which at least 50% of the assets of the
issuer are situated. See "Other Portfolio Strategies-Foreign Securities" in
the Prospectus.(11)
OVER-THE-COUNTER OPTIONS
The staff of the Securities and Exchange Commission has taken the position
that purchased over-the-counter ("OTC") options and the assets used as cover for
written OTC options are illiquid securities. Therefore, the Company has adopted
an investment policy pursuant to which it will not purchase or sell OTC options
if, as a result of such transactions, the sum of the market value of OTC options
currently outstanding which are held by a Fund, the market value of the
underlying securities covered by OTC call options currently outstanding which
were sold by the Fund and margin deposits on the Fund's existing OTC options on
futures contracts exceeds 15% of the total assets of the Fund, taken at market
value, together with all other assets of the Fund which are illiquid or are
otherwise not readily marketable. However, if an OTC option is sold by a Fund to
a primary U.S. Government securities dealer recognized by the Federal Reserve
Bank of New York and if the Fund has the unconditional contractual right to
repurchase such OTC option from the dealer at a predetermined price, then the
Fund will treat as illiquid such amount of the underlying securities equal to
the repurchase price less the amount by which the option is "in-the-money"
(i.e., current market value of the underlying securities minus the option's
strike price). The repurchase price with the primary dealers is typically a
formula price which is generally based on a multiple of the premium received for
the option, plus the amount by which the option is "in-the-money." This policy
as to OTC options is not a fundamental policy of any Fund and may be amended by
the Directors of the Company without the approval of the Company's shareholders.
However, the Company will not change or modify this policy prior to the change
or modification by the Commission staff of its position.
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(10) The Capital Focus Fund and Global Growth Focus Fund each are permitted to
pledge their assets to secure borrowings.
(11) Notwithstanding this restriction, each of the Prime Bond Fund and the High
Current Income Fund may invest up to 25% of its total assets in securities
(i) issued, assumed or guaranteed by foreign governments, or political
subdivisions or instrumentalities thereof, (ii) assumed or guaranteed by
domestic issuers, including Eurodollar securities or (iii) issued, assumed
or guaranteed by foreign issuers having a class of securities listed for
trading on the New York Stock Exchange.
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RESTRICTED SECURITIES
From time to time a Fund may invest in securities the disposition of which
is subject to legal restrictions, such as restrictions imposed by the Securities
Act of 1933 (the "Securities Act") on the resale of securities acquired in
private placements. If registration of such securities under the Securities Act
is required, such registration may not be readily accomplished and if such
securities may be sold without registration, such resale may be permissible only
in limited quantities. In either event, a Fund may not be able to sell its
restricted securities at a time which, in the judgment of the Investment
Adviser, would be most opportune.
Each of the Funds is subject to limitations on the amount of securities
which are illiquid, because of restrictions under the Securities Act or
otherwise, they may purchase. Each Fund may, however, purchase without regard to
that limitation securities that are not registered under the Securities Act, but
that can be offered and sold to "qualified institutional buyers" under Rule 144A
under the Securities Act, provided that the Company's Board of Directors
continuously determines, based on the trading markets for the specific Rule 144A
security, that it is liquid. The Board of Directors may adopt guidelines and
delegate to the Investment Adviser the daily function of determining and
monitoring liquidity of restricted securities. The Board has determined that
securities which are freely tradeable in their primary market offshore should be
deemed liquid. The Board, however, will retain sufficient oversight and be
ultimately responsible for the determinations.
Since it is not possible to predict with assurance exactly how the market
for restricted securities sold and offered under Rule 144A will develop, the
Board of Directors will carefully monitor the Fund's investments in these
securities, focusing on such factors, among others, as valuation, liquidity and
availability of information. This investment practice could have the effect of
increasing the level of illiquidity in a Fund to the extent that qualified
institutional buyers become for a time uninterested in purchasing these
restricted securities.
PORTFOLIO STRATEGIES
Liquidity. In order to assure that each Fund has sufficient liquidity, as
a matter of operating policy no Fund may invest more than 10% of its net assets,
except that each of the Developing Capital Markets Focus Fund, Global Growth
Focus Fund and Capital Focus Fund may not invest more than 15% of its net assets
in securities for which market disposition is not readily available. Market
disposition may not be readily available for repurchase agreements maturing in
more than seven days and for securities having restrictions on resale.
Lending of Portfolio Securities. Subject to any applicable investment
restriction above, each Fund may from time to time loan securities from its
portfolio to brokers, dealers and financial institutions and receive collateral
in cash, securities issued or guaranteed by the U.S. Government or, in the case
of the Domestic Money Market and Reserve Assets Fund, cash equivalents which
while the loan is outstanding will be maintained at all times in an amount equal
to at least 100% of the current market value of the loaned securities. Such cash
collateral will be invested in short-term securities, the income from which will
increase the return to the Fund. The Fund will retain all rights of beneficial
ownership as to the loaned portfolio securities, including voting rights and
rights to interest or other distributions, and will have the right to regain
record ownership of loaned securities to exercise such beneficial rights. Such
loans will be terminable at any time. The Fund may pay reasonable finders',
administrative and custodial fees to persons unaffiliated with the Fund in
connection with the arranging of such loans. The dividends, interest and other
distributions received by the Company on loaned securities may, for tax
purposes, be treated as income other than qualified income for the 90% test
discussed under "Dividends, Distributions and Taxes-Federal Income Taxes." The
Company intends to lend portfolio securities only to the extent that such
activity does not jeopardize the Company's qualification as a regulated
investment company under Subchapter M of the Internal Revenue Code of 1986, as
amended.
Forward Commitments. Securities may be purchased or sold on a delayed
delivery basis or may be purchased on a forward commitment basis by each of the
Company's Funds at fixed purchase terms with periods of up to 180 days between
the commitment and settlement dates. The purchase will be recorded on the date
the purchasing Fund enters into the commitment and the value of security will
thereafter be reflected in the calculation of the Fund's net asset value. The
value of the security on the delivery date may be more or less than its purchase
price. A separate account of the Fund will be established with The Bank of New
York or Brown Brothers Harriman & Co. (for Developing Capital Markets Focus
Fund) (the "Custodian") consisting of cash or liquid securities having a market
value at all times until the delivery date at least equal to the amount of its
commitments in connection with such delayed delivery and purchase transactions.
Although a Fund will
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generally enter into forward commitments with the intention of acquiring
securities for its portfolio, it may dispose of a commitment prior to settlement
if the Investment Adviser deems it appropriate to do so. There can, of course,
be no assurance that the judgment upon which these techniques are based will be
accurate or that such techniques when applied will be effective. The Funds will
enter into forward commitment arrangements only with respect to securities in
which they may otherwise invest as described under "Investment Objectives and
Policies of the Funds" in the Prospectus.
Eurodollar and Yankeedollar Obligations. The Reserve Assets Fund (and, for
temporary or defensive purposes, the Natural Resources Focus, Global Strategy
Focus, Global Bond Focus, Global Utility Focus, International Equity Focus,
Developing Capital Markets Focus and the Quality Equity Funds) may invest in
obligations issued by foreign branches or subsidiaries of U.S. banks
("Eurodollar" obligations), by U.S. branches or subsidiaries of foreign banks
("Yankeedollar" obligations), or by foreign depository institutions and their
foreign branches and subsidiaries ("foreign bank obligations"). Investment in
such obligations may involve different risks from the risks of investing in
obligations of U.S. banks. Such risks include adverse political and economic
developments, the possible imposition of withholding taxes on interest income
payable on such obligations, the possible seizure or nationalization of foreign
deposits and the possible establishment of exchange controls or other foreign
governmental laws or restrictions which might adversely affect the payment of
principal and interest. Generally the issuers of such obligations are subject to
fewer U.S. regulatory requirements than are applicable to U.S. banks. Foreign
depository institutions and their foreign branches and subsidiaries, and foreign
branches or subsidiaries of U.S. banks, may be subject to less stringent reserve
requirements than U.S. banks. U.S. branches or subsidiaries of foreign banks are
subject to the reserve requirements of the state in which they are located.
There may be less publicly available information about a foreign depository
institution, branch or subsidiary, or a U.S. branch or subsidiary of a foreign
bank, than about a U.S. bank, and such institutions may not be subject to the
same accounting, auditing and financial record keeping standards and
requirements as U.S. banks. Evidence of ownership of Eurodollar and foreign bank
obligations may be held outside of the United States, and a Fund may be subject
to the risks associated with the holding of such property overseas. Eurodollar
and foreign bank obligations of the Fund held overseas will be held by foreign
branches of the Custodian for the Fund or by other U.S. or foreign banks under
subcustodian arrangements complying with the requirements of the Investment
Company Act of 1940.
The Investment Adviser will consider the above factors in making
investments in Eurodollar, Yankeedollar and foreign bank obligations and will
not knowingly purchase obligations which, at the time of purchase, are subject
to exchange controls or withholding taxes. Generally, the Reserve Assets Fund
will limit its Yankeedollar investments to obligations of banks organized in
Canada, France, Germany, Japan, the Netherlands, Switzerland, the United Kingdom
and other western industrialized nations.
Standby Commitment Agreements. The High Current Income Fund, Global
Utility Focus Fund, International Equity Focus Fund, Global Growth Focus Fund
and Developing Capital Markets Focus Fund may from time to time enter into
standby commitment agreements. Such agreements commit a Fund, for a stated
period of time, to purchase a stated amount of a fixed income security which may
be issued and sold to the Fund at the option of the issuer. The price and coupon
of the security is fixed at the time of the commitment. At the time of entering
into the agreement the Fund is paid a commitment fee, regardless of whether or
not the security is ultimately issued, which is typically approximately 0.5% of
the aggregate purchase price of the security which the Fund has committed to
purchase. A Fund will enter into such agreements only for the purpose of
investing in the security underlying the commitment at a yield and price which
is considered advantageous to the Fund. A Fund will not enter into a standby
commitment with a remaining term in excess of 45 days and will limit its
investment in such commitments so that the aggregate purchase price of the
securities subject to such commitments, together with the value of portfolio
securities subject to legal restrictions on resale, will not exceed 10% of its
assets taken at the time of acquisition of such commitment or security. A Fund
will at all times maintain a segregated account with its custodian of cash or
liquid securities in an amount equal to the purchase price of the securities
underlying the commitment.
There can be no assurance that the securities subject to a standby
commitment will be issued and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Since the issuance of
the security underlying the commitment is at the option of the issuer, a Fund
may bear the risk of a decline in the value of such security and may not benefit
from an appreciation in the value of the security during the commitment period.
11
<PAGE> 222
The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
can reasonably be expected to be issued and the value of the security will
thereafter be reflected in the calculation of a Fund's net asset value. If the
security is issued, the cost basis of the security will be adjusted by the
amount of the commitment fee. In the event the security is not issued, the
commitment fee will be recorded as income on the expiration date of the standby
commitment.
12
<PAGE> 223
MANAGEMENT OF THE COMPANY
Information about the Directors and executive officers of the Company,
their ages and principal occupations for at least the last five years are set
forth below. Unless otherwise noted, the address of each executive officer and
director is P.O. Box 9011, Princeton, New Jersey 08543-9011.
ARTHUR ZEIKEL (64) -- President and Director(1)(2) -- Chairman of the
Investment Adviser and Fund Asset Management, L.P. ("FAM") (which terms as used
here, include their corporate predecessors) since 1997; President of the
Investment Adviser and FAM from 1977 to 1997; Chairman of Princeton Services,
Inc. ("Princeton Services") since 1997, Director since 1993 and President from
1993 to 1997; Executive Vice President of Merrill Lynch & Co., Inc. ("ML&Co.")
since 1990.
JOE GRILLS (62) -- Director -- P.O. Box 98 Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") since 1986, member of CIEBA's Executive Committee since 1988
and its Chairman from 1991 to 1992; Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds from 1986 until 1993; Member of the Investment Advisory
Committee of the State of New York Common Retirement Fund; Member of the
Investment Advisory Committee of the Howard Hughes Medical Institute; Director,
Duke Management Company since 1993; Director, LaSalle Street Fund since 1995;
Director, Kimco Realty Corporation since January 1997.
WALTER MINTZ (68) -- Director -- 1114 Avenue of the Americas, New York, New
York 10036. Special Limited Partner of Cumberland Partners (investment
partnership) since 1982.
MELVIN R. SEIDEN (67) -- Director -- 780 Third Avenue, Suite 2502, New
York, New York 10017. Director of Silbanc Properties, Ltd. (real estate,
consulting and investments) since 1996 and President thereof since 1987;
Chairman and President of Seiden & de Cuevas, Inc. (private investment firm)
from 1964 to 1987.
ROBERT S. SALOMON, JR. (61) -- Director -- 106 Dolphin Cove Quay, Stamford,
Connecticut 06902. Principal of STI Management (investment adviser); Chairman
and CEO of Salomon Brothers Asset Management from 1992 until 1995; Chairman of
Salomon Brothers equity mutual funds from 1992 until 1995; Director of Stock
Research and U.S. Equity Strategist at Salomon Brothers from 1975 until 1991.
Director, Common Fund.
STEPHEN B. SWENSRUD (64) -- Director -- 24 Federal Street, Suite 400,
Boston, Massachusetts 02110. Chairman of Fernwood Associates (financial
consultants) since 1996; Principal, Fernwood Associates (financial consultant)
since 1975.
TERRY K. GLENN (57) -- Executive Vice President(1)(2)--Executive Vice
President of the Investment Adviser and FAM since 1983; Executive Vice President
and Director of Princeton Services since 1993; President of the Distributor
since 1986 and Director thereof since 1991; President of Princeton
Administrators, L.P. since 1988.
NORMAN HARVEY (64) -- Senior Vice President(1)(2) -- Senior Vice President
of the Investment Adviser and FAM since 1982.
JOSEPH T. MONAGLE, JR. (49) -- Senior Vice President(1)(2) -- Senior Vice
President of the Investment Adviser since 1990; Department Head of the Global
Fixed Income Division of the Investment Adviser since 1997; Senior Vice
President of Princeton Services since 1993.
CHRISTOPHER G. AYOUB (42) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1998; Vice President of the Investment
Adviser from 1985 to 1997.
DONALD C. BURKE (37) -- Vice President(1)(2) -- First Vice President of the
Investment Adviser since 1997; Vice President of the Investment Adviser from
1990 to 1997; and Director of Taxation of the Investment Adviser since 1990.
13
<PAGE> 224
JAY C. HARBECK (63) -- Senior Vice President(1)(2) -- First Vice President
of the Investment Adviser since 1997; Vice President of the Investment Adviser
from 1986 to 1997.
VINCENT T. LATHBURY, III (57) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997; Vice President of the Investment
Adviser and FAM and Portfolio Manager of the Investment Adviser and FAM from
1982 to 1997.
GRACE PINEDA (41) -- Senior Vice President(1)(2) -- First Vice President of
the Investment Adviser since 1997; Vice President of the Investment Adviser from
1989 to 1997. Prior to joining the Investment Adviser, Ms. Pineda was a
portfolio manager with Clemente Capital, Inc.
KEVIN RENDINO (31) -- Senior Vice President(1)(2) -- First Vice President
of the Investment Adviser since 1997; Vice President of the Investment Adviser
from December 1993 to 1997; Senior Research Analyst from 1990 to 1992; Corporate
Analyst from 1988 to 1990.
THOMAS R. ROBINSON (54) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997; Senior Portfolio Manager of the
Investment Adviser from November 1995 to 1997; Manager of International Equity
Strategy of ML&Co.'s Global Securities Research and Economics Group from 1989 to
1995.
JACQUELINE ROGERS (39) -- Vice President(1)(2) -- Vice President of the
Investment Adviser since January 1986.
WALTER D. ROGERS (55) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997; Vice President of the Investment
Adviser from 1987 to 1997; Vice President of Continental Insurance Asset
Management from 1984 to 1987.
PAOLO VALLE (40) -- Senior Vice President -- First Vice President of the
Investment Adviser since 1997; Vice President of the Investment Adviser from
1992 to 1997.
R. ELISE BAUM (37) -- Vice President(1)(2) -- Director of the Investment
Adviser since 1997; Vice President of the Investment Adviser from 1995 to 1997;
Senior Fund Analyst from 1994-1995; Fund Analyst from 1993-1994; Consultant from
1992-1993.
DANIEL V. SZEMIS (38) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997; Vice President of the Investment
Adviser from 1996 to 1997; Portfolio Manager with Prudential Mutual Fund
Investment Management Advisors from 1990 to 1996.
KURT SCHANSINGER (37) -- Vice President(1)(2) -- First Vice President of
the Investment Adviser since 1997; Vice President of the Investment Adviser from
1996 to 1997. Prior to joining the Investment Adviser, Mr. Schansinger spent 12
years with Oppenheimer Capital, where he rose to Senior Vice President.
LAWRENCE R. FULLER (57) -- Vice President(1)(2) -- Vice President of the
Investment Adviser since 1992.
ROBERT SHEARER (42) -- Senior Vice President(1)(2) -- First Vice President
of the Investment Adviser since January 1998; Vice President from 1997 to 1998;
Vice President and Assistant Portfolio Manager at David L. Babson and Company,
Incorporated from 1996 to 1997; Vice President/Section Manager at Concert
Capital Management from 1993 to 1996.
ERIC S. MITOFSKY (43) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997; Vice President of the Investment
Adviser from 1992 to 1997; Senior Desk Analyst with Merrill Lynch Program
Trading Desk from 1987 to 1992.
KEVIN J. MCKENNA (41) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997; Vice President of the Investment
Adviser from 1985 to 1997.
ROBERT F. MURRAY (40) -- Vice President(1)(2) -- Vice President of the
Investment Adviser since 1993. Employed by the Investment Adviser since 1989.
GERALD M. RICHARD (48) -- Treasurer(1)(2) -- Senior Vice President and
Treasurer of the Investment Adviser and FAM since 1984; Treasurer of the
Distributor since 1984 and Vice President since 1981; and Senior Vice President
and Treasurer of Princeton Administrators, Inc. since 1988.
14
<PAGE> 225
JENNIFER L. SAWIN (36) -- Secretary(1)(2) -- Vice President of the
Investment Adviser since 1998; Attorney associated with the Investment Adviser
and FAM since 1995. Prior to 1995 Ms. Sawin was an attorney in private practice.
- ---------------
(1) Interested person, as defined in the Investment Company Act of 1940, of the
Company.
(2) The Officers of the Company are officers of certain other investment
companies for which the Investment Adviser or FAM acts as investment
adviser.
Pursuant to the terms of the Investment Advisory Agreements, the Investment
Adviser pays all compensation of officers and employees of the Company as well
as the fees of all directors of the Company who are affiliated persons of
Merrill Lynch & Co., Inc. or its subsidiaries. The Company pays each Director
not affiliated with the Company (each a "non-interested Director") a fee of
$5,000 per year plus $1,250 for each quarterly meeting of the Board of Directors
attended, $5,000 per year for serving on the Audit Committee of the Board of
Directors plus $1,250 for each meeting of the Audit Committee attended if such
meeting is held on a day other than a day on which the Board of Directors meets,
and reimbursement of out-of-pocket expenses. For the year ended December 31,
1997, such fees and expenses aggregated $99,375.
The following table sets forth for the fiscal year ended December 31, 1997,
compensation paid by the Company to the non-interested Directors and for the
calendar year ended December 31, 1997, the aggregate compensation paid by all
investment companies (including the Company) advised by the Investment Adviser
and its affiliate, FAM ("MLAM/FAM Advised Funds") to the non-interested
Directors:
<TABLE>
<CAPTION>
PENSION OR RETIREMENT TOTAL COMPENSATION FROM
AGGREGATE BENEFITS ACCRUED COMPANY AND
COMPENSATION AS PART OF MLAM/FAM ADVISED
NAME OF DIRECTOR FROM COMPANY COMPANY EXPENSE FUNDS PAID TO DIRECTORS(1)
---------------- ----------------- ---------------------- ---------------------------
<S> <C> <C> <C>
Walter Mintz(1)......................... $20,000 NONE $159,500
Melvin R. Seiden(1)..................... $20,000 NONE $159,500
Stephen B. Swendsrud(1)................. $20,000 NONE $175,500
Joe Grills(1)........................... $20,000 NONE $171,500
Robert S. Salomon, Jr.(1)............... $20,000 NONE $159,500
</TABLE>
- ---------------
(1) The Directors serve on the boards of other MLAM/FAM Advised Funds as
follows: Mr. Grills (21 registered investment companies consisting of 49
portfolios); Mr. Mintz (20 registered investment companies consisting of 39
portfolios); Mr. Salomon (20 registered investment companies consisting of
39 portfolios); Mr. Seiden (20 registered investment companies consisting of
39 portfolios); and Mr. Swensrud (23 registered investment companies
consisting of 54 portfolios).
Mr. Zeikel and the officers of the Company owned on March 31, 1997 in the
aggregate less than 1% of the outstanding Common Stock of Merrill Lynch & Co.,
Inc. The Company has an Audit Committee consisting of all of the directors of
the Company who are not interested persons of the Company.
15
<PAGE> 226
INVESTMENT ADVISORY ARRANGEMENTS
The Company has entered into seven separate investment advisory
agreements (the "Investment Advisory Agreements") relating to the Funds with
Merrill Lynch Asset Management, L.P. ("MLAM"), the Investment Adviser (the
"Investment Advisor"), a wholly owned subsidiary of Merrill Lynch & Co., Inc.
The principal business address of the Investment Adviser is 800 Scudders Mill
Road, Plainsboro, New Jersey 08536. The Investment Adviser or its affiliate Fund
Asset Management, L.P. ("FAM") currently acts as the investment adviser to over
140 other registered investment companies.
The principal executive officers and directors of the Investment Adviser
are Jeffery M. Peek, President, Arthur Zeikel, Chairman; Terry K. Glenn,
Executive Vice President; Robert W. Crook, Senior Vice President; Linda L.
Federici, Senior Vice President; Vincent R. Giordano, Senior Vice President;
Elizabeth Griffin, Senior Vice President; Norman R. Harvey, Senior Vice
President; Michael J. Hennewinkel, Senior Vice President; Philip L. Kirstein,
Senior Vice President, General Counsel, Director and Secretary; Ronald M. Kloss,
Senior Vice President and Controller; Debra W. Landsman-Yaros, Senior Vice
President; Richard L. Reller, Senior Vice President; Stephen M. M. Miller,
Senior Vice President; Joseph T. Monagle, Jr., Senior Vice President; Michael L.
Quinn, Senior Vice President; Gerald M. Richard, Senior Vice President and
Treasurer; Gregory Upah, Senior Vice President; Ronald L. Welburn, Senior Vice
President; and Anthony Wiseman, Senior Vice President.
Securities held by any Fund may also be held by other funds for which the
Investment Adviser or FAM acts as an adviser or by investment advisory clients
of the Investment Adviser. Because of different investment objectives or other
factors, a particular security may be bought for one or more clients when one or
more clients are selling the same security. If purchases or sales of securities
for any Fund or other funds for which the Investment Adviser or FAM acts as
investment adviser or for their advisory clients arise for consideration at or
about the same time, transactions in such securities will be made, insofar as
feasible, for the respective funds and clients in a manner deemed equitable to
all. To the extent that transactions on behalf of more than one client of the
Investment Adviser or FAM during the same period may increase the demand for
securities being purchased or the supply of securities being sold, there may be
an adverse effect on price.
Advisory Fee. As compensation for its services to the Company and its
Funds, the Investment Adviser receives a fee from the Company at the end of each
month at an annual rate of 0.75% of the average daily net assets of each of the
Special Value Focus Fund, Global Growth Focus Fund, and International Equity
Focus Fund, 0.60% of the average daily net assets of the Capital Focus Fund,
0.65% of the average daily net assets of each of the Natural Resources Focus
Fund and Global Strategy Focus Fund, 0.55% of the average daily net assets of
the American Balanced Fund, 0.50% of the average daily net assets of the
Domestic Money Market Fund and Government Bond Fund, 0.60% of the average daily
net assets of the Basic Value Focus Fund, Global Bond Focus Fund and Global
Utility Focus Fund, 1.00% of the average daily net assets of the Developing
Capital Markets Focus Fund, 0.30% of the average daily net assets of the Index
500 Fund and at the following annual rates with respect to the other Funds:
RESERVE ASSETS FUND
Portion of average daily value of net assets of the Fund:
<TABLE>
<CAPTION>
ADVISORY
FEE
--------------
<S> <C>
Not exceeding $500 million.................................. 0.500%
In excess of $500 million but not exceeding $750 million.... 0.425%
In excess of $750 million but not exceeding $1 billion...... 0.375%
In excess of $1 billion but not exceeding $1.5 billion...... 0.350%
In excess of $1.5 billion but not exceeding $2 billion...... 0.325%
In excess of $2 billion but not exceeding $2.5 billion...... 0.300%
In excess of $2.5 billion................................... 0.275%
</TABLE>
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<PAGE> 227
QUALITY EQUITY FUND
Portion of average daily value of net assets of the Fund:
<TABLE>
<S> <C>
Not exceeding $250 million................................ 0.500%
In excess of $250 million but not exceeding $500
million................................................. 0.450%
In excess of $300 million but not exceeding $400
million................................................. 0.425%
In excess of $400 million................................. 0.400%
</TABLE>
PRIME BOND FUND AND HIGH CURRENT INCOME FUND
Portion of aggregate average daily value of net assets of both Funds:
<TABLE>
<CAPTION>
ADVISORY FEE
----------------------------------
HIGH CURRENT PRIME BOND
INCOME FUND FUND
---------------- ----------------
<S> <C> <C>
Not exceeding $250 million.................................. 0.55% 0.50%
In excess of $250 million but not more than $500 million.... 0.50% 0.45%
In excess of $500 million but not more than $750 million.... 0.45% 0.40%
In excess of $750 million................................... 0.40% 0.35%
</TABLE>
These fee rates for the Prime Bond Fund and High Current Income Fund are
applied to the average daily net assets of each Fund, with the reduced rates
shown below applicable to portions of each Fund to the extent that the aggregate
of the average daily net assets of the combined Fund exceed $250 million, $300
million, $400 million and $800 million (each such amount being a "breakpoint
level"). The portion of the assets of a Fund to which the rate at each
breakpoint level applies will be determined on a "uniform percentage" basis. The
uniform percentage applicable to a breakpoint level is determined by dividing
the amount of the aggregate of the average daily net assets of the combined Fund
that falls within that breakpoint level by the aggregate of the average daily
net assets of the combined Fund. The amount of the fee for a Fund at each
breakpoint level is determined by multiplying the average daily net assets of
that Fund by the uniform percentage applicable to that breakpoint level and
multiplying the product by the advisory fee rate.
The Investment Adviser and Merrill Lynch Life Agency, Inc. ("MLLA")
entered into two reimbursement agreements, dated April 30, 1985 and February 11,
1992 and amended effective October 9, 1997 (as so amended, the "Reimbursement
Agreements"), that provide that the expenses paid by each Fund (excluding
interest, taxes, brokerage fees and commissions and extraordinary charges such
as litigation costs, and excluding the distribution fees if any imposed on Class
B shares of such Fund) will be limited to 1.25% of its average net assets. Any
such expenses in excess of this percentage will be reimbursed to the Fund by the
Investment Adviser which, in turn, will be reimbursed by MLLA. The Reimbursement
Agreements may be amended or terminated by the parties thereto upon prior
written notice to the Company. For the fiscal year ended December 31, 1997, the
Investment Adviser earned fees of $30,733,366 and reimbursed $217,067 for the
Developing Capital Markets Focus Fund, and $78,164 for the Government Bond Fund.
For the fiscal year ended December 31, 1996, the Investment Adviser earned fees
of $765,718 for the Developing Capital Markets Focus Fund of which $52,388 was
voluntarily waived, $297,926 for the Government Bond Fund of which $264,214 was
voluntarily waived, and $1,638 for the Index 500 Fund, all of which was
voluntarily waived. In addition, the Investment Adviser has also reimbursed the
Index 500 Fund $1,651 in additional expenses. For the fiscal year ended December
31, 1995, the Investment Adviser earned fees of $21,376,742 and reimbursed
$49,477 for the Developing Capital Markets Focus Fund, $190,005 for the
Government Bond Fund and $112,261 for the Global Bond Focus Fund.
The Investment Advisory Agreements relating to the Company's Funds,
unless earlier terminated as described below, will continue in effect from year
to year if approved annually (a) by the Board of Directors of the Company or by
a majority of the outstanding shares of the respective Funds, and (b) by a
majority of the directors who are not parties to such contracts or interested
persons (as defined in the Investment Company Act of 1940) of any such party.
The Board of Directors of the Company approved the continuation of the
Investment Advisory Agreements relating to all Funds, other than the Capital
Focus Fund and Global Growth Focus Fund, at a meeting held on March 31, 1998.
The Board of Directors of the Company approved the Investment Advisory Agreement
relating to the Capital Focus Fund and Global Growth Focus Fund at a meeting
held on March 31,
17
<PAGE> 228
1998. The Investment Advisory Agreements are not assignable and may be
terminated without penalty on 60 days' written notice at the option of either
party or by the vote of the shareholders of the respective Funds.
The Investment Adviser has entered into a sub-advisory agreement (the
"Sub-Advisory Agreement") with MLAM U.K., an indirect wholly owned subsidiary of
ML & Co., and an affiliate of the Investment Adviser, pursuant to which the
Investment Adviser pays MLAM U.K. a fee for providing investment advisory
services to the Investment Adviser with respect to the Funds in an amount to be
determined from time to time by the Investment Adviser and MLAM U.K. but in no
event in excess of the amount that the Investment Adviser actually receives for
providing services to the Funds pursuant to the Investment Advisory Agreement.
The Investment Adviser has entered into administrative services agreements
with certain Insurance Companies, including MLLIC and ML of New York, pursuant
to which the Investment Adviser compensates such companies for administrative
responsibilities relating to the Company which are performed by such Insurance
Companies.
Payment of Expenses. The Investment Advisory Agreements obligate the
Investment Adviser to provide investment advisory services and to pay all
compensation of and furnish office space for officers and employees of the
Company connected with investment and economic research, trading and investment
management of the Funds, as well as the fees of all directors of the Company who
are affiliated persons of Merrill Lynch & Co., Inc. or any of its subsidiaries.
Each Fund will pay all other expenses incurred in its operation, including a
portion of the Company's general administrative expenses allocated on the basis
of the Fund's asset size. Expenses that will be borne directly by the Funds
include redemption expenses, expenses of portfolio transactions, shareholder
servicing costs, expenses of registering the shares under federal and state
securities laws, pricing costs (including the daily calculation of net asset
value), interest, certain taxes, charges of the Custodian and Transfer Agent and
other expenses attributable to a particular Fund. Expenses which will be
allocated on the basis of size of the respective Funds include directors' fees,
legal expenses, state franchise taxes, auditing services, costs of printing
proxies and stock certificates, Securities and Exchange Commission fees,
accounting costs and other expenses properly payable by the Company and
allocable on the basis of size of the respective Funds. Accounting services are
provided for the Company by the Investment Adviser, and the Company reimburses
the Investment Adviser for its costs in connection with such services. For the
fiscal year ended December 31, 1997, the amount of such reimbursement was
$1,157,644. Depending upon the nature of the lawsuit, litigation costs may be
directly applicable to the Funds or allocated on the basis of the size of the
respective Funds. The Board of Directors has determined that this is an
appropriate method of allocation of expenses.
DETERMINATION OF NET ASSET VALUE
As set forth in the Prospectus, since the net investment income of the
Domestic Money Market and Reserve Assets Funds (including realized gains and
losses on its portfolio securities) is declared as a dividend each time the net
income of the Funds are determined (see "Dividends, Distributions and Taxes"),
the net asset value per share of the Funds normally remains at $1.00 per share
immediately after each such determination and dividend declaration. The Board of
Directors of the Company expects that the Domestic Money Market and Reserve
Assets Funds will have a positive net income at the time of each determination.
If for any reason the net income of either Fund is a negative amount (i.e., net
realized and unrealized losses and expenses exceed interest income), that Fund
will reduce the number of its outstanding shares. This reduction will be
effected by having the Separate Accounts of the Insurance Companies
proportionately contribute to the capital of the Fund the necessary shares that
represent the amount of the excess upon such determination. It is anticipated
that the Insurance Companies will agree to such contribution in these
circumstances. Any such contribution will be treated as a negative dividend for
purposes of the Net Investment Factor under the Contracts described in the
Prospectus for the Contracts. See "Dividends, Distributions and Taxes" for a
discussion of the tax effect of such a reduction. This procedure will permit the
net asset value per share of the Domestic Money Market and Reserve Assets Funds
to be maintained at a constant value of $1.00 per share.
If in the view of the Board of Directors of the Company it is inadvisable
to continue the practice of maintaining the net asset value of the Domestic
Money Market and Reserve Assets Funds at $1.00 per share, the Board of Directors
of the Company reserves the right to alter the procedure. The Company will
notify the Insurance Companies of any such alteration.
18
<PAGE> 229
Each of the International Equity Focus Fund, Global Utility Focus Fund,
Global Bond Focus Fund, Global Growth Focus Fund, and Developing Capital Markets
Focus Fund may invest a substantial portion of its assets in foreign securities
which are traded on days on which such Fund's net asset value is not computed.
On any such day, shares of such a Fund may not be purchased or redeemed since
shares of a Fund may only be purchased or redeemed on days on which the Fund's
net asset value is computed.
As set forth in the Prospectus, securities held by the Domestic Money
Market and Reserve Assets Funds with a remaining maturity of 60 days or less are
valued on an amortized cost basis, unless particular circumstances dictate
otherwise. Under this method of valuation, the security is initially valued at
cost on the date of purchase (or in the case of securities purchased with more
than 60 days remaining to maturity, the market value on the 61st day prior to
maturity); and thereafter the Domestic Money Market and Reserve Assets Funds
assume a constant proportionate amortization in value until maturity of any
discount or premium, regardless of the impact of fluctuating interest rates on
the market value of the security. For purposes of this method of valuation, the
maturity of a variable rate certificate of deposit is deemed to be the next
coupon date on which the interest rate is to be adjusted. If, due to the
impairment of the creditworthiness of the issuer of a security held by either
Fund or to other factors with respect to such security, the fair value of such
security is not fairly reflected through the amortized cost method of valuation,
such security will be valued at fair value as determined in good faith by the
Board of Directors.
PORTFOLIO TRANSACTIONS AND BROKERAGE
If the securities in which a particular Fund of the Company invests are
traded primarily in the over-the-counter market, where possible, the Fund will
deal directly with the dealers who make a market in the securities involved,
except in those circumstances where better prices and execution are available
elsewhere. Such dealers usually are acting as principals for their own account.
On occasions, securities may be purchased directly from the issuer. Bonds and
money market securities are generally traded on a net basis and do not normally
involve either brokerage commissions or transfer taxes. The cost of executing
portfolio securities transactions of each Fund will primarily consist of
brokerage commissions or underwriter or dealer spreads. Under the Investment
Company Act of 1940, persons affiliated with the Company are prohibited from
dealing with the Company as a principal in the purchase and sale of the
Company's portfolio securities unless an exemptive order allowing such
transactions is obtained from the Securities and Exchange Commission. Since
over-the-counter transactions are usually principal transactions, affiliated
persons of the Company, including Merrill Lynch Government Securities Inc.
("GSI"), Merrill Lynch Money Markets Inc. ("MMI") and Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"), may not serve as the Company's
dealer in connection with such transactions except pursuant to exemptive orders
from the Securities and Exchange Commission, such as the one described below.
However, affiliated persons of the Company may serve as its broker in
over-the-counter transactions conducted on an agency basis, subject to the
Company's policy of obtaining best price and execution. The Company may not
purchase securities from any underwriting syndicate of which Merrill Lynch is a
member except in accordance with rules and regulations under the Investment
Company Act of 1940.
The Securities and Exchange Commission has issued an exemptive order
permitting the Company to conduct principal transactions with respect to the
Domestic Money Market and Reserve Assets Funds with GSI and MMI in U.S.
Government and government agency securities, and certain other money market
securities, subject to a number of conditions, including conditions designed to
insure that the prices to the Funds available from GSI and MMI are equal to or
better than those available from other sources. GSI and MMI have informed the
Company that they will in no way, at any time, attempt to influence or control
the activities of the Company or the Investment Adviser in placing such
principal transactions. The exemptive order allows GSI and MMI to receive a
dealer spread on any transaction with the Company no greater than their
customary dealer spreads for transactions of the type involved. Certain court
decisions have raised questions as to whether investment companies should seek
to "recapture" brokerage commissions and underwriting and dealer spreads by
effecting their purchases and sales through affiliated entities. In order to
effect such an arrangement, the Company would be required to seek an exemption
from the Investment Company Act so that it could engage in principal
transactions with affiliates. The Board of Directors has considered the
possibilities of seeking to recapture spreads for the benefit of the Company
and, after reviewing all factors deemed relevant, has made a determination not
to seek such recapture at this time. The Board will reconsider this matter from
time to time. The Company will take such steps as may be necessary to effect
recapture, including the filing of applications for exemption under the
19
<PAGE> 230
Investment Company Act of 1940, if the Directors should determine that recapture
is in the best interests of the Company or otherwise required by developments in
the law.
While the Investment Adviser seeks to obtain the most favorable net results
in effecting transactions in the Funds' portfolio securities, dealers who
provide supplemental investment research of the Investment Adviser may receive
orders for transactions by the Funds. Such supplemental research services
ordinarily consist of assessments and analysis of the business or prospects of a
company, industry or economic sector. If, in the judgment of the Investment
Adviser, a particular Fund or Funds will be benefited by such supplemental
research services, the Investment Adviser is authorized to pay spreads or
commissions to brokers or dealers furnishing such services which are in excess
of spreads or commissions which another broker or dealer may charge for the same
transaction. Information so received will be in addition to and not in lieu of
the services required to be performed by the Investment Adviser under the
Investment Advisory Agreements. The expenses of the Investment Adviser will not
necessarily be reduced as a result of the receipt of such supplemental
information. In some cases, the Investment Adviser may use such supplemental
research in providing investment advice to its other investment advisory
accounts. For the fiscal year ended December 31, 1997, the Company paid
brokerage commissions of $8,344,021, of which $302,843 was paid to Merrill
Lynch. For the fiscal year ended December 31, 1996, the Company paid brokerage
commissions of $6,656,814 of which $266,405 was paid to Merrill Lynch. For the
fiscal year ended December 31, 1995, the Company paid brokerage commissions of
$5,789,335, of which $264,999 was paid to Merrill Lynch.
PORTFOLIO TURNOVER
Each Fund has a different expected rate of portfolio turnover; however,
rate of portfolio turnover will not be a limiting factor when management of the
Company deems it appropriate to purchase or sell securities for a Fund. Because
of the short-term nature of the securities in which the Domestic Money Market
and Reserve Assets Funds will invest, and because such Funds' investments will
be constantly changing in response to market conditions, no portfolio turnover
rate may be accurately stated for the Domestic Money Market and Reserve Assets
Funds.
Below are portfolio turnover rates for each of the Funds, other than the
Global Growth Focus Fund and the Capital Focus Fund, for the fiscal years ended
December 31, 1997 and December 31, 1996:
<TABLE>
<CAPTION>
1997 1996
---------------- ----------------
<S> <C> <C>
American Balanced Fund...................................... 136.71% 236.50%
Basic Value Focus Fund...................................... 95.52% 68.41%
Developing Capital Markets Focus Fund....................... 93.62% 87.33%
Global Bond Focus Fund*..................................... 568.76% 267.13%
Global Strategy Focus Fund*................................. 108.66% 173.44%
Global Utility Focus Fund................................... 7.70% 11.39%
Government Bond Fund*....................................... 117.65% 21.23%
High Current Income Fund.................................... 53.63% 48.92%
Index 500 Fund.............................................. 36.85% .04%**
International Equity Focus Fund............................. 127.96% 49.87%
Natural Resources Focus Fund................................ 20.93% 31.11%
Prime Bond Fund............................................. 89.22% 91.88%
Quality Equity Fund......................................... 100.08% 88.30%
Special Value Focus Fund.................................... 147.06% 80.84%
</TABLE>
- ---------------
* In connection with a reorganization on December 6, 1996 conducted by the
Company with respect to certain of its Funds, the Company, with the approval
of the affected shareholders of the Funds, caused (i) Global Bond Focus
Fund(a) to acquire substantially all of the assets and assume substantially
all the liabilities of the International Bond Fund, a separate Fund of the
Company, (b) to implement a change in its investment objective and policies
from seeking high current income from a global portfolio of fixed income
securities, including non-investment grade securities, to seeking a high
total investment return by investing in a global portfolio of investment
grade fixed income securities and (c) to change its name from the World
Income Focus Fund to its current name; (ii) the Government Bond Fund (x) to
implement a change in its
20
<PAGE> 231
investment objective so that the Fund may invest in any debt securities
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities without regard to remaining maturity and (y) to change its
name from the Intermediate Government Bond Fund to its current name; and
(iii) the Global Strategy Focus Fund to acquire substantially all of the
assets and assume substantially all the liabilities of the Flexible Strategy
Fund, a separate Fund of the Company. As a result, the portfolio turnover
rates for the fiscal years set forth in the table for the Global Bond Focus
Fund, the Global Strategy Focus Fund and the Government Bond Fund may not be
indicative of future portfolio turnover rates of such Funds.
** For the period from December 13, 1996 (commencement of operations) to
December 31, 1996.
REDEMPTION OF SHARES
The right to redeem shares or to receive payment with respect to any
redemption may only be suspended for any period during which trading on the New
York Stock Exchange is restricted as determined by the Securities and Exchange
Commission or such Exchange is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists as defined by the
Securities and Exchange Commission as a result of which disposal of portfolio
securities or determination of the net asset value of each Fund is not
reasonably practicable, and for such other periods as the Securities and
Exchange Commission may by order permit for the protection of shareholders of
each Fund.
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
Reference is made to "Dividends, Distributions and Taxes" in the Appendix
to the Prospectus.
FEDERAL INCOME TAXES
Under the Internal Revenue Code of 1986, as amended (the "Code"), each Fund
of the Company will be treated as a separate corporation for federal income tax
purposes and, thus, each Fund is required to satisfy the qualification
requirements under the Code for treatment as a regulated investment company.
There will be no offsetting of capital gains and losses among the Funds. Each
Fund intends to continue to qualify as a regulated investment company under
certain provisions of the Code. Under such provisions, a Fund will not be
subject to federal income tax on such part of its net ordinary income and net
realized capital gains which it distributes to shareholders. To qualify for
treatment as a regulated investment company, a Fund must, among other things,
derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans, and gains from the sale or
other disposition of securities. In addition, the Code requires that each Fund
meet certain diversification requirements, including the requirement that not
more than 25% of the value of a Fund's total assets be invested in the
securities (other than U.S. Government securities or the securities of other
regulated investment companies) of any one issuer. Each of the Company's Funds,
including the Natural Resources Focus Fund, intends to comply with the
above-described requirements.
On occasion, some amount of the distributions of the Domestic Money Market
Fund or the Reserve Assets Fund for a fiscal year may constitute a return of
capital, in which case such amount would be applied against and reduce the
Separate Account's tax basis in shares of such Fund. If such amount were to
exceed the Separate Account's tax basis for shares of the Domestic Money Market
Fund or the Reserve Assets Fund, the excess would be treated as gain from the
sale or exchange of such shares.
On occasion the net income of the Domestic Money Market Fund or the Reserve
Assets Fund may be a negative amount as a result of a net decline in the value
of the portfolio securities of the Fund which is in excess of the interest
earned. Consequently, the Fund will reduce the number of its outstanding shares
to reflect the negative net income. The adjustment may result in gross income to
shareholders in excess of the net dividend credited to such shareholders for a
period. In such a case, such shareholders' tax basis in the shares of the
Domestic Money Market Fund or the Reserve Assets Fund may be adjusted to reflect
the difference between taxable income and net dividends actually distributed.
Such difference may be realized as a capital loss when the shares are
liquidated.
21
<PAGE> 232
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury Regulations promulgated thereunder. The Code and these Regulations
are subject to change by legislative or administrative action, and such change
may apply retroactively.
DISTRIBUTION ARRANGEMENTS
The Company has entered into a distribution agreement (the "Distribution
Agreement") with Merrill Lynch Funds Distributor, Inc. with respect to the sale
of the Company's shares to the Distributor for resale to Insurance Companies'
accounts. Such shares will be sold at their respective net asset values and
therefore will involve no sales charge. The Distributor is a wholly owned
subsidiary of the Investment Adviser. The continuation of the previously
existing Distribution Agreement and extension to shares of the Global Growth
Focus Fund and Capital Focus Fund was approved by the Company's Board of
Directors at a meeting held on March 31, 1998.
The Distribution Agreement is subject to the same renewal requirements and
termination provisions as the Investment Advisory Agreements described above.
PERFORMANCE DATA
From time to time the average annual total return and other total return
data, as well as yield, of one or more of the Company's Funds may be included in
advertisements or information furnished to present or prospective Contract
Owners. Total return and yield figures are based on the Fund's historical
performance and are not intended to indicate future performance. Average annual
total return and yield are determined in accordance with formulas specified by
the Securities and Exchange Commission. In connection with its reorganization on
December 6, 1996, the Global Bond Focus Fund (i) acquired substantially all of
the assets and assumed substantially all the liabilities of the International
Bond Fund, a separate Fund of the Company, (ii) implemented a change in its
investment objective and policies from seeking high current income from a global
portfolio of fixed income securities, including non-investment grade securities,
to seeking a high total investment return by investing in a global portfolio of
investment grade fixed income securities and (iii) changed its name from the
World Income Focus Fund to its current name. For the period from the
commencement of the World Income Focus Fund's operations through its
reorganization on December 6, 1996, the portfolio of the Fund included debt
securities rated below investment grade (i.e., junk bonds). On December 6, 1996,
the Government Bond Fund (i) implemented a change in its investment objective so
that the Fund may invest in any debt securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities without regard to remaining
maturity and (ii) changed its name from the Intermediate Government Bond Fund to
its current name. For the period from the commencement of the Fund's operations
through December 6, 1996, the portfolio of the Intermediate Government Bond Fund
consisted primarily of intermediate-term debt securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities with a maximum maturity
not to exceed fifteen years. As a result of the foregoing changes in the
investment objective of each of the Global Bond Focus Fund and the Government
Bond Fund, the performance information set forth herein and in the Prospectus
for the period prior to December 6, 1996 may not be indicative of future
performance of each Fund.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses.
The Reserve Assets Fund and the Domestic Money Market Fund normally compute
annualized yield by determining the net change for a seven-day base period,
exclusive of capital changes, in the value of a hypothetical pre-existing
account having a balance of one share at the beginning of the period, dividing
the net change in account value by the value of the account at the beginning of
the base period to obtain the base period
22
<PAGE> 233
return, and multiplying the base period return by 365 and then dividing by
seven. Under this calculation, the yield does not reflect realized and
unrealized gains and losses on portfolio securities. The Funds may also include
its yield in advertisements, calculated in the same manner as set forth above
but including realized and unrealized gains and losses. The Securities and
Exchange Commission also permits the calculation of a standardized effective or
compounded yield. This is computed by compounding the unannualized base period
return by dividing the base period by seven, adding one to the quotient, raising
the sum to the 365th power, and subtracting one from the result. This compounded
yield calculation also excludes realized or unrealized gains or losses on
portfolio securities.
Set forth below is average annual total return information for the shares
of each of the Company's Funds, other than the Reserve Assets Fund and Domestic
Money Market Fund. The total return quotations may be of limited use for
comparative purposes because they do not reflect charges imposed at the Separate
Account level which, if included, would decrease total return.
AVERAGE ANNUAL TOTAL RETURN
FOR CLASS A SHARES
<TABLE>
<CAPTION>
REDEEMABLE VALUE
EXPRESSED AS A OF A HYPOTHETICAL
PERCENTAGE BASED $1,000 INVESTMENT
ON A HYPOTHETICAL AT THE END
$1,000 INVESTMENT OF THE PERIOD
----------------- -----------------
<S> <C> <C>
PRIME BOND FUND:
One Year Ended December 31, 1997............................ 8.64% $1,086.40
Five Years Ended December 31, 1997.......................... 7.31% 1,422.80
Ten Years Ended December 31, 1997........................... 8.70% 2,302.00
HIGH CURRENT INCOME FUND:
One Year Ended December 31, 1997............................ 11.00% 1,110.00
Five Years Ended December 31, 1997.......................... 10.46% 1,644.70
Ten Years Ended December 31, 1997........................... 12.17% 3,151.90
QUALITY EQUITY FUND:
One Year Ended December 31, 1997............................ 23.70% 1,237.00
Five Years Ended December 31, 1997.......................... 15.14% 2,023.90
Ten Years Ended December 31, 1997........................... 14.99% 4,043.40
SPECIAL VALUE FOCUS FUND:
One Year Ended December 31, 1997............................ 11.72% 1,117.20
Five Years Ended December 31, 1997.......................... 13.99% 1,924.90
Ten Years Ended December 31, 1997........................... 11.81% 3,054.80
INDEX 500 FUND:
One Year Ended December 31, 1997............................ 32.81% 1,328.10
Inception* Through December 31, 1997........................ 33.16% 1,350.50
NATURAL RESOURCES FOCUS FUND:
One Year Ended December 31, 1997............................ (12.52%) 874.80
Five Years Ended December 31, 1997.......................... 4.63% 1,253.80
Inception* Through December 31, 1997........................ 3.33% 1,368.30
AMERICAN BALANCED FUND:
One Year Ended December 31, 1997............................ 17.11% 1,171.10
Five Years Ended December 31, 1997.......................... 11.04% 1,688.10
Inception* Through December 31, 1997........................ 10.83% 2,679.70
</TABLE>
23
<PAGE> 234
<TABLE>
<CAPTION>
REDEEMABLE VALUE
EXPRESSED AS A OF A HYPOTHETICAL
PERCENTAGE BASED $1,000 INVESTMENT
ON A HYPOTHETICAL AT THE END
$1,000 INVESTMENT OF THE PERIOD
----------------- -----------------
<S> <C> <C>
GLOBAL STRATEGY FOCUS FUND:
One Year Ended December 31, 1997............................ 11.94% 1,119.40
Five Years Ended December 31, 1997.......................... 10.82% 1,671.10
Inception* Through December 31, 1997........................ 9.67% 1,714.90
BASIC VALUE FOCUS FUND:
One Year Ended December 31, 1997............................ 20.62% 1,206.20
Inception* Through December 31, 1997........................ 17.26% 2,047.60
GLOBAL BOND FOCUS FUND:
One Year Ended December 31, 1997............................ 1.95% 1,019.50
Inception* Through December 31, 1997........................ 6.07% 1,303.60
GLOBAL UTILITY FOCUS FUND:
One Year Ended December 31, 1997............................ 25.90% $1,259.00
Inception* Through December 31, 1997........................ 12.93% 1,728.50
INTERNATIONAL EQUITY FOCUS FUND:
One Year Ended December 31, 1997............................ (4.55%) 954.50
Inception* Through December 31, 1997........................ 3.95% 1,190.40
DEVELOPING CAPITAL MARKETS FOCUS FUND:
One Year Ended December 31, 1997............................ (6.53%) 934.70
Inception* Through December 31, 1997........................ (0.76%) 972.40
GOVERNMENT BOND FUND:
One Year Ended December 31, 1997............................ 8.88% 1,088.80
Inception* Through December 31, 1997........................ 7.62% 1,309.10
</TABLE>
AVERAGE ANNUAL TOTAL RETURN
FOR CLASS B SHARES
<TABLE>
<CAPTION>
REDEEMABLE VALUE
EXPRESSED AS A OF A HYPOTHETICAL
PERCENTAGE BASED $1,000 INVESTMENT
ON A HYPOTHETICAL AT THE END
$1,000 INVESTMENT OF THE PERIOD
----------------- -----------------
<S> <C> <C>
SPECIAL VALUE FOCUS FUND:
Inception* Through December 31, 1997........................ (11.18%) $888.20
BASIC VALUE FOCUS FUND:
Inception* Through December 31, 1997........................ (0.31%) 996.90
DEVELOPING CAPITAL MARKETS FOCUS FUND:
Inception* Through December 31, 1997........................ (0.86%) 991.40
</TABLE>
- ---------------
* Inception for the Class A Common Stock of the Natural Resources Focus Fund is
June 1, 1988; American Balanced Fund is June 1, 1988; Global Strategy Focus
Fund is February 28, 1992; Basic Value Focus Fund is July 1, 1993; Global Bond
Focus Fund is July 1, 1993; Global Utility Focus Fund is July 1, 1993;
International Equity Focus Fund is July 1, 1993; Developing Capital Markets
Focus Fund is May 2, 1994; Government Bond Fund is May 2, 1994; and Index 500
Fund is December 13, 1996. Inception for the Class B Common Stock of the Basic
Value Focus Fund is November 3, 1997; Developing Capital Markets Focus Fund is
November 3, 1997; and Special Value Focus Fund is October 23, 1997.
24
<PAGE> 235
ADDITIONAL INFORMATION
Under a separate agreement Merrill Lynch has granted the Company the right
to use the "Merrill Lynch" name and has reserved the right to withdraw its
consent to the use of such name by the Company at any time, or to grant the use
of such name to any other company, and the Company has granted Merrill Lynch,
under certain conditions, the use of any other name it might assume in the
future, with respect to any corporation organized by Merrill Lynch.
25
<PAGE> 236
[THIS PAGE INTENTIONALLY LEFT BLANK]
26
<PAGE> 237
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
AND GLOBAL GROWTH FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDER,
CAPITAL FOCUS FUND AND GLOBAL GROWTH FOCUS FUND
OF MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statements of assets and liabilities of Capital
Focus Fund and Global Growth Focus Fund (the "Funds") of Merrill Lynch Variable
Series Funds, Inc. as of April 16, 1998. These financial statements are the
responsibility of the Funds' management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such statements of assets and liabilities present fairly, in all
material respects, the financial position of Capital Focus Fund and Global
Growth Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of April 16,
1998 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
April 16, 1998
27
<PAGE> 238
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CAPITAL FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF APRIL 16, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS:
Cash in Bank................................................ $ 1,000
Deferred organization expenses (Note 3)..................... 13,000
-------
Total assets................................................ 14,000
-------
- ---------------------------------------------------------------------
LIABILITIES:
Accrued expenses............................................ 13,000
-------
- ---------------------------------------------------------------------
Net Assets (equivalent to $10.00 per share on 100 Class A
shares of Common Stock (par value $0.10) outstanding with
100,000,000 shares authorized (Note 1).................... $ 1,000
=======
- ---------------------------------------------------------------------
</TABLE>
NOTES TO STATEMENT OF ASSETS AND LIABILITIES.
(1) Capital Focus Fund (the "Fund") is one of the eighteen funds of Merrill
Lynch Variable Series Funds, Inc. (the "Company") which was organized as a
Maryland corporation on October 16, 1981. The Company is registered under
the Investment Company Act of 1940 as an open-end management investment
company. To date, the Fund has not had any transactions other than those
relating to organizational matters and the sale of 100 Class A shares of
Common Stock to Merrill Lynch Life Insurance Company ("MLLIC").
(2) The Fund has entered into an Investment Advisory Agreement (the "Investment
Advisory Agreement") with Merrill Lynch Asset Management, L.P. (the
"Investment Adviser"), and a distribution plan (the "Distribution Plan")
with Merrill Lynch Funds Distributor, Inc. (the "Distributor"). The general
partner of the Investment Adviser is Princeton Services, Inc., a
wholly-owned subsidiary of Merrill Lynch & Co., Inc. Certain officers and/or
directors of the Company are officers and/or directors of the Investment
Adviser and/or the Distributor.
(3) Deferred organization expenses will be amortized over a period from the date
the Fund commences operations not exceeding five years. In the event that
the Investment Adviser (or any subsequent holder) redeems any of its
original shares prior to the end of the five-year period, the proceeds of
the redemption payable in respect of such shares shall be reduced by the pro
rata share (based on the proportionate share of the original shares redeemed
to the total number of original shares outstanding at the time of
redemption) of the unamortized deferred organization expenses as of the date
of such redemption. In the event that the Fund is liquidated prior to the
end of the five-year period, the Investment Adviser (or any subsequent
holder) shall bear the unamortized deferred organization expenses.
28
<PAGE> 239
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF APRIL 16, 1998
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS:
Cash in Bank................................................ $ 1,000
Deferred organization expenses (Note 3)..................... 13,000
-------
Total assets................................................ 14,000
-------
- ---------------------------------------------------------------------
LIABILITIES:
Accrued expenses............................................ 13,000
-------
- ---------------------------------------------------------------------
Net Assets (equivalent to $10.00 per share on 100 Class A
shares of Common Stock (par value $0.10) outstanding with
100,000,000 shares authorized (Note 1).................... $ 1,000
=======
- ---------------------------------------------------------------------
</TABLE>
NOTES TO STATEMENT OF ASSETS AND LIABILITIES.
(1) Global Growth Focus Fund (the "Fund") is one of the eighteen funds of
Merrill Lynch Variable Series Funds, Inc. (the "Company") which was
organized as a Maryland corporation on October 16, 1981. The Company is
registered under the Investment Company Act of 1940 as an open-end
management investment company. To date, the Fund has not had any
transactions other than those relating to organizational matters and the
sale of 100 Class A shares of Common Stock to Merrill Lynch Life Insurance
Company ("MLLIC").
(2) The Fund has entered into an Investment Advisory Agreement (the "Investment
Advisory Agreement") with Merrill Lynch Asset Management, L.P. (the
"Investment Adviser"), and a distribution plan (the "Distribution Plan")
with Merrill Lynch Funds Distributor, Inc. (the "Distributor"). The general
partner of the Investment Adviser is Princeton Services, Inc., a
wholly-owned subsidiary of Merrill Lynch & Co., Inc. Certain officers and/or
directors of the Company are officers and/or directors of the Investment
Adviser and/or the Distributor.
(3) Deferred organization expenses will be amortized over a period from the date
the Fund commences operations not exceeding five years. In the event that
the Investment Adviser (or any subsequent holder) redeems any of its
original shares prior to the end of the five-year period, the proceeds of
the redemption payable in respect of such shares shall be reduced by the pro
rata share (based on the proportionate share of the original shares redeemed
to the total number of original shares outstanding at the time of
redemption) of the unamortized deferred organization expenses as of the date
of such redemption. In the event that the Fund is liquidated prior to the
end of the five-year period, the Investment Adviser (or any subsequent
holder) shall bear the unamortized deferred organization expenses.
29
<PAGE> 240
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statements of assets and liabilities, including
the schedules of investments, of American Balanced, Basic Value Focus,
Developing Capital Markets Focus, Domestic Money Market, Global Bond Focus,
Global Strategy Focus, Global Utility Focus, Government Bond, High Current
Income, Index 500, International Equity Focus, Natural Resources Focus, Prime
Bond, Quality Equity, Reserve Assets, and Special Value Focus Funds of Merrill
Lynch Variable Series Funds, Inc. as of December 31, 1997, the related
statements of operations for the year then ended and changes in net assets for
each of the periods in the two-year period then ended, and the financial
highlights for each of the periods presented. These financial statements and the
financial highlights are the responsibility of the Funds' management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1997 by correspondence with the custodians and brokers or other alternative
procedures. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial positions of American Balanced,
Basic Value Focus, Developing Capital Markets Focus, Domestic Money Market,
Global Bond Focus, Global Strategy Focus, Global Utility Focus, Government Bond,
High Current Income, Index 500, International Equity Focus, Natural Resources
Focus, Prime Bond, Quality Equity, Reserve Assets, and Special Value Focus Funds
of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of their operations, the changes in their net assets, and the financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 20, 1998
30
<PAGE> 241
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AEROSPACE 40,000 GenCorp, Inc. .............. $ 1,167,450 $ 1,000,000 0.5%
11,000 +Orbital Sciences
Corporation............... 282,356 327,250 0.2
------------ ------------ -----
1,449,806 1,327,250 0.7
- -----------------------------------------------------------------------------------------------------------------------
AIRLINES 40,800 +US Airways Group Inc. ..... 1,510,369 2,550,000 1.3
- -----------------------------------------------------------------------------------------------------------------------
APPLIANCES 46,800 Sunbeam Corporation......... 1,635,876 1,971,450 1.0
- -----------------------------------------------------------------------------------------------------------------------
AUTO--RELATED 51,500 +Avis Rent-A-Car, Inc. ..... 1,120,992 1,644,781 0.9
59,500 Hertz Corp. (Class A)....... 1,916,588 2,394,875 1.2
------------ ------------ -----
3,037,580 4,039,656 2.1
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE PARTS 46,000 Federal-Mogul Corp. ........ 1,786,846 1,863,000 0.9
- -----------------------------------------------------------------------------------------------------------------------
BANKING 52,300 Bank of New York, Co.,
Inc. ..................... 1,353,566 3,023,594 1.6
32,100 BankAmerica Corp. .......... 1,714,033 2,343,300 1.2
------------ ------------ -----
3,067,599 5,366,894 2.8
- -----------------------------------------------------------------------------------------------------------------------
BANKING & FINANCIAL 45,000 First Union Corporation..... 2,213,132 2,306,250 1.2
- -----------------------------------------------------------------------------------------------------------------------
BROADCASTING/CABLE 26,200 +Chancellor Media Corp. .... 1,661,883 1,955,175 1.0
92,376 +Tele-Communications, Inc.
(Class A)................. 1,505,409 2,574,981 1.3
52,824 +Tele-Communications TCI
Ventures Group............ 860,848 1,495,579 0.8
------------ ------------ -----
4,028,140 6,025,735 3.1
- -----------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES 49,600 +Gartner Group, Inc. (Class
A)........................ 1,682,775 1,847,600 0.9
- -----------------------------------------------------------------------------------------------------------------------
COMMUNICATION EQUIPMENT 70,600 +WorldCom, Inc. ............ 1,895,225 2,135,650 1.1
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES 18,000 +Cisco Systems, Inc. ....... 1,026,042 1,003,500 0.5
10,200 +Microsoft Corp. ........... 1,399,950 1,317,713 0.7
------------ ------------ -----
2,425,992 2,321,213 1.2
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER SOFTWARE 22,700 +BMC Software, Inc. ........ 932,880 1,486,850 0.8
28,000 Computer Associates
International, Inc. ...... 826,665 1,480,500 0.7
------------ ------------ -----
1,759,545 2,967,350 1.5
- -----------------------------------------------------------------------------------------------------------------------
COMPUTERS 11,400 Compaq Computer
Corporation............... 414,789 643,388 0.3
6,600 International Business
Machines Corp. ........... 383,499 690,113 0.4
37,500 +Quantum Corporation........ 1,059,051 752,344 0.4
------------ ------------ -----
1,857,339 2,085,845 1.1
- -----------------------------------------------------------------------------------------------------------------------
CONGLOMERATES 54,600 AlliedSignal Inc. .......... 2,058,394 2,125,988 1.1
77,900 The Dial Corporation........ 1,503,330 1,621,294 0.8
------------ ------------ -----
3,561,724 3,747,282 1.9
- -----------------------------------------------------------------------------------------------------------------------
CONTAINERS 69,100 +Owens-Illinois, Inc. ...... 2,060,288 2,621,481 1.3
- -----------------------------------------------------------------------------------------------------------------------
ELECTRONIC COMPONENTS 27,000 General Electric Company.... 1,901,801 1,981,125 1.0
- -----------------------------------------------------------------------------------------------------------------------
ELECTRONICS 53,000 +National Semiconductor
Corporation............... 2,148,196 1,374,687 0.7
- -----------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT 21,500 Royal Caribbean Cruises
Ltd. ..................... 937,070 1,146,219 0.6
- -----------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 11,100 American Express Company.... 705,395 990,675 0.5
43,100 MGIC Investment Corp. ...... 1,645,089 2,866,150 1.5
------------ ------------ -----
2,350,484 3,856,825 2.0
- -----------------------------------------------------------------------------------------------------------------------
HARDWARE & TOOLS 34,600 The Black & Decker
Corporation............... 1,181,145 1,351,563 0.7
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
31
<PAGE> 242
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INSURANCE 30,000 Hartford Life, Inc. (Class
A)........................ $ 1,026,133 $ 1,359,375 0.7%
69,000 Provident Companies,
Inc. ..................... 2,280,888 2,665,125 1.4
52,800 Travelers Group, Inc. ...... 1,895,669 2,844,600 1.5
18,200 Travelers Property Casualty
Corp. (Class A)........... 736,471 800,800 0.4
40,400 UNUM Corporation............ 1,296,640 2,196,750 1.1
------------ ------------ -----
7,235,801 9,866,650 5.1
- -----------------------------------------------------------------------------------------------------------------------
LEISURE & TOURISM 72,300 Brunswick Corporation....... 1,851,165 2,191,594 1.1
- -----------------------------------------------------------------------------------------------------------------------
MACHINERY 27,000 Harnischfeger Industries,
Inc. ..................... 1,169,988 953,437 0.5
54,100 Ingersoll-Rand Co. ......... 1,747,663 2,191,050 1.1
21,000 SPX Corporation............. 1,191,177 1,449,000 0.8
------------ ------------ -----
4,108,828 4,593,487 2.4
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL EQUIPMENT 44,000 DENTSPLY International,
Inc. ..................... 1,110,475 1,342,000 0.7
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL SERVICES 83,985 +HEALTHSOUTH Corporation.... 2,276,673 2,330,584 1.2
- -----------------------------------------------------------------------------------------------------------------------
NATURAL GAS 21,000 Enron Corp. ................ 842,925 872,812 0.4
- -----------------------------------------------------------------------------------------------------------------------
OFFICE EQUIPMENT 24,000 Danka Business Systems PLC
(ADR)(a).................. 1,184,193 382,500 0.2
- -----------------------------------------------------------------------------------------------------------------------
OIL SERVICES 33,400 +Smith International,
Inc. ..................... 1,592,276 2,049,925 1.0
- -----------------------------------------------------------------------------------------------------------------------
PETROLEUM 48,500 Unocal Corp. ............... 1,762,226 1,882,406 1.0
- -----------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 21,500 Bristol-Myers Squibb
Company................... 2,042,518 2,034,437 1.0
32,000 Lilly (Eli) & Co. .......... 2,019,878 2,228,000 1.1
28,000 Pfizer, Inc. ............... 2,048,305 2,087,750 1.1
14,000 Warner-Lambert Company...... 2,002,840 1,736,000 0.9
------------ ------------ -----
8,113,541 8,086,187 4.1
- -----------------------------------------------------------------------------------------------------------------------
RAILROADS 18,600 Burlington Northern Santa Fe
Inc. ..................... 1,560,109 1,728,637 0.9
- -----------------------------------------------------------------------------------------------------------------------
REAL ESTATE INVESTMENT 50,000 Glenborough Realty Trust
TRUSTS Inc. ..................... 1,250,000 1,481,250 0.8
55,200 Prentiss Properties Trust... 1,242,693 1,542,150 0.8
24,000 Starwood Lodging Trust...... 1,080,000 1,389,000 0.7
------------ ------------ -----
3,572,693 4,412,400 2.3
- -----------------------------------------------------------------------------------------------------------------------
RESTAURANTS 30,000 +Tricon Global Restaurants,
Inc. ..................... 1,031,641 871,875 0.4
- -----------------------------------------------------------------------------------------------------------------------
RETAIL 23,000 +Safeway Inc. .............. 1,255,380 1,454,750 0.8
31,400 Sears, Roebuck & Co. ....... 1,397,894 1,420,850 0.7
39,000 Wal-Mart Stores, Inc. ...... 1,610,128 1,538,062 0.8
------------ ------------ -----
4,263,402 4,413,662 2.3
- -----------------------------------------------------------------------------------------------------------------------
RETAIL--DRUG STORES 43,760 Rite Aid Corp. ............. 1,513,691 2,568,165 1.3
- -----------------------------------------------------------------------------------------------------------------------
TRANSPORT SERVICES 44,000 +OMI Corporation............ 569,909 404,250 0.2
- -----------------------------------------------------------------------------------------------------------------------
TRAVEL & LODGING 40,500 Carnival Corp. (Class A).... 1,233,934 2,242,687 1.2
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES 37,500 Texas Utilities Company..... 1,496,485 1,558,594 0.8
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES--COMMUNICATIONS 73,400 Edison International........ 1,422,534 1,995,563 1.0
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES--GAS 37,200 El Paso Natural Gas Co. .... 1,927,997 2,473,800 1.3
- -----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS 91,161,430 109,154,853 56.0
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
32
<PAGE> 243
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
INDUSTRY AMOUNT FIXED-INCOME INVESTMENTS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FINANCIAL SERVICES $ 2,000,000 General Electric Capital
Corp., 8.75% due
5/21/2007................. $ 2,249,100 $ 2,351,460 1.2%
- -----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 2,759,945 Federal Home Loan Mortgage
MORTGAGE-BACKED Corp., Pool #10036, 7.50%
OBLIGATIONS** due 6/01/2007............. 2,812,557 2,834,353 1.5
Federal National Mortgage
Association, Pool:
3,676,648 #50933, 6% due 11/01/2000... 3,639,882 3,656,831 1.9
8,041,482 #313201, 6% due 6/01/2001... 7,959,811 7,986,559 4.1
4,580,174 #313202, 6% due 2/01/2004... 4,525,784 4,547,517 2.3
------------ ------------ -----
18,938,034 19,025,260 9.8
- -----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT OBLIGATIONS 22,930,000 US Treasury Bonds, 6.625%
due 2/15/2027............. 21,847,692 24,893,267 12.8
US Treasury Notes:
9,000,000 6% due 8/15/1999............ 9,024,609 9,043,560 4.6
18,000,000 6.50% due 5/31/2002......... 18,120,938 18,525,960 9.5
5,200,000 6.25% due 2/15/2007......... 5,176,281 5,365,724 2.8
------------ ------------ -----
54,169,520 57,828,511 29.7
- -----------------------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS 75,356,654 79,205,231 40.7
- -----------------------------------------------------------------------------------------------------------------------
SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER* 5,373,000 General Motors Acceptance
Corp., 6.75% due
1/02/1998................. 5,370,985 5,370,985 2.8
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 5,370,985 5,370,985 2.8
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS........... $171,889,069 193,731,069 99.5
============
OTHER ASSETS LESS
LIABILITIES............... 1,015,935 0.5
------------ -----
NET ASSETS.................. $194,747,004 100.0%
============ =====
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper is traded on a discount basis; the interest rate shown is the
discount rate paid at the time of purchase by the Fund.
** Mortgage-Backed Obligations are subject to principal paydowns as a result of
prepayments or refinancing of the underlying mortgage instrument. As a
result, the average life may be substantially less than original maturity.
(a) American Depositary Receipts (ADR).
+ Non-income producing security.
See Notes to Financial Statements.
33
<PAGE> 244
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$171,889,069) (Note
1a)....................................................... $193,731,069
Cash........................................................ 557
Receivables:
Interest.................................................. $1,108,578
Dividends................................................. 120,121
Capital shares sold....................................... 181 1,228,880
----------
Prepaid expenses and other assets........................... 13,360
------------
Total assets................................................ 194,973,866
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser (Note 2)............................... 96,123
Securities purchased...................................... 66,779
Capital shares redeemed................................... 31,433 194,335
----------
Accrued expenses and other liabilities...................... 32,527
------------
Total liabilities........................................... 226,862
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $194,747,004
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 1,174,224
Paid-in capital in excess of par............................ 150,194,272
Undistributed investment income--net........................ 6,345,477
Undistributed realized capital gains on investments--net.... 15,191,031
Unrealized appreciation on investments--net................. 21,842,000
------------
NET ASSETS.................................................. $194,747,004
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $194,747,004 and 11,742,245
shares outstanding........................................ $ 16.59
============
- ---------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
34
<PAGE> 245
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1c & 1d):
Interest and discount earned................................ $ 6,237,455
Dividends................................................... 1,314,159
-----------
Total income................................................ 7,551,614
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $1,102,076
Accounting services (Note 2)................................ 41,545
Custodian fees.............................................. 26,889
Professional fees........................................... 25,268
Transfer agent fees (Note 2)................................ 5,010
Directors' fees and expenses................................ 3,275
Pricing services............................................ 533
Other....................................................... 1,532
----------
Total expenses.............................................. 1,206,128
-----------
Investment income--net...................................... 6,345,486
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN ON INVESTMENTS--NET (NOTES 1b, 1d
& 3):
Realized gain on investments--net........................... 15,251,840
Change in unrealized appreciation on investments--net....... 9,866,947
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $31,464,273
===========
- --------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
35
<PAGE> 246
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
<S> <C> <C>
- -----------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 6,345,486 $ 7,339,770
Realized gain on investments--net........................... 15,251,840 21,869,723
Change in unrealized appreciation/depreciation on
investments--net............................................ 9,866,947 (9,430,963)
------------ ------------
Net increase in net assets resulting from operations........ 31,464,273 19,778,530
------------ ------------
- -----------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1e):
Investment income--net:
Class A................................................... (3,604,297) (7,882,096)
Realized gain on investments--net:
Class A................................................... (20,656,058) (328,715)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................... (24,260,355) (8,210,811)
------------ ------------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital share
transactions................................................ (24,503,928) (12,432,919)
------------ ------------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (17,300,010) (865,200)
Beginning of year........................................... 212,047,014 212,912,214
------------ ------------
End of year*................................................ $194,747,004 $212,047,014
============ ============
- -----------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 6,345,477 $ 3,604,288
============ ============
- -----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
36
<PAGE> 247
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A
FINANCIAL STATEMENTS. --------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year....................... $ 16.01 $ 15.17 $ 13.08 $ 14.08 $ 12.85
-------- -------- -------- -------- --------
Investment income--net................................... .54 .53 .59 .48 .32
Realized and unrealized gain (loss) on
investments--net....................................... 1.87 .89 2.06 (1.06) 1.37
-------- -------- -------- -------- --------
Total from investment operations......................... 2.41 1.42 2.65 (.58) 1.69
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................. (.27) (.56) (.56) (.37) (.34)
Realized gain on investments--net...................... (1.56) (.02) -- -- (.12)
In excess of realized gain on investments--net......... -- -- -- (.05) --
-------- -------- -------- -------- --------
Total dividends and distributions........................ (1.83) (.58) (.56) (.42) (.46)
-------- -------- -------- -------- --------
Net asset value, end of year............................. $ 16.59 $ 16.01 $ 15.17 $ 13.08 $ 14.08
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share....................... 17.11% 9.73% 20.81% (4.19%) 13.49%
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................. .60% .60% .61% .63% .70%
======== ======== ======== ======== ========
Investment income--net................................... 3.17% 3.39% 4.22% 3.95% 3.20%
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................... $194,747 $212,047 $212,912 $158,951 $115,420
======== ======== ======== ======== ========
Portfolio turnover....................................... 136.71% 236.50% 38.40% 35.36% 12.55%
======== ======== ======== ======== ========
Average commission rate paid**........................... $ .0608 $ .0610 -- -- --
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
** For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share of purchases and
sales of equity securities.
See Notes to Financial Statements.
37
<PAGE> 248
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. American Balanced Fund (the "Fund") is classified as
"diversified", as defined in the Investment Company Act of 1940. The following
is a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Short-term securities are valued
at amortized cost, which approximates market value. Securities for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity and debt markets. Losses may arise due to
changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premium paid (or received) is added to (or deducted from) the basis of the
security acquired or deducted from (or added to) the proceeds of the security
sold. When an option expires (or the Fund enters into a closing transaction),
the Fund realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the closing
transaction exceeds the premium paid or received).
Written options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(e) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
38
<PAGE> 249
- --------------------------------------------------------------------------------
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.55% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc. (MLPF&S), a subsidiary of ML & Co., earned $6,237 in commissions on the
execution of portfolio security transactions.
For the year ended December 31, 1997, Merrill Lynch Security Pricing Service,
an affiliate of MLPF&S, earned $248 for providing security price quotations to
compute the Fund's net asset value.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $246,639,319 and $291,661,740, respectively.
Net realized and unrealized gains(losses) as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains
- --------------------------------------------------------------------
<S> <C> <C>
Long-term investments................. $15,251,895 $21,842,000
Short-term investments................ (55) --
----------- -----------
Total................................. $15,251,840 $21,842,000
=========== ===========
- --------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $21,622,632, of which $24,791,879 related to appreciated
securities and $3,169,247 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$172,108,437.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$24,503,928 and $12,432,919 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 62,221 $ 951,862
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 1,723,037 24,260,354
---------- ------------
Total issued......................... 1,785,258 25,212,216
Shares redeemed...................... (3,285,875) (49,716,144)
---------- ------------
Net decrease......................... (1,500,617) $(24,503,928)
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 578,134 $ 8,724,352
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 554,530 8,210,811
---------- ------------
Total issued......................... 1,132,664 16,935,163
Shares redeemed...................... (1,921,234) (29,368,082)
---------- ------------
Net decrease......................... (788,570) $(12,432,919)
========== ============
- -----------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.807862 per Class A Share and a long-term capital
gains distribution in the amount of $1.044927 per Class A Share payable on
January 9, 1998 to shareholders of record as of December 31, 1997.
39
<PAGE> 250
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
LOW PRICE TO BOOK VALUE
- ----------------------------------------------------------------------------------------------------------------------
METALS--NON FERROUS 450,000 ASARCO Inc. ............... $ 12,726,022 $ 10,096,875 1.5%
HEALTH MAINTENANCE ORGANIZATIONS 270,000 Aetna, Inc. ................ 21,409,730 19,051,875 2.8
INFORMATION PROCESSING 500,000 +Apple Computer, Inc. ...... 10,502,715 6,531,250 1.0
RETAIL 1,700,000 +Charming Shoppes, Inc. .... 7,070,329 7,862,500 1.2
COMPUTER SERVICES 700,000 +Compuserve Corporation .... 8,005,978 8,487,500 1.3
INFORMATION PROCESSING 275,000 +Digital Equipment Corporation... 9,623,430 10,175,000 1.5
TECHNOLOGY 879,200 +Exabyte Corporation ....... 10,803,293 5,659,850 0.8
SEMICONDUCTORS 750,000 +Integrated Device
Technology, Inc. ......... 8,372,460 7,031,250 1.1
RETAIL 1,000,000 +Kmart Corporation.......... 11,285,019 11,562,500 1.7
SOFTWARE 1,137,500 +Mentor Graphics Corporation... 11,232,266 11,019,531 1.6
SOFTWARE 1,450,000 +Novell, Inc. .............. 11,396,972 10,784,375 1.6
COMPUTER SERVICES 950,000 Scitex Corporation
Ltd.(ADR)(a).............. 10,783,715 11,340,625 1.7
COMPUTER SERVICES 275,000 +Seagate Technology,
Inc. ..................... 8,002,248 5,293,750 0.8
BEVERAGE & ENTERTAINMENT 500,000 Seagram Company Ltd. (The)... 17,915,499 16,156,250 2.4
INSURANCE 400,000 TIG Holdings, Inc. ......... 11,728,529 13,275,000 2.0
INSURANCE 275,000 Travelers Property Casualty
Corp. (Class A)........... 9,762,500 12,100,000 1.8
TELECOMMUNICATIONS 450,000 +U S West Media Group,
Inc. ..................... 8,483,690 12,993,750 1.9
STEEL 1,050,000 +WHX Corporation (b)........ 10,356,874 12,468,750 1.9
BANKING 50,000 Wells Fargo & Company....... 12,746,277 16,971,875 2.5
OIL--INTERNATIONAL 350,000 Yacimentos Petroliferos
Fiscales S.A. (ADR)(a).... 7,185,793 11,965,625 1.8
------------ ------------ -----
219,393,339 220,828,131 32.9
- ----------------------------------------------------------------------------------------------------------------------
BELOW-AVERAGE PRICE/EARNINGS RATIO
- ----------------------------------------------------------------------------------------------------------------------
CHEMICALS 125,000 duPont (E.I.) de Nemours &
Co. ...................... 7,462,998 7,507,812 1.1
AUTOMOTIVE 190,000 Ford Motor Company.......... 6,177,479 9,250,625 1.4
AUTOMOTIVE 200,000 General Motors
Corporation............... 10,702,284 12,125,000 1.8
CHEMICALS 330,000 Great Lakes Chemical
Corporation............... 14,477,567 14,808,750 2.2
ENTERTAINMENT 425,400 +Harrah's Entertainment,
Inc. ..................... 7,997,140 8,029,425 1.2
BANKING 600,000 Hibernia Corporation (Class
A)........................ 7,345,555 11,287,500 1.7
CHEMICALS 255,300 Hercules Inc. .............. 12,362,092 12,780,956 1.9
INFORMATION PROCESSING 120,000 International Business
Machines Corp. ........... 8,367,029 12,547,500 1.9
RETAIL 300,000 +Woolworth Corporation...... 6,448,726 6,112,500 0.9
------------ ------------ -----
81,340,870 94,450,068 14.1
- ----------------------------------------------------------------------------------------------------------------------
ABOVE-AVERAGE YIELD
- ----------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 300,000 AT&T Corp. ................. 10,658,850 18,375,000 2.7
BANKING 100,000 Bankers Trust New York
Corporation............... 7,867,192 11,243,750 1.7
PHARMACEUTICALS 80,000 Bristol-Myers Squibb Co. ... 3,296,133 7,570,000 1.1
PUBLISHING 250,000 Dow Jones & Company,
Inc. ..................... 9,759,114 13,421,875 2.0
OIL SERVICES 250,000 Dresser Industries, Inc. ... 7,730,690 10,484,375 1.6
PHOTOGRAPHY 312,300 Eastman Kodak Company....... 20,301,369 18,991,744 2.8
MACHINERY 400,000 ITT Industries Inc. ........ 9,221,079 12,550,000 1.9
FOREST PRODUCTS & PAPER 250,000 International Paper
Company .................. 10,177,464 10,781,250 1.6
FOREST PRODUCTS & PAPER 500,000 Louisiana-Pacific
Corporation .............. 11,883,702 9,500,000 1.4
OIL--DOMESTIC 400,000 Occidental Petroleum
Corporation............... 9,176,500 11,725,000 1.7
PHARMACEUTICALS 475,000 Pharmacia & Upjohn, Inc. ... 15,746,539 17,396,875 2.6
TOBACCO 250,000 Philip Morris Companies,
Inc. ..................... 10,534,180 11,328,125 1.7
RETAIL TRADE 200,000 Sears, Roebuck & Co. ....... 9,011,460 9,050,000 1.3
SERVICES 350,000 Tupperware Corporation...... 9,336,800 9,756,250 1.5
STEEL 400,000 USX-US Steel Group, Inc. ... 11,903,144 12,500,000 1.9
OIL--DOMESTIC 250,000 Unocal Corporation.......... 9,725,214 9,703,125 1.4
------------ ------------ -----
166,329,430 194,377,369 28.9
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
40
<PAGE> 251
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SPECIAL SITUATIONS
- ----------------------------------------------------------------------------------------------------------------------
HEALTH MAINTENANCE ORGANIZATIONS 650,600 +Humana, Inc. .............. $ 12,749,489 $ 13,499,950 2.0%
AEROSPACE & DEFENSE 122,000 Lockheed Martin
Corporation............... 11,801,919 12,017,000 1.8
MEDICAL SERVICES 725,000 +Pharmaceutical Product
Development, Inc. ........ 13,229,805 11,146,875 1.7
FOREST PRODUCTS & PAPER 1,000,000 +Stone Container
Corporation............... 14,226,851 10,437,500 1.6
SEMICONDUCTORS 200,000 Texas Instruments Inc. ..... 8,820,882 9,000,000 1.3
OIL--DOMESTIC 500,000 Union Texas Petroleum
Holdings, Inc. ........... 11,533,850 10,406,250 1.5
BEVERAGE & ENTERTAINMENT 400,000 +Viacom, Inc. (Class B)..... 11,321,864 16,575,000 2.5
------------ ------------ -----
83,684,660 83,082,575 12.4
- ----------------------------------------------------------------------------------------------------------------------
TOTAL STOCKS 550,748,299 592,738,143 88.3
- ----------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SHORT-TERM SECURITIES
- ----------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER* $ 9,634,000 Atlantic Asset
Securitization Corp.,
5.90% due 1/12/1998....... 9,615,053 9,615,053 1.4
157,000 CIT Group Holdings, Inc.
(The), 6.75% due
1/02/1998................. 156,941 156,941 0.0
15,000,000 Corporate Receivables Corp.,
5.75% due 1/14/1998....... 14,966,458 14,966,458 2.2
15,132,000 General Electric Capital
Corp., 6.75% due
1/02/1998................. 15,126,326 15,126,326 2.3
Lexington Parker Capital
LLC:
9,485,000 5.89% due 1/07/1998......... 9,474,137 9,474,137 1.4
11,000,000 5.90% due 1/21/1998......... 10,962,142 10,962,142 1.6
10,000,000 Riverwoods Funding Corp.,
5.80% due 1/08/1998....... 9,987,111 9,987,111 1.5
10,000,000 WCP Funding Inc., 5.875% due
1/09/1998................. 9,985,313 9,985,313 1.5
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 80,273,481 80,273,481 11.9
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS........... $631,021,780 673,011,624 100.2
============
LIABILITIES IN EXCESS OF
OTHER ASSETS.............. (1,338,685) (0.2)
------------ -----
NET ASSETS.................. $671,672,939 100.0%
============ =====
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Non-income producing security.
* Commercial Paper is traded on a discount basis; the interest rates shown are
the discount rates paid at the time of purchase by the Fund.
(a) American Depositary Receipts (ADR).
(b) Investments in companies 5% or more of whose outstanding securities are held
by the Fund (such companies are defined as "Affiliated Companies" in section
2(a)(3) of the Investment Company Act of 1940) are as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
NET SHARE NET DIVIDEND
INDUSTRY AFFILIATE ACTIVITY COST INCOME
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Steel WHX Corporation 240,700 $1,733,666 +
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Non-income producing security.
See Notes to Financial Statements.
41
<PAGE> 252
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$631,021,780) (Note
1a)....................................................... $673,011,624
Receivables:
Securities sold........................................... $1,503,776
Dividends................................................. 828,105
Capital shares sold....................................... 637,125 2,969,006
----------
Deferred organization expenses (Note 1e).................... 720
Prepaid expenses and other assets........................... 36,788
------------
Total assets................................................ 676,018,138
------------
- -----------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 3,747,053
Investment adviser (Note 2)............................... 354,686
Capital shares redeemed................................... 23,398 4,125,137
----------
Accrued expenses and other liabilities...................... 220,062
------------
Total liabilities........................................... 4,345,199
------------
- -----------------------------------------------------------------------------------------
NET ASSETS.................................................. $671,672,939
============
- -----------------------------------------------------------------------------------------
NET ASSET CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... $ 4,237,711
Class B Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... 2,197
Paid-in capital in excess of par............................ 522,248,964
Undistributed investment income--net........................ 7,897,468
Undistributed realized capital gains on investments--net.... 95,296,755
Unrealized appreciation on investments--net................. 41,989,844
------------
NET ASSETS.................................................. $671,672,939
============
- -----------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $671,324,915 and 42,377,106
shares outstanding........................................ $ 15.84
============
Class B--Based on net assets of $348,024 and 21,965 shares
outstanding............................................... $ 15.84
============
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
42
<PAGE> 253
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1c & 1d):
Dividends (net of $59,411 foreign withholding tax).......... $ 7,315,648
Interest and discount earned................................ 4,354,162
------------
Total income................................................ 11,669,810
------------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $3,489,377
Accounting services (Note 2)................................ 129,561
Custodian fees.............................................. 56,867
Professional fees........................................... 54,700
Registration fees (Note 1e)................................. 22,558
Directors' fees and expenses................................ 10,215
Transfer agent fees--Class A (Note 2)....................... 5,004
Amortization of organization expenses (Note 1e)............. 720
Pricing services............................................ 298
Distribution fees--Class B (Note 2)*........................ 35
Other....................................................... 2,979
----------
Expenses.................................................... 3,772,314
------------
Investment income--net...................................... 7,897,496
------------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1B, 1D & 3):
Realized gain on investments--net........................... 96,532,191
Change in unrealized appreciation on investments--net....... (914,299)
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $103,515,388
============
- -----------------------------------------------------------------------------------------
</TABLE>
* Class B Shares commenced operations on November 3, 1997.
See Notes to Financial Statements.
43
<PAGE> 254
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
---------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 7,897,496 $ 5,533,281
Realized gain on investments--net........................... 96,532,191 56,406,548
Change in unrealized appreciation/depreciation on
investments--net.......................................... (914,299) 13,550,612
------------ ------------
Net increase in net assets resulting from operations........ 103,515,388 75,490,441
------------ ------------
- -----------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A................................................... (3,224,650) (4,571,085)
Realized gain on investments--net:
Class A................................................... (54,136,801) (16,947,347)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (57,361,451) (21,518,432)
------------ ------------
- -----------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 100,588,838 164,495,262
------------ ------------
- -----------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 146,742,775 218,467,271
Beginning of year........................................... 524,930,164 306,462,893
------------ ------------
End of year*................................................ $671,672,939 $524,930,164
============ ============
- -----------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 7,897,468 $ 3,224,622
============ ============
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
44
<PAGE> 255
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED -----------------------------------------------------------------------
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE PERIOD
FOR THE YEAR ENDED DECEMBER 31, JULY 1, 1993+ TO
---------------------------------------------------- DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................. $ 14.74 $ 13.10 $ 11.10 $ 10.95 $ 10.00
-------- -------- -------- -------- -------
Investment income--net............................... .19 .17 .18 .17 .04
Realized and unrealized gain on investments--net..... 2.52 2.37 2.49 .08 .91
-------- -------- -------- -------- -------
Total from investment operations..................... 2.71 2.54 2.67 .25 .95
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income--net............................. (.09) (.18) (.19) (.10) --
Realized gain on investments--net.................. (1.52) (.72) (.48) -- --
-------- -------- -------- -------- -------
Total dividends and distributions.................... (1.61) (.90) (.67) (.10) --
-------- -------- -------- -------- -------
Net asset value, end of period....................... $ 15.84 $ 14.74 $ 13.10 $ 11.10 $ 10.95
======== ======== ======== ======== =======
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share................... 20.62% 20.69% 25.49% 2.36% 9.50%++
======== ======== ======== ======== =======
- -----------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................. .65% .66% .66% .72% .86%*
======== ======== ======== ======== =======
Investment income--net............................... 1.36% 1.37% 1.68% 2.08% 1.69%*
======== ======== ======== ======== =======
- -----------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)............. $671,325 $524,930 $306,463 $164,307 $47,207
======== ======== ======== ======== =======
Portfolio turnover................................... 95.52% 68.41% 74.10% 60.55% 30.86%
======== ======== ======== ======== =======
Average commission rate paid++++..................... $ .0562 $ .0549 -- -- --
======== ======== ======== ======== =======
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Aggregate total investment return.
++++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities.
See Notes to Financial Statements.
45
<PAGE> 256
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
--------------------
FOR THE PERIOD
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM INFORMATION PROVIDED IN THE NOVEMBER 3, 1997+
FINANCIAL STATEMENTS. TO DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1997
- -----------------------------------------------------------------------------------------------------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period....................................... $ 15.89
--------
Investment income--net..................................................... .01
Realized and unrealized gain on investments--net........................... (.06)
--------
Total from investment operations........................................... (.05)
--------
Net asset value, end of period............................................. $ 15.84
========
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share......................................... (0.31%)++
========
- -----------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................................... .82%*
========
Investment income--net..................................................... 1.27%*
========
- -----------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)................................... $ 348
========
Portfolio turnover......................................................... 95.52%
========
Average commission rate paid............................................... $ .0562
========
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
46
<PAGE> 257
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. Basic Value Focus Fund (the "Fund") is classified as
"diversified", as defined in the Investment Company Act of 1940. The following
is a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Short-term securities are valued
at amortized cost, which approximates market value. Securities for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity and debt markets. Losses may arise due to
changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premiums received is added to (or deducted from) the basis of the security
acquired or deducted from (or added to) the proceeds of the security sold. When
an option expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums received (or
gain or loss to the extent the cost of the closing transaction exceeds the
premium received).
Written options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(e) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a five-year period.
(f) Dividends and distributions to shareholders--Dividends and distributions
paid by the Fund are recorded on the ex-dividend dates.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
47
<PAGE> 258
- --------------------------------------------------------------------------------
Agreement and Distribution Plan with Merrill Lynch Funds Distributor, Inc.
("MLFD" or "Distributor"), a wholly-owned subsidiary of Merrill Lynch Group,
Inc.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.60% of the average daily value of the Fund's net assets.
Pursuant to the Distribution Plan adopted by the Company, pursuant to Rule
12b-1 under the Investment Company Act of 1940, the Fund pays the Distributor an
ongoing distribution fee each month at the annual rate of 0.15% of the average
daily value of the Fund's Class B net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc., a subsidiary of ML & Co., earned $30,147 in commissions on the execution
of portfolio security transactions.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, MLFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $545,266,359 and $480,847,418, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Realized Unrealized
Gains(Losses) Gains
- --------------------------------------------------------------------
<S> <C> <C>
Long-term investments.................. $96,532,195 $41,989,844
Short-term investments................. (4) --
----------- -----------
Total.................................. $96,532,191 $41,989,844
=========== ===========
- --------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $40,936,770, of which $73,244,765 related to appreciated
securities and $32,307,995 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$632,074,854.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions was
$100,588,838 and $164,495,262 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares for each class were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Dollar
Ended December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 9,505,073 $141,108,871
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 4,361,868 57,361,452
---------- ------------
Total issued......................... 13,866,941 198,470,323
Shares redeemed...................... (7,112,265) (98,226,048)
---------- ------------
Net increase......................... 6,754,676 $100,244,275
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares For the Year Dollar
Ended December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 11,000,199 $149,832,843
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 1,724,353 21,518,432
---------- ------------
Total issued......................... 12,724,552 171,351,275
Shares redeemed...................... (493,551) (6,856,013)
---------- ------------
Net increase......................... 12,231,001 $164,495,262
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Class B Shares for the Period Dollar
November 3, 1997+ to December 31, 1997 Shares Amount
- ------------------------------------------------------------------
<S> <C> <C>
Shares sold............................... 24,431 $383,980
Shares redeemed........................... (2,466) (39,417)
------ --------
Net increase.............................. 21,965 $344,563
====== ========
- ------------------------------------------------------------------
</TABLE>
+ Commencement of operations.
5. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $1.240376 per Class A Share and $1.238798 per Class B
Share and a long-term capital gains distribution in the amount of $1.218343 per
share for each of the two classes payable on January 9, 1998 to shareholders of
record as of December 31, 1997.
48
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
VALUE PERCENT OF
AFRICA INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SOUTH AFRICA BEVERAGE & 133,850 Rembrandt Group Limited..... $ 1,406,842 $ 976,907 0.7%
TOBACCO 27,000 South African Breweries
Ltd. ..................... 699,038 666,118 0.5
12,090 South African Breweries Ltd.
(ADR)(a).................. 402,167 294,392 0.2
------------ ------------ -----
2,508,047 1,937,417 1.4
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 5,700 +Billiton PLC(g)............ 20,604 14,605 0.0
212,200 +Billiton PLC (ADR)(a)(g)... 775,191 519,890 0.4
185,808 Rembrandt Controlling
Investments Ltd. ......... 1,275,779 916,816 0.6
212,263 Sasol Limited............... 2,554,490 2,225,619 1.6
------------ ------------ -----
4,626,064 3,676,930 2.6
-----------------------------------------------------------------------------------------------------
FINANCIAL 94,740 First National Bank Holdings
SERVICES Ltd. ..................... 584,115 842,415 0.6
19,551 Nedcor Ltd. (Ordinary)...... 245,310 434,109 0.3
------------ ------------ -----
829,425 1,276,524 0.9
-----------------------------------------------------------------------------------------------------
MACHINERY 167,340 Gencor Limited.............. 392,282 276,950 0.2
42,440 Gencor Limited (ADR)(a)..... 129,314 70,204 0.0
------------ ------------ -----
521,596 347,154 0.2
-----------------------------------------------------------------------------------------------------
MERCHANDISING 441,850 Pick'n Pay Stores Limited... 503,577 644,062 0.5
11,179 Pick'n Pay Stores Limited
'N'....................... 16,013 15,169 0.0
------------ ------------ -----
519,590 659,231 0.5
-----------------------------------------------------------------------------------------------------
NEWSPAPER/ 86,300 Nasionale Pers Beperk 'N'... 849,613 709,704 0.5
PUBLISHING
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SOUTH AFRICA 9,854,335 8,606,960 6.1
- ----------------------------------------------------------------------------------------------------------------------------
ZIMBABWE BEVERAGE & 736,377 Delta Corporation Ltd. ..... 733,883 504,368 0.4
TOBACCO
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
ZIMBABWE 733,883 504,368 0.4
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
AFRICA 10,588,218 9,111,328 6.5
- ----------------------------------------------------------------------------------------------------------------------------
EUROPE
- ----------------------------------------------------------------------------------------------------------------------------
GREECE BEVERAGE 166,328 Hellenic Bottling Co.
S.A. ..................... 3,457,017 3,861,552 2.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
GREECE 3,457,017 3,861,552 2.7
- ----------------------------------------------------------------------------------------------------------------------------
HUNGARY BANKING 43,678 OTP Bank (GDR)(b)........... 1,040,028 1,659,764 1.2
-----------------------------------------------------------------------------------------------------
HEALTH/PERSONAL 23,559 Gedeon Richter Ltd.
CARE (GDR)(b).................. 679,857 2,738,734 1.9
1,000 Gedeon Richter Ltd.
(GDR)(b)(e)............... 40,875 116,250 0.1
------------ ------------ -----
720,732 2,854,984 2.0
-----------------------------------------------------------------------------------------------------
</TABLE>
49
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
EUROPE VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
HUNGARY TELECOMMUNICATIONS 27,500 +Magyar TavKozlesi
(CONCLUDED) Reszvenytarsasag, Ltd.
(MATAV) (ADR)(a).......... $ 512,875 $ 715,000 0.5%
563,900 +Magyar TavKozlesi
Reszvenytarsasag, Ltd.
(MATAV) (Ordinary)........ 1,779,623 2,996,851 2.1
------------ ------------ -----
2,292,498 3,711,851 2.6
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
HUNGARY 4,053,258 8,226,599 5.8
- ----------------------------------------------------------------------------------------------------------------------------
POLAND AUTOMOTIVE 31,477 T.C. Debica S.A............. 715,104 769,040 0.5
-----------------------------------------------------------------------------------------------------
BANKING 104,975 Wielkopolsky Bank Kredytowy
S.A....................... 694,747 527,857 0.4
-----------------------------------------------------------------------------------------------------
ELECTRICAL & 293,464 Elektrim Towarzystow
ELECTRONICS Handlowe S.A.............. 2,777,085 2,842,932 2.0
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 92,953 +NIF Piast S.A. ............ 280,910 253,508 0.2
80,240 +NIF Progress............... 249,142 189,202 0.1
------------ ------------ -----
530,052 442,710 0.3
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
POLAND 4,716,988 4,582,539 3.2
- ----------------------------------------------------------------------------------------------------------------------------
PORTUGAL BUILDING PRODUCTS 86,784 Cimpor-Cimentos de Portugal
S.A....................... 1,958,718 2,277,726 1.6
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 11,507 Portugal Telecom S.A. ...... 403,111 534,656 0.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
IN PORTUGAL 2,361,829 2,812,382 2.0
- ----------------------------------------------------------------------------------------------------------------------------
RUSSIA ELECTRICAL 32,000 +Lenenergo.................. 31,680 19,232 0.0
COMPONENTS & 3,220,028 +Unified Energy Systems..... 1,167,384 966,008 0.7
DISTRIBUTION 24,710 +Unified Energy Systems
(GDR)(b).................. 884,022 741,300 0.5
------------ ------------ -----
2,083,086 1,726,540 1.2
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 62,183 AO Mosenergo (ADR)(a)....... 1,960,069 2,294,553 1.6
275,000 +Irkutskenergo (GDR)(b)..... 34,732 53,350 0.1
------------ ------------ -----
1,994,801 2,347,903 1.7
-----------------------------------------------------------------------------------------------------
NATURAL GAS 13,480 RAO Gazprom (ADR)(a)(e)..... 212,310 325,205 0.2
-----------------------------------------------------------------------------------------------------
OIL & RELATED 26,000 Lukoil Oil Company
(ADR)(a).................. 1,426,675 2,392,000 1.7
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 82,300 +Bashinformsvyaz............ 220,980 98,760 0.1
523 +Moscow City Telephone...... 1,096,200 627,600 0.4
31,142 +Nizhnovsvyazinform......... 164,974 93,426 0.1
170,193 +Rostelecom (Ordinary)...... 660,040 587,166 0.4
6,000 Tyumentlecom................ 40,770 23,520 0.0
------------ ------------ -----
2,182,964 1,430,472 1.0
-----------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 199,692 +Bashkirenergo.............. 117,784 101,843 0.1
& GAS
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
RUSSIA 8,017,620 8,323,963 5.9
- ----------------------------------------------------------------------------------------------------------------------------
TURKEY BANKING 6,246,300 Akbank T.A.S. (Ordinary).... 450,545 550,700 0.4
17,160,000 Yapi Ve Kredi Bankasi
A.S....................... 414,962 654,899 0.5
------------ ------------ -----
865,507 1,205,599 0.9
-----------------------------------------------------------------------------------------------------
BUILDING PRODUCTS 1,808,700 Adana Cimento Sanayii A.S.
(Class A)................. 164,363 152,909 0.1
8,517,792 Akcansa Cimento A.S......... 1,299,765 1,193,314 0.8
------------ ------------ -----
1,464,128 1,346,223 0.9
-----------------------------------------------------------------------------------------------------
</TABLE>
50
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
EUROPE SHARES HELD/ VALUE PERCENT OF
(CONCLUDED) INDUSTRY FACE AMOUNT INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
TURKEY INVESTMENT 40,921 +Haci Omer Sabanci Holding
(CONCLUDED) MANAGEMENT A.S. (ADR)(a)............. $ 592,249 $ 624,045 0.4%
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 1,021,500 Alarko Holdings A.S......... 208,241 219,598 0.2
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 654,400 +Netas Northern Electric
& EQUIPMENT Telekomunikasyon A.S. .... 220,095 237,101 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
TURKEY 3,350,220 3,632,566 2.6
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
EUROPE 25,956,932 31,439,601 22.2
- ----------------------------------------------------------------------------------------------------------------------------
LATIN
AMERICA
- ----------------------------------------------------------------------------------------------------------------------------
ARGENTINA BANKING 22,300 Banco de Galicia y Buenos
Aires S.A. (ADR)(a)....... 730,924 574,225 0.4
-----------------------------------------------------------------------------------------------------
OIL & GAS 77,672 Yacimientos Petroliferos
PRODUCERS Fiscales S.A.
(YPF)(ADR)(a)............. 2,676,974 2,655,411 1.9
-----------------------------------------------------------------------------------------------------
OIL & RELATED 174,132 Companhia Naviera Perez
Companc S.A.C.F.I.M.F.A.
(Class B)................. 818,348 1,243,551 0.9
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
ARGENTINA 4,226,246 4,473,187 3.2
- ----------------------------------------------------------------------------------------------------------------------------
BRAZIL BANKING 47,631,523 Banco Bradesco S.A.
(Preferred)............... 352,463 469,486 0.3
2,036,494 Banco Bradesco S.A.
(Rights)(d)............... 0 3,650 0.0
1,882,000 Banco Itau S.A.
(Preferred)............... 1,091,753 1,011,828 0.7
46,900 +UNIBANCO--Uniao de Bancos
Brasilerios S.A.
(GDR)(b).................. 1,347,982 1,509,594 1.1
------------ ------------ -----
2,792,198 2,994,558 2.1
-----------------------------------------------------------------------------------------------------
BEVERAGE 4,800 Companhia Cervejaria Brahma
S.A. PN (ADR)(a).......... 70,224 68,100 0.1
4,182,525 Companhia Cervejaria Brahma
S.A. PN (Preferred)....... 2,249,358 2,810,837 2.0
------------ ------------ -----
2,319,582 2,878,937 2.1
-----------------------------------------------------------------------------------------------------
GOVERNMENT US$ 174,459 Republic of Brazil, 7.06%
NATIONAL due 4/15/2014(i).......... 123,188 136,514 0.1
BONDS--FOREIGN
-----------------------------------------------------------------------------------------------------
METALS--STEEL US$ 10,296 Companhia de Vale do Rio
Doce S.A., 0.0% due
12/31/2049(h)............. 0 0 0.0
-----------------------------------------------------------------------------------------------------
OIL & RELATED 11,141,666 Petroleo Brasileiro
S.A.--Petrobras
(Preferred)............... 2,149,724 2,605,712 1.9
-----------------------------------------------------------------------------------------------------
STEEL 103,040 Usinas Siderurgicas de Minas
Gerais--Usiminas S.A.
(Preferred)............... 1,053,493 609,376 0.4
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 37,900 Telecomunicacoes Brasileiras
S.A.--Telebras PN
(ADR)(a).................. 4,540,095 4,412,981 3.1
-----------------------------------------------------------------------------------------------------
</TABLE>
51
<PAGE> 262
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LATIN
AMERICA SHARES HELD/ VALUE PERCENT OF
(CONTINUED) INDUSTRY FACE AMOUNT INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BRAZIL UTILITIES-- 42,832,000 Companhia Energetica de
(CONCLUDED) ELECTRICAL & GAS Minas Gerais S.A. (CEMIG)
(Preferred)............... $ 2,059,177 $ 1,861,043 1.3%
32,100 Companhia Paranaense de
Energia S.A.--Copel
(ADR)(a).................. 555,795 439,369 0.3
------------ ------------ -----
2,614,972 2,300,412 1.6
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
BRAZIL 15,593,252 15,938,490 11.3
- ----------------------------------------------------------------------------------------------------------------------------
CHILE AUTOMOBILES 34,106 Chilgener Inc. S.A.
(ADR)(a).................. 985,279 835,597 0.6
-----------------------------------------------------------------------------------------------------
HOLDING COMPANY 69,300 +Quinenco S.A. (ADR)(a)..... 1,287,351 796,950 0.5
-----------------------------------------------------------------------------------------------------
UTILITIES 22,977 Compania de
Telecomunicaciones de
Chile S.A. (ADR)(a)....... 718,237 686,438 0.5
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
CHILE 2,990,867 2,318,985 1.6
- ----------------------------------------------------------------------------------------------------------------------------
MEXICO BANKING 475,000 +Grupo Financiero
Banamex--Accival, S.A. de
C.V. (BANACCI)
(Class B)................. 1,019,084 1,423,585 1.0
10,650 +Grupo Financiero
Banamex--Accival, S.A. de
C.V. (BANACCI)
(Class L)................. 18,179 27,491 0.0
------------ ------------ -----
1,037,263 1,451,076 1.0
-----------------------------------------------------------------------------------------------------
BEVERAGES 131,131 Fomento Economico Mexicano,
S.A. de C.V.
(ADR)(a)(f)............... 1,040,161 1,047,501 0.7
-----------------------------------------------------------------------------------------------------
BROADCAST--MEDIA 93,121 +Grupo Televisa, S.A. de
C.V. (GDR)(b)............. 3,185,893 3,602,619 2.6
-----------------------------------------------------------------------------------------------------
BUILDING & 89,517 Apasco, S.A. de C.V......... 323,221 617,665 0.4
CONSTRUCTION
-----------------------------------------------------------------------------------------------------
BUILDING 182,200 +Cementos Mexicanos, S.A. de
MATERIALS C.V. (Cemex).............. 805,299 972,276 0.7
53,000 +Cementos Mexicanos, S.A. de
C.V. (Cemex) (Class
B) (ADR)(a)............... 547,250 556,500 0.4
------------ ------------ -----
1,352,549 1,528,776 1.1
-----------------------------------------------------------------------------------------------------
FOREIGN US$ 640,000 United Mexican States,
GOVERNMENT BONDS 11.50% due 5/15/2026...... 730,800 758,400 0.5
-----------------------------------------------------------------------------------------------------
HEALTH/PERSONAL 318,221 Kimberly-Clark de
CARE Mexico, S.A. de C.V.
(Series A) ............... 1,011,461 1,524,365 1.1
-----------------------------------------------------------------------------------------------------
LEISURE 431,017 Grupo Carso, S.A. de C.V.
'A1'...................... 2,469,782 2,883,075 2.0
-----------------------------------------------------------------------------------------------------
RETAIL 121,843 Cifra, S.A. de C.V. 'A'..... 154,789 299,693 0.2
801,200 Cifra, S.A. de C.V. 'C'..... 1,151,781 1,799,667 1.3
------------ ------------ -----
1,306,570 2,099,360 1.5
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 73,609 Telefonos de Mexico, S.A. de
C.V. (ADR)(a)............. 3,190,359 4,126,705 2.9
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN MEXICO 15,648,059 19,639,542 13.8
- ----------------------------------------------------------------------------------------------------------------------------
VENEZUELA FOREIGN US$ 153,000 Republic of Venezuela,
GOVERNMENT BONDS 9.25% due 9/15/2027....... 128,329 137,088 0.1
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 64,665 Compania Anonima Nacional
Telefonos de Venezuela,
S.A. (CANTV)(ADR)(a)...... 2,736,558 2,691,681 1.9
-----------------------------------------------------------------------------------------------------
</TABLE>
52
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LATIN
AMERICA VALUE PERCENT OF
(CONCLUDED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
VENEZUELA TEXTILES 52,881 Sudamtex de Venezuela
(CONCLUDED) S.A.C.A. (ADR) (a)(e)..... $ 754,724 $ 475,937 0.3%
-----------------------------------------------------------------------------------------------------
UTILITIES 647,111 C.A. La Electricidad de
Caracas, S.A.............. 868,080 777,098 0.6
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
VENEZUELA 4,487,691 4,081,804 2.9
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN LATIN
AMERICA 42,946,115 46,452,008 32.8
- ----------------------------------------------------------------------------------------------------------------------------
MIDDLE
EAST
- ----------------------------------------------------------------------------------------------------------------------------
EGYPT BANKING 29,620 Commercial International
Bank (Egypt) S.A.E. ...... 350,673 599,031 0.4
39,097 Commercial International
Bank (Egypt) S.A.E.
(GDR)(b).................. 890,405 818,105 0.6
------------ ------------ -----
1,241,078 1,417,136 1.0
-----------------------------------------------------------------------------------------------------
CEMENT 46,065 Torah Portland Cement
Co. ........................ 1,175,643 1,058,206 0.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN EGYPT 2,416,721 2,475,342 1.7
- ----------------------------------------------------------------------------------------------------------------------------
ISRAEL BANKING 688,404 Bank Hapoalim Ltd. ......... 1,565,235 1,655,492 1.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN ISRAEL 1,565,235 1,655,492 1.2
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
MIDDLE EAST 3,981,956 4,130,834 2.9
- ----------------------------------------------------------------------------------------------------------------------------
PACIFIC
BASIN/ASIA
- ----------------------------------------------------------------------------------------------------------------------------
CHINA AUTOMOBILES 1,490,000 Qingling Motor Company...... 756,839 730,816 0.5
-----------------------------------------------------------------------------------------------------
BUILDING PRODUCTS 20,000 +Huaxin Cement Co., Ltd. ... 3,455 1,800 0.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 540,000 +China Telecom (Hong Kong)
Ltd. ..................... 823,362 927,009 0.7
1,416,000 Eastern Communications Co.,
Ltd. (Class B)............ 948,665 1,716,192 1.2
------------ ------------ -----
1,772,027 2,643,201 1.9
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CHINA 2,532,321 3,375,817 2.4
- ----------------------------------------------------------------------------------------------------------------------------
HONG KONG BEVERAGE & 890,000 +Tsingtao Brewery Company
TOBACCO Ltd. ..................... 323,608 207,925 0.2
-----------------------------------------------------------------------------------------------------
CELLULAR 294,625 +Smartone
TELEPHONES Telecommunications........ 691,657 568,525 0.4
-----------------------------------------------------------------------------------------------------
CEMENT 6,581,000 +Anhui Conch Cement Co.
Ltd. ..................... 1,959,746 1,146,738 0.8
-----------------------------------------------------------------------------------------------------
CHEMICALS 26,506 +Beijing Yanhua
Petrochemical (ADR)(a).... 290,806 251,807 0.2
-----------------------------------------------------------------------------------------------------
ELECTRICAL 2,817,000 Harbin Power Equipment
EQUIPMENT Company Ltd. ............. 529,562 341,785 0.2
-----------------------------------------------------------------------------------------------------
FOOD 5,431,007 Tingyi (Cayman
Islands) Holdings Co. .... 1,268,347 708,011 0.5
-----------------------------------------------------------------------------------------------------
METAL FABRICATING 1,796,000 +Jiangxi Copper Company
Ltd. ..................... 507,087 199,362 0.1
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 5,492,000 Sinocan Holdings Ltd. ...... 1,985,311 1,524,079 1.1
-----------------------------------------------------------------------------------------------------
PAPER PRODUCTS 1,647,000 Cheng Loong Co., Ltd. ...... 1,143,829 862,835 0.6
-----------------------------------------------------------------------------------------------------
REAL ESTATE 802,797 Henderson China Holding
Ltd. ..................... 1,380,246 642,445 0.5
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 1,673,000 City Telecom (H.K.) Ltd. ... 317,552 254,810 0.2
& EQUIPMENT
-----------------------------------------------------------------------------------------------------
</TABLE>
53
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN/ASIA VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
HONG KONG UTILITIES 743,000 +Beijing Datang Power
(CONCLUDED) Generation Company Limited
(Class H)................. $ 343,699 $ 340,452 0.2%
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
HONG KONG 10,741,450 7,048,774 5.0
- ----------------------------------------------------------------------------------------------------------------------------
INDIA AUTOMOBILE 1,650 Bajaj Auto Ltd. ............ 28,641 25,531 0.0
47,350 Bajaj Auto Ltd. (GDR)(b).... 1,100,141 950,551 0.7
90,400 +Reliance Industries Ltd.
(GDR)(b).................. 1,023,106 777,440 0.6
------------ ------------ -----
2,151,888 1,753,522 1.3
-----------------------------------------------------------------------------------------------------
BANKING & 80,100 State Bank of India Ltd.
FINANCIAL (GDR)(b).................. 1,633,340 1,457,820 1.0
-----------------------------------------------------------------------------------------------------
BUILDING 70,500 Gujarat Ambuja Cement
MATERIALS & Limited (GDR)(b).......... 608,302 502,313 0.4
COMPONENTS
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 19,747 +Bombay Suburban Electric
Supply Co. Ltd.
(GDR)(b).................. 408,565 345,572 0.2
-----------------------------------------------------------------------------------------------------
FINANCIAL 78,064 Industrial Credit &
SERVICES Investment Corporation of
India Ltd. (GDR)(b)....... 768,720 1,014,832 0.7
-----------------------------------------------------------------------------------------------------
LEISURE 65,822 EIH Ltd. (GDR)(b)(e)........ 893,147 878,724 0.6
14,000 Indian Hotels
Company Limited (The)
(GDR)(b).................. 286,662 267,400 0.2
------------ ------------ -----
1,179,809 1,146,124 0.8
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 42,000 Mahanagar Telephone Nigam
Limited................... 314,461 277,136 0.2
44,034 +Videsh Sanchar Nigam
Ltd.(GDR)(b).............. 743,436 617,577 0.4
16,000 +Videsh Sanchar Nigam Ltd.
(GDR)(b)(e)............... 264,000 224,400 0.2
------------ ------------ -----
1,321,897 1,119,113 0.8
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN INDIA 8,072,521 7,339,296 5.2
- ----------------------------------------------------------------------------------------------------------------------------
INDONESIA FOREST 658,350 P.T. Indah Kiat Pulp & Paper
PRODUCTS & PAPER Corp. 'Foreign'........... 386,538 118,869 0.1
55,440 P.T. Indah Kiat Pulp & Paper
Corp. (Warrants)(c)....... 0 1,540 0.0
------------ ------------ -----
386,538 120,409 0.1
-----------------------------------------------------------------------------------------------------
CEMENT 270,000 P.T. Semen Gresik........... 312,388 161,250 0.1
-----------------------------------------------------------------------------------------------------
INSURANCE 2,133,300 P.T. Asuransi Lippo Life
(Foreign)................. 1,225,583 79,011 0.1
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 657,000 P.T. Astra International
(Foreign)................. 1,031,069 173,375 0.1
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 99,027 P.T. Indonesian Satellite
Corp. (Indosat)(ADR)(a)... 2,725,050 1,912,459 1.3
483,000 P.T. Telekomunikasi
Indonesia................. 748,118 261,625 0.2
52,166 P.T. Telekomunikasi
Indonesia (ADR)(a)........ 1,490,022 577,086 0.4
------------ ------------ -----
4,963,190 2,751,170 1.9
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
INDONESIA 7,918,768 3,285,215 2.3
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
54
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN/ASIA VALUE PERCENT OF
(CONTINUED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
MALAYSIA DIVERSIFIED 354,000 Hicom Holdings BHD.......... $ 834,382 $ 204,108 0.2%
HOLDINGS
-----------------------------------------------------------------------------------------------------
FOOD 92,000 Nestle (Malaysia) BHD....... 712,167 426,255 0.3
-----------------------------------------------------------------------------------------------------
METAL 411,000 Magnum Corporation BHD...... 759,016 247,552 0.2
-----------------------------------------------------------------------------------------------------
NATURAL GAS 121,000 Petronas Gas BHD............ 499,346 275,637 0.2
-----------------------------------------------------------------------------------------------------
OIL & RELATED 211,700 Petronas Dagangan BHD....... 550,067 179,822 0.1
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 736,000 Telekom Malaysia BHD........ 2,115,230 2,178,636 1.5
-----------------------------------------------------------------------------------------------------
TOBACCO 40,000 Rothmans of Pall Mall
(Malaysia) BHD............ 419,742 311,454 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
MALAYSIA 5,889,950 3,823,464 2.7
- ----------------------------------------------------------------------------------------------------------------------------
PAKISTAN TELECOMMUNICATIONS 280,000 Pakistan Telecommunications
Corp. .................... 258,800 211,562 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
PAKISTAN 258,800 211,562 0.2
- ----------------------------------------------------------------------------------------------------------------------------
PHILIPPINES INTERNATIONAL 106,250 +International Container
TRADE Terminal Services,
Inc. ..................... 31,338 13,281 0.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 17,700 Philippine Long Distance
Telephone Co. ............ 615,244 389,400 0.3
31,673 Philippine Long Distance
Telephone Co. (ADR)(a).... 994,152 712,643 0.5
------------ ------------ -----
1,609,396 1,102,043 0.8
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
THE PHILIPPINES 1,640,734 1,115,324 0.8
- ----------------------------------------------------------------------------------------------------------------------------
SOUTH KOREA BANKING & 99,256 +Kookmin Bank
FINANCIAL (GDR)(b)(e)............... 1,522,351 470,972 0.3
-----------------------------------------------------------------------------------------------------
CHEMICAL 55,000 L.G. Chemical Limited....... 777,667 253,097 0.2
-----------------------------------------------------------------------------------------------------
ELECTRONIC 15,498 Samsung Display Devices..... 835,751 292,588 0.2
COMPONENT
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SOUTH KOREA 3,135,769 1,016,657 0.7
- ----------------------------------------------------------------------------------------------------------------------------
TAIWAN BANKING 927,000 E. Sun Commercial Bank...... 715,297 719,889 0.5
-----------------------------------------------------------------------------------------------------
PAPER PRODUCTS 1,713,930 +Chung Hwa Pulp
Corporation............... 1,570,457 987,688 0.7
-----------------------------------------------------------------------------------------------------
REAL ESTATE 640,000 Hung Poo Real Estate
Development Corporation... 1,286,194 857,935 0.6
-----------------------------------------------------------------------------------------------------
TRANSPORT 756,000 +Yang Ming Marine
SERVICES Transport................. 743,061 612,721 0.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
TAIWAN 4,315,009 3,178,233 2.2
- ----------------------------------------------------------------------------------------------------------------------------
THAILAND BANKING 138,500 Bangkok Bank Public Company
Ltd. (Registered
Shares)................... 919,864 349,527 0.3
223,000 Thai Farmers Bank Co.,
Ltd. ..................... 907,071 410,358 0.3
------------ ------------ -----
1,826,935 759,885 0.6
-----------------------------------------------------------------------------------------------------
</TABLE>
55
<PAGE> 266
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN/ASIA VALUE PERCENT OF
(CONCLUDED) INDUSTRY SHARES HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
THAILAND BUILDING PRODUCTS 7,000 Siam Cement Public Company
(CONCLUDED) Limited (Foreign)......... $ 205,098 $ 55,941 0.0%
244,802 Siam City Cement Public
Company Limited........... 878,923 257,415 0.2
------------ ------------ -----
1,084,021 313,356 0.2
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 198,000 +TelecomAsia Corporation
Public Company Ltd.
(Foreign)................. 375,785 38,309 0.0
-----------------------------------------------------------------------------------------------------
TELEVISION 65,000 BEC World Public Company
Limited................... 685,172 262,461 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
THAILAND 3,971,913 1,374,011 1.0
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
PACIFIC BASIN/ASIA 48,477,235 31,768,353 22.5
- ----------------------------------------------------------------------------------------------------------------------------
SHORT-TERM FACE
SECURITIES AMOUNT
- ----------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER* US$ 5,000,000 Atlantic Asset
Securitization, 6.25% due
1/16/1998................. 4,986,111 4,986,111 3.5
4,951,000 General Motors Acceptance
Corp., 6.75% due
1/02/1998................. 4,949,143 4,949,143 3.5
2,000,000 Goldman Sachs Group, 5.80%
due 1/05/1998............. 1,998,389 1,998,389 1.4
------------ ------------ -----
11,933,643 11,933,643 8.4
- ----------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY OBLIGATIONS* Federal Home Loan Mortgage
Corp.:
8,000,000 5.70% due 1/05/1998......... 7,993,667 7,993,667 5.7
3,000,000 5.69% due 1/09/1998......... 2,995,733 2,995,733 2.1
------------ ------------ -----
10,989,400 10,989,400 7.8
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SHORT-TERM SECURITIES 22,923,043 22,923,043 16.2
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS........... $154,873,499 145,825,167 103.1
============
LIABILITIES IN EXCESS OF
OTHER ASSETS................ (4,342,418) (3.1)
------------ -----
NET ASSETS.................. $141,482,749 100.0%
============ =====
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper and certain US Government Agency Obligations are traded on a
discount basis; the interest rates shown are the discount rates paid at the
time of purchase by the Fund.
+ Non-income producing security.
(a) American Depositary Receipts (ADR).
(b) Global Depositary Receipts (GDR).
(c) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and the number of shares are subject to
adjustment under certain conditions until the expiration date.
(d) The rights may be exercised until 2/09/1998.
(e) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(f) Restricted security as to the resale. The value of the Fund's investment in
restricted securities was approximately $1,048,000, representing 0.7% of net
assets.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
ISSUE ACQUISITION DATES COST VALUE (NOTE 1A)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fomento Economico Mexicano, S.A. de C.V. (ADR) 8/05/97-12/29/97 $1,040,161 $1,047,501
- ---------------------------------------------------------------------------------------------------
TOTAL $1,040,161 $1,047,501
========== ==========
- ---------------------------------------------------------------------------------------------------
</TABLE>
(g) Consistent with the general policy of the Securities and Exchange
Commission, the nationality or domicile of an issuer for determination of
foreign issuer status may be (i) the country under whose laws the issue is
organized, (ii) the country in which the issuer's securities are principally
traded, or (iii) the country in which the issuer derives a significant
proportion (at least 50%) of its revenue or profits from goods produced or
sold, investments made, or services performed in the country, or in which at
least 50% of the assets of the issuer are situated.
(h) Received through a bonus issue from Companhia de Vale do Rio Doce S.A. As of
December 31, 1997, the bonds have not commenced trading and the coupon rate
has not been determined.
(i) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
See Notes to Financial Statements.
56
<PAGE> 267
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$154,873,499) (Note
1a)....................................................... $145,825,167
Foreign cash (Note 1c)...................................... 46,289
Receivables:
Dividends................................................. $ 259,365
Investment adviser (Note 2)............................... 93,519
Capital shares sold....................................... 79,745
Interest.................................................. 15,984 448,613
----------
Prepaid expenses and other assets........................... 7,404
------------
Total assets................................................ 146,327,473
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 4,648,079
Capital shares redeemed................................... 32,948 4,681,027
----------
Accrued expenses and other liabilities...................... 163,697
------------
Total liabilities........................................... 4,844,724
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $141,482,749
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... $ 1,534,022
Class B Shares Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... 345
Paid-in capital in excess of par............................ 152,596,746
Undistributed investment income--net........................ 973,652
Accumulated realized capital losses on investments and
foreign currency transactions--net (Note 5)............... (4,569,219)
Unrealized depreciation on investments and foreign currency
transactions--net......................................... (9,052,797)
------------
NET ASSETS.................................................. $141,482,749
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $141,450,947 and 15,340,223
shares outstanding........................................ $ 9.22
============
Class B--Based on net assets of $31,802 and 3,448 shares
outstanding............................................... $ 9.22
============
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
57
<PAGE> 268
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $149,592 withholding tax on foreign
dividends)................................................ $ 2,348,288
Interest and discount earned................................ 787,002
------------
Total income................................................ 3,135,290
------------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 1,306,661
Custodian fees.............................................. 435,055
Accounting services (Note 2)................................ 30,648
Registration fees........................................... 21,617
Pricing services............................................ 20,098
Professional fees........................................... 13,984
Transfer agent fees (Note 2)................................ 5,012
Directors' fees and expenses................................ 2,178
Distribution fees--Class B* (Note 2)........................ 6
Other....................................................... 15,140
------------
Total expenses before reimbursement......................... 1,850,399
Reimbursement of expenses (Note 2).......................... (217,067)
------------
Total expenses after reimbursement.......................... 1,633,332
------------
Investment income--net...................................... 1,501,958
------------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized loss from:
Investments--net.......................................... (515,189)
Foreign currency transactions--net........................ (508,908) (1,024,097)
------------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (13,343,200)
Foreign currency transactions--net........................ 3,105 (13,340,095)
------------ ------------
Net realized and unrealized loss on investments and foreign
currency transactions..................................... (14,364,192)
------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $(12,862,234)
============
- -----------------------------------------------------------------------------------------
</TABLE>
*Class B commenced operations on November 3, 1997.
See Notes to Financial Statements.
58
<PAGE> 269
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 1,501,958 $ 1,857,960
Realized loss on investments and foreign currency
transactions--net......................................... (1,024,097) (156,983)
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (13,340,095) 4,829,141
------------ -----------
Net increase (decrease) in net assets resulting from
operations................................................ (12,862,234) 6,530,118
------------ -----------
- ---------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 1F):
Investment income--net:
Class A................................................... (1,771,806) (1,385,673)
------------ -----------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (1,771,806) (1,385,673)
------------ -----------
- ---------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 60,517,887 35,245,827
------------ -----------
- ---------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 45,883,847 40,390,272
Beginning of year........................................... 95,598,902 55,208,630
------------ -----------
End of year*................................................ $141,482,749 $95,598,902
============ ===========
- ---------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1g)............ $ 973,652 $ 1,752,408
============ ===========
- ---------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
59
<PAGE> 270
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM -------------------------------------------------
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE YEAR ENDED FOR THE PERIOD
DECEMBER 31, MAY 2, 1994+ TO
------------------------------ DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period......................... $ 10.05 $ 9.32 $ 9.51 $ 10.00
-------- ------- ------- -------
Investment income--net....................................... .11 .20 .20 .09
Realized and unrealized gain (loss) on investments and foreign
currency transactions--net................................. (.75) .76 (.30) (.58)
-------- ------- ------- -------
Total from investment operations............................. (.64) .96 (.10) (.49)
-------- ------- ------- -------
Less dividends from investment income--net................... (.19) (.23) (.09) --
-------- ------- ------- -------
Net asset value, end of period............................... $ 9.22 $ 10.05 $ 9.32 $ 9.51
======== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share........................... (6.53%) 10.59% (1.08%) (4.90%)#
======== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement............................... 1.25% 1.25% 1.25% 1.29%*
======== ======= ======= =======
Expenses..................................................... 1.42% 1.31% 1.36% 1.35%*
======== ======= ======= =======
Investment income--net....................................... 1.15% 2.42% 2.73% 2.18%*
======== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)..................... $141,451 $95,599 $55,209 $36,676
======== ======= ======= =======
Portfolio turnover........................................... 93.62% 87.33% 62.53% 29.79%
======== ======= ======= =======
Average commission rate paid++............................... $ .0015 $ .0003 -- --
======== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into US
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
# Aggregate total investment return.
See Notes to Financial Statements.
60
<PAGE> 271
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE ----------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE FOR THE PERIOD
FINANCIAL STATEMENTS. NOV. 3, 1997+
INCREASE (DECREASE) IN NET ASSET VALUE: TO DEC. 31, 1997
<S> <C>
- -------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 9.30
-------
Investment income--net...................................... .01
Realized and unrealized loss on investments and foreign
currency transactions--net.................................. (.09)
-------
Total from investment operations............................ (.08)
-------
Net asset value, end of period.............................. $ 9.22
=======
- -------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... (.86%)#
=======
- -------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.............................. 1.39%*
=======
Expenses.................................................... 1.58%*
=======
Investment income--net...................................... 1.16%*
=======
- -------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 32
=======
Portfolio turnover.......................................... 93.62%
=======
Average commission rate paid++.............................. $ .0015
=======
- -------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment return excludes insurance-related fees and expenses.
+ Commencement of operations.
++ The "Average Commission Rate Paid" includes commissions paid in foreign
currencies, which have been converted into US dollars using the prevailing
exchange rate on the date of the transaction. Such conversions may
significantly affect the rate shown.
# Aggregate total investment return.
See Notes to Financial Statements.
61
<PAGE> 272
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and Variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. Developing Capital Markets Focus Fund (the "Fund") is classified
as "non-diversified", as defined in the Investment Company Act of 1940. The
following is a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Options purchased are valued at
the last sale price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter market, the last bid price. Futures
contracts are valued at the settlement price at the close of the applicable
exchange. Short-term securities are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts. Premium or discount is amortized over the life
of the contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or deducted from)
the basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell futures contracts
and options on such futures contracts for the purpose of hedging the market risk
on existing securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific future date and
at a specific price or yield. Upon entering into a contract, the Fund deposits
and maintains as collateral such initial margin as required by the exchange on
which the transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are known as
variation margin and are recorded by the Fund as unrealized gains or losses.
When the
62
<PAGE> 273
- --------------------------------------------------------------------------------
contract is closed, the Fund records a realized gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $508,908 have been reclassified between accumulated net
realized capital losses and undistributed net investment income. These
reclassifications have no effect on net assets or net asset values per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with Merrill Lynch Funds Distributor, Inc.
("MLFD" or "Distributor"), a wholly-owned subsidiary of Merrill Lynch Group,
Inc.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 1.00% of the average daily value of the Fund's net assets.
Pursuant to the Distribution Plan adopted by the Company in accordance with
Rule 12b-1 under the Investment Company Act of 1940, the Fund pays the
Distributor an ongoing distribution fee each month at the annual rate of 0.15%
of the average daily value of the Fund's Class B net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA. For
the year ended December 31, 1997, MLAM earned fees of $1,306,661, of which
$217,067 was voluntarily waived.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc., a subsidiary of ML & Co., earned $64,325 in commissions on the execution
of portfolio security transactions.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
63
<PAGE> 274
- --------------------------------------------------------------------------------
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, MLFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $162,296,755 and $109,852,357, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Realized Unrealized
Gains (Losses) Losses
- ------------------------------------------------------------
<S> <C> <C>
Long-term investments...... $ (515,243) $(9,048,332)
Short-term investments..... 54 --
Foreign currency
transactions.............. (508,908) (4,465)
----------- -----------
Total...................... $(1,024,097) $(9,052,797)
=========== ===========
- ------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized depreciation for Federal income tax
purposes aggregated $9,503,219, of which $14,550,981 related to appreciated
securities and $24,054,200 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$155,328,386.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$60,517,887 and $35,245,827 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold........................... 7,394,743 $ 77,069,163
Shares issued to shareholders in
reinvestment of dividends............ 176,082 1,736,172
---------- ------------
Total issued.......................... 7,570,825 78,805,335
Shares redeemed....................... (1,738,665) (18,318,396)
---------- ------------
Net increase.......................... 5,832,160 $ 60,486,939
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold........................... 4,462,492 $ 44,124,402
Shares issued to shareholders in
reinvestment of dividends............ 151,274 1,385,673
---------- ------------
Total issued.......................... 4,613,766 45,510,075
Shares redeemed....................... (1,027,712) (10,264,248)
---------- ------------
Net increase.......................... 3,586,054 $ 35,245,827
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Class B Shares for the Period November 3, 1997+ to Dollar
December 31, 1997 Shares Amount
- ---------------------------------------------------------------------
<S> <C> <C>
Shares sold..................................... 5,548 $ 50,330
Shares redeemed................................. (2,100) (19,382)
------ --------
Net increase.................................... 3,448 $ 30,948
====== ========
- ---------------------------------------------------------------------
+ Commencement of operations.
</TABLE>
5. CAPITAL LOSS CARRYFORWARD:
At December 31, 1997, the Fund had net capital loss carryforward of
approximately $2,114,000, of which $2,024,000 expires in 2003 and $90,000
expires in 2004. This amount will be available to offset like amounts of any
future taxable gains.
6. COMMITMENTS:
At December 31, 1997, the Fund had entered into foreign exchange contracts,
under which it agreed to purchase various foreign currencies with a value of
approximately $1,915,000.
7. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.114234 per Class A Share and $.112494 per Class B
Share, payable on January 9, 1998 to shareholders of record as of December 31,
1997.
64
<PAGE> 275
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BANK NOTES--11.1% $ 1,250,000 Bank of America N.T. & S.A. .......... 5.93% 6/24/98 $ 1,249,989
2,000,000 Bank of America N.T. & S.A.+.......... 6.10 6/30/98 1,999,213
1,900,000 Bank of New York...................... 5.85 8/20/98 1,899,096
4,000,000 FNB of Chicago........................ 6.02 6/11/98 4,001,263
2,000,000 FNB of Chicago........................ 5.89 8/26/98 1,999,591
1,000,000 Keybank National Association+......... 5.64 5/06/98 999,835
2,300,000 Keybank National Association+......... 5.62 8/20/98 2,298,940
4,000,000 Keybank National Association+......... 5.62 8/28/98 3,998,237
1,400,000 LaSalle National Bank, Chicago........ 5.75 10/08/98 1,397,918
2,000,000 Morgan Guaranty Trust Co. of New
York+............................... 5.615 2/19/98 1,999,860
3,500,000 Northern Trust Company................ 5.96 6/17/98 3,500,323
1,500,000 Northern Trust Company................ 5.95 6/24/98 1,500,123
5,800,000 PNC Bank N.A.+........................ 5.60 10/01/98 5,797,078
2,000,000 US Bank N.A.+......................... 5.856 8/28/98 1,999,296
500,000 US National Bank of Oregon+........... 5.665 4/14/98 499,925
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL BANK NOTES (COST--$35,138,925) 35,140,687
- ---------------------------------------------------------------------------------------------------------------------------
CERTIFICATES OF 2,750,000 Chase Manhattan Bank USA, N.A......... 5.87 7/21/98 2,749,431
DEPOSIT--3.4% 4,000,000 Chase Manhattan Bank USA, N.A......... 5.75 10/06/98 3,994,633
4,000,000 Morgan Guaranty Trust Co. of New
York................................ 5.71 1/06/98 3,999,866
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL CERTIFICATES OF DEPOSIT (COST--$10,749,983) 10,743,930
- ---------------------------------------------------------------------------------------------------------------------------
COMMERCIAL 3,338,000 AESOP Funding Corp.................... 5.77 1/16/98 3,330,510
PAPER--55.5% 12,000,000 AESOP Funding Corp. .................. 6.05 2/13/98 11,915,300
2,558,000 Allomon Funding Corp. ................ 5.90 1/07/98 2,555,904
2,359,000 Atlantic Asset Securitization
Corp. .............................. 6.25 1/15/98 2,353,676
4,545,000 Atlantic Asset Securitization
Corp. .............................. 6.40 1/16/98 4,533,688
4,941,000 Atlantic Asset Securitization
Corp. .............................. 5.89 1/20/98 4,926,449
15,000,000 Block Financial Corp. ................ 5.67 4/03/98 14,785,771
9,000,000 CSW Credit, Inc. ..................... 5.90 1/07/98 8,992,625
1,400,000 CSW Credit, Inc. ..................... 5.80 1/09/98 1,398,421
2,000,000 CSW Credit, Inc. ..................... 5.86 1/09/98 1,997,721
3,050,000 CSW Credit, Inc. ..................... 5.62 2/05/98 3,033,091
10,440,000 Centric Capital Corp. ................ 6.50 1/07/98 10,430,575
12,000,000 Countrywide Home Loans, Inc. ......... 5.87 1/14/98 11,976,520
3,000,000 Countrywide Home Loans, Inc. ......... 6.30 1/30/98 2,985,300
4,500,000 Finova Capital Corp. ................. 5.80 2/20/98 4,464,046
5,000,000 Finova Capital Corp. ................. 5.74 3/13/98 4,945,069
3,529,000 Finova Capital Corp. ................. 5.73 3/18/98 3,487,461
2,000,000 Finova Capital Corp. ................. 5.63 4/21/98 1,965,786
4,000,000 Ford Motor Credit Co. ................ 5.60 3/30/98 3,945,383
5,000,000 General Electric Capital Corp. ....... 5.545 3/17/98 4,941,931
4,500,000 General Electric Capital Corp. ....... 5.55 3/23/98 4,443,500
3,000,000 General Motors Acceptance Corp. ...... 5.59 3/02/98 2,972,221
3,000,000 General Motors Acceptance Corp. ...... 5.62 4/14/98 2,951,975
3,000,000 Goldman Sachs Group, L.P. ............ 5.71 4/17/98 2,950,563
7,700,000 Lehman Brothers Holdings Inc. ........ 5.90 1/15/98 7,683,595
7,800,000 Lehman Brothers Holdings Inc. ........ 5.60 1/29/98 7,766,187
4,528,000 Lexington Parker Capital Co., LLC..... 5.90 1/12/98 4,520,579
3,500,000 Lexington Parker Capital Co., LLC..... 6.05 1/14/98 3,492,942
6,000,000 Lexington Parker Capital Co., LLC..... 5.92 2/20/98 5,952,062
4,300,000 New Center Asset Trust................ 5.68 3/18/98 4,249,385
5,000,000 Park Avenue Receivables Corp. ........ 5.90 2/06/98 4,971,319
7,256,000 Republic Industries Funding Corp. .... 5.90 1/09/98 7,247,676
8,364,000 Republic Industries Funding Corp. .... 5.75 1/21/98 8,338,618
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL COMMERCIAL PAPER (COST--$176,507,860) 176,505,849
- ---------------------------------------------------------------------------------------------------------------------------
CORPORATE NOTES--10.2% 4,000,000 Asset-Backed Securities Investment
Trust 1997-F+....................... 5.94 9/15/98 4,000,000
3,000,000 CIT Group Holdings, Inc. (The)........ 6.50 7/13/98 3,009,900
500,000 CIT Group Holdings, Inc. (The)........ 5.58 8/17/98 499,730
3,750,000 IBM Credit Corp. ..................... 5.868 8/13/98 3,749,753
2,000,000 IBM Credit Corp. ..................... 5.635 11/23/98 1,999,226
2,000,000 International Business Machines
Corp. .............................. 5.67 1/28/98 1,999,565
2,600,000 International Business Machines
Corp. .............................. 5.93 3/18/98 2,600,931
2,000,000 Republic Mase Australia Limited,
Ltd.**.............................. 5.945 6/30/98 2,000,242
1,814,843 Newcourt Receivables Asset Trust
1997-1.............................. 5.815 12/21/98 1,814,480
2,900,000 Norwest Corporation................... 6.00 10/13/98 2,902,233
8,000,000 SMM Trust 1997-Q+..................... 5.98 1/15/98 7,999,997
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE NOTES (COST--$32,573,630) 32,576,057
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
65
<PAGE> 276
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (Note 1a)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FUNDING AGREEMENTS--1.6% $ 5,000,000 Jackson National Life Insurance
Co.+................................ 5.72% 5/01/98 $ 5,000,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL FUNDING AGREEMENTS (COST--$5,000,000) 5,000,000
- ---------------------------------------------------------------------------------------------------------------------------
MASTER NOTES--2.5% 8,000,000 Goldman Sachs Group L.P.+............. 5.969 4/28/98 8,000,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL MASTER NOTES (COST--$8,000,000) 8,000,000
- ---------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT, AGENCY & 75,000 Federal National Mortgage
Association......................... 5.57 1/29/98 74,686
INSTRUMENTALITY 3,000,000 Federal National Mortgage
OBLIGATIONS-- Association......................... 5.46 7/06/98 2,916,430
DISCOUNT--3.5% 4,500,000 Federal National Mortgage
Association......................... 5.44 8/05/98 4,354,361
3,750,000 US Treasury Bills..................... 5.08 1/15/98 3,743,026
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT, AGENCY & INSTRUMENTALITY
OBLIGATIONS -- DISCOUNT (COST--$11,087,433) 11,088,503
- ---------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT, AGENCY & 1,040,000 Federal Home Loan Bank+............... 5.85 1/26/98 1,040,018
INSTRUMENTALITY 3,000,000 Federal Home Loan Bank+............... 5.899 10/20/98 2,999,304
OBLIGATIONS--...............
NON-DISCOUNT--15.3% 500,000 Federal Home Loan Bank................ 6.08 6/30/99 502,033
1,850,000 Federal Home Loan Bank................ 5.99 8/11/99 1,848,261
1,000,000 Federal Home Loan Mortgage Corp.+..... 5.58 4/15/98 999,864
1,000,000 Federal Home Loan Mortgage Corp.+..... 5.57 4/20/98 999,827
2,900,000 Federal Home Loan Mortgage Corp....... 5.685 8/21/98 2,897,274
700,000 Federal Home Loan Mortgage Corp. ..... 6.36 5/20/99 701,372
500,000 Federal Home Loan Mortgage Corp. ..... 6.10 9/10/99 500,250
2,000,000 Federal National Mortgage
Association......................... 5.19 1/08/98 1,999,764
2,000,000 Federal National Mortgage
Association+........................ 5.57 3/26/98 1,999,733
2,500,000 Federal National Mortgage
Association+........................ 5.629 3/27/98 2,499,610
5,500,000 Federal National Mortgage
Association+........................ 5.669 4/24/98 5,499,354
3,000,000 Federal National Mortgage
Association+........................ 5.894 10/20/98 2,998,957
800,000 Federal National Mortgage
Association......................... 6.375 5/21/99 801,600
520,000 Federal National Mortgage
Association......................... 5.88 8/10/99 519,048
2,300,000 Federal National Mortgage
Association+........................ 5.929 10/27/99 2,298,034
3,300,000 Student Loan Marketing Association.... 5.86 6/10/98 3,301,716
2,000,000 Student Loan Marketing Association.... 5.60 8/11/98 1,997,260
1,900,000 Student Loan Marketing Association+... 5.877 10/06/98 1,900,000
1,100,000 Student Loan Marketing Association+... 5.619 11/10/98 1,095,240
2,000,000 Student Loan Marketing Association+... 5.909 11/25/98 1,999,480
1,000,000 Student Loan Marketing Association.... 5.80 12/18/98 998,534
1,170,000 US Treasury Notes..................... 5.00 1/31/98 1,169,131
4,000,000 US Treasury Notes..................... 7.875 4/15/98 4,026,248
1,200,000 US Treasury Notes..................... 5.625 11/30/98 1,200,000
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT, AGENCY & INSTRUMENTALITY
OBLIGATIONS--NON-DISCOUNT (COST--$48,779,723) 48,791,912
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$327,837,554)--103.1%.......... 327,846,938
LIABILITIES IN EXCESS OF OTHER
ASSETS--(3.1%)........................ (9,795,201)
------------
NET ASSETS--100.0%.................... $318,051,737
============
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper and certain US Government Obligations are traded on a
discount basis; the interest rates shown are the discount rates paid at the time
of purchase by the Fund. Other securities bear interest at the rates shown,
payable at fixed dates or upon maturity. The interest rates on variable rate
securities are adjusted periodically based upon appropriate indexes; the
interest rates shown are the rates in effect at December 31, 1997.
** Guarantor Republic National Bank of New York.
+ Variable Rate Notes.
See Notes to Financial Statements.
66
<PAGE> 277
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$327,837,554*) (Note
1a)....................................................... $327,846,938
Cash........................................................ 16,052
Receivables:
Interest.................................................. $2,033,874
Capital shares sold....................................... 58,865 2,092,739
----------
Prepaid expenses and other assets........................... 4,561
------------
Total assets................................................ 329,960,290
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 7,269,625
Capital shares redeemed................................... 4,470,314
Investment adviser (Note 2)............................... 140,299 11,880,238
----------
Accrued expenses and other liabilities...................... 28,315
------------
Total liabilities........................................... 11,908,553
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $318,051,737
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value,
1,300,000,000 shares authorized+.......................... $ 31,804,236
Paid-in capital in excess of par............................ 286,238,117
Unrealized appreciation on investments--net................. 9,384
------------
NET ASSETS.................................................. $318,051,737
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $318,051,737 and 318,042,353
shares outstanding........................................ $ 1.00
============
- ---------------------------------------------------------------------------------------
</TABLE>
* Cost for Federal income tax purposes. As of December 31, 1997, net unrealized
appreciation for Federal income tax purposes amounted to $9,384, of which
$28,038 related to appreciated securities and $18,654 related to depreciated
securities.
+ The Fund is authorized to issue 1,300,000,000 Class B Shares.
See Notes to Financial Statements.
67
<PAGE> 278
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1c):
Interest and discount earned................................ $17,522,944
- ----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $1,549,078
Accounting services (Note 2)................................ 63,184
Professional fees........................................... 32,394
Custodian fees.............................................. 16,122
Directors' fees and expenses................................ 5,826
Transfer agent fees (Note 2)................................ 4,999
----------
Total expenses.............................................. 1,671,603
-----------
Investment income--net...................................... 15,851,341
-----------
- ----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN ON INVESTMENTS--NET (NOTE 1c):
Realized gain on investments--net........................... 13,669
Change in unrealized appreciation/depreciation on
investments--net.......................................... 28,848
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $15,893,858
===========
- ----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
68
<PAGE> 279
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $15,851,341 $ 13,810,153
Realized gain on investments--net........................... 13,669 12,359
Change in unrealized appreciation/depreciation on
investments--net.......................................... 28,848 (157,747)
------------ ------------
Net increase in net assets resulting from operations........ 15,893,858 13,664,765
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1d):
Investment income--net: Class A............................. (15,851,341) (13,810,153)
Realized gain on investments--net: Class A.................. (13,669) (12,359)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (15,865,010) (13,822,512)
------------ ------------
- ------------------------------------------------------------------------------------------
CLASS A CAPITAL SHARE TRANSACTIONS (NOTE 3):
Net proceeds from sale of shares............................ 242,312,822 103,681,145
Net asset value of shares issued to shareholders in
reinvestment of dividends and distributions (Note 1d)..... 15,869,707 13,824,990
------------ ------------
258,182,529 117,506,135
Cost of shares redeemed..................................... (214,915,654) (146,504,203)
------------ ------------
Net increase (decrease) in net assets derived from Class A
capital share transactions................................ 43,266,875 (28,998,068)
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... 43,295,723 (29,155,815)
Beginning of year........................................... 274,756,014 303,911,829
------------ ------------
End of year................................................. $318,051,737 $274,756,014
============ ============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
69
<PAGE> 280
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM --------------------------------------------------------
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE YEAR ENDED
DECEMBER 31,
--------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year......................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
-------- -------- -------- -------- --------
Investment income--net..................................... .0511 .0504 .0547 .0386 .0302
Realized and unrealized gain (loss) on investments--net.... .0001 (.0005) .0012 (.0007) .0005
-------- -------- -------- -------- --------
Total from investment operations........................... .0512 .0499 .0559 .0379 .0307
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................... (.0511) (.0504) (.0547) (.0386) (.0302)
Realized gain on investments--net........................ --+ (.0001) (.0002) -- (.0005)
-------- -------- -------- -------- --------
Total dividends and distributions.......................... (.0511) (.0505) (.0549) (.0386) (.0307)
-------- -------- -------- -------- --------
Net asset value, end of year............................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share......................... 5.24% 5.13% 5.64% 3.93% 3.10%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement............................. .54% .54% .55% .50% .36%
======== ======== ======== ======== ========
Expenses................................................... .54% .54% .55% .57% .63%
======== ======== ======== ======== ========
Investment income--net, and realized gain on investments--
net...................................................... 5.12% 4.97% 5.50% 4.02% 3.03%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)..................... $318,052 $274,756 $303,912 $363,199 $170,531
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Amount is less than $.0001 per share.
See Notes to Financial Statements.
70
<PAGE> 281
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A and each fund began offering Class B Shares. Both classes of shares have equal
voting, dividend, liquidation and other rights, except that only shares of the
respective classes are entitled to vote on matters concerning only that class
and Class B Shares bear certain expenses related to the distribution of such
shares. Domestic Money Market Fund (the "Fund") is classified as "diversified",
as defined in the Investment Company Act of 1940. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Money market securities maturing more than sixty
days after the valuation date are valued at the most recent bid price or yield
equivalent as obtained from dealers that make markets in the securities. When
such securities are valued with sixty days or less to maturity, the difference
between the valuation existing on the sixty-first day before maturity and
maturity value is amortized on a straight-line basis to maturity. Investments
maturing within sixty days from their date of acquisition are valued at
amortized cost, which approximates market value. Securities for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Board of Directors of the Company.
(b) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(c) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of premium and discount) is recognized
on the accrual basis. Realized gains and losses on security transactions are
determined on the identified cost basis.
(d) Dividends and distributions to shareholders--The Fund declares dividends
daily and reinvests monthly such dividends (net of non-resident alien tax and
back-up withholding tax withheld) in additional Fund shares at net asset value.
Dividends and distributions are declared from the total of net investment income
and net realized gain or loss on investments.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.50% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Fund are officers and/or directors of
MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. CAPITAL SHARE TRANSACTIONS:
The number of shares sold and redeemed during the periods corresponds to the
amounts included in the Statements of Changes in Net Assets with respect to net
proceeds from sale of shares and cost of shares redeemed, respectively, since
shares are recorded at $1.00 per share.
71
<PAGE> 282
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NORTH FACE VALUE PERCENT OF
AMERICA INDUSTRY AMOUNT FIXED-INCOME INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CANADA FOREIGN Canadian Government
GOVERNMENT Bonds:
OBLIGATIONS C$ 350,000 7% due 12/01/2006........ $ 248,559 $ 268,070 0.4%
NZ$ 4,200,000 6.625% due 10/03/2007.... 2,542,374 2,302,480 3.0
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN CANADA 2,790,933 2,570,550 3.4
- --------------------------------------------------------------------------------------------------------------------------
UNITED STATES BANKING US$ 3,800,000 Bank of New York
Institutional Capital
Trust, Series A, 7.78%
due 12/01/2026(c)...... 3,830,020 3,942,956 5.2
4,600,000 Comerica Bank, 7.875% due
9/15/2026.............. 4,972,858 5,184,108 6.8
50,000 Mellon Capital II, 7.995%
due 1/15/2027.......... 49,192 53,681 0.1
2,800,000 Wells Fargo Capital I,
7.96% due 12/15/2026... 2,801,414 2,943,948 3.8
----------- ----------- -----
11,653,484 12,124,693 15.9
------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 4,000,000 Associates Corp. of North
America, 7.375% due
6/11/2007.............. 4,202,800 4,250,000 5.6
3,000,000 BT Institutional Capital
Trust, 8.09% due
12/01/2026(c).......... 3,022,730 3,148,872 4.2
----------- ----------- -----
7,225,530 7,398,872 9.8
------------------------------------------------------------------------------------------------------
GAMING 500,000 ++Harrah's Jazz Company,
14.25% due
11/15/2001............. 482,500 155,000 0.2
------------------------------------------------------------------------------------------------------
INDUSTRIAL 800,000 Chrysler Corporation,
7.45% due 3/01/2027.... 833,200 855,248 1.1
2,500,000 Phelps Dodge Corporation,
7.125% due
11/01/2027............. 2,488,000 2,549,275 3.4
----------- ----------- -----
3,321,200 3,404,523 4.5
------------------------------------------------------------------------------------------------------
SPECIAL SITUATIONS 6,150,000 PNC Institutional Capital
Bank, 8.315% due
5/15/2027(c)........... 6,273,000 6,632,252 8.7
------------------------------------------------------------------------------------------------------
US GOVERNMENT US Treasury Notes:
OBLIGATIONS 1,050,000 6.50% due 10/15/2006..... 1,063,453 1,099,381 1.4
1,470,000 6.125% due 8/15/2007..... 1,499,483 1,510,660 2.0
----------- ----------- -----
2,562,936 2,610,041 3.4
------------------------------------------------------------------------------------------------------
UTILITIES 233,383 +Tucson Electric Power
Co., 10.732% due
1/01/2013.............. 223,464 247,810 0.3
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN THE UNITED
STATES 31,742,114 32,573,191 42.8
- --------------------------------------------------------------------------------------------------------------------------
SHARES
HELD WARRANTS
- --------------------------------------------------------------------------------------------------------------------------
UNITED STATES BROADCASTING/CABLE 4,700 American Telecasting Inc.
(Warrants)(a).......... 11,222 1,880 0.0
------------------------------------------------------------------------------------------------------
TOTAL WARRANTS IN THE
UNITED STATES 11,222 1,880 0.0
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
NORTH AMERICA 34,544,269 35,145,621 46.2
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
72
<PAGE> 283
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC FACE VALUE PERCENT OF
BASIN INDUSTRY AMOUNT FIXED-INCOME INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CAYMAN ISLANDS BANKING US$ 450,000 Fuji Bank Limited
(Cayman), 7.30% due
3/29/2049.............. $ 454,932 $ 419,625 0.5%
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN THE CAYMAN
ISLANDS 454,932 419,625 0.5
- --------------------------------------------------------------------------------------------------------------------------
JAPAN BANKING Y 65,000,000 Asian Development Bank,
5.625% due 2/18/2002... 750,697 586,672 0.8
20,000,000 IBRD World Bank, 4.50%
due 6/20/2000.......... 173,986 167,509 0.2
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN JAPAN 924,683 754,181 1.0
- --------------------------------------------------------------------------------------------------------------------------
THAILAND INDUSTRIAL US$ 1,750,000 PTTEP International
Limited, 7.625% due
10/01/2006(c).......... 1,784,755 1,346,706 1.8
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN THAILAND 1,784,755 1,346,706 1.8
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
PACIFIC BASIN 3,164,370 2,520,512 3.3
- --------------------------------------------------------------------------------------------------------------------------
WESTERN
EUROPE
- --------------------------------------------------------------------------------------------------------------------------
DENMARK BANKING US$ 2,100,000 Den Danske Bank A/S,
7.40% due 6/15/2010.... 2,172,030 2,191,064 2.9
------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES Dkr 35,854,000 Nykredit A/S, 6% due
10/01/2026............. 4,999,003 5,100,243 6.7
------------------------------------------------------------------------------------------------------
FOREIGN 2,800,000 Denmark Government Bonds,
GOVERNMENT 8% due 5/15/2003....... 516,582 462,225 0.6
OBLIGATIONS
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN DENMARK 7,687,615 7,753,532 10.2
- --------------------------------------------------------------------------------------------------------------------------
FINLAND FOREIGN GOVERNMENT Fmk 60,000,000 Republic of Finland, 6%
OBLIGATIONS due 1/29/2002.......... 654,914 548,177 0.7
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN FINLAND 654,914 548,177 0.7
- --------------------------------------------------------------------------------------------------------------------------
FRANCE FOREIGN GOVERNMENT Frf 2,000,000 French Government B-Tan,
OBLIGATIONS 7% due 10/12/2000...... 420,453 354,212 0.4
2,300,000 French OAT, 7.25% due
4/25/2006.............. 483,739 434,016 0.6
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN FRANCE 904,192 788,228 1.0
- --------------------------------------------------------------------------------------------------------------------------
GERMANY BANKING DM 6,700,000 Depfa-Bank PLC, 5.50% due
2/12/2008.............. 3,716,810 3,676,284 4.8
------------------------------------------------------------------------------------------------------
FOREIGN Bundesrepublic
GOVERNMENT Deutschland:
OBLIGATIONS 625,000 7.50% due 11/11/2004..... 452,947 393,318 0.5
500,000 6.25% due 4/26/2006...... 337,334 296,170 0.4
9,500,000 11.69% due
7/04/2007(b)........... 3,282,886 3,211,030 4.2
Deutschland Republic:
450,000 6.75% due 4/22/2003...... 311,821 271,831 0.4
5,000,000 6% due 7/04/2007......... 3,016,655 2,914,443 3.8
1,900,000 German Unity Fund, 8% due
1/21/2002.............. 1,416,586 1,179,736 1.6
----------- ----------- -----
8,818,229 8,266,528 10.9
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN GERMANY 12,535,039 11,942,812 15.7
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
73
<PAGE> 284
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE FACE VALUE PERCENT OF
(CONCLUDED) INDUSTRY AMOUNT FIXED-INCOME INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ITALY FOREIGN Buoni Poliennali del
GOVERNMENT Tesoro (Italian
OBLIGATIONS Government Bonds):
Lit 500,000,000 9.50% due 5/01/2001...... $ 358,425 $ 321,049 0.4%
1,700,000,000 8.50% due 8/01/2004...... 1,100,516 1,118,952 1.5
750,000,000 Government of Italy,
8.50% due 4/01/2004.... 515,391 488,102 0.6
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN ITALY 1,974,332 1,928,103 2.5
- --------------------------------------------------------------------------------------------------------------------------
SPAIN FOREIGN Government of Spain:
GOVERNMENT Pta 75,000,000 10.10% due 2/28/2001..... 650,217 566,149 0.8
OBLIGATIONS 55,000,000 8% due 5/30/2004......... 425,126 412,473 0.5
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN SPAIN 1,075,343 978,622 1.3
- --------------------------------------------------------------------------------------------------------------------------
SWEDEN FOREIGN Skr 8,500,000 Government of Sweden,
GOVERNMENT 10.25% due 5/05/2000..... 1,411,881 1,181,938 1.6
OBLIGATIONS
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN SWEDEN 1,411,881 1,181,938 1.6
- --------------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM BANKING L 2,450,000 Royal Bank of Scotland,
9.50% due 8/29/2049.... 4,682,942 4,844,040 6.4
------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 1,500,000 Scottish Life Finance, 9%
due 11/29/2049......... 2,528,895 2,699,038 3.5
------------------------------------------------------------------------------------------------------
FOREIGN GOVERNMENT United Kingdom Treasury
OBLIGATIONS Gilt:
800,000 7% due 11/06/2001........ 1,299,561 1,331,246 1.7
300,000 8% due 6/10/2003......... 490,794 526,473 0.7
530,000 8.50% due 12/07/2005..... 945,081 983,965 1.3
150,000 9% due 7/12/2011......... 252,237 305,736 0.4
----------- ----------- -----
2,987,673 3,147,420 4.1
------------------------------------------------------------------------------------------------------
TOTAL FIXED-INCOME
INVESTMENTS IN THE UNITED
KINGDOM 10,199,510 10,690,498 14.0
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
WESTERN EUROPE 36,442,826 35,811,910 47.0
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
74
<PAGE> 285
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
AMOUNT SHORT-TERM SECURITIES COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
COMMERCIAL US$ 435,000 General Motors Acceptance
PAPER* Corp., 6.75% due
1/02/1998.............. $ 434,918 $ 434,918 0.6%
- --------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT United States Treasury
OBLIGATIONS* Bills:
60,000 4.95% due 1/29/1998...... 59,769 59,769 0.1
40,000 4.98% due 1/29/1998...... 39,845 39,845 0.0
----------- ----------- -----
99,614 99,614 0.1
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SHORT-TERM SECURITIES 534,532 534,532 0.7
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS........ $74,685,997 74,012,575 97.2
===========
UNREALIZED APPRECIATION
ON FORWARD FOREIGN
EXCHANGE CONTRACTS--
NET**.................. 319,209 0.4
OTHER ASSETS LESS
LIABILITIES............ 1,775,420 2.4
----------- -----
NET ASSETS............... $76,107,204 100.0%
=========== =====
- --------------------------------------------------------------------------------------------------------------------------
(a) Warrants entitle the Fund to purchase a predetermined
number of shares of common stock. The purchase price and
number of shares are subject to adjustments under certain
conditions until the expiration date.
(b) Represents a zero coupon or step bond. The interest rate
shown is the effective yield at the time of purchase by the
Fund.
(c) The security may be offered and sold to "qualified
institutional buyers" under Rule 144A of the Securities Act
of 1933.
</TABLE>
* Commercial Paper and certain US Government Obligations are traded on a
discount basis; the interest rates shown are the discount rates paid at the time
of purchase by the Fund.
** Forward foreign exchange contracts as of December 31, 1997 were as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
FOREIGN CURRENCY SOLD EXPIRATION DATE (NOTE 1B)
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Dkr28,000,000.................................................. January 1998 $ 67,700
DM 17,600,000.................................................. January 1998 221,441
L 2,400,000................................................... January 1998 23,762
NZ$4,667,537................................................... January 1998 6,306
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL UNREALIZED APPRECIATION ON FORWARD FOREIGN EXCHANGE CONTRACTS--NET (US$
COMMITMENT--$20,839,501) $319,209
========
</TABLE>
- --------------------------------------------------------------------------------
+ Restricted security as to resale. The value of the Fund's investment in
restricted securities was approximately $248,000, representing 0.3% of net
assets.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
VALUE
ISSUE ACQUISITION DATE COST (NOTE 1A)
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tucson Electric Power Co., 10.732% due 1/01/2013............ 8/19/1993 $223,464 $247,810
- --------------------------------------------------------------------------------------------------------
TOTAL $223,464 $247,810
======== ========
- --------------------------------------------------------------------------------------------------------
</TABLE>
++ Non-income producing security.
See Notes to Financial Statements.
75
<PAGE> 286
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$74,685,997) (Note
1a)....................................................... $74,012,575
Unrealized appreciation on forward foreign exchange
contracts (Note 1b)....................................... 319,209
Foreign cash (Note 1c)...................................... 51,923
Receivables:
Interest.................................................. $1,394,558
Forward foreign exchange contracts (Note 1b).............. 226,985
Capital shares sold....................................... 94,550
Securities sold........................................... 21,312 1,737,405
----------
Deferred organization expenses (Note 1f).................... 789
Prepaid expenses and other assets........................... 52,029
-----------
Total assets................................................ 76,173,930
-----------
- ------------------------------------------------------------------------------------------
LIABILITIES:
Payables:...................................................
Investment adviser (Note 2)............................... 41,381
Capital shares redeemed................................... 234 41,615
----------
Accrued expenses and other liabilities...................... 25,111
-----------
Total liabilities........................................... 66,726
-----------
- ------------------------------------------------------------------------------------------
NET ASSETS.................................................. $76,107,204
===========
- ------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 200,000,000
shares authorized+........................................ $ 816,925
Paid-in capital in excess of par............................ 79,432,255
Accumulated distributions in excess of investment
income--net (Note 1g)..................................... (439,594)
Accumulated realized capital losses on investments and
foreign currency transactions--net (Note 5)............... (3,323,454)
Unrealized depreciation on investments and foreign currency
transactions--net......................................... (378,928)
-----------
NET ASSETS.................................................. $76,107,204
===========
- ------------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $76,107,204 and 8,169,247
shares outstanding........................................ $ 9.32
===========
- ------------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 200,000,000 Class B Shares.
See Notes to Financial Statements.
76
<PAGE> 287
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Interest and discount earned (net of $23,182 foreign
withholding tax).......................................... $ 5,513,636
Dividends................................................... 138
-----------
Total income................................................ 5,513,774
-----------
- -------------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 483,479
Custodian fees.............................................. 44,213
Professional fees........................................... 32,353
Accounting services (Note 2)................................ 17,268
Transfer agent fees (Note 2)................................ 5,007
Directors' fees and expenses................................ 1,959
Pricing services............................................ 1,668
Amortization of organization expenses (Note 1f)............. 1,578
Other....................................................... 1,188
-----------
Total expenses.............................................. 588,713
-----------
Investment income--net...................................... 4,925,061
-----------
- -------------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized loss from:
Investments--net.......................................... (2,295,949)
Foreign currency transactions--net........................ (2,470,800) (4,766,749)
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... 202,738
Foreign currency transactions--net........................ 454,476 657,214
----------- -----------
Net realized and unrealized loss on investments and foreign
currency transactions..................................... (4,109,535)
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 815,526
===========
- -------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
77
<PAGE> 288
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 4,925,061 $ 6,880,110
Realized gain (loss) on investments and foreign currency
transactions--net......................................... (4,766,749) 830,715
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ 657,214 (706,098)
------------ -----------
Net increase in net assets resulting from operations........ 815,526 7,004,727
------------ -----------
- ----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 1g):
Investment income--net:
Class A................................................... (2,532,863) (6,810,949)
Return of capital:
Class A................................................... (2,511,049) --
In excess of investment income--net:
Class A................................................... (276,658) --
------------ -----------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (5,320,570) (6,810,949)
------------ -----------
- ----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net redemptions from capital shares......................... (13,177,662) (6,069,072)
Net proceeds from issuance of capital shares resulting from
reorganization............................................ -- 17,820,572
------------ -----------
Net increase (decrease) in net assets derived from capital
share transactions........................................ (13,177,662) 11,751,500
------------ -----------
- ----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (17,682,706) 11,945,278
Beginning of year........................................... 93,789,910 81,844,632
------------ -----------
End of year*................................................ $ 76,107,204 $93,789,910
============ ===========
- ----------------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess of)
investment income--net (Note 1h).......................... $ (439,594) $ 118,851
============ ===========
- ----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
78
<PAGE> 289
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE PERIOD
FOR THE YEAR ENDED DECEMBER 31, JULY 1, 1993+ TO
---------------------------------------- DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1997++ 1996++ 1995++ 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 9.76 $ 9.79 $ 9.17 $ 10.38 $ 10.00
------- ------- ------- ------- --------
Investment income--net................................ .56 .78 .85 .76 .25
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net.................. (.40) (.03) .61 (1.19) .33
------- ------- ------- ------- --------
Total from investment operations...................... .16 .75 1.46 (.43) .58
------- ------- ------- ------- --------
Less dividends and distributions:
Investment income--net.............................. (.29) (.78) (.84) (.76) (.20)
Return of capital................................... (.28) -- -- -- --
In excess of investment income--net................. (.03) -- -- -- --
In excess of realized gain on investments--net...... -- -- -- (.02) --
------- ------- ------- ------- --------
Total dividends and distributions..................... (.60) (.78) (.84) (.78) (.20)
------- ------- ------- ------- --------
Net asset value, end of period........................ $ 9.32 $ 9.76 $ 9.79 $ 9.17 $ 10.38
======= ======= ======= ======= ========
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................... 1.95% 8.02% 16.69% (4.21%) 5.90%#
======= ======= ======= ======= ========
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................. .73% .69% .68% .75% .94%*
======= ======= ======= ======= ========
Investment income--net................................ 6.11% 7.95% 8.99% 8.01% 6.20%*
======= ======= ======= ======= ========
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).............. $76,107 $93,790 $81,845 $75,150 $ 50,737
======= ======= ======= ======= ========
Portfolio turnover.................................... 568.76% 267.13% 132.57% 117.58% 54.80%
======= ======= ======= ======= ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
See Notes to Financial Statements.
79
<PAGE> 290
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. Global Bond Focus Fund (the "Fund") is classified as "non-
diversified", as defined in the Investment Company Act of 1940. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Options purchased are valued at
the last sale price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter market, the last bid price. Futures
contracts are valued at the settlement price at the close of the applicable
exchange. Short-term securities are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts. Premium or discount is amortized over the life
of the contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or deducted from)
the basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell futures contracts
and options on such futures contracts for the purpose of hedging the market risk
on existing securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific future date and
at a specific price or yield. Upon entering into a contract, the Fund deposits
and maintains as collateral such initial margin as required by the exchange on
which the transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are known as
variation margin and are recorded by the Fund as unrealized gains or losses.
When the
80
<PAGE> 291
- --------------------------------------------------------------------------------
contract is closed, the Fund records a realized gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses and prepaid registration fees--Deferred
organization expenses are charged to expense on a straight-line basis over a
five-year period. Prepaid registration fees are charged to expense as the
related shares are issued.
(g) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions from capital gains are recorded on the
ex-dividend dates. Distributions in excess of net investment income are due
primarily to differing tax treatments for foreign currency transactions. A
portion of the net investment income dividends paid by the Fund during the year
ended December 31, 1997 is characterized as a return of capital.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $2,673,985 have been reclassified between accumulated
net realized capital losses and accumulated distributions in excess of net
investment income and differences of $2,511,049 have been reclassified between
paid-in capital in excess of par and accumulated distributions in excess of net
investment income. These reclassifications have no effect on net assets or net
asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.60% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch Security Pricing Service,
an affiliate of Merrill Lynch, Pierce, Fenner & Smith Inc., earned $116 for
providing security price quotations to compute the Fund's net asset value.
81
<PAGE> 292
- --------------------------------------------------------------------------------
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $432,416,067 and $440,662,159, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- ---------------------------------------------------------------------
<S> <C> <C>
Long-term investments............... $(1,709,149) $(673,422)
Short-term investments.............. (59) --
Financial futures contracts......... (586,741) --
Foreign currency transactions....... (3,696,332) (24,715)
Forward foreign exchange
contracts.......................... 1,225,532 319,209
----------- ---------
Total............................... $(4,766,749) $(378,928)
=========== =========
- ---------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized depreciation for Federal income tax
purposes aggregated $768,140, of which $1,807,788 related to appreciated
securities and $2,575,928 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$74,780,715.
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital share transactions
were $(13,177,662) and $11,751,500 for the years ended December 31, 1997 and
December 31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 493,520 $ 4,682,144
Shares issued to shareholders in
reinvestment of dividends........... 578,466 5,320,557
---------- ------------
Total issued......................... 1,071,986 10,002,701
Shares redeemed...................... (2,511,890) (23,180,363)
---------- ------------
Net decrease......................... (1,439,904) $(13,177,662)
========== ============
- -----------------------------------------------------------------
</TABLE>
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 844,095 $ 8,236,250
Shares issued to shareholders in
reinvestment of dividends........... 704,764 6,810,949
Shares issued resulting from
reorganization...................... 1,883,889 17,820,572
---------- ------------
Total issued......................... 3,432,748 32,867,771
Shares redeemed...................... (2,183,963) (21,116,271)
---------- ------------
Net increase......................... 1,248,785 $ 11,751,500
========== ============
- -----------------------------------------------------------------
</TABLE>
5. CAPITAL LOSS CARRYFORWARD:
At December 31, 1997, the Fund had net capital loss carryforward of
approximately $2,872,000, of which $513,000 expires in 2002 and $2,359,000
expires in 2005. This amount will be available to offset like amounts of any
future taxable gains.
6. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.053800 per Class A Share payable on January 2, 1998
to shareholders of record as of December 31, 1997.
82
<PAGE> 293
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD US STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AEROSPACE 100,000 GenCorp, Inc. .................... $ 2,842,382 $ 2,500,000 0.3%
25,500 +Orbital Sciences Corporation..... 654,914 758,625 0.1
------------ ------------ -----
3,497,296 3,258,625 0.4
- ------------------------------------------------------------------------------------------------------------------------
AIRLINES 96,000 +US Airways Group, Inc. .......... 4,126,132 6,000,000 0.7
- ------------------------------------------------------------------------------------------------------------------------
APPLIANCES 105,000 Sunbeam Corporation............... 4,144,224 4,423,125 0.5
- ------------------------------------------------------------------------------------------------------------------------
AUTO--RELATED 131,600 +Avis Rent-A-Car, Inc. ........... 3,128,250 4,202,975 0.5
122,400 Hertz Corp. (Class A)............. 4,153,083 4,926,600 0.6
------------ ------------ -----
7,281,333 9,129,575 1.1
- ------------------------------------------------------------------------------------------------------------------------
AUTOMOBILE PARTS 105,000 Federal Mogul Corp. .............. 4,052,275 4,252,500 0.5
- ------------------------------------------------------------------------------------------------------------------------
BANKING 51,600 Bank of New York Co., Inc. ....... 1,613,910 2,983,125 0.3
28,000 Bank of New York Co., Inc.
(Warrants)(a)................... 210,563 4,739,000 0.5
70,400 BankAmerica Corp. ................ 4,409,027 5,139,200 0.6
------------ ------------ -----
6,233,500 12,861,325 1.4
- ------------------------------------------------------------------------------------------------------------------------
BANKING & FINANCIAL 115,000 First Union Corporation........... 5,681,941 5,893,750 0.7
- ------------------------------------------------------------------------------------------------------------------------
BROADCASTING/CABLE 52,400 +Chancellor Media Corp. .......... 3,323,684 3,910,350 0.4
237,583 +Tele-Communications, Inc. (Class
A).............................. 4,588,904 6,622,626 0.8
145,417 +Tele-Communications TCI Ventures
Group........................... 2,794,815 4,117,119 0.5
------------ ------------ -----
10,707,403 14,650,095 1.7
- ------------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES 99,400 +Gartner Group Inc. .............. 3,372,841 3,702,650 0.4
- ------------------------------------------------------------------------------------------------------------------------
COMMUNICATION EQUIPMENT 142,000 +WorldCom, Inc. .................. 3,759,906 4,295,500 0.5
- ------------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES 40,800 +Cisco Systems, Inc. ............. 2,337,450 2,274,600 0.3
21,000 +Microsoft Corp. ................. 2,500,931 2,712,938 0.3
------------ ------------ -----
4,838,381 4,987,538 0.6
- ------------------------------------------------------------------------------------------------------------------------
COMPUTER SOFTWARE 61,200 +BMC Software, Inc. .............. 2,720,906 4,008,600 0.5
68,200 Computer Associates International,
Inc. ........................... 2,287,280 3,606,075 0.4
------------ ------------ -----
5,008,186 7,614,675 0.9
- ------------------------------------------------------------------------------------------------------------------------
COMPUTERS 22,400 COMPAQ Computer Corp. ............ 854,330 1,264,200 0.2
27,600 International Business Machines
Corporation..................... 1,771,806 2,885,925 0.3
87,500 +Quantum Corporation.............. 2,399,156 1,755,469 0.2
------------ ------------ -----
5,025,292 5,905,594 0.7
- ------------------------------------------------------------------------------------------------------------------------
CONGLOMERATES 124,300 AlliedSignal Inc. ................ 4,612,901 4,839,931 0.6
177,800 The Dial Corporation.............. 3,442,999 3,700,463 0.4
------------ ------------ -----
8,055,900 8,540,394 1.0
- ------------------------------------------------------------------------------------------------------------------------
CONTAINERS 159,100 +Owens-Illinois, Inc. ............ 4,781,249 6,035,856 0.7
- ------------------------------------------------------------------------------------------------------------------------
ELECTRONIC COMPONENTS 62,500 General Electric Company.......... 4,431,072 4,585,938 0.5
- ------------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT 50,000 Royal Caribbean Cruises Ltd. ..... 2,196,512 2,665,625 0.3
- ------------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 40,600 American Express Company.......... 2,425,666 3,623,550 0.4
62,000 MGIC Investment Corp. ............ 2,409,075 4,123,000 0.5
------------ ------------ -----
4,834,741 7,746,550 0.9
- ------------------------------------------------------------------------------------------------------------------------
HARDWARE & TOOLS 80,900 The Black & Decker Corporation.... 2,792,532 3,160,156 0.4
- ------------------------------------------------------------------------------------------------------------------------
INSURANCE 37,000 Hartford Life, Inc. (Class A)..... 1,254,821 1,676,563 0.2
180,000 Provident Companies, Inc. ........ 6,034,106 6,952,500 0.8
105,750 Travelers Group, Inc. ............ 4,133,918 5,697,281 0.7
44,800 Travelers Property Casualty Corp.
(Class A)....................... 1,814,661 1,971,200 0.2
112,600 UNUM Corporation.................. 3,571,593 6,122,625 0.7
------------ ------------ -----
16,809,099 22,420,169 2.6
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
83
<PAGE> 294
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD US STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
LEISURE 128,500 Brunswick Corporation............. $ 3,332,694 $ 3,895,156 0.5%
- ------------------------------------------------------------------------------------------------------------------------
MACHINERY 68,000 Harnischfeger Industries, Inc. ... 2,880,446 2,401,250 0.3
123,000 Ingersoll-Rand Co. ............... 3,928,469 4,981,500 0.6
45,000 SPX Corporation................... 2,553,321 3,105,000 0.4
------------ ------------ -----
9,362,236 10,487,750 1.3
- ------------------------------------------------------------------------------------------------------------------------
MEDICAL EQUIPMENT 96,000 DENTSPLY International, Inc. ..... 2,422,734 2,928,000 0.3
- ------------------------------------------------------------------------------------------------------------------------
MEDICAL SPECIALTIES 216,000 +HEALTHSOUTH Corporation.......... 5,856,983 5,994,000 0.7
32,400 Warner-Lambert Company............ 4,478,544 4,017,600 0.5
------------ ------------ -----
10,335,527 10,011,600 1.2
- ------------------------------------------------------------------------------------------------------------------------
NATURAL GAS 55,000 Enron Corp. ...................... 2,057,325 2,285,938 0.3
- ------------------------------------------------------------------------------------------------------------------------
OFFICE EQUIPMENT 51,500 Danka Business Systems PLC
(ADR)*.......................... 2,539,015 820,781 0.1
- ------------------------------------------------------------------------------------------------------------------------
OIL SERVICES 40,000 Schlumberger Ltd. ................ 1,953,287 3,220,000 0.3
68,000 +Smith International, Inc. ....... 3,395,848 4,173,500 0.5
------------ ------------ -----
5,349,135 7,393,500 0.8
- ------------------------------------------------------------------------------------------------------------------------
PETROLEUM 115,000 Unocal Corp. ..................... 4,037,135 4,463,438 0.5
- ------------------------------------------------------------------------------------------------------------------------
PHARMACEUTICAL--DIVERSIFIED 49,200 Bristol-Myers Squibb Company...... 4,680,631 4,655,550 0.5
- ------------------------------------------------------------------------------------------------------------------------
PHARMACEUTICAL--PRESCRIPTION 64,000 Pfizer Inc. ...................... 4,715,183 4,772,000 0.5
- ------------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 72,800 Eli Lilly & Co. .................. 4,607,998 5,068,700 0.6
- ------------------------------------------------------------------------------------------------------------------------
RAILROADS 39,000 Burlington Northern Santa Fe
Inc. ........................... 3,386,514 3,624,563 0.4
- ------------------------------------------------------------------------------------------------------------------------
REAL ESTATE INVESTMENT 106,000 Glenborough Realty Trust Inc. .... 2,650,000 3,140,250 0.4
TRUSTS
115,000 Prentiss Properties Trust......... 2,348,760 3,212,813 0.4
44,950 Starwood Lodging Trust............ 1,228,009 2,601,481 0.3
------------ ------------ -----
6,226,769 8,954,544 1.1
- ------------------------------------------------------------------------------------------------------------------------
RESTAURANTS 70,000 +Tricon Global Restaurants,
Inc............................. 2,407,706 2,034,375 0.2
- ------------------------------------------------------------------------------------------------------------------------
RETAIL 55,000 +Safeway Inc. .................... 3,093,871 3,478,750 0.4
80,000 Sears, Roebuck & Co. ............. 3,728,944 3,620,000 0.4
90,000 Wal-Mart Stores, Inc. ............ 3,715,638 3,549,375 0.4
------------ ------------ -----
10,538,453 10,648,125 1.2
- ------------------------------------------------------------------------------------------------------------------------
RETAIL--DRUG STORES 81,105 Rite Aid Corp. ................... 2,783,712 4,759,850 0.5
- ------------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS 140,000 +National Semiconductor
Corporation..................... 5,386,785 3,631,250 0.4
- ------------------------------------------------------------------------------------------------------------------------
TRANSPORT SERVICES 114,000 +OMI Corporation.................. 1,424,919 1,047,375 0.1
- ------------------------------------------------------------------------------------------------------------------------
TRAVEL & LODGING 130,000 Carnival Corp. (Class A).......... 4,268,818 7,198,750 0.8
- ------------------------------------------------------------------------------------------------------------------------
UTILITIES 87,000 Texas Utilities Company........... 3,477,633 3,615,937 0.4
- ------------------------------------------------------------------------------------------------------------------------
UTILITIES--COMMUNICATIONS 206,000 Edison International.............. 4,247,251 5,600,625 0.6
- ------------------------------------------------------------------------------------------------------------------------
UTILITIES--GAS 92,500 El Paso Natural Gas Co. .......... 4,859,456 6,151,250 0.7
- ------------------------------------------------------------------------------------------------------------------------
TOTAL US STOCKS & WARRANTS 214,077,444 256,178,697 29.5
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
84
<PAGE> 295
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY HELD FOREIGN STOCKS++ COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ARGENTINA 114,400 Yacimientos Petroliferos Fiscales
S.A. (YPF)(ADR)* (21)........... $ 2,731,185 $ 3,911,050 0.5%
- ------------------------------------------------------------------------------------------------------------------------
AUSTRALIA 713,000 Broken Hill Proprietary Co., Ltd.
(19)............................ 9,381,161 6,614,323 0.8
- ------------------------------------------------------------------------------------------------------------------------
BAHAMAS 61,500 +Sun International Hotels
Ltd.(33) ....................... 2,359,095 2,313,938 0.3
- ------------------------------------------------------------------------------------------------------------------------
BRAZIL 33,400 Telecomunicacoes Brasileiras
S.A.-- Telebras(ADR)* (27)...... 3,338,365 3,889,012 0.4
69,200 +Unibanco Holdings (ADR)* (3)..... 2,335,979 2,227,375 0.3
------------ ------------ -----
5,674,344 6,116,387 0.7
- ------------------------------------------------------------------------------------------------------------------------
CANADA 438,000 +Gulf Canada Resources Limited
(28)............................ 4,066,909 3,066,000 0.3
225,200 +Imax Corporation(32)............. 3,584,449 4,841,800 0.6
108,800 Magna International Inc. (Class A)
(1)............................. 5,411,041 6,834,000 0.8
------------ ------------ -----
13,062,399 14,741,800 1.7
- ------------------------------------------------------------------------------------------------------------------------
FINLAND 290,000 +Amer Group Ltd. (10)............. 5,251,766 5,563,102 0.6
132,000 Finnlines OY (8).................. 2,486,828 5,233,961 0.6
198,800 Orion-Yhtymae OY (22)............. 5,494,455 5,112,782 0.6
339,900 UPM-Kymmene OY (13)............... 7,086,032 6,776,162 0.8
------------ ------------ -----
20,319,081 22,686,007 2.6
- ------------------------------------------------------------------------------------------------------------------------
FRANCE 57,500 +SGS-Thomson Microelectronics N.V.
(NY Registered Shares) (20)..... 2,178,003 3,511,094 0.4
153,100 Scor S.A. (16).................... 5,700,758 7,320,515 0.9
83,000 Thomson-CSF SA (11)............... 2,608,063 2,615,900 0.3
------------ ------------ -----
10,486,824 13,447,509 1.6
- ------------------------------------------------------------------------------------------------------------------------
GERMANY 70,000 Bayerische Vereinsbank AG (3)..... 4,221,821 4,580,276 0.5
13,500 Henkel KGaA (9)................... 600,048 758,005 0.1
121,500 Henkel KGaA (Preferred) (9)....... 5,163,053 7,666,361 0.9
16,300 Mannesmann AG (17)................ 5,829,883 8,236,991 0.9
------------ ------------ -----
15,814,805 21,241,633 2.4
- ------------------------------------------------------------------------------------------------------------------------
INDONESIA 248,580 P.T. Indonesian Satellite Corp.
(ADR)* (27)..................... 6,430,682 4,800,701 0.6
- ------------------------------------------------------------------------------------------------------------------------
ITALY 750,000 Arnoldo Mondadori Editore S.p.A.
(23)............................ 6,327,223 5,892,494 0.7
1,161,800 Danieli & Company (17)............ 4,276,177 4,176,491 0.5
164,000 Gucci Group N.V. (NY Registered
Shares)(25)..................... 11,573,447 6,867,500 0.8
------------ ------------ -----
22,176,847 16,936,485 2.0
- ------------------------------------------------------------------------------------------------------------------------
JAPAN 131,000 Amway Japan Ltd. (31)............. 5,024,087 2,514,395 0.3
296,000 Bridgestone Corporation (26)...... 5,256,265 6,431,324 0.7
803,000 Maeda Corp. (4)................... 7,177,535 1,787,869 0.2
235,000 Matsushita Electric Industries,
Ltd. (12)....................... 3,719,946 3,446,065 0.4
440,000 Matsushita Electric Works, Ltd.
(12)............................ 5,008,321 3,817,274 0.4
906,000 Okumura Corp. (4)................. 6,730,420 2,156,315 0.3
38,000 Rohm Company, Ltd. (12)........... 2,467,912 3,880,230 0.4
77,000 Sony Corporation (12)............. 5,677,742 6,857,582 0.8
354,000 Tokio Marine and Fire
Insurance Co., Ltd. (16).......... 3,841,719 4,022,418 0.5
------------ ------------ -----
44,903,947 34,913,472 4.0
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
85
<PAGE> 296
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY HELD FOREIGN STOCKS++ COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
MEXICO 246,700 Grupo Carso, S.A. de C.V. (ADR)*
(18).............................. $ 3,187,234 $ 3,268,775 0.4%
175,000 +Grupo Financiera Bancomer (ADR)*
(5)............................... 2,497,912 2,187,500 0.2
95,500 Panamerican Beverages, Inc. (Class
A) (6).......................... 2,434,347 3,115,687 0.3
45,000 Telefonos de Mexico, S.A. de C.V.
(Telmex) (ADR)* (27)............ 1,809,504 2,522,812 0.3
------------ ------------ -----
9,928,997 11,094,774 1.2
- ------------------------------------------------------------------------------------------------------------------------
NETHERLANDS 466 ABN-AMRO Holdings N.V.
(Convertible Preferred) (3)..... 15,383 35,164 0.0
72,000 Royal Dutch Petroleum Co. (ADR)*
(28).............................. 3,932,690 3,901,500 0.4
------------ ------------ -----
3,948,073 3,936,664 0.4
- ------------------------------------------------------------------------------------------------------------------------
NORWAY 641,000 Color Line ASA (8)................ 2,499,223 2,482,470 0.3
- ------------------------------------------------------------------------------------------------------------------------
PHILIPPINES 1,517,960 San Miguel Corp. (Class B) (6).... 3,266,021 1,878,475 0.2
- ------------------------------------------------------------------------------------------------------------------------
SOUTH AFRICA 287,000 De Beers Consolidated Mines
Ltd.(ADR)* (7).................. 9,811,387 5,865,563 0.7
593,700 Sasol Ltd. (10)................... 7,000,856 6,225,062 0.7
------------ ------------ -----
16,812,243 12,090,625 1.4
- ------------------------------------------------------------------------------------------------------------------------
SOUTH KOREA 141,500 +Hyundai Engineering &
Construction Co., Ltd.(GDR)**
(b) (29)........................ 1,815,963 123,812 0.0
2,763 +Hyundai Engineering &
Construction Co., Ltd. (New
Shares) (GDR)** (b) (29)........ 35,459 2,418 0.0
------------ ------------ -----
1,851,422 126,230 0.0
- ------------------------------------------------------------------------------------------------------------------------
SPAIN 168,800 Repsol S.A. (ADR)* (21)........... 5,764,803 7,184,550 0.8
- ------------------------------------------------------------------------------------------------------------------------
SWEDEN 322,200 Bure Investment AB (30)........... 2,845,754 4,240,809 0.5
214,600 +Castellum AB (24)................ 1,439,624 2,135,323 0.2
536,900 +Nordhanken Holding AB (3)........ 2,912,368 3,036,313 0.4
293,000 Perstorp AB (Class B) (9)......... 5,488,280 5,240,380 0.6
278,000 Sparbanken Sverige AB (Class A)
(3)............................. 3,575,154 6,320,171 0.7
130,000 Spectra-Physics AB (14)........... 3,966,604 2,464,261 0.3
------------ ------------ -----
20,227,784 23,437,257 2.7
- ------------------------------------------------------------------------------------------------------------------------
SWITZERLAND 4,500 Novartis AG (22).................. 4,790,131 7,307,297 0.8
793 Roche Holdings AG (22)............ 6,661,394 7,881,100 0.9
------------ ------------ -----
11,451,525 15,188,397 1.7
- ------------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM 750,100 Diageo PLC (6).................... 5,394,255 6,893,260 0.8
484,000 Dixons Group PLC (25)............. 5,096,628 4,857,267 0.6
465,300 Imperial Chemical Industries PLC
(28)............................ 6,166,241 7,268,067 0.8
2,513,900 LucasVarity PLC (1)............... 8,649,324 8,877,524 1.0
629,000 Rio Tinto PLC (19)................ 9,470,454 7,738,162 0.9
------------ ------------ -----
34,776,902 35,634,280 4.1
- ------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN STOCKS 263,867,363 260,777,027 30.0
- ------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT FOREIGN BONDS++
- ------------------------------------------------------------------------------------------------------------------------
CANADA C$7,350,000 Canadian Government Bonds, 7% due
12/01/2006 (15)................. 5,583,958 5,629,470 0.7
- ------------------------------------------------------------------------------------------------------------------------
DENMARK Dkr72,500,000 Government of Denmark, 7% due
11/15/2007
(15)............................ 11,582,614 11,628,616 1.3
- ------------------------------------------------------------------------------------------------------------------------
FRANCE Fim73,700,000 Government of France, 5.50% due
10/25/2007 (15)................. 12,134,726 12,391,494 1.4
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
86
<PAGE> 297
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
COUNTRY AMOUNT FOREIGN BONDS++ COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
GERMANY
Bundesrepublik Deutschland (15):
DM7,900,000 6.50% due 10/14/2005.............. $ 5,092,717 $ 4,734,818 0.6%
33,000,000 6% due 7/04/2007.................. 19,300,518 19,235,324 2.2
7,500,000 6% due 6/20/2016.................. 4,172,640 4,322,882 0.5
7,550,000 Treuhandanstalt, 6.875% due
6/11/2003 (15).................. 5,020,900 4,577,513 0.5
------------ ------------ -----
33,586,775 32,870,537 3.8
- ------------------------------------------------------------------------------------------------------------------------
ITALY Lit30,000,000,000 Buoni Poliennali del Tesoro
(Italian Government Bonds),
8.50% due 8/01/2004 (15)........ 19,525,658 19,746,213 2.3
- ------------------------------------------------------------------------------------------------------------------------
SPAIN Pta 1,670,000,000 Spanish Government Bonds, 7.90%
due 2/28/2002 (15).............. 13,081,909 12,114,914 1.4
- ------------------------------------------------------------------------------------------------------------------------
SWEDEN Skr98,200,000 Government of Sweden, 8% due
8/15/2007 (15).................. 14,051,805 14,157,770 1.6
- ------------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM L11,000,000 United Kingdom Treasury Gilt,
7.25% due 12/07/2007 (15)....... 18,207,288 19,326,579 2.2
- ------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS 127,754,733 127,865,593 14.7
- ------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT OBLIGATIONS
- ------------------------------------------------------------------------------------------------------------------------
US$ 56,600,000 US Treasury Bonds,
6.625% due 2/15/2027.............. 57,947,438 61,446,092 7.1
- ------------------------------------------------------------------------------------------------------------------------
US Treasury Notes:
40,000,000 6% due 8/15/1999.................. 40,109,375 40,193,600 4.6
10,000,000 6.50% due 5/31/2002............... 10,073,125 10,292,200 1.2
6,250,000 6.25% due 2/15/2007............... 6,164,062 6,449,187 0.7
8,450,000 6.625% due 5/15/2007.............. 8,555,977 8,943,818 1.0
------------ ------------ -----
64,902,539 65,878,805 7.5
- ------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT OBLIGATIONS 122,849,977 127,324,897 14.6
- ------------------------------------------------------------------------------------------------------------------------
<CAPTION>
SHORT-TERM SECURITIES
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
COMMERCIAL PAPER*** US$36,697,000 General Motors Acceptance Corp.,
6.75% due 1/02/1998............. 36,690,119 36,690,119 4.2
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
87
<PAGE> 298
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
AMOUNT SHORT-TERM SECURITIES COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
US GOVERNMENT AGENCY US$ 57,000,000 Federal Home Loan Mortgage
OBLIGATIONS*** Corp., 5.75% due
1/06/1998................ $ 56,954,479 $ 56,954,479 6.6%
- ------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 93,644,598 93,644,598 10.8
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS................................. $822,194,115 865,790,812 99.6
============
UNREALIZED DEPRECIATION ON FORWARD FOREIGN
EXCHANGE CONTRACTS+++............................. (147,743) (0.0)
OTHER ASSETS LESS LIABILITIES..................... 4,003,745 0.4
------------ -----
NET ASSETS........................................ $869,646,814 100.0%
============ =====
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Global Depositary Receipts (GDR).
*** Commercial Paper and certain US Government Agency Obligations are traded on
a discount basis; the interest rates shown are the discount rates paid at the
time of purchase by the Fund.
(a) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and number of shares are subject to adjustment
under certain conditions until the expiration date.
(b) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
+ Non-income producing security.
++ Corresponding industry groups for foreign stocks and bonds:
<TABLE>
<S> <C> <C>
(1) Auto--Parts (12) Electronics (22) Pharmaceutical
(2) Office Equipment (13) Paper & Forest Products (23) Printing & Publishing
(3) Banking (14) Industrial Components (24) Real Estate
(4) Building & Construction (15) Government (Bonds) (25) Retail Trade
(5) Financial Services (16) Insurance (26) Tire & Rubber
(6) Beverages (17) Machinery & Equipment (27) Telecommunications
(7) Mining (18) Multi-Industry (28) Oil--Integrated
(8) Transportation (19) Metals (29) Engineering & Construction
(9) Chemicals (20) Semiconductor Capital Equipment (30) Investment Management
(10) Diversified (21) Petroleum (31) Retailers
(11) Electrical Equipment (32) Leisure & Entertainment
(33) Hotels & Casinos
</TABLE>
+++ Forward foreign exchange contracts sold as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- ------------------------------------------------
UNREALIZED
APPRECIATION
FOREIGN EXPIRATION (DEPRECIATION)
CURRENCY SOLD DATE (NOTE 1B)
- ------------------------------------------------
<S> <C> <C> <C>
A$ 9,840,000 January 1998 $ 85,264
C$ 30,000,000 March 1998 128,228
L 20,250,000 January 1998 (529,902)
Y 4,500,000,000 January 1998 168,667
- ------------------------------------------------
TOTAL UNREALIZED DEPRECIATION ON
FORWARD FOREIGN EXCHANGE
CONTRACTS--NET (US$
COMMITMENT--$95,114,964) $ (147,743)
==========
- ------------------------------------------------
</TABLE>
See Notes to Financial Statements.
88
<PAGE> 299
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$822,194,115) (Note
1a)....................................................... $865,790,812
Cash........................................................ 282
Foreign cash (Note 1c)...................................... 252,458
Receivables:
Interest.................................................. $5,760,306
Dividends................................................. 845,615
Capital shares sold....................................... 13,839 6,619,760
-----------
Prepaid expenses and other assets........................... 52,050
-------------
Total assets................................................ 872,715,362
-------------
- -----------------------------------------------------------------------------------------
LIABILITIES:
Unrealized depreciation on forward foreign exchange
contracts (Note 1b)....................................... 147,743
Payables:
Forward foreign exchange contracts (Note 1b).............. 1,500,097
Investment adviser (Note 2)............................... 509,408
Securities purchased...................................... 442,208
Capital shares redeemed................................... 255,295 2,707,008
----------
Accrued expenses and other liabilities...................... 213,797
------------
Total liabilities........................................... 3,068,548
------------
- -----------------------------------------------------------------------------------------
NET ASSETS.................................................. $869,646,814
============
- -----------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 200,000,000
shares authorized+........................................ $ 5,912,071
Paid-in capital in excess of par............................ 691,213,759
Undistributed investment income--net........................ 29,735,941
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 99,432,497
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 43,352,546
-------------
NET ASSETS.................................................. $869,646,814
=============
- -----------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $869,646,814 and 59,120,710
shares outstanding........................................ $ 14.71
=============
- -----------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 200,000,000 Class B Shares.
See Notes to Financial Statements.
89
<PAGE> 300
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Interest and discount earned (net of $26,730 foreign
withholding tax).......................................... $ 13,970,349
Dividends (net of $1,196,379 foreign withholding tax)....... 13,585,037
Other income................................................ 28,445
------------
Total income................................................ 27,583,831
------------
- ------------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 5,860,619
Custodian fees.............................................. 330,613
Accounting services (Note 2)................................ 188,773
Professional fees........................................... 136,823
Directors' fees and expenses................................ 17,241
Pricing services............................................ 13,520
Transfer agent fees (Note 2)................................ 5,475
Other....................................................... 45,624
-----------
Total expenses.............................................. 6,598,688
------------
Investment income--net...................................... 20,985,143
------------
- ------------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET
(NOTES 1b, 1c, 1e & 3):
Realized gain from:
Investments--net.......................................... 99,629,063
Foreign currency transactions--net........................ 7,097,141 106,726,204
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (30,261,812)
Foreign currency transactions--net........................ 2,531,352 (27,730,460)
----------- ------------
Net realized and unrealized gain on investments and foreign
currency transactions..................................... 78,995,744
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 99,980,887
============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
90
<PAGE> 301
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 20,985,143 $ 15,340,737
Realized gain on investments and foreign currency
transactions--net......................................... 106,726,204 60,957,413
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (27,730,460) 24,598,652
------------ ------------
Net increase in net assets resulting from operations........ 99,980,887 100,896,802
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A................................................... (18,926,819) (12,699,527)
Realized gain on investments--net:
Class A................................................... (26,410,838) --
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (45,337,657) (12,699,527)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase (decrease) in net assets derived from capital
share transactions........................................ (55,199,234) 241,763,930
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (556,004) 329,961,205
Beginning of year........................................... 870,202,818 540,241,613
------------ ------------
End of year*................................................ $869,646,814 $870,202,818
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1g)............ $ 29,735,941 $ 20,579,673
============ ============
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
91
<PAGE> 302
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
----------------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM FOR THE YEAR ENDED DECEMBER 31,
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ----------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year........................... $ 13.87 $ 12.55 $ 11.73 $ 12.17 $ 10.22
-------- -------- -------- -------- --------
Investment income--net....................................... .35 .28 .39 .30 .16
Realized and unrealized gain (loss) on investments and foreign
currency transactions--net................................. 1.21 1.33 .82 (.48) 1.96
-------- -------- -------- -------- --------
Total from investment operations............................. 1.56 1.61 1.21 (.18) 2.12
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net..................................... (.30) (.29) (.39) (.21) (.17)
Realized gain on investments--net.......................... (.42) -- --+ (.04) --
In excess of realized gain on investments--net............. -- -- -- (.01) --
-------- -------- -------- -------- --------
Total dividends and distributions............................ (.72) (.29) (.39) (.26) (.17)
-------- -------- -------- -------- --------
Net asset value, end of year................................. $ 14.71 $ 13.87 $ 12.55 $ 11.73 $ 12.17
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share........................... 11.94% 13.17% 10.60% (1.46%) 21.03%
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses..................................................... .73% .71% .72% .77% .88%
======== ======== ======== ======== ========
Investment income--net....................................... 2.33% 2.68% 3.33% 2.85% 2.41%
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)....................... $869,647 $870,203 $540,242 $515,407 $269,627
======== ======== ======== ======== ========
Portfolio turnover........................................... 108.66% 173.44% 27.23% 21.03% 17.07%
======== ======== ======== ======== ========
Average commission rate paid++............................... $ .0149 $ .0143 -- -- --
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Amount is less than $.01 per share.
++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into US
dollars using the prevailing exchange rate on the date of the transaction. Such
conversions may significantly affect the rate shown.
See Notes to Financial Statements.
92
<PAGE> 303
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A and each fund began offering Class B Shares. Both classes of shares have equal
voting, dividend, liquidation and other rights, except that only shares of the
respective classes are entitled to vote on matters concerning only that class
and Class B Shares bear certain expenses related to the distribution of such
shares. Global Strategy Focus Fund (the "Fund") is classified as "non-
diversified", as defined in the Investment Company Act of 1940. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Options purchased are valued at
the last sale price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter market, the last bid price. Short-term
securities are valued at amortized cost, which approximates market value.
Futures contracts are valued at the settlement price at the close of the
applicable exchange. Securities for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts. Premium or discount is amortized over the life
of the contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid or received is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the proceeds of
the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell futures contracts
and options on such futures contracts for the purpose of hedging the market risk
on existing securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific future date and
at a specific price or yield. Upon entering into a contract, the Fund deposits
and maintains as collateral such initial margin as required by the exchange on
which the transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are known as
variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the
93
<PAGE> 304
- --------------------------------------------------------------------------------
value of the contract at the time it was opened and the value at the time it was
closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $7,097,944 have been reclassified between undistributed
net realized capital gains and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.65% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc. ("MLPF&S"), a subsidiary of ML & Co., earned $83,224 in commissions on the
execution of portfolio security transactions.
For the year ended December 31, 1997, Merrill Lynch Security Pricing Service,
an affiliate of MLPF&S, earned $239 for providing security price quotations to
compute the Fund's net asset value.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
94
<PAGE> 305
- --------------------------------------------------------------------------------
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $885,155,828 and $1,023,036,391, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
REALIZED UNREALIZED
GAINS GAINS
(LOSSES) (LOSSES)
- ------------------------------------------------------------
<S> <C> <C>
Long-term investments......... $ 99,628,693 $43,596,697
Short-term investments........ 370 --
Foreign currency
transactions................ (11,782,112) (96,408)
Forward foreign exchange
contracts................... 18,879,253 (147,743)
------------ -----------
Total......................... $106,726,204 $43,352,546
============ ===========
- ------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $42,373,042, of which $89,173,124 related to appreciated
securities and $46,800,082 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$823,417,770.
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital share transactions
were $(55,199,234) and $241,763,930 for the years ended December 31, 1997 and
December 31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
CLASS A SHARES FOR THE YEAR ENDED DOLLAR
DECEMBER 31, 1997 SHARES AMOUNT
- ----------------------------------------------------------------------------
<S> <C> <C>
Shares sold.................................... 1,193,286 $ 17,737,325
Shares issued to shareholders in reinvestment
of dividends and distributions................ 3,479,483 45,337,657
---------- -------------
Total issued................................... 4,672,769 63,074,982
Shares redeemed................................ (8,275,362) (118,274,216)
---------- -------------
Net decrease................................... (3,602,593) $ (55,199,234)
========== =============
- ----------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
CLASS A SHARES FOR THE YEAR ENDED DOLLAR
DECEMBER 31, 1996 SHARES AMOUNT
- ----------------------------------------------------------------------------
<S> <C> <C>
Shares sold.................................... 1,190,964 $ 14,964,723
Shares issued to shareholders in reinvestment
of dividends.................................. 1,034,164 12,699,527
Shares issued resulting from reorganization.... 23,634,508 294,328,812
----------- ------------
Total issued................................... 25,859,636 321,993,062
Shares redeemed................................ (6,200,613) (80,229,132)
----------- ------------
Net increase................................... 19,659,023 $241,763,930
=========== ============
- ----------------------------------------------------------------------------
</TABLE>
5. LOANED SECURITIES:
At December 31, 1997, the Fund held US Treasury notes having an aggregate value
of approximately $2,786,000 as collateral for portfolio securities loaned having
a market value of approximately $2,601,000.
6. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $1.189210 per Class A Share and a long-term capital
gains distribution in the amount of $1.191055 per Class A Share payable on
January 9, 1998 to shareholders of record as of December 31, 1997.
95
<PAGE> 306
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ARGENTINA TELECOMMUNICATIONS 51,200 Telecom Argentina STET S.A.
(ADR)*....................... $ 1,160,819 $ 1,830,400 1.3%
44,800 Telefonica de Argentina S.A.
(ADR)*....................... 1,173,168 1,668,800 1.2
----------- ------------ -----
2,333,987 3,499,200 2.5
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 7,900 Central Costanera S.A.
(ADR)*(b).................... 261,847 205,437 0.2
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN
ARGENTINA 2,595,834 3,704,637 2.7
- -------------------------------------------------------------------------------------------------------------------------
AUSTRALIA TELECOMMUNICATIONS 205,000 Telstra Corporation Limited.... 399,749 432,394 0.3
------------------------------------------------------------------------------------------------------
UTILITIES--GAS 434,496 Australian Gas & Light Co.,
Ltd. ........................ 1,238,060 3,026,569 2.2
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN
AUSTRALIA 1,637,809 3,458,963 2.5
- -------------------------------------------------------------------------------------------------------------------------
AUSTRIA UTILITIES--GAS 13,560 Energie-Versorgung
Niederoesterreich AG (EVN)... 1,388,213 1,782,374 1.3
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN AUSTRIA 1,388,213 1,782,374 1.3
- -------------------------------------------------------------------------------------------------------------------------
BRAZIL TELECOMMUNICATIONS 26,000 Telecomunicacoes Brasileiras
S.A.--Telebras (ADR)*........ 1,330,477 3,027,375 2.2
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 100,000 +Companhia Paranaense de
& GAS Energia (Copel) (ADR)*....... 1,800,000 1,368,750 1.0
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN BRAZIL 3,130,477 4,396,125 3.2
- -------------------------------------------------------------------------------------------------------------------------
CANADA TELECOMMUNICATIONS 56,000 BC Telecom, Inc. .............. 1,052,989 1,741,318 1.3
------------------------------------------------------------------------------------------------------
UTILITIES--GAS 70,100 TransCanada Pipelines Co., Ltd.
(ADR)*....................... 1,045,275 1,568,488 1.1
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CANADA 2,098,264 3,309,806 2.4
- -------------------------------------------------------------------------------------------------------------------------
CHILE TELECOMMUNICATIONS 41,700 Compania de TeleCommunicaciones
de Chile S.A. (Sponsored)
(ADR)*....................... 922,765 1,245,788 0.9
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 26,598 Chilgener S.A. (ADR)*.......... 622,719 651,651 0.5
35,150 Distribuidora Chilectra
Metropolitana S.A.
(ADR)*(b).................... 517,443 897,815 0.6
48,300 Enersis S.A. (ADR)*............ 1,026,061 1,400,700 1.0
----------- ------------ -----
2,166,223 2,950,166 2.1
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CHILE 3,088,988 4,195,954 3.0
- -------------------------------------------------------------------------------------------------------------------------
DENMARK TELECOMMUNICATIONS 77,000 Tele Danmark A/S (ADR)*........ 1,826,433 2,372,563 1.7
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN DENMARK 1,826,433 2,372,563 1.7
- -------------------------------------------------------------------------------------------------------------------------
FRANCE UTILITIES--WATER 16,984 +Generale des Eaux S.A. ....... 1,939,819 2,370,254 1.7
16,731 Generale des Eaux S.A.
(Warrants)(a)................ 0 11,369 0.0
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS & WARRANTS
IN FRANCE 1,939,819 2,381,623 1.7
- -------------------------------------------------------------------------------------------------------------------------
GERMANY TELECOMMUNICATIONS 8,100 Deutsche Telekom AG............ 154,054 152,427 0.1
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 15,000 RWE AG......................... 674,750 804,703 0.6
20,000 Veba AG........................ 652,699 1,362,019 1.0
1,500 Viag AG........................ 661,615 808,039 0.6
----------- ------------ -----
1,989,064 2,974,761 2.2
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN GERMANY 2,143,118 3,127,188 2.3
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
96
<PAGE> 307
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INDONESIA TELECOMMUNICATIONS 1,110 P.T. Indonesian Satellite Corp.
(Indosat)(ADR)*.............. $ 35,575 $ 21,437 0.0%
8,000 P.T. Telekomunikasi Indonesia
(PERSERO) (ADR)*............. 144,000 88,500 0.1
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN
INDONESIA 179,575 109,937 0.1
- -------------------------------------------------------------------------------------------------------------------------
ITALY TELECOMMUNICATIONS 651,600 Telecom Italia Mobile S.p.A.... 620,263 3,007,186 2.2
405,333 Telecom Italia S.p.A........... 950,865 2,588,889 1.9
761,900 Telecom Italia S.p.A.
(Registered
Non-Convertible)............. 1,629,934 3,359,044 2.4
----------- ------------ -----
3,201,062 8,955,119 6.5
------------------------------------------------------------------------------------------------------
UTILITIES--GAS 513,400 Italgas Torino S.p.A. ......... 1,581,576 2,118,370 1.5
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN ITALY 4,782,638 11,073,489 8.0
- -------------------------------------------------------------------------------------------------------------------------
JAPAN TELECOMMUNICATIONS 110 Nippon Telegraph & Telephone
Corp. ....................... 938,962 945,874 0.7
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN JAPAN 938,962 945,874 0.7
- -------------------------------------------------------------------------------------------------------------------------
MEXICO TELECOMMUNICATIONS 29,000 Telefonos de Mexico, S.A. de
C.V. (Telemex)(ADR)*......... 1,706,306 1,625,813 1.2
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN MEXICO 1,706,306 1,625,813 1.2
- -------------------------------------------------------------------------------------------------------------------------
NEW ZEALAND TELECOMMUNICATIONS 20,100 Telecom Corporation of New
Zealand Ltd. (ADR)*.......... 477,195 778,875 0.6
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN NEW
ZEALAND 477,195 778,875 0.6
- -------------------------------------------------------------------------------------------------------------------------
PERU TELECOMMUNICATIONS 73,000 Telefonica del Peru, S.A.
(ADR)*....................... 1,496,500 1,701,813 1.2
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN PERU 1,496,500 1,701,813 1.2
- -------------------------------------------------------------------------------------------------------------------------
PHILIPPINES TELECOMMUNICATIONS 43,600 Philippine Long Distance
Telephone Co. (ADR)*......... 1,270,791 981,000 0.7
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 96,330 Manila Electric Co. (MERALCO)
'B'.......................... 518,117 322,706 0.2
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
PHILIPPINES 1,788,908 1,303,706 0.9
- -------------------------------------------------------------------------------------------------------------------------
PORTUGAL TELECOMMUNICATIONS 65,720 Portugal Telecom, S.A. (ADR)*.. 1,417,539 3,088,840 2.2
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 2,940 +EDP-Electricidade de Portugal,
S.A. (ADR)*.................. 75,970 113,925 0.1
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN PORTUGAL 1,493,509 3,202,765 2.3
- -------------------------------------------------------------------------------------------------------------------------
SOUTH KOREA UTILITIES--ELECTRIC 63,700 Korea Electric Power Corp.
(ADR)*....................... 1,250,735 640,981 0.5
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SOUTH
KOREA 1,250,735 640,981 0.5
- -------------------------------------------------------------------------------------------------------------------------
SPAIN TELECOMMUNICATIONS 42,700 Telefonica de Espana, S.A.
(ADR)*....................... 1,681,058 3,888,369 2.8
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 145,600 Empresa Nacional de
Electricidad, S.A. (Endesa)
(ADR)*....................... 1,634,684 2,648,100 1.9
7,500 HidroElectrica del Cantabrico,
S.A. ........................ 251,742 328,288 0.2
131,000 Iberdrola I, S.A. ............. 879,896 1,721,086 1.3
----------- ------------ -----
2,766,322 4,697,474 3.4
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SPAIN 4,447,380 8,585,843 6.2
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
97
<PAGE> 308
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED KINGDOM TELECOMMUNICATIONS 57,000 British Telecommunications
PLC.......................... $ 406,712 $ 447,984 0.3%
10,000 British Telecommunications PLC
(ADR)*....................... 741,450 803,125 0.6
30,000 Vodafone Group PLC (ADR)*...... 859,933 2,175,000 1.6
----------- ------------ -----
2,008,095 3,426,109 2.5
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 167,500 National Power PLC............. 1,238,839 1,650,713 1.2
95,139 PowerGen PLC................... 705,721 1,237,625 0.9
----------- ------------ -----
1,944,560 2,888,338 2.1
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
UNITED KINGDOM 3,952,655 6,314,447 4.6
- -------------------------------------------------------------------------------------------------------------------------
UNITED TELECOMMUNICATIONS 17,000 AT&T Corporation............... 683,145 1,041,250 0.7
STATES
36,400 +AirTouch Communications,
Inc.......................... 879,157 1,512,875 1.1
25,800 Ameritech Corp. ............... 1,030,404 2,076,900 1.5
23,808 Bell Atlantic Corporation...... 1,184,107 2,166,528 1.6
37,400 BellSouth Corp. ............... 1,138,507 2,106,088 1.5
42,000 Frontier Corp. ................ 969,520 1,010,625 0.7
33,500 GTE Corp. ..................... 1,124,815 1,750,375 1.3
23,300 SBC Communications, Inc. ...... 982,372 1,706,725 1.2
30,000 Sprint Corp. .................. 864,273 1,758,750 1.3
24,900 U S West Communications
Group........................ 606,619 1,123,612 0.8
40,000 +WorldCom, Inc. ............... 1,323,316 1,210,000 0.9
----------- ------------ -----
10,786,235 17,463,728 12.6
------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 65,600 Allegheny Energy, Inc. ........ 1,689,846 2,132,000 1.5
25,000 American Electric Power
Company, Inc. ............... 1,092,125 1,290,625 0.9
72,500 Boston Edison Co. ............. 2,012,799 2,745,937 2.0
38,192 CINergy Corp. ................. 885,217 1,463,231 1.1
49,300 Consolidated Edison Co. of New
York......................... 1,597,050 2,021,300 1.5
31,500 DTE Energy Co. ................ 989,953 1,092,656 0.8
26,400 Dominion Resources, Inc. ...... 1,242,516 1,123,650 0.8
31,000 Duke Energy Corp. ............. 1,172,492 1,716,625 1.2
31,000 Edison International........... 544,360 842,812 0.6
50,000 Enova Corporation Holding
Co. ......................... 1,184,750 1,353,125 1.0
54,300 Entergy Corp. ................. 1,905,240 1,625,606 1.2
30,000 FPL Group, Inc. ............... 1,374,501 1,775,625 1.3
71,200 GPU, Inc. ..................... 2,090,069 2,999,300 2.2
26,200 Houston Industries, Inc. ...... 450,312 699,212 0.5
56,000 NIPSCO Industries, Inc. ....... 1,787,890 2,768,500 2.0
44,000 New Century Energies, Inc. .... 1,312,146 2,109,250 1.5
33,800 New York State Electric & Gas
Corp. ....................... 932,936 1,199,900 0.9
93,800 PECO Energy Co. ............... 2,719,313 2,274,650 1.7
72,800 PacifiCorp. ................... 1,401,416 1,988,350 1.4
50,200 Southern Co. .................. 1,041,077 1,298,925 0.9
80,000 Texas Utilities Holding Co. ... 2,984,864 3,325,000 2.4
----------- ------------ -----
30,410,872 37,846,279 27.4
------------------------------------------------------------------------------------------------------
</TABLE>
98
<PAGE> 309
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
COUNTRY INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED STATES UTILITIES--GAS 29,000 The Coastal Corp. ............. $ 892,505 $ 1,796,187 1.3%
(CONCLUDED)
24,800 El Paso Natural Gas Co. ....... 895,148 1,649,200 1.2
33,000 KeySpan Energy Corporation..... 855,855 1,214,812 0.9
11,000 KN Energy, Inc. ............... 445,212 594,000 0.4
26,100 National Fuel Gas Company...... 788,314 1,270,744 0.9
25,000 New Jersey Resources Corp. .... 656,623 1,001,562 0.7
32,500 Questar Corp. ................. 1,084,684 1,450,312 1.1
27,200 Sonat, Inc. ................... 890,624 1,244,400 0.9
49,800 Washington Gas Light Co. ...... 1,046,197 1,540,687 1.1
83,800 Williams Co., Inc. ............ 866,744 2,377,825 1.7
----------- ------------ -----
8,421,906 14,139,729 10.2
------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
UNITED STATES 49,619,013 69,449,736 50.2
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
COMMON STOCKS & WARRANTS 91,982,331 134,462,512 97.3
- -------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT
- -------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER** $3,477,000 General Motors Acceptance
Corp., 6.75% due 1/02/1998..... 3,475,696 3,475,696 2.5
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SHORT-
TERM SECURITIES 3,475,696 3,475,696 2.5
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS.............. $95,458,027 137,938,208 99.8
===========
OTHER ASSETS LESS
LIABILITIES.................... 267,958 0.2
------------ -----
NET ASSETS..................... $138,206,166 100.0%
============ =====
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
* American Depositary Receipts (ADR).
** Commercial Paper is traded on a discount basis; the interest rate shown is
the discount rate paid at the time of purchase by the Fund.
+ Non-income producing security.
(a) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and number of shares are subject to
adjustment under certain conditions until the expiration date.
(b) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
See Notes to Financial Statements.
99
<PAGE> 310
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$95,458,027) (Note
1a)....................................................... $137,938,208
Cash........................................................ 566
Foreign cash (Note 1c)...................................... 14,064
Receivables:
Dividends................................................. $360,283
Capital shares sold....................................... 4,979 365,262
--------
Deferred organization expenses (Note 1f).................... 1,551
Prepaid expenses and other assets (Note 1f)................. 7,388
------------
Total assets................................................ 138,327,039
------------
- -------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser (Note 2)............................... 72,770
Capital shares redeemed................................... 21,039 93,809
--------
Accrued expenses............................................ 27,064
------------
Total liabilities........................................... 120,873
------------
- -------------------------------------------------------------------------------------
NET ASSETS.................................................. $138,206,166
============
- -------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 931,439
Paid-in capital in excess of par............................ 87,337,273
Undistributed investment income--net........................ 852,184
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 6,606,939
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 42,478,331
------------
NET ASSETS.................................................. $138,206,166
============
- -------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $138,206,166 and 9,314,389
shares outstanding........................................ $ 14.84
============
- -------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
100
<PAGE> 311
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $272,108 foreign withholding tax)......... $ 5,062,929
Interest and discount earned................................ 192,535
-----------
Total income................................................ 5,255,464
-----------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 813,756
Custodian fees.............................................. 31,424
Accounting services (Note 2)................................ 24,980
Professional fees........................................... 18,286
Transfer agent fees (Note 2)................................ 5,006
Directors' fees and expenses................................ 2,852
Pricing services............................................ 2,657
Amortization of organization expenses (Note 1f)............. 863
Other....................................................... 3,035
-----------
Total expenses.............................................. 902,859
-----------
Investment income--net...................................... 4,352,605
-----------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized gain (loss) from:
Investments--net.......................................... 9,235,314
Foreign currency transactions--net........................ (28,510) 9,206,804
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... 17,642,788
Foreign currency transactions--net........................ (2,585) 17,640,203
----------- -----------
Net realized and unrealized gain on investments and foreign
currency transactions..................................... 26,847,007
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $31,199,612
===========
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
101
<PAGE> 312
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 4,352,605 $ 5,748,285
Realized gain on investments and foreign currency
transactions--net......................................... 9,206,804 1,196,792
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ 17,640,203 10,430,510
------------ ------------
Net increase in net assets resulting from operations........ 31,199,612 17,375,587
------------ ------------
- -----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 1g):
Investment income--net:
Class A................................................... (4,603,931) (6,739,387)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders................................................ (4,603,931) (6,739,387)
------------ ------------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital shares
transactions................................................ (30,827,316) (16,423,676)
------------ ------------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (4,231,635) (5,787,476)
Beginning of year........................................... 142,437,801 148,225,277
------------ ------------
End of year*................................................ $138,206,166 $142,437,801
============ ============
- -----------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1h)............ $ 852,184 $ 1,132,021
============ ============
- -----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
102
<PAGE> 313
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
---------------------------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN FOR THE PERIOD
DERIVED FROM INFORMATION PROVIDED IN THE FINANCIAL FOR THE YEAR ENDED DECEMBER 31, JULY 1, 1993+ TO
STATEMENTS. -------------------------------------------- DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............... $ 12.19 $ 11.30 $ 9.45 $ 10.66 $ 10.00
-------- -------- -------- -------- --------
Investment income--net............................. .43 .46 .45 .35 .04
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net........... 2.66 .95 1.79 (1.25) .64
-------- -------- -------- -------- --------
Total from investment operations................... 3.09 1.41 2.24 (.90) .68
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net........................... (.44) (.52) (.39) (.29) (.02)
In excess of realized gain on investments--net... -- -- -- (.02) --
-------- -------- -------- -------- --------
Total dividends and distributions.................. (.44) (.52) (.39) (.31) (.02)
-------- -------- -------- -------- --------
Net asset value, end of period..................... $ 14.84 $ 12.19 $ 11.30 $ 9.45 $ 10.66
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share................. 25.90% 12.96% 24.33% (8.51%) 6.85%#
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses........................................... .67% .66% .66% .73% .89%*
======== ======== ======== ======== ========
Investment income--net............................. 3.21% 3.90% 4.44% 3.68% 2.84%*
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)........... $138,206 $142,438 $148,225 $126,243 $104,517
======== ======== ======== ======== ========
Portfolio turnover................................. 7.70% 11.39% 11.05% 9.52% 1.72%
======== ======== ======== ======== ========
Average commission rate paid++..................... $ .0273 $ .0522 -- -- --
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into US
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
# Aggregate total investment return.
See Notes to Financial Statements.
103
<PAGE> 314
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. Global Utility Focus Fund (the "Fund") is classified as
"diversified", as defined in the Investment Company Act of 1940. The following
is a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Options purchased are valued at
the last sale price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter market, the last bid price. Futures
contracts are valued at the settlement price at the close of the applicable
exchange. Short-term securities are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts. Premium or discount is amortized over the life
of the contracts.
- - Options--The Fund may write call and put options and purchase put options.
When the Fund writes an option, an amount equal to the premium received by the
Fund is reflected as an asset and an equivalent liability. The amount of the
liability is subsequently marked to market to reflect the current market value
of the option written. When a security is purchased or sold through an exercise
of an option, the related premium paid (or received) is added to (or deducted
from) the basis of the security acquired or deducted from (or added to) the
proceeds of the security sold. When an option expires (or the Fund enters into a
closing transaction), the Fund realizes a gain or loss on the option to the
extent of the premiums received or paid (or gain or loss to the extent the cost
of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell futures contracts
and options on such futures contracts for the purpose of hedging the market risk
on existing securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific future date and
at a specific price or yield. Upon entering into a contract, the Fund deposits
and maintains as collateral such initial margin as required by the exchange on
which the transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are known as
variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized
104
<PAGE> 315
- --------------------------------------------------------------------------------
gain or loss equal to the difference between the value of the contract at the
time it was opened and the value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses and prepaid registration fees--Deferred
organization expenses are charged to expense on a straight-line basis over a
five-year period. Prepaid registration fees are charged to expense as the
related shares are issued.
(g) Dividends and distributions--Dividends from net investment income are
declared and paid quarterly. Distributions of capital gains are recorded on the
ex-dividend date.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $28,511 have been reclassified between undistributed net
realized capital gains and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.60% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc. ("MLPF&S"), a subsidiary of ML & Co., earned $13,129 in commissions on the
execution of portfolio security transactions for the Fund.
For the year ended December 31, 1997, Merrill Lynch Security Pricing Service,
an affiliate of MLPF&S, earned $43 for providing security price quotations to
compute the Fund's net asset value.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
105
<PAGE> 316
- --------------------------------------------------------------------------------
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $10,174,873 and $39,720,575, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- --------------------------------------------------------------------------------
<S> <C> <C>
Long-term investments.......................... $9,235,304 $42,480,181
Short-term investments......................... 10 --
Foreign currency transactions.................. (28,510) (1,850)
---------- -----------
Total.......................................... $9,206,804 $42,478,331
========== ===========
- --------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $42,480,181, of which $45,171,036 related to appreciated
securities and $2,690,855 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$95,458,027.
4. CAPITAL SHARE TRANSACTIONS:
Net decreases in net assets derived from capital share transactions were
$30,827,316 and $16,423,676 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 926,005 $ 12,113,010
Shares issued to shareholders in
reinvestment of dividends........... 358,250 4,603,931
---------- ------------
Total issued......................... 1,284,255 16,716,941
Shares redeemed...................... (3,656,796) (47,544,257)
---------- ------------
Net decrease......................... (2,372,541) $(30,827,316)
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- ------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 858,704 $ 9,800,413
Shares issued to shareholders in
reinvestment of dividends............. 595,856 6,739,387
---------- ------------
Total issued........................... 1,454,560 16,539,800
Shares redeemed........................ (2,881,155) (32,963,476)
---------- ------------
Net decrease........................... (1,426,595) $(16,423,676)
========== ============
- ------------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.091530 per Class A Share and a long-term capital
gains distribution in the amount of $.709326 per Class A Share payable on
January 9, 1998 to shareholders of record as of December 31, 1997.
106
<PAGE> 317
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT ISSUE COST (NOTE 1A)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
US GOVERNMENT & AGENCY OBLIGATIONS
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL FARM CREDIT Federal Farm Credit Bank:
BANK--12.3% $13,000,000 6.33% due 11/06/2000..................... $ 13,043,810 $ 13,004,030
2,000,000 6.27% due 7/10/2002...................... 2,013,620 2,028,120
7,000,000 6.40% due 10/09/2007..................... 7,075,390 7,134,540
- ----------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL FARM CREDIT BANK 22,132,820 22,166,690
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL HOME LOAN 13,575,000 Federal Home Loan Bank,
BANK--7.6% 6.055% due 7/28/2000..................... 13,634,730 13,651,291
- ----------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL HOME LOAN BANK 13,634,730 13,651,291
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL HOME Federal Home Loan Mortgage Corporation:
LOAN MORTGAGE 10,000,000 7.125% due 7/21/1999..................... 10,212,200 10,195,300
CORPORATION--12.8% 5,000,000 8.065% due 1/27/2005..................... 5,540,700 5,571,850
3,000,000 7.14% due 9/13/2006...................... 3,064,440 3,200,610
4,000,000 7.935% due 9/13/2006..................... 4,018,750 4,112,480
- ----------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL HOME LOAN MORTGAGE
CORPORATION 22,836,090 23,080,240
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL NATIONAL Federal National Mortgage Association:
MORTGAGE 2,000,000 8.90% due 6/12/2000...................... 2,171,480 2,124,060
ASSOCIATION--13.9% 1,045,000 7.50% due 2/11/2002...................... 1,088,232 1,103,290
4,000,000 6% due 11/04/2002........................ 3,995,880 4,003,760
4,000,000 7.40% due 7/01/2004...................... 4,157,540 4,303,760
500,000 7.85% due 9/10/2004...................... 499,297 515,080
2,000,000 7.65% due 3/10/2005...................... 2,091,140 2,185,000
3,000,000 7.375% due 3/28/2005..................... 3,158,430 3,231,570
5,000,000 7.12% due 7/03/2006...................... 5,331,400 5,350,000
2,000,000 6.96% due 4/02/2007...................... 1,980,560 2,123,440
- ----------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION 24,473,959 24,939,960
- ----------------------------------------------------------------------------------------------------------------------
PRIVATE EXPORT Private Export Funding Corporation:
FUNDING CORPORATION--10.8% 2,200,000 9.10% due 10/30/1998..................... 2,272,490 2,257,398
3,895,000 5.50% due 3/15/2001...................... 3,847,286 3,850,753
11,000,000 6.31% due 9/30/2004...................... 11,108,350 11,214,170
2,000,000 7.11% due 4/15/2007...................... 2,145,460 2,145,460
- ----------------------------------------------------------------------------------------------------------------------
TOTAL PRIVATE EXPORT FUNDING CORPORATION 19,373,586 19,467,781
- ----------------------------------------------------------------------------------------------------------------------
STUDENT LOAN 8,000,000 Student Loan Marketing Association,
MARKETING ASSOCIATION--4.6% 7.50% due 3/08/2000...................... 8,266,160 8,272,480
- ----------------------------------------------------------------------------------------------------------------------
TOTAL STUDENT LOAN MARKETING ASSOCIATION 8,266,160 8,272,480
- ----------------------------------------------------------------------------------------------------------------------
US TREASURY BONDS & US Treasury Bonds:
NOTES--31.1% 2,000,000 10.625% due 8/15/2015.................... 2,826,250 3,005,940
1,500,000 9.25% due 2/15/2016...................... 1,862,344 2,035,305
7,500,000 8.875% due 8/15/2017..................... 9,044,297 9,955,050
1,000,000 8.75% due 5/15/2020...................... 1,216,406 1,332,030
9,500,000 8.125% due 8/15/2021..................... 11,135,078 11,983,395
6,000,000 7.50% due 11/15/2024..................... 6,390,938 7,177,500
3,000,000 6.50% due 11/15/2026..................... 2,861,641 3,202,500
US Treasury Notes:
1,000,000 5.875% due 8/31/1999..................... 1,000,937 1,003,120
4,000,000 7.75% due 12/31/1999..................... 4,181,562 4,155,640
3,000,000 6.25% due 10/31/2001..................... 3,044,062 3,051,090
5,000,000 7.50% due 11/15/2001..................... 5,140,469 5,300,800
1,500,000 6.375% due 8/15/2002..................... 1,497,422 1,538,670
2,000,000 6.625% due 5/15/2007..................... 2,109,688 2,116,880
- ----------------------------------------------------------------------------------------------------------------------
TOTAL US TREASURY BONDS & NOTES 52,311,094 55,857,920
- ----------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT & AGENCY
OBLIGATIONS--93.1% 163,028,439 167,436,362
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
107
<PAGE> 318
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE
AMOUNT SHORT-TERM SECURITIES COST (NOTE 1A)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REPURCHASE $ 8,252,000 HSBC Holdings PLC, purchased on
AGREEMENTS**--4.6% 12/31/1997 to yield 6.57% to 1/02/1998... $ 8,252,000 $ 8,252,000
- ----------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 3,000,000 Federal National Mortgage Association,
OBLIGATIONS*--1.7% 5.75% due 1/06/1998...................... 2,997,125 2,997,125
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES--6.3% 11,249,125 11,249,125
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS--99.4%................... $174,277,564 178,685,487
============
OTHER ASSETS LESS LIABILITIES--0.6%........ 1,134,884
------------
NET ASSETS--100.0%......................... $179,820,371
============
</TABLE>
- --------------------------------------------------------------------------------
* Certain US Government Agency Obligations are traded on a discount basis; the
interest rates shown are the discount rates paid at the time of purchase by
the Fund.
** Repurchase Agreements are fully collateralized by US Government Obligations.
See Notes to Financial Statements.
108
<PAGE> 319
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost $174,277,564) (Note
1a)....................................................... $178,685,487
Cash........................................................ 5,323
Receivables:
Interest.................................................. $3,243,192
Capital shares sold....................................... 175,073 3,418,265
----------
Prepaid expenses and other assets........................... 10,837
------------
Total assets................................................ 182,119,912
------------
- --------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 2,175,875
Investment adviser (Note 2)............................... 79,729
Capital shares redeemed................................... 353 2,255,957
----------
Accrued expenses and other liabilities...................... 43,584
------------
Total liabilities........................................... 2,299,541
------------
- --------------------------------------------------------------------------------------
NET ASSETS.................................................. $179,820,371
============
- --------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 1,697,134
Paid-in capital in excess of par............................ 172,802,795
Undistributed investment income--net........................ 936,827
Accumulated distributions in excess of realized capital
gains on investments--net (Note 1d)....................... (24,308)
Unrealized appreciation on investments--net................. 4,407,923
------------
NET ASSETS.................................................. $179,820,371
============
- --------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $179,820,371 and 16,971,339
shares outstanding........................................ $ 10.60
============
- --------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
109
<PAGE> 320
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1c):
Interest and discount earned................................ $ 9,139,720
Other income................................................ 12,843
-----------
Total income................................................ 9,152,563
-----------
- ------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $675,675
Accounting services (Note 2)................................ 27,684
Registration fees........................................... 24,945
Custodian fees.............................................. 15,707
Professional fees........................................... 12,828
Transfer agent fees (Note 2)................................ 5,005
Pricing services............................................ 2,190
Directors' fees and expenses................................ 2,096
Other....................................................... 1,315
--------
Total expenses before reimbursement......................... 767,445
Reimbursement of expenses (Note 2).......................... (78,164)
--------
Expenses after reimbursement................................ 689,281
-----------
Investment income--net...................................... 8,463,282
-----------
- ------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN ON INVESTMENTS--NET (NOTES 1c &
3):
Realized gain on investments--net........................... 974,626
Change in unrealized appreciation on investments--net....... 3,456,357
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $12,894,265
===========
- ------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
110
<PAGE> 321
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
--------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 8,463,282 $ 3,815,911
Realized gain (loss) on investments--net.................... 974,626 (154,413)
Change in unrealized appreciation/depreciation on
investments--net.......................................... 3,456,357 (1,012,273)
------------ -----------
Net increase in net assets resulting from operations........ 12,894,265 2,649,225
------------ -----------
- ----------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1d):
Investment income--net:
Class A................................................... (8,011,058) (3,530,361)
Realized gain on investments--net:
Class A................................................... (820,212) (137,668)
In excess of realized gain on investments--net:
Class A................................................... (24,308) --
------------ -----------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (8,855,578) (3,668,029)
------------ -----------
- ----------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 86,200,892 49,603,169
------------ -----------
- ----------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 90,239,579 48,584,365
Beginning of year........................................... 89,580,792 40,996,427
------------ -----------
End of year*................................................ $179,820,371 $89,580,792
============ ===========
- ----------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 936,827 $ 484,603
============ ===========
- ----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
111
<PAGE> 322
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM -----------------------------------------------------
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE PERIOD
FOR THE YEAR ENDED DECEMBER 31, MAY 2, 1994+ TO
-------------------------------- DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period......................... $ 10.40 $ 10.79 $ 9.97 $ 10.00
-------- ------- ------- -------
Investment income--net....................................... .63 .65 .62 .25
Realized and unrealized gain (loss) on investments--net...... .25 (.36) .81 (.07)
-------- ------- ------- -------
Total from investment operations............................. .88 .29 1.43 .18
-------- ------- ------- -------
Less dividends and distributions:
Investment income--net..................................... (.63) (.64) (.61) (.21)
Realized gain on investments--net.......................... (.05) (.04) -- --
In excess of realized gain on investments--net............. --++ -- -- --
-------- ------- ------- -------
Total dividends and distributions............................ (.68) (.68) (.61) (.21)
-------- ------- ------- -------
Net asset value, end of period............................... $ 10.60 $ 10.40 $ 10.79 $ 9.97
======== ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share........................... 8.88% 2.86% 14.83% 1.79%++
======== ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement............................... .51% .15% .00% .00%*
======== ======= ======= =======
Expenses..................................................... .57% .59% .66% .80%*
======== ======= ======= =======
Investment income--net....................................... 6.26% 6.39% 6.28% 4.66%*
======== ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)..................... $179,820 $89,581 $40,996 $17,811
======== ======= ======= =======
Portfolio turnover........................................... 117.65% 21.23% 45.39% 103.03%
======== ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Amount is less than $.01 per share.
++ Aggregate total investment return.
See Notes to Financial Statements.
112
<PAGE> 323
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A and each fund began offering Class B Shares. Both classes of shares have equal
voting, dividend, liquidation and other rights, except that only shares of the
respective classes are entitled to vote on matters concerning only that class
and Class B Shares bear certain expenses related to the distribution of such
shares. Government Bond Fund (the "Fund") is classified as "diversified", as
defined in the Investment Company Act of 1940. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Short-term securities are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Company.
(b) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(c) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of premium and discount) is recognized
on the accrual basis. Realized gains and losses on security transactions are
determined on the identified cost basis.
(d) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates. Distributions in excess of realized capital gains are due
primarily to differing tax treatments for post-October losses.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.50% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, MLAM earned fees of $675,675, of which
$78,164 was voluntarily waived.
For the year ended December 31, 1997, Merrill Lynch Security Pricing Service,
an affiliate of Merrill Lynch, Pierce, Fenner & Smith Inc., earned $1,676 for
providing security price quotations to compute the Fund's net asset value.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
113
<PAGE> 324
- --------------------------------------------------------------------------------
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $223,611,299 and $141,865,078, respectively.
Net realized and unrealized gains as of December 31, 1997 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Realized Unrealized
Gains Gains
- ------------------------------------------------------------------
<S> <C> <C>
Long-term investments...................... $974,255 $4,407,923
Short-term investments..................... 371 --
-------- ----------
Total...................................... $974,626 $4,407,923
======== ==========
- ------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $4,407,923, of which $4,553,038 related to appreciated
securities and $145,115 related to depreciated securities. At December 31, 1997,
the aggregate cost of investments for Federal income tax purposes was
$174,277,564.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$86,200,892 and $49,603,169 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 7,848,272 $80,971,426
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 854,723 8,855,578
--------- -----------
Total issued........................... 8,702,995 89,827,004
Shares redeemed........................ (348,658) (3,626,112)
--------- -----------
Net increase........................... 8,354,337 $86,200,892
========= ===========
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 4,677,811 $48,169,342
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 354,243 3,668,029
--------- -----------
Total issued........................... 5,032,054 51,837,371
Shares redeemed........................ (215,188) (2,234,202)
--------- -----------
Net increase........................... 4,816,866 $49,603,169
========= ===========
- -----------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.055200 per Class A Share payable on January 2, 1998
to Shareholders of record as of December 31, 1997.
114
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AEROSPACE & B- B2 $ 3,000,000 L-3 Communications Corp.,
DEFENSE--0.6% 10.375% due 5/01/2007....... $ 3,000,000 $ 3,255,000
- ---------------------------------------------------------------------------------------------------------------------------
AIRLINES--0.8% B+ B1 4,000,000 USAir, Inc., 10.375% due
3/01/2013................... 3,935,000 4,476,640
- ---------------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE--0.9% B B3 2,000,000 Collins & Aikman Corp., 11.50%
due 4/15/2006............... 2,000,000 2,247,500
B+ B2 3,000,000 Venture Holdings Trust, 9.50%
due 7/01/2005............... 2,905,772 3,015,000
------------ ------------
4,905,772 5,262,500
- ---------------------------------------------------------------------------------------------------------------------------
BROADCASTING-- BB+ Ba2 706,000 Argyle Television Inc., 9.75%
RADIO & TV--1.9% due 11/01/2005.............. 681,290 790,720
B- B3 2,000,000 SFX Broadcasting Inc., 10.75%
due 5/15/2006............... 1,990,000 2,195,000
B- B3 2,500,000 Salem Communications Corp.,
9.50% due 10/01/2007(e)..... 2,551,250 2,537,500
Sinclair Broadcasting Group
Inc.:
B B2 2,000,000 10% due 9/30/2005............. 1,993,750 2,120,000
B B2 3,000,000 8.75% due 12/15/2007.......... 2,988,240 3,000,000
------------ ------------
10,204,530 10,643,220
- ---------------------------------------------------------------------------------------------------------------------------
BUILDING MATERIALS-- BB+ B1 1,500,000 Cemex S.A., 12.75% due
1.5% 7/15/2006(e)................ 1,500,000 1,796,250
B+ B1 3,000,000 Nortek Inc., 9.125% due
9/01/2007................... 2,975,760 3,045,000
B+ B3 3,340,000 Pacific Lumber Co., 10.50% due
3/01/2003................... 3,252,088 3,456,900
------------ ------------
7,727,848 8,298,150
- ---------------------------------------------------------------------------------------------------------------------------
CABLE-- CCC+ Caa 5,023,939 American Telecasting, Inc.,
DOMESTIC--5.0% 14.38% due 6/15/2004(d)..... 4,012,196 1,657,900
Century Communications Corp.:
BB- Ba3 3,000,000 9.50% due 3/01/2005........... 2,953,750 3,180,000
BB- Ba3 2,500,000 8.375% due 12/15/2007......... 2,454,475 2,462,500
B B2 4,000,000 Intermedia Capital Partners
L.P., 11.25%
due 8/01/2006............... 3,997,500 4,380,000
BB+ Ba3 5,000,000 Lenfest Communications, Inc.,
8.375% due 11/01/2005....... 4,627,500 5,137,500
B B1 4,000,000 Olympus Communications L.P.,
10.625% due 11/15/2006...... 4,000,000 4,430,000
BB+ Ba3 2,000,000 TCI Communications Inc., 9.65%
due 3/31/2027............... 2,052,500 2,341,240
B- B3 4,000,000 TCI Satellite Entertainment,
Inc., 10.875%
due 2/15/2007(e)............ 4,110,000 4,190,000
------------ ------------
28,207,921 27,779,140
- ---------------------------------------------------------------------------------------------------------------------------
CABLE-- Australis Media Ltd.(g):
INTERNATIONAL--2.7% CCC+ Caa 8,000,000 1.75%/15.75% due
5/15/2003(h)................ 5,575,080 3,290,818
CCC+ Caa 70,864 1.75%/15.75% due 5/15/2003.... 47,904 30,195
International Cabletel Inc.:
B- B3 2,000,000 10% due 2/15/2007............. 1,955,000 2,105,000
B B3 5,500,000 Series B, 10.98% due
2/01/2006(d)................ 4,013,521 4,269,375
B+ B1 7,000,000 TeleWest Communications PLC,
11.45% due 10/01/2007(d).... 5,050,062 5,442,500
------------ ------------
16,641,567 15,137,888
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
115
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CAPITAL GOODS--1.9% B+ B1 $ 4,000,000 Bucyrus International Inc.,
9.75% due 9/15/2007......... $ 4,000,000 $ 4,040,000
BB- B1 1,660,000 Essex Group, Inc., 10% due
5/01/2003................... 1,668,925 1,738,850
B- B3 4,500,000 International Wire Group,
Inc., 11.75% due
6/01/2005................... 4,490,625 4,927,500
------------ ------------
10,159,550 10,706,350
- ---------------------------------------------------------------------------------------------------------------------------
CHEMICALS--1.3% BB- Ba3 3,100,000 Agricultural Minerals &
Chemicals Co., L.P., 10.75%
due 9/30/2003............... 3,119,125 3,340,250
BB- Ba3 3,500,000 ISP Holdings Inc., 9.75% due
2/15/2002................... 3,500,000 3,696,875
------------ ------------
6,619,125 7,037,125
- ---------------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES-- CCC B3 3,000,000 Dictaphone Corp., 11.75% due
ELECTRONICS--0.5% 8/01/2005................... 2,943,750 2,910,000
- ---------------------------------------------------------------------------------------------------------------------------
CONGLOMERATES--0.7% NR* NR* 755,000 MacAndrews & Forbes Group,
Inc., 13% due 3/01/1999..... 752,837 757,831
Sequa Corp.:
BB B1 750,000 9.625% due 10/15/1999......... 740,625 770,625
B+ B3 2,500,000 9.375% due 12/15/2003......... 2,512,812 2,600,000
------------ ------------
4,006,274 4,128,456
- ---------------------------------------------------------------------------------------------------------------------------
CONSUMER B B3 8,500,000 CLN Holdings Inc., 11.906% due
PRODUCTS--2.7% 5/15/2001(d)................ 5,756,461 5,631,250
B+ Ba3 3,500,000 Coty Inc., 10.25% due
5/01/2005................... 3,618,125 3,718,750
B+ B1 7,000,000 International Semi-Tech
Microelectronics, Inc.,
13.13% 8/15/2003(d)......... 4,780,684 2,520,000
B+ B1 2,500,000 Playtex Products Inc., Series
B, 8.875% due 7/15/2004..... 2,520,625 2,540,625
B+ B1 708,000 Samsonite Corp., 11.125% due
7/15/2005................... 696,035 796,500
------------ ------------
17,371,930 15,207,125
- ---------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED--1.0% B- B2 2,000,000 Koppers Industries, Inc.,
9.875% due 12/01/2007(e).... 2,000,000 2,060,000
B+ B2 3,500,000 RBX Corp., 12% due
1/15/2003(e)................ 3,500,000 3,561,250
------------ ------------
5,500,000 5,621,250
- ---------------------------------------------------------------------------------------------------------------------------
ENERGY--7.1% B- B3 2,000,000 Bellwether Exploration Co.,
10.875% due 4/01/2007....... 2,000,000 2,200,000
B+ B2 4,500,000 Benton Oil & Gas Co., 11.625%
due 5/01/2003............... 4,500,000 4,961,250
BB- Ba3 2,000,000 Chesapeake Energy Corporation,
9.125% due 4/15/2006........ 1,995,100 2,070,000
B+ B3 1,500,000 Clark USA Inc., Series B,
10.875% due 12/01/2005...... 1,635,000 1,633,125
B B1 2,000,000 Cliffs Drilling Co., Series D,
10.25% due 5/15/2003(e)..... 2,155,000 2,177,500
B B2 4,000,000 Energy Corp. of America, 9.50%
due 5/15/2007............... 4,000,000 3,990,000
B+ B1 1,750,000 Parker Drilling Co., 9.75% due
11/15/2006.................. 1,758,750 1,876,875
BB B1 3,000,000 Petroleo Brasileiro S.A. -
Petrobras, 10% due
10/17/2006(e)............... 3,000,312 3,030,000
B B3 3,000,000 Southwest Royalties Inc.,
10.50% due 10/15/2004(e).... 2,963,730 2,985,000
</TABLE>
116
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ENERGY--(CONCLUDED) Transamerican Energy(e):
B+ B3 $ 525,000 11.50% due 6/15/2002.......... $ 517,125 $ 514,500
B+ B3 13,525,000 13.112% due 6/15/2002(d)...... 11,210,409 10,820,000
B- B2 3,000,000 United Refining Co., 10.75%
due 6/15/2007(e)............ 3,015,000 3,150,000
------------ ------------
38,750,426 39,408,250
- ---------------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT--1.5% B B1 3,000,000 Fox/Liberty Networks LLC,
8.875% due 8/15/2007(e)..... 3,052,500 3,000,000
B B2 5,000,000 Six Flags Theme Parks Corp.,
12.25% due 6/15/2005(d)..... 4,746,678 5,325,000
------------ ------------
7,799,178 8,325,000
- ---------------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES--0.8% BB- B1 4,000,000 Reliance Group Holdings Inc.,
9.75% due 11/15/2003........ 3,898,750 4,246,600
- ---------------------------------------------------------------------------------------------------------------------------
FOOD & BEVERAGE--1.1% B+ B1 4,500,000 Chiquita Brands International
Inc., 9.125% due
3/01/2004................... 4,448,750 4,680,000
BB- B2 1,421,000 Del Monte Corp., 10% due
5/01/2003................... 1,230,277 1,477,840
------------ ------------
5,679,027 6,157,840
- ---------------------------------------------------------------------------------------------------------------------------
FOREIGN GOVERNMENT BB- NR* 2,000,000 City of St. Petersburg, 9.50%
OBLIGATIONS--1.1% due 6/18/2002............... 1,820,000 1,800,000
BB Ba3 4,000,000 Republic of Argentina, Global
Bonds, 11% due 10/09/2006... 4,115,000 4,270,000
------------ ------------
5,935,000 6,070,000
- ---------------------------------------------------------------------------------------------------------------------------
GAMING--4.6% BB- B1 2,000,000 Boyd Gaming Corp., 9.50% due
7/15/2007................... 1,978,000 2,095,000
B B3 4,000,000 Greate Bay Properties, Inc.,
10.875% due 1/15/2004....... 3,590,000 3,360,000
D Caa 4,500,000 Harrah's Jazz Company, 14.25%
due 11/15/2001(c)........... 4,468,750 1,395,000
B+ B2 3,000,000 Hollywood Casino Corp., 12.75%
due 11/01/2003.............. 3,240,000 3,217,500
B+ B2 3,000,000 Station Casinos Inc., 9.75%
due 4/15/2007............... 2,945,140 3,105,000
BB- B1 6,000,000 Trump Atlantic City
Association, 11.25% due
5/01/2006................... 5,935,000 5,925,000
NR* Caa 4,000,000 Trump Castle Funding, Inc.,
11.75% due 11/15/2003....... 3,567,279 3,680,000
B- B3 3,000,000 Venetian Casino Resort LLC,
12.25% due 11/15/2004(e).... 3,015,000 3,003,750
------------ ------------
28,739,169 25,781,250
- ---------------------------------------------------------------------------------------------------------------------------
HEALTH SERVICES--2.7% B+ B1 4,000,000 Beverly Enterprises, Inc., 9%
due 2/15/2006............... 3,740,000 4,135,000
B- B2 2,000,000 Extendicare Inc., 9.35% due
12/15/2007(e)............... 2,000,000 2,050,000
B- B3 2,500,000 Paragon Health Network, Inc.,
9.50% due 11/01/2007(e)..... 2,488,850 2,493,750
B+ B2 3,000,000 Quest Diagnostic Inc., 10.75%
due 12/15/2006.............. 3,000,000 3,270,000
B B1 3,000,000 Vencor Inc., 8.625% due
7/15/2007................... 2,970,000 2,996,250
------------ ------------
14,198,850 14,945,000
- ---------------------------------------------------------------------------------------------------------------------------
HOME BUILDERS--0.5% B- B2 2,500,000 Del E. Webb Corporation, 9%
due 2/15/2006............... 2,497,500 2,562,500
- ---------------------------------------------------------------------------------------------------------------------------
HOTELS--0.9% BB- Ba3 4,500,000 HMC Acquisition Properties, 9%
due 12/15/2007.............. 4,202,500 4,702,500
BB- Ba3 500,000 HMH Properties Inc., 8.875%
due 7/15/2007............... 500,625 526,250
------------ ------------
4,703,125 5,228,750
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
117
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INDEPENDENT POWER B+ Ba1 $ 6,000,000 AES Corporation (The), 10.25%
PRODUCERS--2.4% due 7/15/2006............... $ 6,480,000 $ 6,525,000
BB- Ba3 4,000,000 Calpine Corporation, 8.75% due
7/15/2007(e)................ 4,005,882 4,080,000
Midland Cogeneration Venture
L.P.:
BB Ba3 2,028,321 10.33% due 7/23/2002(f)....... 2,062,972 2,180,425
B B2 250,000 11.75% due 7/23/2005.......... 250,000 300,338
------------ ------------
12,798,854 13,085,763
- ---------------------------------------------------------------------------------------------------------------------------
MEDIA & BB- Ba3 3,000,000 Antenna TV S.A., 9% due
COMMUNICATIONS--3.6% 8/01/2007................... 2,933,211 3,000,000
BB- B1 3,000,000 Comtel Brasileira Ltd., 10.75%
due 9/26/2004(e)............ 3,000,000 2,940,000
BB- B1 5,000,000 Globo Communicacoes e
Participacoes, Ltd., 10.50%
due 12/20/2006(e)........... 5,101,250 4,750,000
BB Ba2 4,000,000 Grupo Televise, S.A. de C.V.,
11.375% due 5/15/2003....... 4,025,000 4,370,000
BBB- Ba3 4,000,000 Telefonica de Argentina S.A.,
11.875% due 11/01/2004...... 3,917,780 4,650,000
------------ ------------
18,977,241 19,710,000
- ---------------------------------------------------------------------------------------------------------------------------
METALS & MINING--1.8% CCC+ B2 4,500,000 Kaiser Aluminum Corp., 12.75%
due 2/01/2003............... 4,770,000 4,786,875
CCC+ B3 3,000,000 Maxxam Group, Inc., 12.25% due
8/01/2003(d)................ 2,797,787 2,745,000
B B3 2,000,000 Westmin Resources Ltd., 11%
due 3/15/2007............... 2,000,000 2,190,000
------------ ------------
9,567,787 9,721,875
- ---------------------------------------------------------------------------------------------------------------------------
PACKAGING--1.9% B B2 2,000,000 AEP Industries, Inc., 9.875%
due 11/15/2007(e)........... 1,984,480 2,050,000
B B2 4,000,000 Portola Packaging Inc., 10.75%
due 10/01/2005.............. 4,000,000 4,220,000
Silgan Holdings, Inc.:
NR* B1 2,810,000 13.25% due 7/15/2006(a)....... 3,142,137 3,032,414
B B1 1,000,000 9% due 6/01/2009.............. 1,000,000 1,022,500
------------ ------------
10,126,617 10,324,914
- ---------------------------------------------------------------------------------------------------------------------------
PAPER--0.4% B+ B1 2,000,000 S.D. Warren Co., 12% due
12/15/2004.................. 2,000,000 2,235,000
- ---------------------------------------------------------------------------------------------------------------------------
PAPER & FOREST B B3 4,000,000 Ainsworth Lumber Ltd., 12.50%
PRODUCTS--3.1% due 7/15/2007(a)............ 3,897,996 3,783,441
B B2 3,000,000 Bear Island Paper Co. LLC, 10%
due 12/01/2007(e)........... 3,000,000 3,037,500
B+ B2 2,000,000 Container Corp. of America,
Series B, 10.75% due
5/01/2002................... 2,190,000 2,190,000
BB- B1 5,000,000 Doman Industries Limited,
9.25% due 11/15/2007(e)..... 5,000,000 4,875,000
BB Ba3 4,000,000 Pindo Deli Finance Mauritius,
10.75% due 10/01/2007(e).... 3,987,920 3,440,000
------------ ------------
18,075,916 17,325,941
- ---------------------------------------------------------------------------------------------------------------------------
PRINTING & B+ B1 4,000,000 Garden State Newspapers, 8.75%
PUBLISHING--1.9% due 10/01/2009(e)........... 3,976,600 4,015,000
BB- B1 5,000,000 Hollinger International, Inc.,
9.25% due 2/01/2006......... 4,961,250 5,250,000
BB- Ba3 1,000,000 Primedia, Inc., 10.25% due
6/01/2004................... 995,000 1,080,000
------------ ------------
9,932,850 10,345,000
- ---------------------------------------------------------------------------------------------------------------------------
PRODUCT B- B3 4,000,000 AmeriServe Food Distribution,
DISTRIBUTION--0.8% Inc., 10.125% due
7/15/2007................... 4,000,000 4,200,000
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
118
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
RESTAURANTS--0.9% Foodmaker, Inc.:
B Ba3 $ 2,850,000 9.25% due 3/01/1999........... $ 2,857,125 $ 2,892,750
B+ Ba3 2,000,000 9.75% due 11/01/2003.......... 1,972,075 2,060,000
------------ ------------
4,829,200 4,952,750
- ---------------------------------------------------------------------------------------------------------------------------
RETAIL SPECIALTY--0.4% D Caa 4,500,000 Bradlees, Inc., 11% due
8/01/2002(c)................ 4,466,562 315,000
NR* NR* 1,783,000 Cumberland Farms, Inc., 10.50%
due 10/01/2003.............. 1,745,111 1,756,255
------------ ------------
6,211,673 2,071,255
- ---------------------------------------------------------------------------------------------------------------------------
STEEL--2.0% NR* B1 5,000,000 CSN Iron S.A., 9.125% due
6/01/2007(e)................ 4,850,000 4,250,000
B B2 3,500,000 Weirton Steel Inc., 10.75% due
6/01/2005................... 3,346,250 3,587,500
BB- B2 3,500,000 Wheeling-Pittsburgh Corp.,
9.25% due 11/15/2007(e)..... 3,486,755 3,377,500
------------ ------------
11,683,005 11,215,000
- ---------------------------------------------------------------------------------------------------------------------------
SUPERMARKETS--1.0% B- B3 2,000,000 Pueblo Xtra Intl., 9.50% due
8/01/2003................... 1,819,921 1,900,000
B B1 1,000,000 Ralph's Grocery Co., 10.45%
due 6/15/2004............... 962,500 1,130,000
B B1 2,000,000 Ralph's Grocery Co. (New),
10.45% due 6/15/2004........ 1,906,688 2,240,000
------------ ------------
4,689,109 5,270,000
- ---------------------------------------------------------------------------------------------------------------------------
TELEPHONY--COMPETITIVE NR* NR* 6,000,000 Brooks Fiber Properties Inc.,
LOCAL EXCHANGE--2.2% 10.735% due 11/01/2006(d)... 4,161,380 4,800,000
B+ B2 3,000,000 GCI Inc., 9.75% due
8/01/2007................... 3,000,000 3,097,500
NR* NR* 5,000,000 Ionica PLC, 13.373% due
5/01/2007(d)................ 3,003,201 2,000,000
B+ B1 2,000,000 Teleport Communications Group
Inc., 9.875% due
7/01/2006................... 2,104,000 2,257,500
------------ ------------
12,268,581 12,155,000
- ---------------------------------------------------------------------------------------------------------------------------
TEXTILES--2.2% B+ B2 2,000,000 Pillowtex Corp., 9% due
12/15/2007(e)............... 2,000,000 2,050,000
BB+ Ba3 4,000,000 P.T. Polysindo International
Finance, 9.375% due
7/30/2007................... 3,601,250 2,880,000
B+ B1 3,500,000 Tultex Corp., 10.625% due
3/15/2005................... 3,500,000 3,815,000
B+ B2 3,500,000 Westpoint Stevens Industries,
Inc., 9.375% due
12/15/2005.................. 3,291,250 3,675,000
------------ ------------
12,392,500 12,420,000
- ---------------------------------------------------------------------------------------------------------------------------
TRANSPORTATION--4.3% BB- NR* 5,000,000 Autopistas del Sol S.A.,
10.25% due 8/01/2009(e)..... 4,971,250 4,512,500
BB Ba3 6,000,000 GS Superhighway Holdings,
10.25% due 8/15/2007(e)..... 5,956,875 5,250,000
B NR* 4,500,000 MRS Logistica S.A., 10.625%
due 8/15/2005(e)............ 4,449,375 4,050,000
BB- B1 4,000,000 Sea Containers Ltd., 12.50%
due 12/01/2004.............. 4,380,000 4,530,000
NR* B3 3,700,000 Transtar Holdings Inc., 11.02%
due 12/15/2003(d)........... 3,010,321 3,237,500
BB Ba2 1,955,000 Viking Star Shipping Co.,
9.625% due 7/15/2003........ 1,858,894 1,984,325
------------ ------------
24,626,715 23,564,325
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
119
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT ISSUE COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UTILITIES--4.6% BB- B1 $ 3,137,000 Beaver Valley Funding Corp.,
9% due 6/01/2017............ $ 2,952,025 $ 3,487,591
BB Ba2 1,000,000 Cleveland Electric
Illuminating Co., 9.50% due
5/15/2005................... 998,080 1,109,020
NR* NR* 2,500,000 Companhia de Saneamento Basico
do Estado de Sao-Paulo, 10%
due 7/28/2005(e)............ 2,340,000 2,225,000
BB- B1 5,000,000 Espirito Santo--Escelsa S.A.,
10% due 7/15/2007(e)........ 4,973,750 4,475,000
BB+ NR* 3,000,000 Inversora de Electrica, 9% due
9/16/2004(e)................ 3,000,000 2,850,000
BBB- Ba3 4,000,000 Metrogas S.A., 12% due
8/15/2000................... 3,935,000 4,270,000
BBB- Baa3 2,974,800 Trans Gas de Occidente S.A.,
9.79% due
11/01/2010(e)(f)............ 2,974,800 3,193,034
Tucson Electric & Power
Co.(f):
NR* NR* 3,070,687 10.21% due 1/01/2009.......... 2,948,074 3,225,848
NR* NR* 500,000 +10.732% due 1/01/2013........ 461,050 530,910
------------ ------------
24,582,779 25,366,403
- ---------------------------------------------------------------------------------------------------------------------------
WASTE MANAGEMENT--0.2% D Ca 3,500,000 Mid-American Waste Systems,
Inc., 12.25% due
2/15/2003(c)................ 2,233,034 980,000
- ---------------------------------------------------------------------------------------------------------------------------
WIRELESS BB+ Ba3 3,000,000 Comcast Cellular, 9.50% due
COMMUNICATION-- 5/01/2007................... 2,995,110 3,127,500
DOMESTIC PAGING--5.5% CCC NR* 7,505,000 McCaw International Ltd.,
12.484%
due 4/15/2007(d)............ 4,541,468 4,427,950
B- B3 8,000,000 Millicom International
Cellular S.A., 13.31% due
6/01/2006(d)................ 5,169,816 5,880,000
NR* NR* 10,000,000 Nextel Communications, Inc.,
13.128%
due 8/15/2004(d)............ 7,463,115 8,900,000
B B2 4,000,000 Paging Network, Inc., 10% due
10/15/2008.................. 4,000,000 4,160,000
B- B2 4,000,000 USA Mobile Communications
Holdings, Inc., 9.50% due
2/01/2004................... 3,662,500 3,900,000
------------ ------------
27,832,009 30,395,450
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CORPORATE
BONDS--81.0% 450,252,162 448,526,710
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SHARES
HELD PREFERRED STOCKS
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CABLE--DOMESTIC--1.6% BB- B2 55,797 Cablevision Systems Corp.
(Series M)(a)............... 4,427,500 6,444,554
BB+ Ba3 95,000 TCI Communications Financing
II.......................... 2,541,250 2,541,250
------------ ------------
6,968,750 8,985,804
- ---------------------------------------------------------------------------------------------------------------------------
CABLE--INTERNATIONAL-- B- NR* 3,304 NTL, Inc.(a).................. 3,310,650 3,799,600
0.7%
- ---------------------------------------------------------------------------------------------------------------------------
ENERGY--0.4% B+ Caa1 2,000 Clark USA, Inc.(a)(c)(e)...... 2,000,000 2,120,000
- ---------------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT--1.2% BB+ Ba3 5,945 Time Warner Inc. (Series
M)(a)....................... 6,006,885 6,673,263
- ---------------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES--0.6% BB Ba2 120,000 California Federal Bank
(Series A).................. 3,030,000 3,150,000
- ---------------------------------------------------------------------------------------------------------------------------
PRINTING & NR* NR* 15,704 Primedia Inc. (Series B)(a)... 1,557,630 1,692,110
PUBLISHING--0.3%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
120
<PAGE> 331
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S SHARES VALUE
INDUSTRY RATINGS RATINGS HELD PREFERRED STOCKS COST (NOTE 1A)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
STEEL--0.6% BB+ Ba2 120,000 USX Capital Corp.............. $ 3,000,000 $ 3,045,000
- ---------------------------------------------------------------------------------------------------------------------------
TELEPHONY--COMPETITIVE CCC+ Ccc2 3,343 Intermedia Community of
LOCAL EXCHANGE--0.7% Florida(a).................. 3,315,503 4,028,315
- ---------------------------------------------------------------------------------------------------------------------------
WIRELESS COMMUNICATIONS-- NR* NR* 2,060 Nextel Communications,
DOMESTIC PAGING--0.4% Inc.(a)(c).................. 2,067,950 2,348,400
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN PREFERRED
STOCKS--6.5% 31,257,368 35,842,492
- ---------------------------------------------------------------------------------------------------------------------------
COMMON STOCKS
- ---------------------------------------------------------------------------------------------------------------------------
ENERGY--0.2% 86,527 CHI Energy, Inc. (Series
A)(c)....................... 1,257,994 1,124,851
- ---------------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT--0.2% 93,747 On Command Corporation(c)..... 2,744,654 1,171,838
- ---------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL SERVICES--0.0% 311 Thermadyne Industries,
Inc.(c)..................... 4,495 8,786
- ---------------------------------------------------------------------------------------------------------------------------
SUPERMARKETS--0.0% 53,022 Grand Union Co.(c)............ 3,090,000 109,358
- ---------------------------------------------------------------------------------------------------------------------------
WIRELESS COMMUNICATION-- 9,295 Nextel Communications, Inc.
DOMESTIC PAGING--0.1% (Class A)(c)................ 149,988 239,346
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN COMMON
STOCKS--0.5% 7,247,131 2,654,179
- ---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
TRUSTS & WARRANTS
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CABLE--DOMESTIC--0.0% 23,350 American Telecasting, Inc.
(Warrants)(b)............... 4,776 9,340
- ---------------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT--0.0% 29,830 On Command Corporation
(Warrants)(b)............... 238,640 165,929
- ---------------------------------------------------------------------------------------------------------------------------
GAMING--0.0% 250 +Goldriver Hotel & Casino
Finance Corp. (Liquidating
Trust)(c)................... 6,000 0
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN TRUSTS &
WARRANTS--0.0% 249,416 175,269
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT SHORT-TERM SECURITIES
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
COMMERCIAL PAPER**--6.9% $15,000,000 AIG Funding, Inc., 6.05%
due 1/05/1998............... 14,987,396 14,987,396
23,252,000 General Motors Acceptance
Corp., 6.75% due
1/02/1998................... 23,243,280 23,243,280
------------ ------------
38,230,676 38,230,676
- ----------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT AGENCY 20,000,000 Federal Home Loan Mortgage
OBLIGATIONS**--3.6% Corp., 5.75%
due 1/07/1998............... 19,977,639 19,977,639
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SHORT-
TERM SECURITIES--10.5% 58,208,315 58,208,315
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS--98.5%...... $547,214,392 545,406,965
============
OTHER ASSETS LESS
LIABILITIES--1.5%............. 8,539,150
------------
NET ASSETS--100.0%............ $553,946,115
============
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Not Rated.
** Commercial Paper and certain US Government Agency Obligations are traded on a
discount basis; the interest rates shown are the discount rates paid at the
time of purchase by the Fund.
(a) Represents a pay-in-kind security which may pay interest/dividend in
additional face/shares.
(b) Warrants entitle the portfolio to purchase a predetermined number of shares
of common stock/face amount of bonds. The purchase price and number of
shares/face amount are subject to adjustment under certain conditions until
the expiration date.
(c) Non-income producing security.
121
<PAGE> 332
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
(d) Represents a zero coupon or step bond; the interest rate shown is the
effective yield at the time of purchase.
(e) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(f) Subject to principal paydowns.
(g) Represents a step bond. Coupon payments are paid-in-kind, in which the Fund
receives additional face amount at an annual rate of 1.75% until May 15,
2000. Subsequently, the Fund will receive cash coupon payments at an annual
rate of 15.75% until maturity.
(h) Each $1,000 face amount contains one warrant of Australis Media Ltd.
+ Restricted securities as to resale. The value of the Fund's investment in
restricted securities was approximately $531,000, representing 0.10% of net
assets.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
VALUE
ISSUE ACQUISITION DATE COST (NOTE 1A)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Goldriver Hotel & Casino Finance Corp. (Liquidating Trust) 8/31/1992 $ 6,000 0
Tucson Electric & Power Co., 10.732% due 1/01/2013 3/01/1993 461,050 $530,910
- -----------------------------------------------------------------------------------------------------------
TOTAL $467,050 $530,910
======== ========
- -----------------------------------------------------------------------------------------------------------
Ratings of issues shown have not been audited by Deloitte &
Touche LLP.
</TABLE>
See Notes to Financial Statements.
122
<PAGE> 333
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$547,214,392) (Note
1a)....................................................... $545,406,965
Receivables:
Interest.................................................. $9,514,440
Capital shares sold....................................... 305,252 9,819,692
----------
Prepaid expenses and other assets........................... 518,950
------------
Total assets................................................ 555,745,607
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Custodian bank (Note 1e).................................. 1,388,107
Investment adviser (Note 2)............................... 232,354
Capital shares redeemed................................... 4,434 1,624,895
----------
Accrued expenses and other liabilities...................... 174,597
------------
Total liabilities........................................... 1,799,492
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $553,946,115
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 4,806,620
Paid-in capital in excess of par............................ 544,656,068
Undistributed investment income--net........................ 4,466,281
Undistributed realized capital gains on investments--net.... 1,824,573
Unrealized depreciation on investments--net................. (1,807,427)
------------
NET ASSETS.................................................. $553,946,115
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $553,946,115 and 48,066,198
shares outstanding........................................ $ 11.52
============
- ---------------------------------------------------------------------------------------
+ The Fund is authorized to issue 100,000,000 Class B
Shares.
</TABLE>
See Notes to Financial Statements.
123
<PAGE> 334
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1B & 1C):
Interest and discount earned................................ $43,216,855
Dividends................................................... 2,561,182
Other income................................................ 502,196
-----------
Total income................................................ 46,280,233
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $2,277,140
Accounting services (Note 2)................................ 106,402
Professional fees........................................... 77,385
Custodian fees.............................................. 45,407
Registration fees........................................... 37,427
Pricing services............................................ 8,810
Directors' fees and expenses................................ 8,765
Transfer agent fees (Note 2)................................ 5,006
Other....................................................... 2,254
----------
Total expenses.............................................. 2,568,596
-----------
Investment income--net...................................... 43,711,637
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1C & 3):
Realized gain on investments--net........................... 8,171,656
Change in unrealized appreciation/depreciation on
investments--net.......................................... (2,363,743)
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $49,519,550
===========
- --------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
124
<PAGE> 335
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE
YEAR ENDED
DECEMBER 31,
---------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $43,711,637 $ 36,909,359
Realized gain (loss) on investments--net.................... 8,171,656 (3,777,610)
Change in unrealized appreciation/depreciation on
investments--net.......................................... (2,363,743) 8,565,962
------------ ------------
Net increase in net assets resulting from operations........ 49,519,550 41,697,711
------------ ------------
- -----------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1D):
Investment income--net:
Class A................................................... (42,928,118) (36,130,450)
Realized gain on investments--net:
Class A................................................... (972,470) --
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (43,900,588) (36,130,450)
------------ ------------
- -----------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 133,712,235 52,695,717
------------ ------------
- -----------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 139,331,197 58,262,978
Beginning of year........................................... 414,614,918 356,351,940
------------ ------------
End of year*................................................ $553,946,115 $414,614,918
============ ============
- -----------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1f)............ $ 4,466,281 $ 3,786,391
============ ============
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
125
<PAGE> 336
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
------------------------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FOR THE YEAR ENDED DECEMBER 31,
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997+ 1996+ 1995 1994 1993
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year....................... $ 11.39 $ 11.25 $ 10.61 $ 12.06 $ 11.13
-------- -------- -------- -------- --------
Investment income--net................................... 1.05 1.08 1.09 1.05 .95
Realized and unrealized gain (loss) on
investments--net....................................... .14 .12 .65 (1.47) .95
-------- -------- -------- -------- --------
Total from investment operations......................... 1.19 1.20 1.74 (.42) 1.90
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................. (1.04) (1.06) (1.10) (1.03) (.97)
Realized gain on investments--net...................... (.02) -- -- -- --
-------- -------- -------- -------- --------
Total dividends and distributions........................ (1.06) (1.06) (1.10) (1.03) (.97)
-------- -------- -------- -------- --------
Net asset value, end of year............................. $ 11.52 $ 11.39 $ 11.25 $ 10.61 $ 12.06
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share....................... 11.00% 11.27% 17.21% (3.59%) 17.84%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................. .54% .54% .55% .61% .72%
======== ======== ======== ======== ========
Investment income--net................................... 9.11% 9.50% 9.92% 9.73% 8.62%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................... $553,946 $414,615 $356,352 $255,719 $163,428
======== ======== ======== ======== ========
Portfolio turnover....................................... 53.63% 48.92% 41.60% 51.88% 35.67%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
See Notes to Financial Statements.
126
<PAGE> 337
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A and each fund began offering Class B Shares. Both classes of shares have equal
voting, dividend, liquidation and other rights, except that only shares of the
respective classes are entitled to vote on matters concerning only that class
and Class B Shares bear certain expenses related to the distribution of such
shares. High Current Income Fund (the "Fund") is classified as "diversified", as
defined in the Investment Company Act of 1940. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Short-term securities are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Company.
(b) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(c) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(d) Dividends and distributions to shareholders--Dividends from net investment
income are declared and paid monthly. Distributions from capital gains are
recorded on the ex-dividend dates.
(e) Custodian bank--The Fund recorded an amount payable to the Custodian Bank
reflecting an overnight overdraft which resulted from a timing difference of a
security transaction settlement.
(f) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $103,629 have been reclassified between undistributed
net realized capital gains and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
based upon the aggregate daily value of net assets of the Fund and the Company's
Prime Bond Fund at the following annual rates: 0.55% of such average daily net
assets not exceeding $250 million; 0.50% of such average daily net assets in
excess of $250 million but not more than $500 million; 0.45% of such average
daily net assets in excess of $500 million but not more than $750 million; and
0.40% of such average daily net assets in excess of $750 million. For the year
ended December 31, 1997, the aggregate average daily net assets of the Fund and
Prime Bond Fund was approximately $1,003,875,000.
127
<PAGE> 338
- --------------------------------------------------------------------------------
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc. ("MLPF&S"), a subsidiary of ML & Co., earned $1,250 in commissions on the
execution of portfolio security transactions.
For the year ended December 31, 1997, Merrill Lynch Security Pricing Service,
an affiliate of MLPF&S, earned $7,008 for providing security price quotations to
compute the Fund's net asset value.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $323,346,117 and $222,609,834, respectively.
Net realized and unrealized gains(losses) as of December 31, 1997 were as
follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Realized
Gains Unrealized
(Losses) Losses
- -------------------------------------------------------------------------------
<S> <C> <C>
Long-term investments.............................. $8,171,687 $(1,807,427)
Short-term investments............................. (31) --
---------- -----------
Total.............................................. $8,171,656 $(1,807,427)
========== ===========
- -------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized depreciation for Federal income tax
purposes aggregated $2,395,717, of which $25,300,888 related to appreciated
securities and $27,696,605 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$547,802,682.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$133,712,235 and $52,695,717 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares were as follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -------------------------------------------------------------------------------
<S> <C> <C>
Shares sold....................................... 9,559,388 $109,578,509
Shares issued to shareholders in reinvestment of
dividends and distributions...................... 3,761,677 42,928,115
---------- ------------
Total issued...................................... 13,321,065 152,506,624
Shares redeemed................................... (1,644,648) (18,794,389)
---------- ------------
Net increase...................................... 11,676,417 $133,712,235
========== ============
- -------------------------------------------------------------------------------
</TABLE>
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -------------------------------------------------------------------------------
<S> <C> <C>
Shares sold....................................... 3,441,094 $ 38,643,510
Shares issued to shareholders in reinvestment of
dividends........................................ 3,229,888 36,130,450
---------- ------------
Total issued...................................... 6,670,982 74,773,960
Shares redeemed................................... (1,968,366) (22,078,243)
---------- ------------
Net increase...................................... 4,702,616 $ 52,695,717
========== ============
- -------------------------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.099236 per Class A Share, payable on January 9, 1998
to shareholders of record as of December 31, 1997.
128
<PAGE> 339
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
+3Com Corporation.............. 9,577 $ 334,596
ALLTEL Corporation............. 5,130 210,651
+ALZA Corporation.............. 2,341 74,473
AMP Inc. ...................... 6,067 254,814
+AMR Corporation............... 2,515 323,177
ASARCO Inc. ................... 1,117 25,063
AT&T Corp...................... 44,975 2,754,719
Abbott Laboratories............ 21,173 1,388,155
Adobe Systems Inc. ............ 1,986 81,674
+Advanced Micro Devices,
Inc. ........................ 3,924 70,387
Aeroquip-Vickers Inc. ......... 773 37,925
Aetna, Inc. ................... 4,113 290,224
Ahmanson (H.F.) & Company...... 2,613 174,908
Air Products and Chemicals,
Inc.......................... 3,063 251,932
+Airtouch Communications,
Inc. ........................ 13,973 580,753
Alberto-Culver Company (Class
B)........................... 1,543 49,472
Albertson's, Inc. ............. 6,798 322,055
Alcan Aluminium Ltd............ 6,255 172,794
Allegheny Teledyne, Inc. ...... 4,828 124,925
Allergan, Inc. ................ 1,807 60,647
AlliedSignal, Inc. ............ 15,628 608,515
Allstate Corporation (The)..... 11,870 1,078,686
Aluminum Company of America.... 4,792 337,237
Amerada Hess Corporation....... 2,565 140,754
American Electric Power
Company, Inc. ............... 5,233 270,154
American Express Company....... 12,866 1,148,291
American General Corporation... 6,742 364,489
American Greetings
Corporation.................. 2,075 81,184
American Home Products
Corporation.................. 17,984 1,375,776
American International Group,
Inc. ........................ 19,397 2,109,424
American Stores Company........ 7,557 155,391
Ameritech Corporation.......... 15,171 1,221,266
Amgen Inc. .................... 7,285 394,301
Amoco Corporation.............. 13,479 1,147,400
Anadarko Petroleum
Corporation.................. 1,654 100,377
+Andrew Corporation............ 2,496 59,904
Anheuser-Busch Companies,
Inc. ........................ 13,563 596,772
Aon Corporation................ 4,608 270,144
Apache Corporation............. 2,504 87,797
+Apple Computer, Inc. ......... 3,499 45,924
+Applied Materials, Inc. ...... 10,085 303,811
Archer-Daniels-Midland
Company...................... 15,433 334,703
+Armco Inc. ................... 2,950 14,566
Armstrong World Industries,
Inc. ........................ 1,135 84,841
Ashland Inc. .................. 2,051 110,113
Atlantic Richfield Company..... 8,886 711,991
Autodesk, Inc. ................ 1,308 48,396
Automatic Data Processing,
Inc. ........................ 8,105 497,444
+AutoZone, Inc. ............... 4,153 120,437
Avery Dennison Corporation..... 2,868 128,343
Avon Products, Inc. ........... 3,662 224,755
BB&T Corporation............... 3,789 242,733
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
Baker Hughes, Inc. ............ 4,667 $ 203,598
Ball Corporation............... 840 29,663
Baltimore Gas and Electric
Company...................... 4,078 138,907
Banc One Corporation........... 16,248 882,470
Bank of New York Company, Inc.
(The)........................ 10,426 602,753
BankAmerica Corporation........ 19,196 1,401,308
BankBoston Corporation......... 4,021 377,723
Bankers Trust New York
Corporation.................. 2,711 304,818
Bard (C.R.) Inc. .............. 1,575 49,317
Barnett Banks, Inc. ........... 5,339 383,741
Barrick Gold Corporation....... 10,317 192,154
Battle Mountain Gold Company... 6,358 37,353
Bausch & Lomb Inc. ............ 1,531 60,666
Baxter International, Inc. .... 7,752 390,992
+Bay Networks, Inc. ........... 5,856 149,694
Becton, Dickinson and
Company...................... 3,408 170,400
Bell Atlantic Corporation...... 21,472 1,953,952
BellSouth Corporation.......... 27,473 1,547,073
Bemis Company, Inc. ........... 1,452 63,979
Beneficial Corporation......... 1,483 123,274
+Bethlehem Steel Corporation... 3,092 26,669
Biomet, Inc. .................. 3,080 78,925
Black & Decker Corporation
(The)........................ 2,605 101,758
Block (H & R) Inc. ............ 2,872 128,702
Boeing Company (The)........... 27,695 1,355,324
Boise Cascade Corporation...... 1,535 46,434
+Boston Scientific
Corporation.................. 5,362 245,982
Briggs & Stratton
Corporation.................. 697 33,848
Bristol-Myers Squibb Co. ...... 27,523 2,604,364
Brown-Forman Corporation (Class
B)........................... 1,906 105,307
Browning-Ferris Industries,
Inc. ........................ 5,459 201,983
Brunswick Corporation.......... 2,725 82,602
Burlington Northern Santa Fe
Inc. ........................ 4,303 399,910
Burlington Resources Inc. ..... 4,882 218,775
CBS Corporation................ 19,523 574,708
CIGNA Corporation.............. 2,066 357,547
CINergy Corporation............ 4,355 166,851
CPC International Inc. ........ 3,966 427,337
CSX Corporation................ 6,040 326,160
CVS Corporation................ 4,757 304,745
+Cabletron Systems, Inc. ...... 4,362 65,430
Caliber System, Inc. .......... 1,079 52,534
Campbell Soup Company.......... 12,665 736,153
Cardinal Health, Inc. ......... 3,011 226,201
Carolina Power & Light
Company...................... 4,178 177,304
Case Corporation............... 2,078 125,589
Caterpillar, Inc. ............. 10,305 500,437
+Cendant Corporation........... 21,899 752,778
Centex Corporation............. 792 49,847
Central and South West
Corporation.................. 5,837 157,964
+Ceridian Corporation.......... 2,076 95,107
Champion International Corp.... 2,639 119,580
+Charming Shoppes, Inc. ....... 2,925 13,711
</TABLE>
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
Chase Manhattan Corp. (The).... 11,666 $ 1,277,427
Chevron Corporation............ 18,181 1,399,937
Chrysler Corporation........... 18,338 645,268
Chubb Corporation.............. 4,710 356,194
Cincinnati Financial
Corporation.................. 1,512 212,814
Cincinnati Milacron Inc. ...... 1,099 28,505
Circuit City Stores--Circuit
City Group................... 2,707 96,268
+Cisco Systems, Inc. .......... 27,852 1,552,749
Citicorp....................... 12,671 1,602,090
+Clear Channel Communications,
Inc. ........................ 2,720 216,070
Clorox Company................. 2,854 225,644
Coastal Corporation (The)...... 2,912 180,362
Coca-Cola Company (The)........ 68,465 4,561,481
Cognizant Corporation.......... 4,489 200,041
Colgate-Palmolive Company...... 8,173 600,716
Columbia Gas System, Inc.
(The)........................ 1,524 119,729
Columbia/HCA Healthcare
Corporation.................. 17,926 531,058
Comcast Corporation (Class A).. 9,653 304,673
Comerica Inc. ................. 2,908 262,447
Compaq Computer Corporation.... 20,955 1,182,648
Computer Associates
International, Inc. ......... 15,133 800,157
+Computer Sciences
Corporation.................. 2,148 179,358
ConAgra, Inc. ................. 13,079 429,155
Conseco, Inc. ................. 5,196 236,093
Consolidated Edison Company of
New York, Inc. .............. 6,491 266,131
Consolidated Natural Gas
Company...................... 2,622 158,631
Cooper Industries, Inc. ....... 3,378 165,522
Cooper Tire & Rubber Company... 2,193 53,454
Coors (Adolph) Company (Class
B)........................... 1,032 34,314
CoreStates Financial Corp...... 5,475 438,342
Corning, Inc. ................. 6,398 237,526
+Costco Companies, Inc. ....... 5,849 261,012
Countrywide Credit Industries,
Inc. ........................ 2,964 127,082
Crane Co. ..................... 1,266 54,913
Crown Cork & Seal Company,
Inc. ........................ 3,546 177,743
Cummins Engine Company, Inc. .. 1,077 63,610
Cyprus Amax Minerals Co. ...... 2,577 39,621
+DSC Communications
Corporation.................. 3,244 77,856
DTE Energy Company............. 4,008 139,028
Dana Corporation............... 2,888 137,180
Darden Restaurants, Inc. ...... 4,235 52,938
+Data General Corporation...... 1,323 23,070
Dayton Hudson Corporation...... 6,036 407,430
Deere & Company................ 6,973 406,613
+Dell Computer Corporation..... 9,037 759,108
Delta Air Lines, Inc. ......... 2,044 243,236
Deluxe Corporation............. 2,271 78,350
+Digital Equipment
Corporation.................. 4,091 151,367
Dillard Department Stores, Inc.
(Class A).................... 3,061 107,900
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
Disney (Walt) Company (The).... 18,690 $ 1,851,478
Dominion Resources, Inc. ...... 5,174 220,218
Donnelley (R.R.) & Sons Co. ... 4,050 150,863
Dover Corporation.............. 6,156 222,386
Dow Chemical Company (The)..... 6,304 639,856
Dow Jones & Company, Inc. ..... 2,660 142,809
Dresser Industries, Inc. ...... 4,857 203,690
Duke Energy Corporation........ 9,950 550,981
Dun & Bradstreet Corp. (The)... 4,706 145,592
duPont (E.I.) de Nemours and
Company...................... 31,324 1,881,398
EG & G, Inc. .................. 1,293 26,911
+EMC Corporation............... 13,729 376,689
Eastern Enterprises............ 561 25,245
Eastman Chemical Company....... 2,152 128,179
Eastman Kodak Company.......... 9,012 548,042
Eaton Corporation.............. 2,131 190,192
Echlin Inc. ................... 1,718 62,170
+Echo Bay Mines Ltd............ 3,846 9,375
Ecolab Inc. ................... 1,785 98,956
Edison International........... 10,559 287,073
Emerson Electric Co. .......... 12,267 692,319
Engelhard Corporation.......... 3,977 69,100
Enron Corp. ................... 8,802 365,833
Entergy Corporation............ 6,752 202,138
Equifax Inc. .................. 4,182 148,200
Exxon Corporation++............ 68,262 4,176,781
+FMC Corporation............... 1,024 68,928
FPL Group, Inc. ............... 5,047 298,719
+Federal Express
Corporation ................. 3,155 192,652
Federal Home Loan Mortgage
Corp. ....................... 19,239 806,836
Federal National Mortgage
Association.................. 29,371 1,675,983
+Federated Department Stores,
Inc. ........................ 5,785 249,117
Fifth Third BanCorp. .......... 4,262 348,419
First Chicago NBD Corporation.. 8,053 672,426
First Data Corporation......... 11,849 346,583
First Union Corporation........ 17,369 890,161
+FirstEnergy Corp. ............ 6,364 184,556
Fleet Financial Group, Inc. ... 6,915 518,193
Fleetwood Enterprises, Inc. ... 983 41,716
Fluor Corporation.............. 2,316 86,561
Ford Motor Company............. 33,218 1,617,301
Fort James Corporation......... 5,780 221,085
Fortune Brands Inc. ........... 4,757 176,306
Foster Wheeler Corporation..... 1,121 30,337
Freeport-McMoRan Copper & Gold
Inc. (Class B)............... 5,353 84,310
Frontier Corporation........... 4,524 108,859
+Fruit of the Loom, Inc. (Class
A)........................... 2,026 51,916
GPU, Inc. ..................... 3,331 140,318
GTE Corporation................ 26,506 1,384,939
Gannett Co., Inc. ............. 7,853 485,414
Gap, Inc. (The)................ 11,126 394,260
General Dynamics Corporation... 1,736 150,056
</TABLE>
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
General Electric Company++..... 90,567 $ 6,645,354
General Mills, Inc. ........... 4,380 313,718
General Motors Corporation..... 19,579 1,186,977
General Re Corporation......... 2,202 466,824
General Signal Corporation..... 1,378 58,134
Genuine Parts Company.......... 4,981 169,043
Georgia-Pacific Corporation.... 2,525 153,394
Giant Food, Inc. (Class A)..... 1,650 55,584
Gillette Company (The)......... 15,484 1,555,174
Golden West Financial
Corporation.................. 1,582 154,739
Goodrich (B.F.) Company
(The)........................ 1,961 81,259
Goodyear Tire & Rubber Co.
(The)........................ 4,297 273,397
Grace (W.R.) & Co. ............ 2,033 163,529
Grainger (W.W.), Inc. ......... 1,375 133,633
Great Atlantic & Pacific Tea
Co., Inc. ................... 1,054 31,291
Great Lakes Chemical
Corporation.................. 1,657 74,358
Green Tree Financial
Corporation.................. 3,780 98,989
Guidant Corporation............ 4,091 254,665
HBO & Company.................. 5,531 265,488
+HEALTHSOUTH Corporation....... 10,896 302,364
Halliburton Company............ 7,251 376,599
Harcourt General, Inc. ........ 1,959 107,255
Harland (John H.) Company
(The)........................ 854 17,934
Harnischfeger Industries,
Inc. ........................ 1,357 47,919
+Harrah's Entertainment,
Inc. ........................ 2,794 52,737
Harris Corporation............. 2,210 101,384
Hartford Financial Services
Group Inc. (The)............. 3,246 303,704
Hasbro, Inc. .................. 3,500 110,250
Heinz (H.J.) Company........... 10,164 516,458
Helmerich & Payne, Inc. ....... 688 46,698
Hercules Inc. ................. 2,673 133,817
Hershey Foods Corporation...... 3,959 245,211
Hewlett-Packard Company........ 28,773 1,798,313
Hilton Hotels Corporation...... 6,907 205,483
Home Depot, Inc. (The)......... 20,250 1,192,219
Homestake Mining Company....... 4,053 35,970
Honeywell Inc. ................ 3,502 239,887
Household International,
Inc. ........................ 2,938 374,779
Houston Industries Inc. ....... 7,890 210,564
+Humana, Inc. ................. 4,496 93,292
Huntington Bancshares, Inc. ... 5,288 190,368
+ITT Corporation............... 3,217 266,609
ITT Industries, Inc. .......... 3,264 102,408
Ikon Office Solutions, Inc. ... 3,699 104,034
Illinois Tool Works Inc. ...... 6,900 414,863
Inco Limited................... 4,632 78,744
Ingersoll-Rand Company......... 4,590 185,895
Inland Steel Industries,
Inc. ........................ 1,351 23,136
Intel Corporation.............. 45,289 3,181,552
International Business Machines
Corp. ....................... 26,912 2,813,986
International Flavors &
Fragrances Inc. ............. 3,041 156,612
International Paper Company.... 8,365 360,741
Interpublic Group of Companies,
Inc. ........................ 3,486 173,646
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
Jefferson-Pilot Corporation.... 1,961 $ 152,713
Johnson & Johnson.............. 37,229 2,452,460
Johnson Controls, Inc. ........ 2,299 109,777
Jostens, Inc. ................. 1,069 24,654
+KLA-Tencor Corporation........ 2,315 89,417
Kaufman and Broad Home
Corporation.................. 1,073 24,075
Kellogg Company................ 11,414 566,420
Kerr-McGee Corporation......... 1,335 84,522
KeyCorp Limited................ 6,081 430,611
Kimberly-Clark Corporation..... 15,152 747,183
King World Productions,
Inc. ........................ 1,029 59,425
+Kmart Corporation............. 13,502 156,117
Knight-Ridder, Inc. ........... 2,337 121,524
Kroger Co. (The)............... 7,032 259,745
+LSI Logic Corporation......... 3,890 76,827
Laidlaw Inc. (Class B)......... 9,091 123,865
Lilly (Eli) & Co............... 30,708 2,138,045
Limited, Inc. (The)............ 7,487 190,919
Lincoln National Corporation... 2,868 224,063
Liz Claiborne, Inc. ........... 1,850 77,353
Lockheed Martin Corporation.... 5,381 530,029
Loews Corporation.............. 3,177 337,159
Longs Drug Stores Corporation.. 1,078 34,631
Louisiana-Pacific
Corporation.................. 3,008 57,152
Lowe's Companies, Inc. ........ 4,831 230,378
Lucent Technologies Inc. ...... 17,764 1,418,899
MBIA, Inc. .................... 2,473 165,227
MBNA Corporation............... 13,842 378,060
MCI Communications
Corporation.................. 19,280 825,425
MGIC Investment Corporation.... 3,156 209,874
Mallinckrodt Inc. ............. 2,035 77,330
Manor Care, Inc. .............. 1,740 60,900
Marriott International,
Inc. ........................ 3,522 243,898
Marsh & McLennan Companies,
Inc. ........................ 4,702 350,593
Masco Corporation.............. 4,564 232,193
Mattel, Inc. .................. 8,066 300,458
May Department Stores Company
(The)........................ 6,432 338,886
Maytag Corporation............. 2,628 98,057
McDermott International,
Inc. ........................ 1,517 55,560
McDonald's Corporation......... 19,032 908,778
McGraw-Hill Companies, Inc. ... 2,748 203,352
Mead Corporation (The)......... 2,884 80,752
Medtronic, Inc. ............... 12,983 679,173
Mellon Bank Corporation........ 7,047 427,224
Mercantile Stores Company,
Inc. ........................ 1,017 61,910
Merck & Co., Inc. ............. 33,170 3,524,312
Meredith Corporation........... 1,476 52,675
Merrill Lynch & Co., Inc. ..... 9,222 672,630
+Micron Technology Inc. ....... 5,827 151,502
+Microsoft Corporation++....... 33,404 4,317,467
Millipore Corporation.......... 1,197 40,623
Minnesota Mining &
Manufacturing Company........ 11,313 928,373
+Mirage Resorts, Inc. ......... 4,966 112,976
Mobil Corporation.............. 21,751 1,570,150
Monsanto Company............... 16,415 689,430
</TABLE>
131
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
Moore Corporation Limited (NY
Registered Shares)........... 2,431 $ 36,769
Morgan (J.P.) & Co., Inc. ..... 4,948 558,505
Morgan Stanley Group Inc. ..... 16,399 969,591
Morton International Inc. ..... 3,716 127,737
Motorola, Inc. ................ 16,525 942,958
NICOR Inc. .................... 1,364 57,544
Nacco Industries, Inc. (Class
A)........................... 226 24,224
Nalco Chemical Company......... 1,856 73,428
National City Corporation...... 5,951 391,278
+National Semiconductor
Corporation.................. 4,518 117,186
National Service Industries,
Inc. ........................ 1,196 59,277
NationsBank Corporation........ 19,693 1,197,581
+Navistar International
Corporation.................. 2,083 51,684
New York Times Company (The)
(Class A).................... 2,662 176,025
Newell Co. .................... 4,389 186,532
Newmont Mining Corporation..... 4,312 126,665
+NextLevel Systems, Inc. ...... 4,094 73,180
+Niagara Mohawk Power Corp. ... 3,987 41,863
Nike Inc. (Class B)............ 8,039 315,531
Nordstrom, Inc. ............... 2,135 128,901
Norfolk & Southern
Corporation.................. 10,438 321,621
Northern States Power
Company...................... 2,041 118,888
Northern Telecom Limited....... 7,251 645,339
Northrop Grumman Corporation... 1,833 210,795
Norwest Corporation............ 20,908 807,571
+Novell, Inc. ................. 9,676 72,570
Nucor Corporation.............. 2,424 117,109
ONEOK, Inc. ................... 846 34,157
Occidental Petroleum
Corporation.................. 9,377 274,863
Omnicom Group, Inc. ........... 4,484 190,009
+Oracle Corporation............ 27,131 605,360
+Oryx Energy Company........... 2,899 73,924
Owens Corning.................. 1,443 49,242
+Owens-Illinois, Inc. ......... 3,881 147,235
PACCAR Inc. ................... 2,168 113,820
PECO Energy Company............ 6,146 149,040
PG&E Corporation............... 12,128 369,146
PNC Bank Corp. ................ 8,444 481,836
PP&L Resources, Inc. .......... 4,591 109,897
PPG Industries, Inc. .......... 4,930 281,626
Pacific Enterprises............ 2,332 87,741
PacifiCorp..................... 8,192 223,744
Pall Corporation............... 3,519 72,799
+Parametric Technology
Company...................... 3,544 167,897
Parker Hannifin Corporation.... 3,081 141,341
Penney (J.C.) Company, Inc. ... 6,884 415,191
Pennzoil Company............... 1,290 86,188
Peoples Energy Corporation..... 965 37,997
Pep Boys--Manny, Moe & Jack
(The)........................ 1,748 41,733
PepsiCo, Inc. ................. 41,996 1,530,229
Perkin-Elmer Corporation
(The)........................ 1,199 85,204
Pfizer Inc. ................... 35,800 2,669,337
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
Pharmacia & Upjohn, Inc. ...... 14,030 $ 513,849
Phelps Dodge Corporation....... 1,627 101,281
Philip Morris Companies,
Inc.++....................... 67,112 3,041,012
Phillips Petroleum Company..... 7,273 353,650
Pioneer Hi-Bred International,
Inc. ........................ 1,818 194,980
Pitney Bowes Inc. ............. 3,991 358,941
Placer Dome, Inc. ............. 6,615 83,928
Polaroid Corporation........... 1,251 60,908
Potlatch Corporation........... 795 34,185
Praxair, Inc. ................. 4,334 195,030
Procter & Gamble Company
(The)........................ 37,204 2,969,344
Progressive Corporation........ 1,977 236,993
Providian Corporation.......... 2,633 118,979
Public Service Enterprise
Group, Inc. ................. 6,420 203,434
Pulte Corporation.............. 605 25,297
Quaker Oats Company (The)...... 3,833 202,191
Ralston Purina Company......... 2,933 272,586
Raychem Corporation............ 2,380 102,489
Raytheon Company (Class A)..... 3,361 165,744
Raytheon Company (Class B)..... 6,021 304,060
+Reebok International Ltd. .... 1,539 44,342
Republic New York Corporation.. 1,519 173,451
Reynolds Metals Company........ 2,020 121,200
Rite Aid Corporation........... 3,452 202,589
Rockwell International
Corporation.................. 5,776 301,796
Rohm & Haas Company............ 1,694 162,200
+Rowan Companies, Inc. ........ 2,364 72,102
Royal Dutch Petroleum Co. (NY
Registered Shares)........... 59,333 3,215,107
Rubbermaid Inc. ............... 4,139 103,475
Russell Corporation............ 1,038 27,572
Ryder System, Inc. ............ 2,150 70,412
SAFECO Corporation............. 3,907 189,978
SBC Communications Inc. ....... 25,373 1,858,572
Safety-Kleen Corp. ............ 1,609 44,147
Sara Lee Corporation........... 13,316 749,857
Schering-Plough Corporation.... 20,256 1,258,404
Schlumberger Limited........... 13,693 1,102,286
Schwab (Charles) Corporation
(The)........................ 7,320 306,982
Scientific-Atlanta, Inc. ...... 2,183 36,565
+Seagate Technology, Inc. ..... 6,786 130,630
Seagram Company Ltd. (The)..... 9,867 318,827
Sears, Roebuck and Co. ........ 10,817 489,469
Service Corporation
International................ 6,962 257,159
Shared Medical Systems
Corporation.................. 666 43,956
Sherwin-Williams Company
(The)........................ 4,748 131,757
Sigma-Aldrich Corporation...... 2,740 108,915
+Silicon Graphics, Inc. ....... 5,183 64,464
Snap-On, Inc. ................. 1,683 73,421
Sonat Inc. .................... 2,379 108,839
Southern Company (The)......... 19,104 494,316
Southwest Airlines Co. ........ 6,062 149,277
Springs Industries, Inc. ...... 557 28,964
</TABLE>
132
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
Sprint Corporation............. 11,892 $ 697,168
+St. Jude Medical, Inc. ....... 2,525 77,012
St. Paul Companies, Inc.
(The)........................ 2,298 188,580
Standard & Poor's Depositary
Receipts..................... 5,300 513,769
Stanley Works (The)............ 2,455 115,845
State Street Corporation....... 4,441 258,411
+Stone Container Corporation... 2,740 28,599
Sun Company, Inc. ............. 2,013 84,672
+Sun Microsystems, Inc. ....... 10,370 413,504
SunAmerica Inc. ............... 5,395 230,636
SunTrust Banks, Inc. .......... 5,837 416,616
SuperValu Stores Inc. ......... 1,662 69,596
Synovus Financial Corp. ....... 4,827 158,084
Sysco Corporation.............. 4,734 215,693
TJX Companies, Inc. (The)...... 4,516 155,237
TRW Inc. ...................... 3,409 181,955
Tandy Corporation.............. 2,862 110,366
Tektronix, Inc. ............... 1,367 54,253
+Tele-Communications, Inc.
(Class A).................... 14,020 391,684
+Tellabs, Inc. ................ 5,003 264,534
Temple-Inland Inc. ............ 1,536 80,352
+Tenet Healthcare
Corporation.................. 8,450 279,906
Tenneco, Inc. ................. 4,717 186,321
Texaco, Inc. .................. 15,171 824,923
Texas Instruments Inc. ........ 10,802 486,090
Texas Utilities Company........ 6,822 283,539
Textron Inc. .................. 4,566 285,375
+Thermo Electron Corporation... 4,188 186,366
Thomas & Betts Corporation..... 1,520 71,820
Time Warner Inc. .............. 15,477 959,574
Times Mirror Company (The)..... 2,646 162,729
Timken Company (The)........... 1,729 59,434
Torchmark Corporation.......... 3,874 162,950
+Toys 'R' Us, Inc. ............ 7,909 248,639
Transamerica Corporation....... 1,750 186,375
Travelers Group, Inc. ......... 31,744 1,710,208
Tribune Company................ 3,397 211,463
+Tricon Global Restaurants,
Inc. ........................ 4,233 123,022
Tupperware Corporation......... 1,710 47,666
Tyco International Ltd. ....... 14,740 664,221
U S West Communications Group,
Inc. ........................ 13,374 603,502
+U S West Media Group, Inc. ... 16,786 484,696
UNUM Corporation............... 3,862 209,996
US Bancorp..................... 6,796 760,727
+USAir Group, Inc. ............ 2,507 156,687
USF & G Corporation............ 3,118 68,791
UST Inc. ...................... 5,116 188,972
USX-Marathon Group, Inc. ...... 7,945 268,144
USX-US Steel Group, Inc. ...... 2,385 74,531
Unicom Corporation............. 5,962 183,331
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
COMMON STOCKS HELD (NOTE 1A)
- ------------------------------------------------------
<S> <C> <C>
Unilever N.V. (NY Registered
Shares)...................... 17,721 $ 1,106,455
Union Camp Corporation......... 1,918 102,973
Union Carbide Corporation...... 3,435 147,490
Union Electric Company......... 3,789 163,874
Union Pacific Corporation...... 6,833 426,635
Union Pacific Resources Group
Inc. ........................ 7,024 170,332
+Unisys Corporation............ 4,830 67,016
United Healthcare
Corporation.................. 5,213 259,021
United States Surgical
Corporation.................. 2,095 61,410
United Technologies Corp. ..... 6,448 469,495
Unocal Corporation............. 6,831 265,128
V.F. Corporation............... 3,381 155,315
+Viacom, Inc. (Class B)........ 9,762 404,513
Wachovia Corporation........... 5,643 457,829
Wal-Mart Stores, Inc. ......... 62,381 2,460,151
Walgreen Co. .................. 13,596 426,574
Warner--Lambert Company........ 7,538 934,712
Washington Mutual Savings
Bank......................... 7,123 454,536
Waste Management Inc. ......... 12,596 346,390
Wells Fargo & Company.......... 2,399 814,311
Wendy's International, Inc. ... 3,638 87,539
+Western Atlas, Inc. .......... 1,483 109,742
Westvaco Corporation........... 2,815 88,497
Weyerhaeuser Company........... 5,525 271,070
Whirlpool Corporation.......... 2,054 112,970
Whitman Corporation............ 2,844 74,122
Willamette Industries, Inc. ... 3,070 98,816
Williams Companies, Inc.
(The)........................ 8,796 249,586
Winn-Dixie Stores, Inc. ....... 4,148 181,216
+Woolworth Corporation......... 3,699 75,367
+WorldCom, Inc. ............... 25,007 756,462
Worthington Industries,
Inc. ........................ 2,673 43,770
Wrigley (Wm.) Jr. Company
(Class B).................... 3,208 255,236
Xerox Corporation.............. 9,021 665,863
- ------------------------------------------------------
TOTAL COMMON STOCKS
(COST--$189,981,756)--97.4% 209,586,482
- ------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SHORT-TERM OBLIGATIONS-- FACE
COMMERCIAL PAPER* AMOUNT
- -------------------------------------------------------
<S> <C> <C>
General Motors Acceptance
Corp., 6.75% due
1/02/1998.................. $5,268,000 5,267,012
- -------------------------------------------------------
TOTAL SHORT-TERM OBLIGATIONS
(COST--$5,267,012)--2.4% 5,267,012
- -------------------------------------------------------
TOTAL INVESTMENTS
(COST--$195,248,768)--99.8% 214,853,494
VARIATION MARGIN ON FINANCIAL
FUTURES CONTRACTS**--0.0%.. 518
OTHER ASSETS LESS
LIABILITIES--0.2%.......... 380,408
------------
NET ASSETS--100.0%........... $215,234,420
============
</TABLE>
- --------------------------------------------------------------------------------
+ Non-income producing security.
++ Portion of holdings pledged as collateral for stock index futures contracts.
* Commercial Paper is traded on a discount basis; the interest rate shown is the
discount rate paid at the time of purchase by the Fund.
133
<PAGE> 344
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
** Financial futures contracts purchased as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------
NUMBER OF EXPIRATION VALUE
CONTRACTS ISSUE DATE (NOTE 1B)
- -------------------------------------------------------
<S> <C> <C> <C>
25 S&P 500 Stock Index March 1998 $6,119,375
- -------------------------------------------------------
TOTAL FINANCIAL FUTURES CONTRACTS PURCHASED
(CONTRACT PRICE--$6,061,025) $6,119,375
==========
- -------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
134
<PAGE> 345
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$195,248,768) (Note
1a)....................................................... $214,853,494
Receivables:
Capital shares sold....................................... $793,038
Dividends................................................. 278,348
Variation margin (Note 1b)................................ 518
Securities sold........................................... 260 1,072,164
--------
Deferred organization expenses (Note 1e).................... 8,169
Prepaid expenses and other assets........................... 10,568
------------
Total assets................................................ 215,944,395
------------
- --------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Custodian bank (Note 1g).................................. 302,013
Capital shares redeemed................................... 213,787
Investment adviser (Note 2)............................... 56,197
Securities purchased...................................... 52,620 624,617
--------
Accrued expenses and other liabilities...................... 85,358
------------
Total liabilities........................................... 709,975
------------
- --------------------------------------------------------------------------------------
NET ASSETS.................................................. $215,234,420
============
- --------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 1,596,923
Paid-in capital in excess of par............................ 181,290,757
Undistributed investment income--net........................ 2,775,828
Undistributed realized capital gains on investments--net.... 9,907,836
Unrealized appreciation on investments--net................. 19,663,076
------------
NET ASSETS.................................................. $215,234,420
============
- --------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $215,234,420 and 15,969,225
shares outstanding........................................ $ 13.48
============
- --------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
135
<PAGE> 346
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1c & 1d):
Dividends (net of $10,703 foreign withholding tax).......... $ 2,078,924
Interest and discount earned................................ 1,166,875
-----------
Total income................................................ 3,245,799
-----------
- ----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $415,327
Registration fees........................................... 56,443
Accounting services (Note 2)................................ 33,298
Custodian fees.............................................. 29,101
Professional fees........................................... 6,383
Transfer agent fees (Note 2)................................ 4,590
Amortization of organization expenses (Note 1e)............. 2,112
Directors' fees and expenses................................ 1,123
Pricing services............................................ 611
Other....................................................... 541
--------
Total expenses before reimbursement......................... 549,529
Reimbursement of expenses (Note 2).......................... (79,567)
--------
Expenses after reimbursement................................ 469,962
-----------
Investment income--net...................................... 2,775,837
-----------
- ----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN ON INVESTMENTS--NET (NOTES 1b, 1d
& 3):
Realized gain on investments--net........................... 9,912,879
Change in unrealized appreciation on investments--net....... 19,509,942
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $32,198,658
===========
- ----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
136
<PAGE> 347
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE FOR THE PERIOD
YEAR ENDED DEC. 13, 1996+
DECEMBER 31, TO DEC. 31,
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 2,775,837 $ 16,863
Realized gain (loss) on investments--net.................... 9,912,879 (193)
Change in unrealized appreciation on investments--net....... 19,509,942 153,134
------------ -----------
Net increase in net assets resulting from operations........ 32,198,658 169,804
------------ -----------
- -------------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A................................................... (16,872) --
Realized gain on investments--net:
Class A................................................... (4,850) --
------------ -----------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (21,722) --
------------ -----------
- -------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 172,305,644 582,036
------------ -----------
- -------------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 204,482,580 751,840
Beginning of period......................................... 10,751,840 10,000,000
------------ -----------
End of period*.............................................. $215,234,420 $10,751,840
============ ===========
- -------------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 2,775,828 $ 16,863
============ ===========
- -------------------------------------------------------------------------------------------------
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
137
<PAGE> 348
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
------------------------------
FOR THE YEAR FOR THE PERIOD
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM INFORMATION PROVIDED ENDED DEC. 13, 1996+
IN THE FINANCIAL STATEMENTS. DECEMBER 31, TO DEC. 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................................... $ 10.17 $ 10.00
-------- -------
Investment income--net................................................. .17 .02
Realized and unrealized gain on investments--net....................... 3.16 .15
-------- -------
Total from investment operations....................................... 3.33 .17
-------- -------
Less dividends and distributions:
Investment income--net............................................... (.02) --
Realized gain on investments--net.................................... --++ --
-------- -------
Total dividends and distributions...................................... (.02) --
-------- -------
Net asset value, end of period......................................... $ 13.48 $ 10.17
======== =======
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share..................................... 32.81% 1.68%++++
======== =======
- -----------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement......................................... .34% .00%*
======== =======
Expenses............................................................... .40% .60%*
======== =======
Investment income--net................................................. 2.01% 3.08%*
======== =======
- -----------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)............................... $215,234 $10,752
======== =======
Portfolio turnover..................................................... 36.85% .04%
======== =======
Average commission rate paid........................................... $.0158 $.0120
======== =======
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Amount is less than $.01 per share.
++++ Aggregate total investment return.
See Notes to Financial Statements.
138
<PAGE> 349
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc.("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. Index 500 Fund (the "Fund") is classified as "non-diversified",
as defined in the Investment Company Act of 1940. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
sale price prior to the time of valuation. Securities traded in the NASDAQ
National Market System are valued at the last sale price prior to the time of
valuation. Portfolio securities which are traded both in the over-the-counter
market and on a stock exchange are valued according to the broadest and most
representative market. Options written are valued at the last sale price in the
case of exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Options purchased are valued at
the last sale price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter market, the last bid price. Futures
contracts are valued at the settlement price at the close of the applicable
exchange. Short-term securities are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity markets. Losses may arise due to changes in the
value of the contract or if the counterparty does not perform under the
contract.
- - Financial futures contracts--The Fund may purchase or sell futures contracts
and options on such futures contracts for the purpose of hedging the market risk
on existing securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific future date and
at a specific price or yield. Upon entering into a contract, the Fund deposits
and maintains as collateral such initial margin as required by the exchange on
which the transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are known as
variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed.
- - Options--The Fund is authorized to purchase and write covered call and put
options. When the Fund writes an option, an amount equal to the premium received
by the Fund is reflected as an asset and an equivalent liability. The amount of
the liability is subsequently marked to market to reflect the current market
value of the option written. When a security is purchased or sold through an
exercise of an option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from (or added to)
the proceeds of the security sold. When an option expires (or the Fund enters
into a closing transaction), the Fund realizes a gain or loss on the option to
the extent of the premiums received or paid (or gain or loss to the extent the
cost of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
139
<PAGE> 350
- --------------------------------------------------------------------------------
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(e) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a five-year period.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Custodian Bank--The Fund recorded an amount payable to the Custodian Bank
reflecting an overnight overdraft which resulted from differences in projected
capital share transaction settlements.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.30% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, MLAM earned fees of $415,327, of which
$79,567 was voluntarily waived.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $218,336,198 and $43,800,898, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Realized Unrealized
Gains (Losses) Gains
- -------------------------------------------------------------------
<S> <C> <C>
Long-term investments................ $6,106,424 $19,604,726
Short-term investments............... (936) --
Options purchased.................... 5,707 --
Options written...................... 3,732 --
Financial futures contracts.......... 3,797,952 58,350
---------- -----------
Total................................ $9,912,879 $19,663,076
========== ===========
- -------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $19,083,826, of which $24,062,080 related to appreciated
securities and $4,978,254 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$195,769,668.
Transactions in put options written for the year ended December 31, 1997 were
as follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Nominal Value Premiums
Covered Received
- ----------------------------------------------------------------------
<S> <C> <C>
Outstanding put options written,
beginning of year................. -- --
Options written.................... 300 $ 5,541
Options closed..................... (300) (5,541)
---- -------
Outstanding put options written,
end of year....................... -- $ --
==== =======
- ----------------------------------------------------------------------
</TABLE>
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions was
$172,305,644 and $582,036 for the year ended December 31, 1997 and the period
ended December 31, 1996, respectively.
140
<PAGE> 351
- --------------------------------------------------------------------------------
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold........................... 19,361,582 $225,105,550
Shares issued to shareholders in
reinvestment of dividends and
distributions........................ 2,149 21,722
---------- ------------
Total issued.......................... 19,363,731 225,127,272
Shares redeemed....................... (4,451,853) (52,821,628)
---------- ------------
Net increase.......................... 14,911,878 $172,305,644
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Class A Shares for the Period December 13, 1996+ Dollar
to December 31, 1996 Shares Amount
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold................................... 57,357 $582,138
Shares redeemed............................... (10) (102)
------ --------
Net increase.................................. 57,347 $582,036
====== ========
- --------------------------------------------------------------------
+ Prior to December 13, 1996 (commencement of operations), the Fund
issued 1,000,000 shares to MLLA for $10,000,000.
</TABLE>
5. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.685491 per Class A Share and a long-term capital
gains distribution in the amount of $.145045 per Class A Share payable on
January 9, 1998 to shareholders of record as of December 31, 1997.
141
<PAGE> 352
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
AFRICA INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SOUTH AFRICA BANKING 60,980 Nedcor Ltd.
(GDR)(b)(e)............ $ 719,592 $ 1,353,341 0.3%
10,259 Nedcor Ltd. (Ordinary)... 151,495 227,790 0.1
------------ ------------ -----
871,087 1,581,131 0.4
-----------------------------------------------------------------------------------------------------
BEVERAGES 138,736 South African Breweries,
Ltd. .................. 3,702,680 3,422,763 0.8
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 71,000 Sasol Limited............ 1,000,038 744,449 0.2
-----------------------------------------------------------------------------------------------------
INSURANCE 49,800 Liberty Life Association
of Africa.............. 1,352,849 1,279,811 0.3
-----------------------------------------------------------------------------------------------------
MINING 5,150 Anglo American Corp. of
South Africa, Ltd. .... 347,236 208,160 0.1
23,800 Anglo American Corp. of
South Africa, Ltd.
(ADR)(a) .............. 1,522,851 957,950 0.2
47,300 Evander Gold Mines
Ltd. .................. 511,564 89,465 0.0
------------ ------------ -----
2,381,651 1,255,575 0.3
-----------------------------------------------------------------------------------------------------
PAPER & FOREST 29,000 Sappi Limited............ 277,418 146,073 0.0
PRODUCTS
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
AFRICA 9,585,723 8,429,802 2.0
- --------------------------------------------------------------------------------------------------------------------------
LATIN AMERICA
- --------------------------------------------------------------------------------------------------------------------------
ARGENTINA BANKING 15,120 Banco de Galicia y Buenos
Aires S.A. de C.V.
(ADR)(a) .............. 386,299 389,340 0.1
17,361 Banco Frances del Rio de
la Plata S.A.
(ADR)(a)............... 508,326 475,257 0.1
------------ ------------ -----
894,625 864,597 0.2
-----------------------------------------------------------------------------------------------------
OIL & RELATED 128,921 Companhia Naviera Perez
Companc
S.A.C.F.I.M.F.A. (Class
B)..................... 796,027 920,680 0.2
19,180 Yacimientos Petroliferos
Fiscales S.A. (YPF)
(ADR)(a)............... 569,186 655,716 0.2
------------ ------------ -----
1,365,213 1,576,396 0.4
-----------------------------------------------------------------------------------------------------
REAL ESTATE 8,350 IRSA Inversiones y
Representaciones S.A.
(GDR)(b)............... 300,550 314,169 0.1
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 22,490 Telefonica de Argentina
S.A. (Class B)
(ADR)(a)............... 809,006 837,753 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
ARGENTINA 3,369,394 3,592,915 0.9
- --------------------------------------------------------------------------------------------------------------------------
BRAZIL BEVERAGES 2,270,000 Companhia Cervejaria
Brahma S.A. PN
(Preferred)............ 1,153,770 1,525,538 0.4
-----------------------------------------------------------------------------------------------------
OIL & GAS 3,500,000 Petroleo Brasileiro
PRODUCERS S.A.--Petrobras
(Preferred)............ 920,556 818,548 0.2
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 16,044 Telecomunicacoes
Brasileiras S.A.--
Telebras (ADR)(a)...... 1,748,375 1,868,123 0.4
-----------------------------------------------------------------------------------------------------
</TABLE>
142
<PAGE> 353
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LATIN
AMERICA SHARES VALUE PERCENT OF
(CONCLUDED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BRAZIL UTILITIES--ELECTRIC 31,500 Companhia Energetica de
(CONCLUDED) Minas Gerais S.A.
(CEMIG)(ADR)(a)........ $ 963,150 $ 1,362,375 0.3%
22,500,000 Companhia Energetica de
Minas Gerais S.A.
(CEMIG)(Preferred)..... 1,276,323 977,621 0.2
------------ ------------ -----
2,239,473 2,339,996 0.5
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
BRAZIL 6,062,174 6,552,205 1.5
- --------------------------------------------------------------------------------------------------------------------------
CHILE TELECOMMUNICATIONS 34,000 Compania de
Telecomunicaciones de
Chile S.A. (ADR)(a).... 1,133,183 1,015,750 0.2
-----------------------------------------------------------------------------------------------------
UTILITIES 20,480 Enersis S.A. (ADR)(a).... 530,086 593,920 0.2
-----------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 42,000 Chilgener S.A. (ADR)(a)
....................... 1,138,834 1,029,000 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
CHILE 2,802,103 2,638,670 0.6
- --------------------------------------------------------------------------------------------------------------------------
MEXICO BEVERAGES 144,400 Fomento Economico
Mexicano, S.A. de C.V.
(Femsa)(Class B)....... 808,695 1,161,221 0.3
-----------------------------------------------------------------------------------------------------
BUILDING & 412,100 Empresas ICA Sociedad
CONSTRUCTION Controladora, S.A. de
C.V. .................. 1,060,022 1,112,332 0.3
-----------------------------------------------------------------------------------------------------
BUILDING PRODUCTS 275,100 Cementos Mexicanos, S.A.
de C.V. (Cemex) (Class
B)(d).................. 1,212,450 1,468,019 0.3
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 155,800 Alfa, S.A. de C.V........ 971,631 1,049,881 0.3
-----------------------------------------------------------------------------------------------------
HEALTH & PERSONAL 41,700 Kimberly-Clark de Mexico,
S.A. de C.V.
(ADR)(a)............... 867,363 969,525 0.2
-----------------------------------------------------------------------------------------------------
MULTI-INDUSTRY 203,500 Grupo Carso, S.A. de C.V.
'A1'................... 1,423,406 1,361,212 0.3
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 347,300 Carso Global Telecom,
S.A. de C.V. 'A1'...... 1,116,346 1,405,061 0.3
574,350 Telefonos de Mexico, S.A.
de C.V. (Series L)..... 1,386,956 1,617,988 0.4
------------ ------------ -----
2,503,302 3,023,049 0.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
MEXICO 8,846,869 10,145,239 2.4
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
LATIN AMERICA 21,080,540 22,929,029 5.4
- --------------------------------------------------------------------------------------------------------------------------
NORTH
AMERICA
- --------------------------------------------------------------------------------------------------------------------------
CANADA ALUMINUM 48,000 Alcan Aluminium Ltd. .... 1,655,994 1,321,501 0.3
3,000 Alcan Aluminium Ltd. (NY
Registered Shares)..... 116,813 82,875 0.0
------------ ------------ -----
1,772,807 1,404,376 0.3
-----------------------------------------------------------------------------------------------------
BUILDING PRODUCTS 232,000 Noranda Forest, Inc...... 1,703,586 1,256,376 0.3
-----------------------------------------------------------------------------------------------------
GOLD PRODUCERS 72,000 Barrick Gold
Corporation............ 1,631,428 1,340,787 0.3
-----------------------------------------------------------------------------------------------------
METALS & MINING 33,000 MSCI Canada Opals (Class
B)(e).................. 5,201,506 5,147,010 1.2
148,000 Noranda, Inc. ........... 3,160,579 2,544,057 0.6
------------ ------------ -----
8,362,085 7,691,067 1.8
-----------------------------------------------------------------------------------------------------
OIL 137,300 Ranger Oil Ltd. ......... 1,297,033 935,417 0.2
-----------------------------------------------------------------------------------------------------
OIL & GAS 19,000 Imperial Oil Ltd. ....... 1,109,952 1,221,438 0.3
PRODUCERS
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 48,000 BC Telecom, Inc. ........ 1,275,260 1,492,558 0.4
-----------------------------------------------------------------------------------------------------
</TABLE>
143
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NORTH
AMERICA SHARES VALUE PERCENT OF
(CONCLUDED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CANADA TELECOMMUNICATIONS 30,000 Newbridge Networks
(CONCLUDED) & EQUIPMENT Corporation(d)......... $ 1,101,083 $ 1,049,193 0.3%
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 82,300 Canadian Pacific Ltd. ... 2,529,363 2,214,066 0.5
4,200 Canadian Pacific Ltd. (NY
Registered Shares)..... 127,838 114,450 0.0
------------ ------------ -----
2,657,201 2,328,516 0.5
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
NORTH AMERICA 20,910,435 18,719,728 4.4
- --------------------------------------------------------------------------------------------------------------------------
PACIFIC
BASIN
- --------------------------------------------------------------------------------------------------------------------------
AUSTRALIA AUTO-RELATED 153,100 Orbital Engine
Corporation Ltd.(d).... 101,098 68,771 0.0
-----------------------------------------------------------------------------------------------------
BANKING 105,000 Australia and New Zealand
Banking Group Ltd. .... 647,142 693,120 0.2
81,000 Coles Myer Limited....... 407,449 388,627 0.1
15,300 Commonwealth Bank of
Australia.............. 181,451 175,301 0.0
288,172 National Australia Bank
Ltd. .................. 3,882,711 4,020,267 0.9
254,900 Westpac Banking
Corporation Ltd. ...... 1,552,426 1,628,866 0.4
------------ ------------ -----
6,671,179 6,906,181 1.6
-----------------------------------------------------------------------------------------------------
BEVERAGES 4,400 Foster's Brewing Group
Ltd. .................. 9,320 8,364 0.0
-----------------------------------------------------------------------------------------------------
BROADCAST--MEDIA 59,800 Seven Network Ltd. ...... 230,952 216,450 0.1
-----------------------------------------------------------------------------------------------------
BUILDING & 74,600 James Hardie Industries
CONSTRUCTION Ltd. .................. 230,234 217,229 0.1
-----------------------------------------------------------------------------------------------------
BUILDING PRODUCTS 195,600 Boral Ltd. .............. 603,764 494,062 0.1
183,300 CSR Ltd. ................ 703,928 620,507 0.1
------------ ------------ -----
1,307,692 1,114,569 0.2
-----------------------------------------------------------------------------------------------------
CLOSED-END FUNDS 68,200 Franked Income Fund
(Units)................ 202,914 194,464 0.0
-----------------------------------------------------------------------------------------------------
COMMERCIAL 25,000 Mayne Nickless Ltd. ..... 142,510 131,990 0.0
SERVICES
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 29,200 Email Ltd. .............. 102,629 68,889 0.0
29,500 Smith (Howard) Ltd. ..... 235,283 244,665 0.1
41,700 Southcorp Ltd. .......... 142,694 137,905 0.0
29,800 Wesfarmers Ltd. ......... 267,024 249,326 0.1
------------ ------------ -----
747,630 700,785 0.2
-----------------------------------------------------------------------------------------------------
FOOD & BEVERAGE 48,000 Coca-Cola Amatil,
Ltd. .................. 437,994 358,290 0.1
-----------------------------------------------------------------------------------------------------
FOODS 56,200 Burns, Philp & Company,
Ltd. .................. 102,741 8,781 0.0
27,000 Foodland Associated
Ltd. .................. 205,981 201,977 0.1
10,000 Goodman Fielder Ltd. .... 14,010 15,884 0.0
71,600 National Foods Ltd. ..... 100,996 111,215 0.0
------------ ------------ -----
423,728 337,857 0.1
-----------------------------------------------------------------------------------------------------
HOTELS 160,500 AAPC Limited............. 102,285 65,826 0.0
-----------------------------------------------------------------------------------------------------
INVESTMENT 54,400 Australian Foundation
MANAGEMENT Investment Company
Ltd. .................. 99,667 102,702 0.0
-----------------------------------------------------------------------------------------------------
MEDIA 22,636 The News Corp., Ltd.
(Ordinary)............. 119,206 124,814 0.0
52,772 The News Corp., Ltd.
(Preferred)............ 224,225 260,889 0.1
------------ ------------ -----
343,431 385,703 0.1
-----------------------------------------------------------------------------------------------------
</TABLE>
144
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AUSTRALIA METALS & MINING 35,500 Aberfoyle Ltd. .......... $ 99,964 $ 57,776 0.0%
(CONCLUDED) 72,000 Ashton Mining Ltd. ...... 100,285 63,230 0.0
56,800 Comalco Ltd. ............ 238,328 234,433 0.1
40,900 Metal Manufactures
Ltd. .................. 99,801 61,506 0.0
39,800 Newcrest Mining Ltd. .... 100,536 43,269 0.0
232,300 Normandy Mining Ltd. .... 249,719 225,329 0.1
31,100 Plutonic Resources
Ltd. .................. 99,222 86,653 0.0
81,700 QCT Resources Ltd. ...... 99,746 65,952 0.0
26,600 RGC Ltd. ................ 99,007 40,521 0.0
401,600 Rio Tinto Ltd. .......... 5,343,510 4,680,589 1.1
125,000 WMC Ltd. ................ 781,163 435,356 0.1
------------ ------------ -----
7,311,281 5,994,614 1.4
-----------------------------------------------------------------------------------------------------
OIL & GAS 38,900 Australian Gas Light Co.,
PRODUCERS Ltd. .................. 257,107 270,966 0.1
62,000 Australian Oil & Gas
Corporation Ltd. ...... 101,805 72,652 0.0
56,000 Woodside Petroleum
Ltd. .................. 407,267 394,454 0.1
------------ ------------ -----
766,179 738,072 0.2
-----------------------------------------------------------------------------------------------------
PACKAGING & 165,000 Amcor Ltd. .............. 1,075,547 725,051 0.2
CONTAINERS
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 39,400 F.H. Faulding & Co.
Ltd. .................. 191,278 196,987 0.0
-----------------------------------------------------------------------------------------------------
PROPERTY 36,927 Lend Lease Corp. ........ 693,489 721,184 0.2
-----------------------------------------------------------------------------------------------------
PUBLISHING 40,500 PMP Communications
Ltd. .................. 94,595 89,643 0.0
-----------------------------------------------------------------------------------------------------
REAL ESTATE 55,000 Capital Property Trust... 99,829 83,068 0.0
INVESTMENT TRUSTS
38,700 Stockland Trust Group.... 100,446 89,614 0.0
66,500 Westfield Holdings
Ltd. .................. 266,949 255,420 0.1
------------ ------------ -----
467,224 428,102 0.1
-----------------------------------------------------------------------------------------------------
RESOURCES 74,700 Broken Hill Proprietary
Co. Ltd. .............. 1,005,966 692,973 0.2
-----------------------------------------------------------------------------------------------------
STEEL 86,500 Australia National
Industries Ltd. ....... 102,236 79,399 0.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 128,000 Telstra Corp. Ltd.(d).... 243,977 269,983 0.1
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 99,400 Brambles Industries
Ltd. .................. 1,933,511 1,970,401 0.5
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
AUSTRALIA 24,935,917 22,715,590 5.4
- --------------------------------------------------------------------------------------------------------------------------
CHINA TELECOMMUNICATIONS 27,600 China Telecom
(Hong Kong) Ltd.
(ADR)(a)(d)............ 889,722 926,325 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
CHINA 889,722 926,325 0.2
- --------------------------------------------------------------------------------------------------------------------------
HONG KONG AIRLINES 292,000 Cathay Pacific Airways... 450,715 237,444 0.0
-----------------------------------------------------------------------------------------------------
BANKING 100,000 Dao Heng Bank Group
Ltd. .................. 471,968 249,758 0.1
65,200 HSBC Holdings Ltd. ...... 995,860 1,607,383 0.4
63,000 Hang Seng Bank Ltd. ..... 698,137 607,841 0.1
------------ ------------ -----
2,165,965 2,464,982 0.6
-----------------------------------------------------------------------------------------------------
CONGLOMERATES 116,140 Hutchison Whampoa
Ltd. .................. 739,598 728,545 0.2
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 162,000 Citic Pacific Ltd. ...... 875,799 644,027 0.1
95,500 Swire Pacific Ltd. 'A'... 788,289 523,879 0.1
298,500 Swire Pacific Ltd. 'B'... 393,371 302,449 0.1
------------ ------------ -----
2,057,459 1,470,355 0.3
-----------------------------------------------------------------------------------------------------
FOODS 3,076,000 C.P. Pokphand Co.
Ltd. .................. 1,051,836 484,378 0.1
-----------------------------------------------------------------------------------------------------
</TABLE>
145
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
HONG KONG PROPERTY 116,000 Cheung Kong Holdings
(CONCLUDED) Ltd. .................. $ 828,352 $ 759,858 0.2%
124,000 Great Eagle Holdings
Ltd. .................. 367,528 173,656 0.0
24,800 Great Eagle Holdings Ltd.
(Warrants)(c).......... 0 3,201 0.0
301,000 Henderson Investment
Ltd. .................. 310,742 236,993 0.1
105,302 Henderson Land
Development Co.,
Ltd. .................. 983,272 496,098 0.1
94,000 New World Development
Co., Ltd. ............. 517,459 325,163 0.1
69,000 Sun Hung Kai Properties
Ltd. .................. 740,464 480,929 0.1
161,000 Wharf (Holdings) Ltd. ... 607,417 353,275 0.1
------------ ------------ -----
4,355,234 2,829,173 0.7
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 968,800 Hong Kong
Telecommunications
Ltd. .................. 1,663,453 1,994,496 0.5
-----------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 293,000 China Light & Power Co.
Ltd. .................. 1,337,448 1,626,202 0.4
113,000 Hong Kong Electric
Holdings Ltd. ......... 393,794 429,539 0.1
------------ ------------ -----
1,731,242 2,055,741 0.5
-----------------------------------------------------------------------------------------------------
UTILITIES--GAS 709,000 Hong Kong and China Gas
Co. Ltd. .............. 1,165,989 1,372,701 0.3
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
HONG KONG 15,381,491 13,637,815 3.2
- --------------------------------------------------------------------------------------------------------------------------
JAPAN AUTOMOBILES 470,000 Mitsubishi Motors
Corp. ................. 3,238,919 1,587,716 0.4
73,000 Toyota Motor Corp. ...... 1,979,859 2,096,123 0.5
------------ ------------ -----
5,218,778 3,683,839 0.9
-----------------------------------------------------------------------------------------------------
BANKING 180,000 Fuji Bank Ltd. .......... 2,421,426 729,674 0.2
4,000,000 Japanese Bank Knock Out
(Warrants)(c).......... 4,126,000 3,632,000 0.8
292,000 Mitsubishi Trust and
Banking Corp. ......... 3,214,294 2,936,814 0.7
269,000 Sakura Bank Ltd. ........ 1,924,634 770,342 0.2
------------ ------------ -----
11,686,354 8,068,830 1.9
-----------------------------------------------------------------------------------------------------
BROADCAST--MEDIA 31,000 Nippon Broadcasting
System Inc. ........... 2,328,033 1,228,100 0.3
-----------------------------------------------------------------------------------------------------
BUILDING & 240,000 Nishimatsu Construction
CONSTRUCTION Co. Ltd. .............. 1,219,017 755,470 0.2
-----------------------------------------------------------------------------------------------------
CAPITAL GOODS 463,000 Mitsubishi Heavy
Industries, Ltd. ...... 3,753,694 1,933,758 0.5
-----------------------------------------------------------------------------------------------------
CHEMICALS 411,000 Kaneka Corp. ............ 2,159,677 1,858,572 0.5
114,000 Shin-Etsu Chemical Co.,
Ltd. (Ordinary)........ 2,093,206 2,179,347 0.5
------------ ------------ -----
4,252,883 4,037,919 1.0
-----------------------------------------------------------------------------------------------------
ELECTRIC 61,000 Taihei Dengyo Kaisha,
CONSTRUCTION Ltd.................... 1,103,158 189,674 0.0
-----------------------------------------------------------------------------------------------------
</TABLE>
146
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
JAPAN ELECTRICAL 194,000 Anritsu Corp............. $ 2,422,348 $ 1,489,443 0.3%
(CONTINUED) EQUIPMENT 296,000 Fujikura Ltd............. 2,242,771 1,963,486 0.5
56,000 Murata Manufacturing Co.,
Ltd.................... 1,921,119 1,410,211 0.3
229,000 NEC Corporation.......... 2,678,931 2,443,839 0.6
29,000 Rohm Co., Ltd............ 1,979,017 2,961,228 0.7
262,000 Sharp Corporation........ 3,807,588 1,806,342 0.4
------------ ------------ -----
15,051,774 12,074,549 2.8
-----------------------------------------------------------------------------------------------------
ELECTRONICS 352,000 Hitachi Ltd. ............ 3,198,447 2,513,321 0.6
178,000 Pioneer Electronic
Corp. ................. 3,408,135 2,746,871 0.6
31,900 Sony Corp. .............. 2,319,824 2,840,998 0.7
------------ ------------ -----
8,926,406 8,101,190 1.9
-----------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 52,000 Jafco Co., Ltd........... 3,092,397 1,776,583 0.4
-----------------------------------------------------------------------------------------------------
GLASS 287,000 Asahi Glass Co., Ltd..... 2,604,317 1,366,142 0.3
-----------------------------------------------------------------------------------------------------
MACHINERY 265,000 Daifuku Co., Ltd......... 3,494,951 1,291,939 0.3
516,000 NSK Ltd.................. 2,866,844 1,287,524 0.3
------------ ------------ -----
6,361,795 2,579,463 0.6
-----------------------------------------------------------------------------------------------------
MANUFACTURING 310,000 Dainippon Screen
Manufacturing Co.,
Ltd. .................. 2,475,687 1,428,023 0.3
220,000 Ube Industries Ltd....... 612,958 280,384 0.1
------------ ------------ -----
3,088,645 1,708,407 0.4
-----------------------------------------------------------------------------------------------------
OFFICE EQUIPMENT 183,000 Ricoh Co., Ltd........... 2,239,951 2,276,084 0.5
-----------------------------------------------------------------------------------------------------
PACKAGING & 1,000 Toyo Seikan Kaisha,
CONTAINERS Ltd.................... 30,312 14,280 0.0
-----------------------------------------------------------------------------------------------------
PAPER & FOREST 437,000 Oji Paper Co., Ltd....... 2,780,243 1,741,290 0.4
PRODUCTS
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 290,000 Fujisawa Pharmaceutical
Co., Ltd............... 2,786,899 2,538,196 0.6
118,000 Taisho Pharmaceutical
Co., Ltd. (Ordinary)... 2,595,534 3,016,814 0.7
------------ ------------ -----
5,382,433 5,555,010 1.3
-----------------------------------------------------------------------------------------------------
PLASTICS 420,000 Nippon Zeon Co., Ltd. ... 2,092,176 870,633 0.2
-----------------------------------------------------------------------------------------------------
REAL ESTATE 199,000 Mitsubishi Estate Co.,
Ltd. .................. 2,316,483 2,169,520 0.5
255,000 Mitsui Fudosan Co.,
Ltd.................... 2,696,882 2,466,795 0.6
------------ ------------ -----
5,013,365 4,636,315 1.1
-----------------------------------------------------------------------------------------------------
RETAIL 64,000 Ito-Yokado Co., Ltd. .... 3,565,834 3,267,562 0.8
286,000 Takashimaya Co........... 2,920,268 1,734,664 0.4
85,000 Uny Co., Ltd............. 1,410,705 1,168,138 0.3
------------ ------------ -----
7,896,807 6,170,364 1.5
-----------------------------------------------------------------------------------------------------
STEEL 966,000 Kawasaki Steel Corp...... 2,701,201 1,320,138 0.3
1,172,000 Nippon Steel Co.......... 3,080,938 1,736,630 0.4
------------ ------------ -----
5,782,139 3,056,768 0.7
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 472 DDI Corp................. 2,678,599 1,250,211 0.3
95,000 Uniden Corporation....... 1,323,639 765,835 0.2
------------ ------------ -----
4,002,238 2,016,046 0.5
-----------------------------------------------------------------------------------------------------
TEXTILES 474,000 Teijin Ltd............... 1,905,547 993,489 0.2
-----------------------------------------------------------------------------------------------------
TIRE & RUBBER 120,000 Bridgestone
Corporation............ 2,187,905 2,607,294 0.6
-----------------------------------------------------------------------------------------------------
TOBACCO 405 Japan Tobacco, Inc....... 2,709,522 2,879,309 0.7
-----------------------------------------------------------------------------------------------------
TRADING 419,000 Mitsui & Co.............. 3,138,187 2,483,440 0.6
805,000 Nissho Iwai Corp......... 2,963,745 1,409,136 0.3
------------ ------------ -----
6,101,932 3,892,576 0.9
-----------------------------------------------------------------------------------------------------
</TABLE>
147
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
JAPAN TRANSPORTATION 475,000 Nippon Express Co.,
Ltd.................... $ 3,021,859 $ 2,370,441 0.6%
(CONCLUDED) 270,000 Tobu Railway Co., Ltd.... 1,304,960 845,758 0.2
500,000 Tokyu Corp............... 3,069,961 1,934,741 0.4
------------ ------------ -----
7,396,780 5,150,940 1.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
JAPAN 124,208,601 89,364,322 21.0
- --------------------------------------------------------------------------------------------------------------------------
MALAYSIA AIRLINES 35,000 Malaysian Airline System
BHD.................... 76,032 28,108 0.0
-----------------------------------------------------------------------------------------------------
CHEMICALS 15,000 Malaysian Oxygen BHD..... 76,593 33,591 0.0
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 38,000 United Engineers
(Malaysia) Ltd......... 267,242 31,691 0.0
17,000 YTL Corporation BHD...... 0 22,973 0.0
------------ ------------ -----
267,242 54,664 0.0
-----------------------------------------------------------------------------------------------------
FINANCE 285 Rashid Hussain BHD
(Warrants) (c)......... 376 53 0.0
-----------------------------------------------------------------------------------------------------
FOODS 14,000 Nestle (Malaysia) BHD.... 107,967 64,865 0.0
-----------------------------------------------------------------------------------------------------
FOREST PRODUCTS 35,000 Lingui Development BHD... 60,688 15,045 0.0
-----------------------------------------------------------------------------------------------------
LEISURE 31,000 Berjaya Sports Toto
BHD.................... 123,873 79,395 0.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 30,800 Telekom Malaysia BHD..... 94,815 91,171 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
MALAYSIA 807,586 366,892 0.1
- --------------------------------------------------------------------------------------------------------------------------
NEW ZEALAND BEVERAGES 60,000 DB Group Ltd............. 89,340 95,750 0.0
-----------------------------------------------------------------------------------------------------
BROADCASTING & 13,000 Independent Newspapers
PUBLISHING Limited................ 72,940 64,878 0.0
-----------------------------------------------------------------------------------------------------
CHEMICALS 17,600 Fernz Corporation Ltd.... 53,399 45,449 0.0
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 700,000 Brierley Investments
Ltd.................... 499,569 499,638 0.1
-----------------------------------------------------------------------------------------------------
ELECTRONICS 17,000 PDL Holdings Ltd......... 82,587 78,921 0.0
-----------------------------------------------------------------------------------------------------
FINANCE 954,600 Wrightson Ltd............ 677,685 443,164 0.1
-----------------------------------------------------------------------------------------------------
FORESTRY 2,450,000 Fletcher Challenge
Forests................ 3,291,210 2,033,081 0.5
-----------------------------------------------------------------------------------------------------
INVESTMENT 451,000 Infrastructure &
COMPANIES Utilities NZ Ltd....... 314,196 259,098 0.1
-----------------------------------------------------------------------------------------------------
LEISURE 20,000 Tourism Holdings Ltd..... 26,938 13,695 0.0
-----------------------------------------------------------------------------------------------------
RESTAURANTS 53,000 Restaurant Brands New
Zealand Ltd.(d)........ 76,981 52,285 0.0
-----------------------------------------------------------------------------------------------------
RETAIL 60,000 Hallenstein Glasson
Holdings Ltd........... 88,686 62,324 0.0
-----------------------------------------------------------------------------------------------------
TEXTILES 306,050 Lane Walker Rudkin
Industries, Ltd........ 321,007 204,241 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
NEW ZEALAND 5,594,538 3,852,524 0.9
- --------------------------------------------------------------------------------------------------------------------------
PHILIPPINES METALS & MINING 30,000 MSCI Philippines Opals
(Class B)(e)........... 1,263,922 1,033,500 0.3
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
THE PHILIPPINES 1,263,922 1,033,500 0.3
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
148
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PACIFIC
BASIN SHARES VALUE PERCENT OF
(CONCLUDED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SINGAPORE AIRLINES 79,000 Singapore Airlines Ltd.
'Foreign'.............. $ 678,479 $ 516,647 0.1%
-----------------------------------------------------------------------------------------------------
AUTO & TRUCK 66,400 Inchcape BHD............. 242,457 102,245 0.0
-----------------------------------------------------------------------------------------------------
BEVERAGES 55,000 Fraser & Neave Ltd.
(Ordinary)............. 397,998 238,704 0.1
-----------------------------------------------------------------------------------------------------
PUBLISHING 11,000 Singapore Press Holdings
Ltd. 'Foreign'......... 222,104 137,990 0.0
-----------------------------------------------------------------------------------------------------
REAL ESTATE 75,000 City Developments Ltd.... 712,457 347,800 0.1
INVESTMENT TRUSTS 101,000 DBS Land Ltd............. 332,192 154,923 0.0
51,000 Singapore Land Ltd....... 239,816 112,188 0.0
419,700 United Industrial
Corporation Ltd........ 316,979 164,686 0.1
80,000 Wing Tai Holdings Ltd.... 218,481 93,698 0.0
------------ ------------ -----
1,819,925 873,295 0.2
-----------------------------------------------------------------------------------------------------
SHIPBUILDING 192,000 Keppel Corporation
Ltd.................... 832,959 552,485 0.1
-----------------------------------------------------------------------------------------------------
STEEL 192,000 NatSteel Ltd............. 504,789 260,262 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SINGAPORE 4,698,711 2,681,628 0.6
- --------------------------------------------------------------------------------------------------------------------------
SOUTH KOREA ELECTRONICS 3,300 Samsung Electronics
Company (GDR)(b)(e).... 198,000 46,184 0.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 42,357 SK Telecom Co. Ltd.
(ADR)(a)............... 539,571 275,318 0.1
-----------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 17,580 Korea Electric Power
Corp................... 752,967 162,835 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SOUTH KOREA 1,490,538 484,337 0.1
- --------------------------------------------------------------------------------------------------------------------------
THAILAND UTILITIES-- 518,000 TelecomAsia Corporation
COMMUNICATIONS Public Company Limited
'Foreign'(d)........... 990,931 100,223 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
THAILAND 990,931 100,223 0.0
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN THE
PACIFIC BASIN 180,261,957 135,163,156 31.8
- --------------------------------------------------------------------------------------------------------------------------
SOUTHEAST ASIA
- --------------------------------------------------------------------------------------------------------------------------
INDIA AUTO & TRUCK 45,400 Mahindra & Mahindra Ltd.
(GDR)(b)............... 627,916 484,645 0.1
66,500 Tata Engineering and
Locomotive Co. Ltd.
(GDR)(b)............... 969,634 553,613 0.1
------------ ------------ -----
1,597,550 1,038,258 0.2
-----------------------------------------------------------------------------------------------------
BANKING 77,000 State Bank of India
(GDR)(b)............... 1,920,505 1,401,400 0.3
-----------------------------------------------------------------------------------------------------
CHEMICALS 20,700 Indian Petrochemicals
Corporation Ltd.
(GDR)(b)............... 279,450 106,088 0.0
67,400 Reliance Industries Ltd.
(GDR)(b)............... 745,434 579,640 0.2
------------ ------------ -----
1,024,884 685,728 0.2
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 6,500 Grasim Industries Ltd.
(GDR)(b)............... 90,687 70,850 0.0
-----------------------------------------------------------------------------------------------------
HOTELS 15,700 Indian Hotels Company
Ltd. (GDR)(b)(d)(e).... 354,333 299,870 0.1
-----------------------------------------------------------------------------------------------------
</TABLE>
149
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SOUTHEAST
ASIA SHARES VALUE PERCENT OF
(CONCLUDED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INDIA INSURANCE 11,100 Indian Rayon and
(CONCLUDED) Industries Ltd.
(GDR)(b)............... $ 92,920 $ 47,453 0.0%
-----------------------------------------------------------------------------------------------------
MACHINERY & 11,300 Larsen & Toubro Ltd.
ENGINEERING (GDR)(b)(d)............ 216,113 125,430 0.0
-----------------------------------------------------------------------------------------------------
MANUFACTURING 20,700 Arvind Mills Ltd.
(GDR)(b)(d)............ 91,894 41,400 0.0
33,900 Gujarat Ambujaya Cements
Ltd. (GDR)(b)(d)....... 368,056 241,538 0.1
------------ ------------ -----
459,950 282,938 0.1
-----------------------------------------------------------------------------------------------------
METALS & MINING 28,500 Hindalco Industries Ltd.
(GDR)(b)............... 1,014,788 570,000 0.1
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 11,600 Ranbaxy Laboratories Ltd.
(GDR)(b)............... 276,726 299,280 0.1
-----------------------------------------------------------------------------------------------------
STEEL 42,900 Steel Authority of India
Ltd. (GDR)(b).......... 356,074 142,643 0.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 52,500 Videsh Sanchar Nigam
Ltd.(GDR)(b)(d)........ 1,111,567 736,313 0.2
-----------------------------------------------------------------------------------------------------
TOBACCO 20,700 ITC Ltd. (GDR)(b)........ 366,520 414,000 0.1
-----------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 23,100 Bombay Suburban Electric
Supply Co. Ltd.
(GDR)(b)............... 472,547 404,250 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
INDIA 9,355,164 6,518,413 1.5
- --------------------------------------------------------------------------------------------------------------------------
INDONESIA BUILDING MATERIALS 305,000 P.T. Semen Gresik........ 992,608 182,153 0.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 845,000 P.T. Telekomunikasi
Indonesia.............. 1,446,133 457,708 0.1
24,100 P.T. Telekomunikasi
Indonesia (ADR)(a)..... 786,702 266,606 0.1
------------ ------------ -----
2,232,835 724,314 0.2
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
INDONESIA 3,225,443 906,467 0.2
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SOUTHEAST ASIA 12,580,607 7,424,880 1.7
- --------------------------------------------------------------------------------------------------------------------------
WESTERN EUROPE
- --------------------------------------------------------------------------------------------------------------------------
DENMARK METALS & MINING 30,000 MSCI Denmark Opals (Class
B)(e) ................. 4,247,900 4,354,500 1.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
DENMARK 4,247,900 4,354,500 1.0
- --------------------------------------------------------------------------------------------------------------------------
FINLAND DIVERSIFIED 39,958 Outokumpu OY............. 661,721 473,114 0.1
-----------------------------------------------------------------------------------------------------
PAPER & FOREST 60,119 Enso OY (R Shares)....... 465,869 466,826 0.1
PRODUCTS
128,950 Metsa Serla OY (Class
B)..................... 959,606 1,006,035 0.3
27,124 UPM-Kymmene OY........... 592,468 540,737 0.1
------------ ------------ -----
2,017,943 2,013,598 0.5
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 6,045 Nokia OY................. 412,806 429,447 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
FINLAND 3,092,470 2,916,159 0.7
- --------------------------------------------------------------------------------------------------------------------------
FRANCE AEROSPACE & 1,400 Labinal S.A.............. 420,805 360,060 0.1
DEFENSE
-----------------------------------------------------------------------------------------------------
AGRICULTURAL 3,400 Eridania Beghin-Say
OPERATIONS S.A.................... 503,228 531,550 0.1
-----------------------------------------------------------------------------------------------------
</TABLE>
150
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FRANCE AUTOMOBILES 6,159 Peugeot S.A.............. $ 708,569 $ 776,654 0.2%
(CONTINUED) 20,400 Renault S.A.(d).......... 618,278 573,803 0.1
------------ ------------ -----
1,326,847 1,350,457 0.3
-----------------------------------------------------------------------------------------------------
AUTOMOBILES & 9,400 Sommer-Allibert S.A...... 358,365 326,244 0.1
EQUIPMENT 7,800 Valeo S.A................ 523,818 528,985 0.1
------------ ------------ -----
882,183 855,229 0.2
-----------------------------------------------------------------------------------------------------
BANKING 25,521 Banque Nationale de Paris
S.A. .................. 1,256,517 1,356,399 0.3
14,573 Compagnie Financiere de
Paribas (Ordinary)..... 799,943 1,266,270 0.3
8,600 Credit Commercial de
France S.A. ........... 514,225 589,384 0.1
23,788 Societe Generale de
Surveillance S.A.
(Class A)(Ordinary).... 3,034,109 3,240,764 0.8
------------ ------------ -----
5,604,794 6,452,817 1.5
-----------------------------------------------------------------------------------------------------
BEVERAGES 9,500 Pernod Ricard S.A. ...... 465,060 558,731 0.1
-----------------------------------------------------------------------------------------------------
BUILDING & 600 Compagnie de Saint Gobain
CONSTRUCTION S.A.................... 95,027 85,230 0.0
-----------------------------------------------------------------------------------------------------
CHEMICALS 2,400 L'Air Liquide S.A. ...... 402,883 375,611 0.1
3,100 Rhone-Poulenc S.A.
(Class A).............. 139,044 138,854 0.0
------------ ------------ -----
541,927 514,465 0.1
-----------------------------------------------------------------------------------------------------
CONSUMER--GOODS 1,300 LVMH (Moet-Hennessy Louis
Vuitton) S.A........... 277,212 215,767 0.1
-----------------------------------------------------------------------------------------------------
COSMETICS--TOILETRIES 4,200 Christian Dior S.A....... 537,704 430,537 0.1
1,500 L'Oreal S.A. ............ 588,114 586,892 0.1
------------ ------------ -----
1,125,818 1,017,429 0.2
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 1,300 Compagnie Generale des
Eaux S.A............... 153,263 181,425 0.0
-----------------------------------------------------------------------------------------------------
ELECTRONICS 10,400 Schneider S.A............ 646,605 564,665 0.1
15,600 Thomson-CSF S.A. ........ 499,484 491,663 0.1
------------ ------------ -----
1,146,089 1,056,328 0.2
-----------------------------------------------------------------------------------------------------
ENGINEERING & 13,702 Bouygues S.A............. 1,348,039 1,552,544 0.4
CONSTRUCTION
-----------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 4,902 EuraFrance S.A. ......... 1,818,898 1,995,331 0.5
4,500 Natexis S.A. ............ 282,624 262,419 0.1
------------ ------------ -----
2,101,522 2,257,750 0.6
-----------------------------------------------------------------------------------------------------
FOODS 1,100 Bongrain S.A. ........... 416,126 464,197 0.1
600 Fromageries Bel S.A. .... 422,935 428,842 0.1
1,400 Groupe Danone S.A. ...... 230,223 250,042 0.1
------------ ------------ -----
1,069,284 1,143,081 0.3
-----------------------------------------------------------------------------------------------------
HOTELS 3,558 Accor S.A. .............. 498,590 661,472 0.2
-----------------------------------------------------------------------------------------------------
INSURANCE 37,835 Assurances Generales de
France S.A. (AGF)...... 1,315,224 2,004,582 0.5
24,189 AXA-UAP.................. 1,530,306 1,871,543 0.4
------------ ------------ -----
2,845,530 3,876,125 0.9
-----------------------------------------------------------------------------------------------------
LEISURE 5,000 Club Mediterranee
S.A.(d)................ 404,936 353,132 0.1
-----------------------------------------------------------------------------------------------------
METALS 9,600 Pechiney S.A. (Class
A)..................... 495,811 378,960 0.1
-----------------------------------------------------------------------------------------------------
OIL & RELATED 32,004 Elf Aquitaine S.A. ...... 3,864,139 3,722,014 0.9
20,900 Total S.A. (Class B)..... 2,335,334 2,274,381 0.5
------------ ------------ -----
6,199,473 5,996,395 1.4
-----------------------------------------------------------------------------------------------------
</TABLE>
151
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FRANCE RETAIL 700 Carrefour S.A. .......... $ 422,787 $ 365,177 0.1%
(CONCLUDED)
8,703 Castorama Dubois
Investissements
S.A. .................. 1,040,309 1,055,523 0.2
8,300 Etablissements
Economiques du Casino
Guichard-Perachon S.A.
(Preferred)............ 401,398 363,358 0.1
------------ ------------ -----
1,864,494 1,784,058 0.4
-----------------------------------------------------------------------------------------------------
STEEL 123,219 Usinor Sacilor S.A. ..... 1,986,255 1,778,988 0.4
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATION 15,153 Alcatel Alsthom Cie
EQUIPMENT Generale d'Electricite
S.A. .................. 1,543,707 1,925,909 0.5
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
FRANCE 32,899,894 34,887,902 8.2
- --------------------------------------------------------------------------------------------------------------------------
GERMANY APPAREL 300 Hugo Boss AG
(Preferred)............ 412,246 383,589 0.1
-----------------------------------------------------------------------------------------------------
AUTOMOBILES 100 Bayerische Motoren Werke
AG (BMW)............... 83,292 74,772 0.0
31,027 Daimler-Benz AG.......... 2,244,999 2,176,789 0.5
5,947 Volkswagen AG............ 3,264,965 3,345,766 0.8
------------ ------------ -----
5,593,256 5,597,327 1.3
-----------------------------------------------------------------------------------------------------
BANKING 14,000 BHF-Bank AG.............. 435,750 396,931 0.1
1,900 Bayerische Vereinsbank
AG..................... 119,162 124,322 0.0
2,600 Commerzbank AG........... 93,517 102,335 0.0
10,100 Deutsche Bank AG......... 746,154 713,087 0.2
22,400 Dresdner Bank AG......... 1,040,695 1,033,578 0.3
------------ ------------ -----
2,435,278 2,370,253 0.6
-----------------------------------------------------------------------------------------------------
BATTERIES 1,100 Varta AG(d).............. 171,525 158,995 0.0
-----------------------------------------------------------------------------------------------------
CHEMICALS 22,095 BASF AG.................. 764,268 783,053 0.2
37,308 Bayer AG................. 1,371,799 1,393,761 0.3
4,199 Henkel KGaA.............. 180,333 235,768 0.1
37,787 Henkel KGaA
(Preferred)............ 1,846,144 2,384,270 0.6
37,608 Hoechst AG............... 1,492,574 1,317,158 0.3
------------ ------------ -----
5,655,118 6,114,010 1.5
-----------------------------------------------------------------------------------------------------
COMPUTER SOFTWARE 2,400 SAP AG (Systeme,
Anwendungen, Produkte
in der
Datenverarbeitung)
(Preferred)............ 741,415 785,190 0.2
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 20,600 Metallgesellschaft AG.... 429,647 376,773 0.1
13,300 RWE AG................... 603,563 713,503 0.2
13,332 Thyssen AG............... 2,836,180 2,853,469 0.7
9,100 VEBA AG.................. 475,310 619,719 0.1
100 Viag AG.................. 49,364 53,869 0.0
------------ ------------ -----
4,394,064 4,617,333 1.1
-----------------------------------------------------------------------------------------------------
ELECTRONICS 11,200 Siemens AG............... 765,019 663,109 0.2
-----------------------------------------------------------------------------------------------------
ENGINEERING & 2,175 Philipp Holzmann AG(d)... 719,437 556,204 0.1
CONSTRUCTION
-----------------------------------------------------------------------------------------------------
FOOTWEAR 3,700 Adidas AG................ 507,777 486,669 0.1
2,300 Salamander AG(d)......... 367,973 364,410 0.1
------------ ------------ -----
875,750 851,079 0.2
-----------------------------------------------------------------------------------------------------
</TABLE>
152
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GERMANY INSURANCE 4,000 AMB Aachener und
(CONCLUDED) Muenchener Beteiligungs
AG..................... $ 415,158 $ 436,958 0.1%
5,400 Allianz AG............... 1,284,295 1,398,933 0.3
------------ ------------ -----
1,699,453 1,835,891 0.4
-----------------------------------------------------------------------------------------------------
MACHINERY & 17,300 AGIV-AG fuer Industrie
EQUIPMENT und Verkehrswesen...... 363,337 326,996 0.1
23,900 FAG Kugelfischer Georg
Schaefer AG............ 378,201 315,558 0.1
30,295 Kloeckner-Werke AG(d).... 2,032,755 2,029,435 0.5
400 Mannesmann AG............ 187,909 202,135 0.0
------------ ------------ -----
2,962,202 2,874,124 0.7
-----------------------------------------------------------------------------------------------------
METALS 10,000 Degussa AG............... 465,421 500,334 0.1
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 5,400 Schering AG.............. 556,061 520,847 0.1
-----------------------------------------------------------------------------------------------------
RETAIL 2,365 Karstadt AG.............. 814,537 807,397 0.2
-----------------------------------------------------------------------------------------------------
RETAIL SPECIALTY 5,500 Moebel Walther AG........ 306,369 177,340 0.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 2,900 Deutsche Telekom AG...... 57,335 54,572 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
GERMANY 28,624,486 28,867,594 6.8
- --------------------------------------------------------------------------------------------------------------------------
IRELAND BUILDING & 52,928 CRH PLC.................. 574,823 613,764 0.1
CONSTRUCTION
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
IRELAND 574,823 613,764 0.1
- --------------------------------------------------------------------------------------------------------------------------
ITALY BUILDING PRODUCTS 134,695 Italcementi S.p.A........ 742,306 938,723 0.2
-----------------------------------------------------------------------------------------------------
CHEMICALS 3,653,875 Montedison S.p.A......... 2,842,591 3,281,713 0.8
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 868,104 Compagnie Industrial
Riunite S.p.A.
(CIR)(d)............... 750,239 694,307 0.2
-----------------------------------------------------------------------------------------------------
INSURANCE 45,981 Assicurazioni Generali
S.p.A.................. 832,583 1,129,253 0.3
291,138 Istituto Nazionale delle
Assicurazioni S.p.A.
(INA).................. 386,943 589,944 0.1
------------ ------------ -----
1,219,526 1,719,197 0.4
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 720,085 Telecom Italia S.p.A..... 2,073,992 3,174,691 0.8
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
ITALY 7,628,654 9,808,631 2.4
- --------------------------------------------------------------------------------------------------------------------------
NETHERLANDS BANKING 20,886 ABN Amro Holding N.V..... 395,888 406,884 0.1
-----------------------------------------------------------------------------------------------------
CHEMICALS 11,223 Akzo Nobel N.V........... 1,410,212 1,935,076 0.4
35,921 European Vinyls
Corporation
International N.V...... 1,395,027 797,221 0.2
------------ ------------ -----
2,805,239 2,732,297 0.6
-----------------------------------------------------------------------------------------------------
ELECTRONICS 27,703 Philips Electronics
N.V.................... 1,255,098 1,661,415 0.4
-----------------------------------------------------------------------------------------------------
ENGINEERING & 8,459 Volker Wessels Stevin
CONSTRUCTION N.V.................... 197,556 262,831 0.1
-----------------------------------------------------------------------------------------------------
INSURANCE 21,179 ING Groep N.V............ 869,889 892,033 0.2
-----------------------------------------------------------------------------------------------------
PACKAGING & 77,289 Koninklijke KNP BT
CONTAINERS N.V.................... 1,687,119 1,780,132 0.4
-----------------------------------------------------------------------------------------------------
STEEL 13,550 Ispat International
N.V.(d)................ 366,994 257,287 0.0
12,469 Ispat International N.V.
(NY Registered
Shares)(d)............. 294,635 269,642 0.1
------------ ------------ -----
661,629 526,929 0.1
-----------------------------------------------------------------------------------------------------
</TABLE>
153
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NETHERLANDS TELECOMMUNICATIONS 29,135 Royal PTT Nederland
(CONCLUDED) N.V.................... $ 1,049,358 $ 1,215,635 0.3%
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
THE NETHERLANDS 8,921,776 9,478,156 2.2
- --------------------------------------------------------------------------------------------------------------------------
NORWAY METALS & MINING 36,000 MSCI Norway Opals (Class
B)(e).................. 4,335,840 4,125,600 1.0
-----------------------------------------------------------------------------------------------------
OIL & GAS 29,758 Saga Petroleum A.S.
PRODUCERS (Class B).............. 380,349 452,901 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
NORWAY 4,716,189 4,578,501 1.1
- --------------------------------------------------------------------------------------------------------------------------
POLAND AUTOMOBILES & 14,928 T.C. Debica S.A.......... 232,447 364,718 0.1
EQUIPMENT
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
POLAND 232,447 364,718 0.1
- --------------------------------------------------------------------------------------------------------------------------
PORTUGAL BUILDING PRODUCTS 4,500 Cimpor-Cimentos de
Portugal S.A. (SGPS)... 116,061 118,107 0.0
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 12,772 Sonae Investimentos--
SGPS, S.A.............. 294,941 517,273 0.1
-----------------------------------------------------------------------------------------------------
METALS & MINING 40,000 MSCI Portugal Opals
(Class B)(e)........... 2,476,379 2,508,400 0.6
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
PORTUGAL 2,887,381 3,143,780 0.7
- --------------------------------------------------------------------------------------------------------------------------
RUSSIA CLOSED-END FUNDS 2,500 Templeton Russia Fund,
Inc.................... 100,920 98,125 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
RUSSIA 100,920 98,125 0.0
- --------------------------------------------------------------------------------------------------------------------------
SPAIN UTILITIES--ELECTRIC 65,997 Endesa S.A............... 1,121,890 1,169,792 0.3
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SPAIN 1,121,890 1,169,792 0.3
- --------------------------------------------------------------------------------------------------------------------------
SWEDEN BUILDING RELATED 11,967 Svedala Industri AB...... 204,406 197,453 0.1
-----------------------------------------------------------------------------------------------------
ELECTRICAL 17,102 Electrolux AB............ 902,631 1,186,876 0.3
-----------------------------------------------------------------------------------------------------
FOREST PRODUCTS 24,684 Mo Och Domsjo AB (Class
B)..................... 723,186 637,347 0.2
487,211 Rottneros Bruks AB....... 640,388 377,398 0.1
50,357 Stora Kopparbergs
Bergslags AB........... 639,127 634,259 0.1
------------ ------------ -----
2,002,701 1,649,004 0.4
-----------------------------------------------------------------------------------------------------
INSURANCE 16,865 Skandia Forsakrings AB... 411,677 795,509 0.2
-----------------------------------------------------------------------------------------------------
METALS & MINING 90,389 Avesta Sheffield AB...... 884,702 597,698 0.1
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 16,615 Pharmacia & Upjohn, Inc.
ADR(a) ................ 507,086 611,069 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SWEDEN 4,913,203 5,037,609 1.2
- --------------------------------------------------------------------------------------------------------------------------
SWITZERLAND DIVERSIFIED 12,572 Oerlikon-Buehrle Holding
AG..................... 1,255,984 1,765,851 0.4
-----------------------------------------------------------------------------------------------------
LEISURE 688 Fotolabo S.A. ........... 252,719 153,203 0.0
-----------------------------------------------------------------------------------------------------
MACHINERY 548 Saurer AG................ 253,573 397,999 0.1
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SWITZERLAND 1,762,276 2,317,053 0.5
- --------------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM ADVERTISING 105,500 Saatchi & Saatchi
PLC(d)................. 193,836 188,879 0.0
-----------------------------------------------------------------------------------------------------
AIRLINES 43,714 British Airways PLC(d)... 402,204 402,081 0.1
-----------------------------------------------------------------------------------------------------
AUTOMOBILE RENTAL 250,100 Thorn PLC................ 614,478 649,047 0.2
-----------------------------------------------------------------------------------------------------
</TABLE>
154
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONTINUED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED KINGDOM AUTOMOBILES & 438,328 LucasVarity PLC.......... $ 1,415,494 $ 1,547,901 0.4%
(CONTINUED) EQUIPMENT
-----------------------------------------------------------------------------------------------------
BANKING 51,600 Barclays PLC............. 1,324,722 1,371,304 0.3
133,227 HSBC Holdings PLC........ 3,617,261 3,413,675 0.8
145,700 Lloyds TSB Group PLC..... 1,852,536 1,883,387 0.5
83,907 National Westminster Bank
PLC (Ordinary)......... 982,882 1,394,711 0.3
------------ ------------ -----
7,777,401 8,063,077 1.9
-----------------------------------------------------------------------------------------------------
BROADCAST--MEDIA 80,800 British Sky Broadcasting
Group PLC.............. 580,791 605,176 0.1
81,700 Carlton Communications
PLC.................... 677,902 630,704 0.2
------------ ------------ -----
1,258,693 1,235,880 0.3
-----------------------------------------------------------------------------------------------------
BUILDING & 128,100 Hanson PLC............... 656,691 571,521 0.1
CONSTRUCTION 319,600 Tarmac PLC............... 630,361 598,435 0.2
------------ ------------ -----
1,287,052 1,169,956 0.3
-----------------------------------------------------------------------------------------------------
CHEMICALS 50,208 Imperial Chemical
Industries PLC......... 772,716 784,258 0.2
143,351 Inspec Group PLC......... 414,824 553,317 0.1
------------ ------------ -----
1,187,540 1,337,575 0.3
-----------------------------------------------------------------------------------------------------
CLOSED-END FUNDS 15,200 Alliance Trust PLC....... 620,724 627,396 0.2
117,700 Scottish Investment Trust
PLC.................... 627,869 624,431 0.1
114,200 Scottish Mortgage & Trust
PLC (The).............. 633,528 614,303 0.1
------------ ------------ -----
1,882,121 1,866,130 0.4
-----------------------------------------------------------------------------------------------------
COMPUTER SERVICES 5,743 Misys PLC................ 112,319 173,565 0.0
-----------------------------------------------------------------------------------------------------
DISTRIBUTION 2,900 BG PLC................... 13,091 13,051 0.0
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 396,933 BTR PLC.................. 1,441,868 1,199,611 0.3
-----------------------------------------------------------------------------------------------------
FOOD & BEVERAGE 114,959 Allied Domecq PLC
(Ordinary)............. 797,507 989,418 0.2
120,616 Cadbury Schweppes PLC.... 996,042 1,215,416 0.3
------------ ------------ -----
1,793,549 2,204,834 0.5
-----------------------------------------------------------------------------------------------------
FOOD PROCESSING 302,626 ASDA Group PLC........... 548,854 882,287 0.2
624,794 Unilever PLC............. 4,593,136 5,346,628 1.3
------------ ------------ -----
5,141,990 6,228,915 1.5
-----------------------------------------------------------------------------------------------------
FOODS 114,900 Booker PLC............... 619,304 603,915 0.1
61,600 Compass Group PLC........ 654,614 757,823 0.2
185,642 Safeway PLC.............. 1,141,498 1,045,865 0.3
------------ ------------ -----
2,415,416 2,407,603 0.6
-----------------------------------------------------------------------------------------------------
HEALTH & PERSONAL 235,000 London International
Group PLC.............. 605,348 617,580 0.1
-----------------------------------------------------------------------------------------------------
INVESTMENT TRUSTS 424,000 Fleming Japanese
Investment Trust PLC
(The)(d)............... 1,038,318 1,009,809 0.2
230,000 G.T. Japan Investment
Trust PLC.............. 642,646 608,218 0.2
466,000 Schroder Japan Growth
Fund(d)................ 400,838 394,184 0.1
------------ ------------ -----
2,081,802 2,012,211 0.5
-----------------------------------------------------------------------------------------------------
LEISURE 151,200 Ladbroke Group PLC....... 687,702 655,633 0.2
-----------------------------------------------------------------------------------------------------
METALS & MINING 50,119 Rio Tinto PLC............ 726,147 616,580 0.1
-----------------------------------------------------------------------------------------------------
</TABLE>
155
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WESTERN
EUROPE SHARES VALUE PERCENT OF
(CONCLUDED) INDUSTRY HELD INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNITED KINGDOM OIL & RELATED 65,900 British Petroleum Co.
(CONCLUDED) PLC.................... $ 997,073 $ 865,926 0.2%
103,800 Shell Transport & Trading
Co. PLC................ 817,651 750,163 0.2
------------ ------------ -----
1,814,724 1,616,089 0.4
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 37,100 Glaxo Wellcome PLC....... 852,902 877,489 0.2
80,400 SmithKline Beecham PLC... 813,023 822,715 0.2
9,100 Zeneca Group PLC......... 318,038 319,412 0.1
------------ ------------ -----
1,983,963 2,019,616 0.5
-----------------------------------------------------------------------------------------------------
PUBLISHING 56,500 Pearson PLC.............. 729,777 734,058 0.2
-----------------------------------------------------------------------------------------------------
REAL ESTATE 73,000 MEPC PLC................. 659,086 609,105 0.2
INVESTMENT TRUSTS 103,000 Slough Estates PLC....... 637,475 580,279 0.1
------------ ------------ -----
1,296,561 1,189,384 0.3
-----------------------------------------------------------------------------------------------------
RETAIL 84,677 W.H. Smith Group PLC..... 517,452 541,029 0.1
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 40,500 British
Telecommunications
PLC.................... 288,801 318,304 0.0
134,532 Cable & Wireless PLC..... 986,152 1,182,183 0.3
------------ ------------ -----
1,274,953 1,500,487 0.3
-----------------------------------------------------------------------------------------------------
TOBACCO 216,050 B.A.T. Industries PLC.... 1,839,290 1,965,936 0.5
133,200 Gallaher Group PLC....... 651,129 707,757 0.2
104,900 Imperial Tobacco Group
PLC.................... 653,694 659,902 0.1
------------ ------------ -----
3,144,113 3,333,595 0.8
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 82,500 BAA PLC.................. 797,222 674,821 0.2
-----------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC 108,631 Energy Group PLC......... 1,142,393 1,199,026 0.3
153,400 National Grid Group
PLC.................... 743,353 728,163 0.1
------------ ------------ -----
1,885,746 1,927,189 0.4
-----------------------------------------------------------------------------------------------------
UTILITIES--WATER 39,708 Anglian Water PLC........ 425,318 541,329 0.1
46,000 Severn Trent PLC......... 680,459 738,928 0.2
142,733 United Utilities PLC..... 1,459,498 1,828,624 0.4
------------ ------------ -----
2,565,275 3,108,881 0.7
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
THE UNITED KINGDOM 47,047,837 49,235,258 11.6
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
WESTERN EUROPE 148,772,146 156,871,542 36.9
- --------------------------------------------------------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT SHORT-TERM SECURITIES
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
COMMERCIAL PAPER* $10,000,000 Atlantic Asset
Securitization Corp.,
5.95% due 1/14/1998.... 9,976,861 9,976,861 2.3
5,000,000 Countrywide Home Loans,
Inc., 6.05% due
1/29/1998.............. 4,975,632 4,975,632 1.2
9,810,000 General Motors Acceptance
Corp., 6.75% due
1/02/1998.............. 9,806,321 9,806,321 2.3
Lexington Parker Capital
Co. LLC:
15,000,000 5.92% due 1/16/1998...... 14,960,533 14,960,533 3.5
5,000,000 5.80% due 1/20/1998...... 4,983,889 4,983,889 1.2
6,000,000 Republic Industries,
Inc.,
6% due 1/07/1998....... 5,993,000 5,993,000 1.4
------------ ------------ -----
50,696,236 50,696,236 11.9
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
156
<PAGE> 367
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE VALUE PERCENT OF
AMOUNT SHORT-TERM SECURITIES COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
US GOVERNMENT &
AGENCY OBLIGATIONS* $18,000,000 Federal Home Loan
Mortgage Corp., 5.72%
due 1/09/1998.......... $ 17,974,260 $ 17,974,260 4.2%
United States Treasury
Bills(f):
1,500,000 5% due 4/02/1998......... 1,480,450 1,480,455 0.4
2,000,000 5.10% due 4/02/1998...... 1,973,933 1,973,940 0.5
------------ ------------ -----
21,428,643 21,428,655 5.1
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SHORT-TERM SECURITIES 72,124,879 72,124,891 17.0
- --------------------------------------------------------------------------------------------------------------------------
NOMINAL
VALUE
OPTIONS COVERED BY PREMIUMS
PURCHASED OPTIONS ISSUE PAID
- --------------------------------------------------------------------------------------------------------------------------
CALL OPTIONS 1,868,261 Thailand Index, expiring
PURCHASED April 1998 at US$1.9838
(European Options)..... 280,239 187 0.0
-----------------------------------------------------------------------------------------------------
CURRENCY PUT 6,500,000 Deutschemark, expiring
OPTIONS PURCHASED February 1998 at
DM1.95................. 43,875 4,550 0.0
4,000,000 Japanese Yen, expiring
February 1998 at
Y120................... 59,800 299,200 0.0
------------ ------------ -----
103,675 303,750 0.0
-----------------------------------------------------------------------------------------------------
PUT OPTIONS 6,145,700 Nikkei 225 Index,
PURCHASED expiring January 1998
at Y15,000............. 152,275 86,242 0.0
-----------------------------------------------------------------------------------------------------
TOTAL OPTIONS PURCHASED 536,189 390,179 0.0
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS 465,852,476 422,053,207 99.2
- --------------------------------------------------------------------------------------------------------------------------
OPTIONS PREMIUMS
WRITTEN RECEIVED
- --------------------------------------------------------------------------------------------------------------------------
PUT OPTIONS 1,868,261 Thailand Index, expiring
WRITTEN April 1998 at US$1.9838
(European Options)..... (280,239) (2,696,835) (0.6)
-----------------------------------------------------------------------------------------------------
TOTAL OPTIONS WRITTEN (280,239) (2,696,835) (0.6)
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS, NET OF OPTIONS WRITTEN..................... $465,572,237 419,356,372 98.6
============
VARIATION MARGIN ON FINANCIAL FUTURES CONTRACTS**............. (98,645) (0.0)
UNREALIZED APPRECIATION ON FORWARD FOREIGN EXCHANGE
CONTRACTS***................................................ 173,441 0.0
OTHER ASSETS LESS LIABILITIES................................. 5,791,691 1.4
------------ -----
NET ASSETS.................................................... $425,222,859 100.0%
============ =====
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) American Depositary Receipts (ADR).
(b) Global Depositary Receipts (GDR).
(c) Warrants entitle the Fund to purchase a predetermined
number of shares of common stock. The purchase price and the
number of shares are subject to adjustment under certain
conditions until the expiration date.
(d) Non-income producing security.
(e) The security may be offered and sold to "qualified
institutional buyers" under Rule 144A of the Securities Act
of 1933.
(f) Securities held as collateral in connection with open
financial futures contracts.
* Commercial Paper and certain US Government & Agency
Obligations are traded on a discount basis; the interest
rates shown are the rates paid at the time of purchase by
the Fund.
157
<PAGE> 368
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED) (IN US DOLLARS)
- --------------------------------------------------------------------------------
** Financial futures contracts purchased as of December 31,
1997 were as follows:
- ------------------------------------------------------------
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION VALUE
CONTRACTS ISSUE EXCHANGE DATE (Notes 1a & 1b)
- ---------------------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
47 All Ordinaries.................................. SFE March 1998 $ 2,016,342
96 FTSE 100........................................ LIFFE March 1998 20,431,386
- ---------------------------------------------------------------------------------------------------------------------
TOTAL FINANCIAL FUTURES CONTRACTS PURCHASED (TOTAL CONTRACT PRICE--$22,676,388) $22,447,728
===========
- ---------------------------------------------------------------------------------------------------------------------
Financial futures contracts sold as of December 31, 1997 were as follows:
- ---------------------------------------------------------------------------------------------------------------------
NUMBER OF EXPIRATION VALUE
CONTRACTS ISSUE EXCHANGE DATE (NOTES 1a & 1b)
- ---------------------------------------------------------------------------------------------------------------------
96 CAC 40 Index.................................... MATIF January 1998 $ 9,598,405
63 DAX Index....................................... DTB March 1998 14,984,740
- ---------------------------------------------------------------------------------------------------------------------
TOTAL FINANCIAL FUTURES CONTRACTS SOLD (TOTAL CONTRACT PRICE -- $23,958,247) $24,583,145
===========
- ---------------------------------------------------------------------------------------------------------------------
*** Forward foreign exchange contracts as of December 31,
1997 were as follows:
- ------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
EXPIRATION (DEPRECIATION)
FOREIGN CURRENCY PURCHASED DATE (Note 1b)
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Y 831,262,500................................................. January 1998 $ (194,409)
Y 240,000,000................................................. February 1998 (50,906)
- ------------------------------------------------------------------------------------------------
TOTAL (US$ COMMITMENT--$8,499,924) (245,315)
-----------
- ------------------------------------------------------------------------------------------------
FOREIGN CURRENCY SOLD
- ------------------------------------------------------------------------------------------------
NZ$ 5,922,166................................................... January 1998 69,366
Y 831,262,500................................................. January 1998 349,390
- ------------------------------------------------------------------------------------------------
TOTAL (US$ COMMITMENT--$10,250,000) 418,756
-----------
- ------------------------------------------------------------------------------------------------
TOTAL UNREALIZED APPRECIATION ON FORWARD FOREIGN EXCHANGE CONTRACTS--NET $ 173,441
===========
- ------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
158
<PAGE> 369
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$465,316,287) (Note
1a)....................................................... $421,663,028
Options purchased, at value (cost--$536,189) (Notes 1a &
1b)....................................................... 390,179
Unrealized appreciation on forward foreign exchange
contracts (Note 1b)....................................... 173,441
Foreign cash (Note 1c)...................................... 14,584,796
Receivables:
Securities sold........................................... $ 2,839,783
Dividends................................................. 614,760
Forward foreign exchange contracts (Note 1b).............. 268,597
Capital shares sold....................................... 111,332 3,834,472
-----------
Deferred organizational expenses (Note 1f).................. 688
Prepaid expenses and other assets........................... 24,393
------------
Total assets................................................ 440,670,997
------------
- --------------------------------------------------------------------------------------------
LIABILITIES:
Options written, at value (premiums received--$280,239)
(Notes 1a & 1b)........................................... 2,696,835
Payables:
Securities purchased...................................... 11,853,371
Investment adviser (Note 2)............................... 289,413
Forward foreign exchange contracts (Note 1b).............. 157,465
Variation margin (Note 1b)................................ 98,645
Capital shares redeemed................................... 69,258 12,468,152
-----------
Accrued expenses and other liabilities...................... 283,151
------------
Total liabilities........................................... 15,448,138
------------
- --------------------------------------------------------------------------------------------
NET ASSETS.................................................. $425,222,859
============
- --------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 3,937,421
Paid-in capital in excess of par............................ 438,832,034
Undistributed investment income--net........................ 2,948,694
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 26,490,907
Unrealized depreciation on investments and foreign currency
transactions--net......................................... (46,986,197)
------------
NET ASSET................................................... $425,222,859
============
- --------------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $425,222,859 and 39,374,210
shares outstanding........................................ $ 10.80
============
- --------------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
159
<PAGE> 370
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $563,814 foreign withholding tax)......... $ 6,120,166
Interest and discount earned (net of $395 foreign
withholding tax).......................................... 4,505,131
------------
Total income................................................ 10,625,297
------------
- --------------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 3,089,994
Custodian fees.............................................. 373,573
Accounting services (Note 2)................................ 92,596
Professional fees........................................... 39,287
Pricing services............................................ 36,178
Registration fees........................................... 34,644
Directors' fees and expenses................................ 7,416
Transfer agent fees (Note 2)................................ 5,007
Amortization of organization expenses (Note 1f)............. 1,402
Other....................................................... 11,043
-----------
Total expenses.............................................. 3,691,140
------------
Investment income--net...................................... 6,934,157
------------
- --------------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized gain (loss) from:
Investments--net.......................................... 28,888,900
Foreign currency transactions--net........................ (1,671,995) 27,216,905
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (58,837,976)
Foreign currency transactions--net........................ 50,906 (58,787,070)
----------- ------------
Net realized and unrealized loss on investments and foreign
currency transactions..................................... (31,570,165)
------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $(24,636,008)
============
- --------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
160
<PAGE> 371
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 6,934,157 $ 6,166,768
Realized gain on investments and foreign currency
transactions--net......................................... 27,216,905 9,939,138
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (58,787,070) 2,510,537
------------ ------------
Net increase (decrease) in net assets resulting from
operations................................................ (24,636,008) 18,616,443
------------ ------------
- -----------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1G):
Investment income--net:
Class A................................................... (6,787,677) (3,669,329)
Realized gain on investments--net:
Class A................................................... (2,626,115) --
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (9,413,792) (3,669,329)
------------ ------------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 110,192,830 68,530,474
------------ ------------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 76,143,030 83,477,588
Beginning of year........................................... 349,079,829 265,602,241
------------ ------------
End of year*................................................ $425,222,859 $349,079,829
============ ============
- -----------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1h)............ $ 2,948,694 $ 4,510,300
============ ============
- -----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
161
<PAGE> 372
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
---------------------------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN FOR THE PERIOD
DERIVED FROM INFORMATION PROVIDED IN THE FINANCIAL FOR THE YEAR ENDED DECEMBER 31, JULY 1, 1993+ TO
STATEMENTS. -------------------------------------------- DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1997++ 1996++ 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............... $ 11.63 $ 11.06 $ 10.90 $ 11.03 $ 10.00
-------- -------- -------- -------- -------
Investment income--net............................. .20 .23 .20 .19 .01
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net........... (.71) .49 .37 (.13) 1.02
-------- -------- -------- -------- -------
Total from investment operations................... (.51) .72 .57 .06 1.03
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income--net........................... (.23) (.15) (.01) (.18) --
Realized gain on investments--net................ (.09) -- (.17) (.01) --
In excess of realized gain on investments--net... -- -- (.23) -- --
-------- -------- -------- -------- -------
Total dividends and distributions.................. (.32) (.15) (.41) (.19) --
-------- -------- -------- -------- -------
Net asset value, end of period..................... $ 10.80 $ 11.63 $ 11.06 $ 10.90 $ 11.03
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share................. (4.55%) 6.62% 5.48% .55% 10.30%#
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses........................................... .90% .89% .89% .97% 1.14%*
======== ======== ======== ======== =======
Investment income--net............................. 1.69% 1.96% 1.95% 1.09% .30%*
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)........... $425,223 $349,080 $265,602 $247,884 $76,906
======== ======== ======== ======== =======
Portfolio turnover................................. 127.96% 49.87% 100.02% 58.84% 17.39%
======== ======== ======== ======== =======
Average commission rate paid***.................... $ .0011 $ .0004 -- -- --
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into US
dollars using the prevailing exchange rate on the date of the transaction. Such
conversions may significantly affect the rate shown.
+ Commencement of operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
See Notes to Financial Statements.
162
<PAGE> 373
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")) and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. International Equity Focus Fund (the "Fund") is classified as
"diversified", as defined in the Investment Company Act of 1940. The following
is a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Options purchased are valued at
the last sale price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter market, the last bid price. Futures
contracts are valued at the settlement price at the close of the applicable
exchange. Short-term securities are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts. Premium or discount is amortized over the life
of the contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid or received is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the proceeds of
the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell futures contracts
and options on such futures contracts for the purpose of hedging the market risk
on existing securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific future date and
at a specific price or yield. Upon entering into a contract, the Fund deposits
and maintains as collateral such initial margin as required by the exchange on
which the transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are known as
variation margin and are recorded by the Fund as unrealized gains or losses.
When the
163
<PAGE> 374
- --------------------------------------------------------------------------------
contract is closed, the Fund records a realized gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a five-year period.
(g) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $1,708,086 have been reclassified between undistributed
net realized capital gains and undistributed net investment income and
differences of $23 have been reclassified between undistributed net realized
capital gains and paid-in capital in excess of par. These reclassifications have
no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.75% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc., a subsidiary of ML & Co., earned $27,975 in commissions on the execution
of portfolio security transactions
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
164
<PAGE> 375
- --------------------------------------------------------------------------------
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $530,260,210 and $417,781,167, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
Realized Unrealized
Gains Gains
(Losses) (Losses)
- ---------------------------------------------------------------
<S> <C> <C>
Investments:
Long-term........................ $24,003,430 $(43,653,271)
Short-term....................... (5,607) 12
Financial futures contracts...... 7,766,045 (853,558)
Options written.................. (1,024,597) (2,416,596)
Options purchased................ (1,850,371) (346,085)
----------- ------------
Total investments................. 28,888,900 (47,269,498)
----------- ------------
Currency transactions:
Options purchased................ 1,181,132 200,075
Foreign currency transactions.... (1,358,697) (90,215)
Forward foreign exchange
contracts...................... (1,494,430) 173,441
----------- ------------
Total currency transactions....... (1,671,995) 283,301
----------- ------------
Total............................. $27,216,905 $(46,986,197)
=========== ============
- ---------------------------------------------------------------
</TABLE>
Transactions in options written for the year ended December 31, 1997, were as
follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Nominal Value
Covered by Premiums
Call Options Written Written Options Received
- ---------------------------------------------------------------------
<S> <C> <C>
Outstanding call options written,
beginning of year................... 35 $ 117,250
Options written...................... 9,989 152,163
Options expired...................... (10,024) (269,413)
-------- ---------
Outstanding call options written, end
of year............................. -- $ --
======== =========
- ---------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Nominal Value
Covered by Premiums
Put Options Written Written Options Received
- ---------------------------------------------------------------------
<S> <C> <C>
Outstanding put options written,
beginning of year................... -- --
Options written...................... 63,510,279 $ 896,659
Options closed....................... (61,642,018) (616,420)
----------- ---------
Outstanding put options written, end
of year............................. 1,868,261 $ 280,239
=========== =========
- ---------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized depreciation for Federal income tax
purposes aggregated $47,679,645, of which $21,501,184 related to appreciated
securities and $69,180,829 related to depreciated securities. At December 31,
1997, the aggregate cost of investments, net of options written, for Federal
income tax purposes was $466,732,267.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$110,192,830 and $68,530,474 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 11,676,001 $137,644,281
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 835,399 9,413,792
---------- ------------
Total issued......................... 12,511,400 147,058,073
Shares redeemed...................... (3,164,784) (36,865,243)
---------- ------------
Net increase......................... 9,346,616 $110,192,830
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold........................... 6,562,205 $ 75,036,616
Shares issued to shareholders in
reinvestment of dividends............ 334,488 3,669,329
--------- ------------
Total issued.......................... 6,896,693 78,705,945
Shares redeemed....................... (886,963) (10,175,471)
--------- ------------
Net increase.......................... 6,009,730 $ 68,530,474
========= ============
- -----------------------------------------------------------------
</TABLE>
5. COMMITMENTS:
At December 31, 1997, the Fund had entered into foreign exchange contracts, in
addition to the contracts listed on the Schedule of Investments, under which it
agreed to purchase and sell various foreign currencies with values of
approximately $11,810,000 and $538,000, respectively.
6. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.405237 per Class A Share and a capital gains
distribution in the amount of $.470907 per Class A Share payable on January 9,
1998 to shareholders of record as of December 31, 1997.
165
<PAGE> 376
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ALUMINUM 8,800 +Alumax, Inc. ................... $ 301,980 $ 299,200 1.1%
3,000 Aluminum Co. of America.......... 157,209 211,125 0.8
5,400 Pechiney, S.A. (A Shares)........ 214,896 213,165 0.8
----------- ----------- -----
674,085 723,490 2.7
- ------------------------------------------------------------------------------------------------------------------------
CHEMICALS 2,700 Air Products & Chemicals, Inc.... 154,427 222,075 0.8
4,800 BASF AG.......................... 115,117 170,113 0.6
1,500 Dow Chemical Co. ................ 106,941 152,250 0.6
6,700 duPont (E.I.) de Nemours & Co. .. 158,309 402,419 1.5
----------- ----------- -----
534,794 946,857 3.5
- ------------------------------------------------------------------------------------------------------------------------
DIAMONDS 11,100 +Aber Resources, Ltd. ........... 186,043 117,120 0.5
25,000 +SouthernEra Resources Ltd. ..... 155,268 249,808 0.9
----------- ----------- -----
341,311 366,928 1.4
- ------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED RESOURCES 20,000 Asahi Glass Co., Ltd. ........... 240,000 95,202 0.3
COMPANIES 4,800 Ashland Inc. .................... 203,468 257,700 1.0
5,100 Coastal Corp. ................... 137,569 315,881 1.2
16,800 Norcen Energy Resources Ltd. .... 108,534 192,523 0.7
68,000 North Ltd. ...................... 255,416 178,931 0.7
52,300 RGC Ltd. ........................ 206,473 79,671 0.3
----------- ----------- -----
1,151,460 1,119,908 4.2
- ------------------------------------------------------------------------------------------------------------------------
GOLD 183,000 +Acacia Resources Ltd. .......... 324,247 166,786 0.6
26,700 +Amax Gold, Inc. ................ 152,967 61,744 0.2
17,500 Ashanti Goldfields Co. Ltd.
(GDR)**........................ 434,367 143,500 0.5
23,500 Cambior Inc. .................... 315,479 138,757 0.5
23,000 +Casmyn Corp. ................... 211,713 40,250 0.1
201,300 Delta Gold N.L. ................. 369,458 211,771 0.8
30,600 Driefontein Consolidated Ltd. ... 477,914 207,607 0.8
6,300 Freeport-McMoRan Copper & Gold,
Inc. (Class B)................. 217,128 99,225 0.4
16,700 +Getchell Gold Corp. ............ 671,591 400,800 1.5
170,000 Great Central Mines N.L. ........ 491,004 182,606 0.7
67,600 +Miramar Mining Corp. ........... 345,062 134,624 0.5
13,864 Newmont Mining Corp. ............ 512,680 407,255 1.5
169,000 Normandy Mining Ltd.............. 190,999 163,928 0.6
39,000 Placer Dome Inc. ................ 819,544 494,813 1.8
24,800 Prime Resource Group, Inc. ...... 242,631 164,629 0.6
199,000 Resolute Ltd. ................... 412,978 145,095 0.5
22,200 +Sutton Resources Ltd. .......... 199,967 149,696 0.6
30,000 +TVX Gold, Inc. ................. 241,535 101,250 0.4
88,966 +William Resources Ltd. ......... 154,215 21,758 0.1
----------- ----------- -----
6,785,479 3,436,094 12.7
- ------------------------------------------------------------------------------------------------------------------------
INTEGRATED OIL 6,900 Amerada Hess Corp. .............. 374,019 378,638 1.4
COMPANIES 3,000 Amoco Corp. ..................... 162,710 255,375 0.9
10,400 British Petroleum, Co. PLC
(ADR)*......................... 396,812 828,750 3.1
11,600 Ente Nazionale Idrocarburi S.p.A
(ENI) (ADR)*................... 542,300 661,925 2.5
1,700 OMV AG........................... 181,957 235,569 0.9
25,000 Petro-Canada..................... 272,871 459,375 1.7
8,200 Societe Nationale Elf Aquitaine
(ADR)*......................... 302,991 480,725 1.8
6,800 Total, S.A. (Class B)............ 417,613 739,990 2.7
8,000 Yacimientos Petroliferos
Fiscales, S.A. (YPF) (ADR)*.... 137,480 273,500 1.0
----------- ----------- -----
2,788,753 4,313,847 16.0
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
166
<PAGE> 377
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
METALS & MINING 5,700 ASARCO Inc. ..................... $ 162,433 $ 127,894 0.5%
281,000 +Centaur Mining & Exploration
Ltd. .......................... 424,224 98,783 0.4
14,600 Falconbridge Ltd. ............... 324,029 185,675 0.7
4,300 Inco Ltd. ....................... 140,517 73,100 0.3
60,800 Industrias Penoles, S.A. de
C.V. .......................... 267,270 275,403 1.0
465,000 M.I.M. Holdings Ltd. ............ 867,286 284,552 1.0
34,376 Minsur S.A. (T Shares)........... 111,555 73,447 0.3
35,000 Mitsubishi Materials Corp. ...... 173,212 56,430 0.2
14,000 Noranda Inc. .................... 249,761 240,654 0.9
14,800 Outokumpu OYJ.................... 263,036 175,236 0.6
9,400 P.T. Tambang Timah (GDR)** (a)... 115,742 101,050 0.4
49,400 Pasminco Ltd. ................... 78,451 56,601 0.2
2,900 Phelps Dodge Corp. .............. 169,146 180,525 0.7
108,000 QNI Ltd. ........................ 216,381 71,714 0.3
6,000 Rio Algom Ltd. .................. 116,616 101,251 0.4
35,400 Rio Tinto PLC.................... 464,920 435,502 1.6
315,000 Savage Resources Ltd. ........... 241,918 147,647 0.5
41,000 Savage Resources Ltd. (Warrants)
(b)............................ 5,506 934 0.0
23,000 Sumitomo Metal Mining Co. Ltd. .. 191,265 75,931 0.3
11,500 Trellborg 'B' Fria............... 148,886 144,845 0.5
126,900 WMC Ltd. ........................ 734,286 441,974 1.6
----------- ----------- -----
5,466,440 3,349,148 12.4
- ------------------------------------------------------------------------------------------------------------------------
OIL & GAS PRODUCERS 15,200 Apache Corp. .................... 406,775 532,950 2.0
12,000 +Baytex Energy Ltd. (Class A) ... 169,535 125,777 0.5
14,000 +Benton Oil & Gas Co. ........... 213,500 181,125 0.7
3,812 Burlington Resources Inc. ....... 91,553 170,825 0.6
19,200 +Chauvco Resources Ltd. ......... 8,705 16,100 0.1
10,400 +Chieftain International,
Inc. .......................... 233,254 221,000 0.8
34,100 +EEX Corp. ...................... 331,601 309,031 1.1
32,700 Enterprise Oil PLC............... 212,325 311,517 1.2
74,300 +Gulf Canada Resources, Ltd. .... 556,159 520,100 1.9
6,000 +Houston Exploration Co.......... 137,365 110,250 0.4
10,700 Mitchell Energy & Development
Corp. (Class B)................ 186,484 311,637 1.2
22,600 +Northrock Resources Ltd. ...... 182,121 351,373 1.3
13,000 +Oryx Energy Co. ................ 216,739 331,500 1.2
8,000 PanCanadian Petroleum Ltd. ...... 152,305 128,572 0.5
9,481 Pioneer Natural Resources Co. ... 254,802 274,356 1.0
40,900 Ranger Oil Ltd. ................. 277,620 281,187 1.0
7,500 Sonat, Inc. ..................... 326,509 343,125 1.3
----------- ----------- -----
3,957,352 4,520,425 16.8
- ------------------------------------------------------------------------------------------------------------------------
OIL SERVICES 8,900 Coflexip Stena Offshore, Inc.
(ADR)*......................... 182,060 493,950 1.8
7,800 McDermott International, Inc..... 294,333 285,675 1.1
7,300 +Petroleum Geo-Services ASA
(ADR)*......................... 214,215 472,675 1.8
3,600 Schlumberger Ltd. ............... 103,056 289,800 1.1
8,300 Smedvig ASA (ADR)*............... 176,375 174,300 0.6
2,500 +Stolt Comex Seaway, S.A. ....... 151,250 121,250 0.4
11,900 +TransCoastal Marine Services,
Inc. .......................... 226,500 163,625 0.6
8,600 Transocean Offshore Inc. ........ 267,925 414,412 1.5
----------- ----------- -----
1,615,714 2,415,687 8.9
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
167
<PAGE> 378
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PAPER & FOREST PRODUCTS 8,466 Aracruz Celulose S.A. (Class B)
(ADR)*......................... $ 135,818 $ 121,699 0.4%
30,100 Avenor Inc. ..................... 579,964 429,069 1.6
4,000 Champion International Corp. .... 208,741 181,250 0.7
3,300 Georgia-Pacific Corp. ........... 156,631 200,475 0.7
3,300 +Georgia-Pacific Corp. (Timber
Group)......................... 65,263 74,869 0.3
4,500 International Paper Co. ......... 151,314 194,062 0.7
24,300 Metsa Serla OY 'B'............... 200,736 189,582 0.7
7,000 Mo Och Domsjo AB 'B' Co. ........ 168,523 180,742 0.7
47,000 Slocan Forest Products Ltd. ..... 474,849 251,240 0.9
12,000 +Stone Container Corp. .......... 147,680 125,250 0.5
9,000 Weyerhaeuser Co. ................ 363,467 441,563 1.6
8,000 Willamette Industries, Inc. ..... 167,500 257,500 1.0
----------- ----------- -----
2,820,486 2,647,301 9.8
- ------------------------------------------------------------------------------------------------------------------------
PLANTATIONS 136,000 Golden Hope Plantations BHD...... 240,608 157,529 0.6
90,000 Kuala Lumpur Kepong BHD.......... 120,553 193,436 0.7
----------- ----------- -----
361,161 350,965 1.3
- ------------------------------------------------------------------------------------------------------------------------
REFINING 10,400 Sun Co. ......................... 283,046 437,450 1.6
5,976 Ultramar Diamond Shamrock
Corp. ......................... 202,960 190,485 0.7
----------- ----------- -----
486,006 627,935 2.3
- ------------------------------------------------------------------------------------------------------------------------
STEEL 104,000 British Steel PLC................ 274,493 222,920 0.8
3,700 Koninklijke Nederlandsche
Hoogovens en Staalfabrienken
N.V. .......................... 134,715 151,642 0.6
128,000 Nippon Steel Corp. .............. 434,280 189,666 0.7
147,000 Sumitomo Metal Industries,
Ltd. .......................... 443,134 188,476 0.7
----------- ----------- -----
1,286,622 752,704 2.8
- ------------------------------------------------------------------------------------------------------------------------
WOOD PRODUCTS 12,400 Louisiana-Pacific Corp. ......... 292,144 235,600 0.8
26,800 Riverside Forest Products
Ltd. .......................... 352,710 210,677 0.8
----------- ----------- -----
644,854 446,277 1.6
- ------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS &
WARRANTS 28,914,517 26,017,566 96.4
- ------------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SHORT-TERM INVESTMENTS
- ------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER*** $693,000 General Motors Acceptance Corp.,
6.75% due 1/02/1998............ 692,740 692,740 2.6
- ------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS 692,740 692,740 2.6
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS................ $29,607,257 26,710,306 99.0
===========
OTHER ASSETS LESS LIABILITIES.... 269,060 1.0
----------- -----
NET ASSETS....................... $26,979,366 100.0%
=========== =====
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(b) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and the number of shares are subject to
adjustment under certain conditions until the expiration date.
* American Depositary Receipts (ADR).
** Global Depositary Receipts (GDR).
*** Commercial Paper is traded on a discount basis; the interest rate shown is
the discount rate paid at the time of purchase by the Fund.
+ Non-income producing security.
See Notes to Financial Statements.
168
<PAGE> 379
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost $29,607,257) (Note
1a)....................................................... $26,710,306
Cash........................................................ 1,060
Receivables:
Securities sold........................................... $267,039
Dividends................................................. 35,274 302,313
--------
Prepaid expenses and other assets........................... 2,068
-----------
Total assets................................................ 27,015,747
-----------
- --------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser (Note 2)............................... 15,970
Capital shares redeemed................................... 4,818 20,788
--------
Accrued expenses and other liabilities...................... 15,593
-----------
Total liabilities........................................... 36,381
-----------
- --------------------------------------------------------------------------------------
NET ASSETS.................................................. $26,979,366
===========
- --------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 253,055
Paid-in capital in excess of par............................ 25,792,644
Undistributed investment income--net........................ 373,737
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 3,457,266
Unrealized depreciation on investments and foreign currency
transactions--net......................................... (2,897,336)
-----------
NET ASSETS.................................................. $26,979,366
============
- --------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $26,979,366 and 2,530,547
shares outstanding........................................ $ 10.66
============
- --------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
169
<PAGE> 380
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $43,563 foreign withholding tax).......... $ 621,538
Interest and discount earned................................ 47,177
-----------
Total income................................................ 668,715
-----------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 241,712
Custodian fees.............................................. 25,768
Pricing services............................................ 11,182
Accounting services (Note 2)................................ 8,602
Professional fees........................................... 8,052
Transfer agent fees (Note 2)................................ 5,006
Directors' fees and expenses................................ 935
Registration fees........................................... 20
Other....................................................... 960
-----------
Total expenses.............................................. 302,237
-----------
Investment income--net...................................... 366,478
-----------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET
(NOTES 1b, 1c, 1e & 3):
Realized gain (loss) from:
Investments--net.......................................... 3,481,351
Foreign currency transactions--net........................ (8,943) 3,472,408
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (7,585,679)
Foreign currency transactions--net........................ (2,450) (7,588,129)
----------- -----------
Net realized and unrealized loss on investments and foreign
currency transactions..................................... (4,115,721)
-----------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $(3,749,243)
===========
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
170
<PAGE> 381
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
---------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 366,478 $ 656,331
Realized gain on investments and foreign currency
transactions--net......................................... 3,472,408 2,957,459
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (7,588,129) 2,057,873
------------ -----------
Net increase (decrease) in net assets resulting from
operations................................................ (3,749,243) 5,671,663
------------ -----------
- -----------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1f):
Investment income--net:
Class A................................................... (223,099) (722,544)
Realized gain on investments--net:
Class A................................................... (2,977,040) (740,711)
------------ -----------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................... (3,200,139) (1,463,255)
------------ -----------
- -----------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net decrease in net assets derived from capital share
transactions.............................................. (11,268,247) (2,113,764)
------------ -----------
- -----------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (18,217,629) 2,094,644
Beginning of year........................................... 45,196,995 43,102,351
------------ -----------
End of year*................................................ $ 26,979,366 $45,196,995
============ ===========
- -----------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1g)............ $ 373,737 $ 221,415
============ ===========
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
171
<PAGE> 382
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED CLASS A
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ----------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year......................... $ 13.12 $ 11.95 $ 10.82 $ 10.82 $ 9.84
-------- ------- ------- ------- -------
Investment income--net..................................... .14 .18 .20 .17 .11
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net....................... (1.68) 1.40 1.15 (.02) .92
-------- ------- ------- ------- -------
Total from investment operations........................... (1.54) 1.58 1.35 .15 1.03
-------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net................................... (.06) (.20) (.19) (.15) (.05)
Realized gain on investments--net........................ (.86) (.21) (.03) -- --
-------- ------- ------- ------- -------
Total dividends and distributions.......................... (.92) (.41) (.22) (.15) (.05)
-------- ------- ------- ------- -------
Net asset value, end of year............................... $ 10.66 $ 13.12 $ 11.95 $ 10.82 $ 10.82
======== ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share......................... (12.52%) 13.52% 12.65% 1.44% 10.47%
======== ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................... .81% .78% .78% .87% 1.13%
======== ======= ======= ======= =======
Investment income--net..................................... .99% 1.43% 1.75% 1.91% 1.34%
======== ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)..................... $ 26,979 $45,197 $43,102 $39,715 $14,778
======== ======= ======= ======= =======
Portfolio turnover......................................... 20.93% 31.11% 30.15% 10.94% 58.44%
======== ======= ======= ======= =======
Average commission rate paid+.............................. $ .0308 $ .0225 -- -- --
======== ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into US
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
See Notes to Financial Statements.
172
<PAGE> 383
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A and each fund began offering Class B Shares. Both classes of shares have equal
voting, dividend, liquidation and other rights, except that only shares of the
respective classes are entitled to vote on matters concerning only that class
and Class B Shares bear certain expenses related to the distribution of such
shares. Natural Resources Focus Fund (the "Fund") is classified as
"non-diversified", as defined in the Investment Company Act of 1940. The
following is a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Options purchased are valued at
the last sale price in the case of exchange-traded options or, in the case of
options traded in the over-the-counter market, the last bid price. Futures
contracts are valued at the settlement price at the close of the applicable
exchange. Short-term investments are valued at amortized cost, which
approximates market value. Securities for which market quotations are not
readily available are valued at fair value as determined in good faith by or
under the direction of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts. Premium or discount is amortized over the life
of the contracts.
- - Options--The Fund may write and purchase call and put options. When the Fund
writes an option, an amount equal to the premium received by the Fund is
reflected as an asset and an equivalent liability. The amount of the liability
is subsequently marked to market to reflect the current market value of the
option written. When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or deducted from)
the basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent of
the premiums received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Financial futures contracts--The Fund may purchase or sell futures contracts
and options on such futures contracts for the purpose of hedging the market risk
on existing securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific future date and
at a specific price or yield. Upon entering into a contract, the Fund deposits
and maintains as collateral such initial margin as required by the exchange on
which the transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the
173
<PAGE> 384
- --------------------------------------------------------------------------------
contract. Such receipts or payments are known as variation margin and are
recorded by the Fund as unrealized gains or losses. When the contract is closed,
the Fund records a realized gain or loss equal to the difference between the
value of the contract at the time it was opened and the value at the time it was
closed.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-US dollar-denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Dividends from foreign
securities where the ex-dividend date may have passed are subsequently recorded
when the Fund has determined the ex-dividend date. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $8,943 have been reclassified between undistributed net
realized capital gains and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.65% of the average daily value of the Fund's net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc., a subsidiary of ML & Co., earned $3,939 in commissions on the execution of
portfolio security transactions.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
174
<PAGE> 385
- --------------------------------------------------------------------------------
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $7,535,738 and $21,652,709, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Losses
- ------------------------------------------------------------------
<S> <C> <C>
Long-term Investments........... $3,481,351 $(2,896,951)
Foreign currency transactions... (8,943) (385)
---------- -----------
Total........................... $3,472,408 $(2,897,336)
========== ===========
- ------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized depreciation for Federal income tax
purposes aggregated $2,991,491, of which $4,512,365 related to appreciated
securities and $7,503,856 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$29,701,797.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$11,268,247 and $2,113,764 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Years Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 25,316 $ 321,714
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 264,256 3,200,139
---------- ------------
Total issued......................... 289,572 3,521,853
Shares redeemed...................... (1,202,808) (14,790,100)
---------- ------------
Net decrease......................... (913,236) $(11,268,247)
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold............................. 450,602 $ 5,663,127
Shares issued to shareholders in
reinvestment of dividends and
distributions.......................... 122,221 1,463,255
-------- -----------
Total issued............................ 572,823 7,126,382
Shares redeemed......................... (737,357) (9,240,146)
-------- -----------
Net decrease............................ (164,534) $(2,113,764)
======== ===========
- -----------------------------------------------------------------
</TABLE>
5. COMMITMENTS:
At December 31, 1997, the Fund had entered into foreign exchange contracts under
which it agreed to sell various foreign currencies with values of approximately
$55,000, respectively.
6. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.321997 per Class A Share and a long-term capital
gains distribution in the amount of $1.309765 per Class A Share payable on
January 9, 1998 to shareholders of record as of December 31, 1997.
175
<PAGE> 386
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSET BACKED AAA Aaa $ 1,944,864 Arcadia Automobile Receivables
SECURITIES++--4.3% Trust, 6.10% due 6/15/2000... $ 1,944,485 $ 1,946,400
AAA Aaa 1,500,000 California Infrastructure, San
Diego, 6.04% due
3/25/2000.................... 1,499,800 1,500,938
Citibank, Credit Card Master
Trust I:
AAA Aaa 7,000,000 6.35% due 8/15/2002.......... 6,994,400 7,042,656
AAA Aaa 4,000,000 6.057% due 12/10/2008........ 3,998,440 3,980,000
AAA Aaa 5,500,000 First Bank, Corporate Card
Master Trust, 6.40% due
2/15/2003.................... 5,493,248 5,544,660
AAA Aaa 2,633,209 GMAC Grantor Trust, 6.50% due
4/15/2002.................... 2,632,475 2,644,769
------------ ------------
22,562,848 22,659,423
- -------------------------------------------------------------------------------------------------------------------------
BANKS & THRIFTS--11.0% BBB+ A3 2,500,000 BB&T Corporation, 7.25% due
6/15/2007.................... 2,488,325 2,628,175
Bank of New York Co., Inc.:
A A2 4,000,000 7.625% due 7/15/2002......... 4,306,000 4,215,160
A A2 2,000,000 7.875% due 11/15/2002........ 2,213,400 2,135,680
BankAmerica Corp.:
A A1 7,000,000 8.375% due 3/15/2002......... 7,361,550 7,522,410
A+ Aa3 1,000,000 7.125% due 5/12/2005......... 985,500 1,037,510
A A2 2,000,000 First Interestate Bancorp,
11.25% due 3/27/2001......... 2,354,060 2,272,620
BBB A2 8,000,000 Fleet Capital Trust II, 7.92%
due 12/11/2026............... 7,922,070 8,437,280
A- A3 2,000,000 Golden West Financial Corp.,
9.15% due 5/23/1998.......... 2,271,480 2,023,180
HSBC Americas Inc.:
A- A3 3,000,000 7% due 11/01/2006............ 2,974,800 3,052,110
BBB+ A2 1,000,000 +7.808% due 12/15/2026....... 988,460 1,020,583
BBB+ A2 3,000,000 Mellon Capital II, 7.995% due
1/15/2027.................... 2,860,410 3,220,860
A A2 5,000,000 NationsBank Corp., 6.50% due
8/15/2003.................... 4,755,150 5,048,100
Norwest Corp.:
AA- Aa3 2,500,000 6.75% due 5/12/2000.......... 2,529,975 2,532,800
AA- Aa3 3,000,000 6.125% due 10/15/2000........ 2,994,660 2,997,210
AA- Aa3 9,000,000 Norwest Financial, Inc., 6.625%
due 7/15/2004................ 8,960,310 9,109,710
BBB+ A1 1,000,000 Wells Fargo Capital I, 7.96%
due 12/15/2026............... 982,070 1,051,410
------------ ------------
56,948,220 58,304,798
- -------------------------------------------------------------------------------------------------------------------------
CANADIAN Province of Quebec (Canada)(2):
PROVINCES*--2.6%
A+ A2 3,500,000 8.80% due 4/15/2003.......... 3,944,780 3,880,660
A+ A2 9,500,000 7.125% due 2/09/2024......... 7,990,800 9,784,145
------------ ------------
11,935,580 13,664,805
- -------------------------------------------------------------------------------------------------------------------------
FINANCE--5.9% Associates Corp. of North
America:
AA- Aa3 5,000,000 8.375% due 1/15/1998......... 5,016,100 5,002,700
AA- Aa3 10,000,000 6.375% due 6/15/2000......... 10,016,600 10,053,200
A A2 1,500,000 Beneficial Corporation, 6.80%
due 9/16/2003................ 1,500,000 1,521,947
A Aa3 6,100,000 CIT Capital Trust I, 7.70% due
2/15/2027.................... 6,072,184 6,257,520
A+ Aa3 5,000,000 CIT Group Holdings, Inc.,
6.625% due 6/15/2005......... 5,016,950 5,038,050
A+ A1 3,250,000 Commercial Credit Co., 10% due
5/01/1999.................... 3,626,350 3,406,780
------------ ------------
31,248,184 31,280,197
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
176
<PAGE> 387
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FINANCE--OTHER-- Bear Stearns Companies, Inc.
11.2% (The):
A A2 $ 3,000,000 6.75% due 8/15/2000.......... $ 2,980,950 $ 3,035,730
A A2 1,000,000 6.70% due 8/01/2003.......... 1,002,800 1,010,460
A+ A1 3,500,000 Dean Witter, Discover & Co.,
6.75% due 8/15/2000.......... 3,486,805 3,548,160
A- A3 5,500,000 Donaldson, Lufkin & Jenrette,
Inc., 6.875% due
11/01/2005................... 5,477,000 5,592,675
+Equitable Life Assurance
Society:
A A2 4,355,000 6.95% due 12/01/2005......... 4,110,249 4,434,170
A A2 1,500,000 7.70% due 12/01/2015......... 1,489,740 1,606,079
AA Aa1 2,000,000 GE Global Insurance, 7% due
2/15/2026.................... 2,054,720 2,076,320
Lehman Brothers Holdings, Inc.:
A Baa1 4,000,000 6.50% due 10/01/2002......... 3,996,200 3,994,800
A Baa1 2,000,000 Series E, 6.625% due
12/27/2002................... 1,999,380 2,014,100
AA Aa2 6,500,000 MBIA, Inc., 7.15% due
7/15/2027.................... 6,484,075 6,894,875
A+ A1 5,500,000 Morgan Stanley, Dean Witter,
Discover & Co., 6.875% due
3/01/2007.................... 5,480,255 5,619,625
PaineWebber Group, Inc.:
BBB+ Baa1 3,000,000 9.25% due 12/15/2001......... 3,501,570 3,280,170
BBB+ Baa1 2,000,000 8.875% due 3/15/2005......... 2,012,540 2,238,240
Smith Barney Holdings, Inc.:
A A2 2,000,000 5.875% due 2/01/2001......... 1,993,680 1,973,414
A A2 2,000,000 6.625% due 11/15/2003........ 1,988,320 2,011,586
A+ Aa3 2,000,000 Travelers Capital II, 7.75% due
12/01/2036................... 2,003,400 2,074,060
Travelers Corp. (The):
AA- Aa3 1,000,000 9.50% due 3/01/2002.......... 1,084,200 1,113,560
AA- Aa3 6,000,000 7.875% due 5/15/2025......... 6,053,840 6,709,620
------------ ------------
57,199,724 59,227,644
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL--CONSUMER Anheuser-Busch Cos., Inc.:
GOODS--4.4% A+ A1 2,500,000 8.75% due 12/01/1999......... 2,839,090 2,615,750
A+ A1 5,000,000 7.375% due 7/01/2023......... 5,127,300 5,133,350
AA- Aa3 7,000,000 Archer-Daniels-Midland Company,
6.75% due 12/15/2027......... 6,921,040 7,010,731
A+ A1 4,000,000 Hershey Foods Corporation,
7.20% due 8/15/2027.......... 4,215,640 4,252,400
A A2 4,000,000 Philip Morris Companies, Inc.,
9% due 1/01/2001............. 4,071,540 4,273,760
------------ ------------
23,174,610 23,285,991
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- AA Aa2 2,000,000 BP America Inc., 9.375% due
ENERGY--1.4% 11/01/2000................... 2,204,960 2,166,800
A Aa3 3,000,000 Dresser Industries, Inc., 7.60%
due 8/15/2096................ 2,991,270 3,363,960
A+ A1 1,500,000 Texaco Capital Inc., 9% due
12/15/1999................... 1,731,670 1,576,200
------------ ------------
6,927,900 7,106,960
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
177
<PAGE> 388
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INDUSTRIAL-- BBB+ A3 $ 5,500,000 Applied Materials Inc., 7.125%
MANUFACTURING--12.4% due 10/15/2017............... $ 5,462,380 $ 5,586,350
AA+ Aa3 9,500,000 Boeing Co., 6.35% due
6/15/2003.................... 8,549,905 9,555,005
duPont (E.I.) de Nemours & Co.:
AA- Aa3 8,750,000 6.75% due 9/01/2007.......... 9,031,708 9,053,887
AA- Aa3 2,950,000 8.25% due 1/15/2022.......... 3,066,304 3,182,106
A A1 2,000,000 Ford Motor Company, 8.875% due
1/15/2022.................... 2,471,480 2,466,760
Ford Motor Credit Company:
A A1 3,000,000 7% due 9/25/2001............. 2,988,060 3,074,550
A A1 2,500,000 7.75% due 3/15/2005.......... 2,497,725 2,682,275
AAA Aaa 3,245,000 General Electric Capital Corp.,
8.125% due 5/15/2012......... 3,449,052 3,744,081
General Motors Acceptance
Corp.:
A- A3 5,000,000 7.70% due 4/15/2016.......... 5,455,750 5,479,250
A- A3 4,000,000 8.80% due 3/01/2021.......... 4,689,040 4,884,600
BBB+ A3 2,500,000 Martin Marietta Corp., 6.50%
due 4/15/2003................ 2,515,325 2,514,250
AA+ A2 2,500,000 McDonnell Douglas Financial
Corp., 6.875% due
11/01/2006................... 2,593,625 2,591,800
A A1 6,910,000 PPG Industries, Inc., 6.50% due
11/01/2007................... 6,888,855 6,977,303
A A2 3,300,000 Phelps Dodge Corporation, 7.75%
due 1/01/2002................ 3,468,564 3,456,123
------------ ------------
63,127,773 65,248,340
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- A+ A1 2,500,000 Bass America, Inc., 8.125% due
SERVICES--9.1% 3/31/2002.................... 2,668,930 2,674,850
A A2 4,000,000 Carnival Cruise Lines, Inc.,
7.70% due 7/15/2004.......... 4,208,480 4,259,920
Dillard's, Inc.:
A+ A2 5,000,000 7.375% due 6/15/1999......... 5,305,840 5,091,750
A+ A2 3,000,000 9.125% due 8/01/2011......... 3,240,150 3,652,590
A A2 1,925,050 +Disney Enterprises, Inc.,
6.85% due 1/10/2007++........ 1,923,760 1,957,429
A+ A1 7,000,000 +Electronic Data Systems Corp.,
6.85% due 5/15/2000.......... 6,994,470 7,120,106
A A2 4,850,000 First Data Corp., 6.375% due
12/15/2007................... 4,837,536 4,825,653
AAA Aaa 3,000,000 Johnson & Johnson, 8.72% due
11/01/2024................... 3,000,000 3,448,200
A- A2 7,000,000 Sears, Roebuck & Co., 6.82% due
10/17/2002................... 7,014,280 7,160,930
AA Aa2 7,000,000 Wal-Mart Stores, Inc., 8.50%
due 9/15/2024................ 7,036,810 7,778,470
------------ ------------
46,230,256 47,969,898
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- Southwest Airlines, Inc.:
TRANSPORTATION--1.7% A- A3 3,000,000 9.40% due 7/01/2001.......... 3,420,210 3,294,570
A- A3 4,000,000 8% due 3/01/2005............. 3,980,450 4,328,040
A- A3 1,000,000 7.875% due 9/01/2007......... 992,600 1,101,570
------------ ------------
8,393,260 8,724,180
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
178
<PAGE> 389
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRY RATINGS RATINGS AMOUNT CORPORATE BONDS & NOTES COST (NOTE 1A)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UTILITIES-- AAA Aaa $ 4,000,000 BellSouth Telecommunications
COMMUNICATIONS-- Inc., 7% due 10/01/2025...... $ 4,162,800 $ 4,198,640
3.6% GTE Corp.:
A Baa1 6,000,000 8.85% due 3/01/1998.......... 6,278,360 6,022,080
A Baa1 1,500,000 9.375% due 12/01/2000........ 1,647,090 1,624,785
AAA Aaa 3,000,000 Indiana Bell Telephone Co.,
Inc., 7.30% due 8/15/2026.... 3,030,280 3,278,070
Southwestern Bell
Telecommunications Corp.:
AA Aa3 1,000,000 6.125% due 3/01/2000......... 1,005,000 1,001,780
AA Aa3 1,000,000 6.625% due 4/01/2005......... 958,450 1,017,990
AA Aa3 2,000,000 6.375% due 11/15/2007........ 2,009,520 2,008,760
------------ ------------
19,091,500 19,152,105
- -------------------------------------------------------------------------------------------------------------------------
UTILITIES-- AAA Aaa 8,000,000 Cleveland Electric/Toledo
ELECTRIC--5.2% Edison (Class B), 7.13% due
7/01/2007.................... 8,392,720 8,519,440
AA Aa3 2,000,000 Northern States Power Company,
7.125% due 7/01/2025......... 2,122,360 2,117,580
Pennsylvania Power & Light Co.:
A- A3 2,500,000 5.50% due 4/01/1998.......... 2,488,425 2,497,850
A- A3 2,000,000 6.875% due 2/01/2003......... 2,032,580 2,057,980
A- A3 4,000,000 Public Service Electric & Gas
Co., 6.50% due 6/01/2000..... 3,998,315 4,027,440
A A2 7,500,000 Virginia Electric & Power Co.,
8.625% due 10/01/2024........ 7,416,540 8,441,700
------------ ------------
26,450,940 27,661,990
- -------------------------------------------------------------------------------------------------------------------------
YANKEE CORPORATES*--7.8% AA- Aa2 1,500,000 ABN AMRO Holding N.V., 7.125%
due 6/18/2007(1)............. 1,499,265 1,568,205
A+ A1 6,000,000 Australia & New Zealand Banking
Group Ltd., 7.55% due
9/15/2006(1)................. 5,990,880 6,333,660
A- Baa1 8,000,000 Enersis S.A., 6.90% due
12/01/2006(3)................ 7,979,360 7,898,320
A+ A1 2,000,000 Ford Capital B.V., 9.50% due
6/01/2010(1)................. 2,217,880 2,477,360
A+ A2 5,500,000 Grand Metropolitan Investment
Corp., 6.50% due
9/15/1999(1)................. 5,615,810 5,533,550
A+ A3 1,000,000 +Hutchison Whampoa Finance
Ltd., 6.95% due
8/01/2007(1)................. 924,140 942,260
A A2 3,000,000 +Petronas Corp., 6.625% due
10/18/2001(3)................ 2,976,900 2,864,307
AA Aa2 12,500,000 Swiss Bank Corp. NY, 7.375% due
6/15/2017(1)................. 13,366,130 13,372,000
------------ ------------
40,570,365 40,989,662
- -------------------------------------------------------------------------------------------------------------------------
YANKEE BBB+ A3 6,000,000 People's Republic of China,
SOVEREIGN*--1.1% 6.625% due 1/15/2003(2)........ 5,970,960 5,908,800
- -------------------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS &
NOTES--81.7% 419,832,120 431,184,793
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
179
<PAGE> 390
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
RATINGS RATINGS AMOUNT US GOVERNMENT OBLIGATIONS COST (NOTE 1A)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
US GOVERNMENT US Treasury Notes & Bonds:
OBLIGATIONS--15.1% AAA Aaa $ 2,000,000 6.375% due 9/30/2001......... $ 2,042,187 $ 2,041,240
AAA Aaa 9,000,000 6.25% due 10/31/2001......... 9,134,297 9,153,270
AAA Aaa 2,500,000 5.75% due 10/31/2002......... 2,491,895 2,502,350
AAA Aaa 7,000,000 5.75% due 11/30/2002......... 6,971,094 7,005,460
AAA Aaa 1,000,000 6.25% due 2/15/2003.......... 982,500 1,022,660
AAA Aaa 16,000,000 5.75% due 8/15/2003.......... 15,814,688 16,009,920
AAA Aaa 500,000 5.875% due 2/15/2004......... 490,156 504,375
AAA Aaa 3,500,000 7.25% due 8/15/2004.......... 3,730,312 3,782,730
AAA Aaa 4,500,000 6.50% due 5/15/2005.......... 4,516,987 4,691,250
AAA Aaa 4,500,000 6.50% due 10/15/2006......... 4,633,828 4,711,635
AAA Aaa 18,650,000 6.125% due 8/15/2007......... 19,025,875 19,165,859
AAA Aaa 1,500,000 6.625% due 2/15/2027......... 1,487,344 1,628,430
AAA Aaa 7,000,000 6.375% due 8/15/2027......... 7,357,070 7,382,830
- -------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT
OBLIGATIONS--15.1% 78,678,233 79,602,009
- -------------------------------------------------------------------------------------------------------------------------
SHORT-TERM SECURITIES
- -------------------------------------------------------------------------------------------------------------------------
REPURCHASE 8,228,000 HSBC Holdings PLC, purchased on
AGREEMENTS**--1.5% 12/31/1997 to yield 6.57% to
1/02/1998.................... 8,228,000 8,228,000
- -------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM
SECURITIES--1.5% 8,228,000 8,228,000
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS--98.3%....... $506,738,353 519,014,802
============
OTHER ASSETS LESS
LIABILITIES--1.7%............ 8,755,241
------------
NET ASSETS--100.0%............. $527,770,043
============
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Corresponding industry groups for foreign securities, which are denominated in
US dollars:
(1) Financial Institution
(2) Government Entity
(3) Industrial
** Repurchase Agreements are fully collateralized by US Government Obligations.
+ The security may be offered and sold to "qualified institutional buyers" under
Rule 144A of the Securities Act of 1933.
++ Subject to principal paydowns.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
180
<PAGE> 391
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$506,738,353) (Note
1a)....................................................... $519,014,802
Cash........................................................ 740
Receivables:
Interest.................................................. $8,908,401
Capital shares sold....................................... 100,298
Loaned securities (Note 6)................................ 3,608 9,012,307
----------
Prepaid expenses and other assets........................... 35,168
------------
Total assets................................................ 528,063,017
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser (Note 2)............................... 199,214
Capital shares redeemed................................... 12,994 212,208
----------
Accrued expenses and other liabilities...................... 80,766
------------
Total liabilities........................................... 292,974
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $527,770,043
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 4,358,581
Paid-in capital in excess of par............................ 524,345,665
Undistributed investment income--net........................ 3,180,103
Accumulated realized capital losses on investments--net
(Note 5).................................................. (16,390,755)
Unrealized appreciation on investments--net................. 12,276,449
------------
NET ASSETS.................................................. $527,770,043
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $527,770,043 and 43,585,807
shares outstanding........................................ $ 12.11
============
- ---------------------------------------------------------------------------------------
</TABLE>
+ The Fund is authorized to issue 100,000,000 Class B Shares.
See Notes to Financial Statements.
181
<PAGE> 392
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1d):
Interest and discount earned................................ $37,099,499
Other income................................................ 48,008
-----------
Total income................................................ 37,147,507
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $2,226,345
Accounting services (Note 2)................................ 110,709
Professional fees........................................... 55,872
Custodian fees.............................................. 44,181
Directors' fees and expenses................................ 10,793
Pricing services............................................ 9,503
Transfer agent fees (Note 2)................................ 5,005
Registration fees........................................... 2,093
Other....................................................... 2,318
----------
Total expenses.............................................. 2,466,819
-----------
Investment income--net...................................... 34,680,688
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1d & 3):
Realized loss on investments--net........................... (659,507)
Change in unrealized appreciation on investments--net....... 8,588,890
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $42,610,071
===========
- --------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
182
<PAGE> 393
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 34,680,688 $ 33,145,431
Realized gain (loss) on investments--net.................... (659,507) 215,210
Change in unrealized appreciation on investments--net....... 8,588,890 (21,044,224)
------------ ------------
Net increase in net assets resulting from operations........ 42,610,071 12,316,417
------------ ------------
- -----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS (NOTE 1e):
Investment income--net:
Class A................................................... (34,630,429) (32,511,472)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (34,630,429) (32,511,472)
------------ ------------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase (decrease) in net assets derived from capital
share transactions........................................ (18,603,327) 68,750,815
------------ ------------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (10,623,685) 48,555,760
Beginning of year........................................... 538,393,728 489,837,968
------------ ------------
End of year*................................................ $527,770,043 $538,393,728
============ ============
- -----------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 3,180,103 $ 3,129,844
============ ============
- -----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
183
<PAGE> 394
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
--------------------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FOR THE YEAR ENDED DECEMBER 31,
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. --------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year....................... $ 11.91 $ 12.45 $ 11.12 $ 12.64 $ 12.04
-------- -------- -------- -------- --------
Investment income--net................................... .78 .80 .82 .77 .70
Realized and unrealized gain (loss) on
investments--net....................................... .20 (.55) 1.34 (1.36) .71
-------- -------- -------- -------- --------
Total from investment operations......................... .98 .25 2.16 (.59) 1.41
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................. (.78) (.79) (.83) (.76) (.70)
Realized gain on investments--net...................... -- -- -- -- (.11)
In excess of realized gain on investments--net......... -- -- -- (.17) --
-------- -------- -------- -------- --------
Total dividends and distributions........................ (.78) (.79) (.83) (.93) (.81)
-------- -------- -------- -------- --------
Net asset value, end of year............................. $ 12.11 $ 11.91 $ 12.45 $ 11.12 $ 12.64
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share....................... 8.64% 2.21% 20.14% (4.80%) 12.02%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................. .47% .49% .50% .54% .63%
======== ======== ======== ======== ========
Investment income--net................................... 6.62% 6.67% 7.00% 6.74% 5.86%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)................... $527,770 $538,394 $489,838 $391,234 $314,091
======== ======== ======== ======== ========
Portfolio turnover....................................... 89.22% 91.88% 90.12% 139.89% 115.26%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
See Notes to Financial Statements.
184
<PAGE> 395
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. Prime Bond Fund (the "Fund") is classified as "diversified", as
defined in the Investment Company Act of 1940. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Short-term securities are valued at amortized cost, which approximates
market value. Securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Board of Directors of the Company.
(b) Repurchase agreements--The Fund invests in US Government securities
pursuant to repurchase agreements with a member bank of the Federal Reserve
System or a primary dealer in US Government securities. Under such agreements,
the bank or primary dealer agrees to repurchase the security at a mutually
agreed upon time and price. The Fund takes possession of the underlying
securities, marks to market such securities and, if necessary, receives
additional securities daily to ensure that the contract is fully collateralized.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of premium and discount) is recognized
on the accrual basis. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend date.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
based upon the aggregate daily value of net assets of the Fund and the Company's
High Current Income Fund at the following annual rates: 0.50% of such average
daily net assets not exceeding $250 million; 0.45% of such average daily net
assets in excess of $250 million but not more than $500 million; 0.40% of such
average daily net assets in excess of $500 million but not more than $750
million; and 0.35% of such average daily net assets in excess of $750 million.
For the year ended December 31, 1997, the aggregate average daily net assets of
the Fund and the Company's High Current Income Fund was approximately
$1,003,875,000.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement
185
<PAGE> 396
- --------------------------------------------------------------------------------
which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, the Fund paid Merrill Lynch Security
Pricing Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith, Inc.,
$8,877 for providing security price quotations to compute the net asset value of
the Fund.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $437,193,344 and $434,431,139, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Realized Unrealized
Losses Gains
- -----------------------------------------------------------------
<S> <C> <C>
Long-term investments.................. $(659,505) $12,276,449
Short-term investments................. (2) --
--------- -----------
Total.................................. $(659,507) $12,276,449
========= ===========
- -----------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $12,217,563, of which $14,696,808 related to appreciated
securities and $2,479,245 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$506,797,239.
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital share transactions
were $(18,603,327) and $68,750,815 for the years ended December 31, 1997 and
December 31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 3,589,337 $ 42,528,752
Shares issued to shareholders in
reinvestment of dividends........... 2,931,101 34,630,429
---------- ------------
Total issued......................... 6,520,438 77,159,181
Shares redeemed...................... (8,146,214) (95,762,508)
---------- ------------
Net decrease......................... (1,625,776) $(18,603,327)
========== ============
- -----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 5,521,436 $ 65,068,417
Shares issued to shareholders in
reinvestment of dividends........... 2,739,002 32,511,472
---------- ------------
Total issued......................... 8,260,438 97,579,889
Shares redeemed...................... (2,399,918) (28,829,074)
---------- ------------
Net increase......................... 5,860,520 $ 68,750,815
========== ============
- -----------------------------------------------------------------
</TABLE>
5. CAPITAL LOSS CARRYFORWARD:
At December 31,1997, the Fund had a net capital loss carryforward of
approximately $16,332,000, of which $14,796,000 expires in 2002, $855,000
expires in 2003 and $681,000 expires in 2005. This amount will be available to
offset like amounts of any future taxable gains.
6. LOANED SECURITIES:
At December 31, 1997, the Fund held US Treasury bonds having an aggregate value
of approximately $20,611,000 as collateral for portfolio securities loaned
having a market value of approximately $20,000,000.
7. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $.072961 per Class A Share payable on January 2, 1998
to shareholders of record as of December 31, 1997.
186
<PAGE> 397
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AEROSPACE & DEFENSE 400,400 AlliedSignal, Inc. ......... $ 14,554,221 $ 15,590,575 1.8%
260,000 GenCorp, Inc. .............. 7,589,255 6,500,000 0.7
80,000 +Orbital Sciences Corp. .... 2,054,827 2,380,000 0.3
------------ ------------ -----
24,198,303 24,470,575 2.8
- -----------------------------------------------------------------------------------------------------------------------
AIRLINES 310,000 +US Airways Group Inc. ..... 11,221,688 19,375,000 2.2
- -----------------------------------------------------------------------------------------------------------------------
APPLIANCES 364,300 Sunbeam Corp. .............. 13,871,579 15,346,138 1.8
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE PARTS 335,000 Federal-Mogul Corp. ........ 13,147,104 13,567,500 1.6
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE RENTAL & LEASING 356,500 +Avis Rent-A-Car, Inc. ..... 7,759,464 11,385,719 1.3
399,800 Hertz Corp. (Class A)....... 13,662,081 16,091,950 1.8
------------ ------------ -----
21,421,545 27,477,669 3.1
- -----------------------------------------------------------------------------------------------------------------------
BANKING 210,000 Bank of New York Co.,
Inc. ..................... 4,459,316 12,140,625 1.4
60,000 Bank of New York Co., Inc.
(Warrants)(c)............. 433,750 10,155,000 1.2
233,200 BankAmerica Corporation..... 12,116,222 17,023,600 1.9
309,900 First Union Corporation..... 15,243,173 15,882,375 1.8
------------ ------------ -----
32,252,461 55,201,600 6.3
- -----------------------------------------------------------------------------------------------------------------------
BROADCASTING--MEDIA 190,000 +Chancellor Media Corp. .... 12,051,610 14,178,750 1.6
- -----------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES 360,000 +Gartner Group, Inc. (Class
A)........................ 12,215,534 13,410,000 1.5
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES 130,500 +Cisco Systems, Inc. ....... 7,438,745 7,275,375 0.8
81,000 +Microsoft Corp. ........... 10,070,419 10,464,188 1.2
------------ ------------ -----
17,509,164 17,739,563 2.0
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER SOFTWARE 159,600 +BMC Software, Inc. ........ 5,981,399 10,453,800 1.2
207,500 Computer Associates
International, Inc. ...... 5,678,779 10,971,563 1.3
------------ ------------ -----
11,660,178 21,425,363 2.5
- -----------------------------------------------------------------------------------------------------------------------
COMPUTERS 70,500 Compaq Computer Corp. ...... 2,074,202 3,978,844 0.5
46,000 International Business
Machines Corp. ........... 2,488,255 4,809,875 0.5
273,000 +Quantum Corporation........ 7,704,003 5,477,063 0.6
------------ ------------ -----
12,266,460 14,265,782 1.6
- -----------------------------------------------------------------------------------------------------------------------
CONSUMER PRODUCTS 569,400 The Dial Corporation........ 11,003,195 11,850,638 1.4
- -----------------------------------------------------------------------------------------------------------------------
CONTAINERS 425,000 +Owens-Illinois, Inc. ...... 12,332,455 16,123,438 1.8
- -----------------------------------------------------------------------------------------------------------------------
CRUISE LINES 158,000 Royal Caribbean Cruises
Ltd. ..................... 6,903,067 8,423,375 1.0
- -----------------------------------------------------------------------------------------------------------------------
DENTAL SUPPLIES & EQUIPMENT 292,000 DENTSPLY International,
Inc. ..................... 7,369,140 8,906,000 1.0
- -----------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 200,000 General Electric Co. ....... 14,106,311 14,675,000 1.7
- -----------------------------------------------------------------------------------------------------------------------
ELECTRONICS 360,000 +National Semiconductor
Corporation............... 14,592,622 9,337,500 1.1
- -----------------------------------------------------------------------------------------------------------------------
ENERGY & RELATED 580,300 Edison International........ 11,081,299 15,776,906 1.8
- -----------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 100,000 American Express Company.... 4,881,087 8,925,000 1.0
340,000 MGIC Investment
Corporation............... 12,900,568 22,610,000 2.6
------------ ------------ -----
17,781,655 31,535,000 3.6
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--ARGENTINA* 46,000 Yacimientos Petroliferos
Fiscales S.A.
(ADR)(a)(10).............. 943,842 1,572,625 0.2
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--BAHAMAS* 166,800 +Sun International Hotels
Ltd.(14) ................. 6,398,324 6,275,850 0.7
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
187
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- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FOREIGN--CANADA* 986,000 +Gulf Canada Resources
Ltd.(9)................... $ 9,138,148 $ 6,902,000 0.8%
289,000 +Imax Corporation(6)........ 7,840,234 6,213,500 0.7
45,400 Magna International, Inc.
(Class A)(1).............. 2,135,685 2,851,688 0.3
------------ ------------ -----
19,114,067 15,967,188 1.8
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--FINLAND* 61,600 Orion-Yhtymae OY (Class
B)(11).................... 1,551,213 1,584,242 0.2
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--FRANCE* 35,600 +SGS-Thomson
Microelectronics N.V. (NY
Registered Shares)(12).... 1,362,112 2,173,825 0.2
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--GERMANY* 15,400 Bayerische Vereinsbank
AG(2)..................... 928,721 1,007,661 0.1
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--JAPAN* 101,000 Bridgestone
Corporation(13)........... 2,493,608 2,194,472 0.2
44,000 Sony Corporation
(ADR)(a)(4)............... 3,235,891 3,993,000 0.5
------------ ------------ -----
5,729,499 6,187,472 0.7
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--NETHERLANDS* 224,000 Royal Dutch Petroleum Co.
(NY Registered
Shares)(9)................ 12,235,037 12,138,000 1.4
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--SOUTH KOREA* 137,700 +Hyundai Engineering &
Construction Co.,
Ltd.(GDR)(b)(e)(5)........ 1,767,195 120,487 0.0
2,688 +Hyundai Engineering &
Construction Co., Ltd.
(New Shares)
(GDR)(b)(e)(5)............ 34,497 2,352 0.0
------------ ------------ -----
1,801,692 122,839 0.0
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--SWEDEN* 27,000 Spectra-Physics AB (Class
A)(7)..................... 823,849 511,808 0.1
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--SWITZERLAND* 41,400 Novartis AG (ADR)(a)(11).... 1,816,850 3,363,750 0.4
- -----------------------------------------------------------------------------------------------------------------------
FOREIGN--UNITED KINGDOM* 143,000 Diageo PLC (ADR)(a)(3)...... 3,842,630 5,416,125 0.6
75,000 Rio Tinto PLC (ADR)(a)(8)... 4,511,938 3,881,250 0.5
------------ ------------ -----
8,354,568 9,297,375 1.1
- -----------------------------------------------------------------------------------------------------------------------
HARDWARE & TOOLS 222,200 Black & Decker
Corporation............... 7,442,791 8,679,687 1.0
- -----------------------------------------------------------------------------------------------------------------------
INSURANCE 95,100 Hartford Life, Inc. (Class
A)........................ 3,085,805 4,309,219 0.5
482,000 Provident Companies,
Inc. ..................... 15,937,649 18,617,250 2.1
378,000 Travelers Group, Inc. ...... 13,296,746 20,364,750 2.3
116,300 Travelers Property Casualty
Corp. (Class A)........... 4,707,524 5,117,200 0.6
305,200 UNUM Corporation............ 9,738,551 16,595,250 1.9
------------ ------------ -----
46,766,275 65,003,669 7.4
- -----------------------------------------------------------------------------------------------------------------------
LEISURE & TOURISM 466,000 Brunswick Corporation....... 11,563,456 14,125,625 1.6
- -----------------------------------------------------------------------------------------------------------------------
MACHINERY 185,000 Harnischfeger Industries,
Inc. ..................... 8,016,637 6,532,812 0.7
399,300 Ingersoll-Rand Company...... 11,982,947 16,171,650 1.9
145,000 SPX Corporation............. 8,226,644 10,005,000 1.1
------------ ------------ -----
28,226,228 32,709,462 3.7
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL SERVICES 548,368 +HEALTHSOUTH Corporation.... 14,867,891 15,217,212 1.7
- -----------------------------------------------------------------------------------------------------------------------
NATURAL GAS 275,000 El Paso Natural Gas
Company................... 13,831,806 18,287,500 2.1
148,000 Enron Corp. ................ 5,772,584 6,151,250 0.7
------------ ------------ -----
19,604,390 24,438,750 2.8
- -----------------------------------------------------------------------------------------------------------------------
OFFICE EQUIPMENT 166,000 Danka Business Systems PLC
(ADR)(a)(d)............... 8,183,680 2,645,625 0.3
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
188
<PAGE> 399
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD STOCKS & WARRANTS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OIL SERVICE 108,000 Schlumberger Ltd. .......... $ 4,559,877 $ 8,694,000 1.0%
207,700 +Smith International,
Inc. ..................... 9,470,352 12,747,587 1.5
------------ ------------ -----
14,030,229 21,441,587 2.5
- -----------------------------------------------------------------------------------------------------------------------
PETROLEUM 407,000 Unocal Corp. ............... 14,976,338 15,796,687 1.8
- -----------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 158,000 Bristol-Myers Squibb Co. ... 15,010,381 14,950,750 1.7
240,000 Lilly (Eli) & Co. .......... 15,149,088 16,710,000 1.9
204,000 Pfizer, Inc. ............... 14,923,388 15,210,750 1.7
103,000 Warner-Lambert Company...... 14,735,180 12,772,000 1.5
------------ ------------ -----
59,818,037 59,643,500 6.8
- -----------------------------------------------------------------------------------------------------------------------
RAILROADS 181,000 Burlington Northern Santa Fe
Inc. ..................... 16,084,375 16,821,687 1.9
- -----------------------------------------------------------------------------------------------------------------------
REAL ESTATE INVESTMENT 350,000 Glenborough Realty Trust,
TRUSTS Inc. ..................... 8,750,000 10,368,750 1.2
329,000 Prentiss Properties Trust... 6,849,900 9,191,437 1.1
170,950 Starwood Lodging Trust...... 5,653,340 9,893,731 1.1
------------ ------------ -----
21,253,240 29,453,918 3.4
- -----------------------------------------------------------------------------------------------------------------------
RESTAURANTS 225,000 +Tricon Global Restaurants,
Inc....................... 7,737,028 6,539,062 0.7
- -----------------------------------------------------------------------------------------------------------------------
RETAIL 170,000 +Safeway Inc. .............. 9,448,760 10,752,500 1.2
275,000 Sears, Roebuck & Co. ....... 11,050,732 12,443,750 1.4
280,000 Wal-Mart Stores, Inc. ...... 11,559,844 11,042,500 1.3
------------ ------------ -----
32,059,336 34,238,750 3.9
- -----------------------------------------------------------------------------------------------------------------------
RETAIL SPECIALTY 340,100 Rite Aid Corporation........ 11,262,366.. 19,959,619 2.3
- -----------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 621,569 +Tele-Communications, Inc.
(Class A)(Convertible
Preferred)................ 10,351,028 17,326,236 2.0
355,431 +Tele-Communications TCI
Ventures Group............ 5,919,015 10,063,140 1.2
528,000 +WorldCom, Inc. ............ 14,105,903 15,972,000 1.8
------------ ------------ -----
30,375,946 43,361,376 5.0
- -----------------------------------------------------------------------------------------------------------------------
TRANSPORT SERVICES 304,000 +OMI Corporation............ 3,937,476 2,793,000 0.3
- -----------------------------------------------------------------------------------------------------------------------
TRAVEL & LODGING 348,300 Carnival Corp. (Class A).... 10,328,886 19,287,112 2.2
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES 277,500 Texas Utilities Company..... 11,074,085 11,533,594 1.3
- -----------------------------------------------------------------------------------------------------------------------
TOTAL STOCKS & WARRANTS 707,637,197 856,978,354 97.9
- -----------------------------------------------------------------------------------------------------------------------
FACE
AMOUNT SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER** $19,251,000 General Motors Acceptance
Corp., 6.75% due
1/02/1998................. 19,243,781 19,243,781 2.2
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 19,243,781 19,243,781 2.2
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS........... $726,880,978 876,222,135 100.1
============
UNREALIZED APPRECIATION ON
FORWARD FOREIGN EXCHANGE
CONTRACTS***.............. 7,475 0.0
LIABILITIES IN EXCESS OF
OTHER ASSETS.............. (1,165,628) (0.1)
------------ -----
NET ASSETS.................. $875,063,982 100.0%
============ =====
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) American Depositary Receipts (ADR).
(b) Global Depositary Receipts (GDR).
(c) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock. The purchase price and number of shares are subject to
adjustment under certain conditions until the expiration date.
(d) Consistent with the general policy of the Securities and Exchange
Commission, the nationality or domicile of an issuer for determination of
foreign issuer status may be (i) the country under whose laws the issuer is
organized, (ii) the country in which the issuer's securities are principally
traded, or (iii) the country in which the issuer derives a significant
proportion (at least 50%) of its revenue or profits from goods produced and
sold, investments made, or services performed in the country, or in which at
least 50% of the assets of the issuer are situated.
(e) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
189
<PAGE> 400
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
+ Non-income producing security.
* Corresponding industry groups for foreign securities:
<TABLE>
<S> <C> <C>
(1) Automobile Parts (6) Entertainment (11) Pharmaceuticals
(2) Banking (7) Laser Components (12) Semiconductors
(3) Beverages (8) Mining (13) Tires & Rubber
(4) Electronics (9) Oil-Integrated (14) Hotels and Casinos
(5) Engineering & Construction (10) Petroleum
</TABLE>
** Commercial Paper is traded on a discount basis; the interest rate shown is
the discount rate paid at the time of purchase by the Fund.
*** Forward foreign exchange contracts sold as of December 31, 1997 were as
follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
EXPIRATION (DEPRECIATION)
FOREIGN CURRENCY SOLD DATE (NOTE 1B)
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
C$ 23,500,000............................................... March 1998 $ 100,445
L 4,950,000............................................... January 1998 (129,532)
Y 810,000,000............................................... January 1998 36,562
- ----------------------------------------------------------------------------------------------
TOTAL UNREALIZED APPRECIATION ON FORWARD FOREIGN EXCHANGE
CONTRACTS--NET (US$ COMMITMENT--$30,818,996) $ 7,475
=========
- ----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
190
<PAGE> 401
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost--$726,880,978) (Note
1a)....................................................... $876,222,135
Unrealized appreciation on forward foreign exchange
contracts (Note 1b)....................................... 7,475
Cash........................................................ 3,573
Receivables:
Dividends................................................. $ 917,014
Capital shares sold....................................... 53,532 970,546
----------
Prepaid expenses and other assets (Note 1f)................. 52,080
------------
Total assets................................................ 877,255,809
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 1,270,981
Forward foreign exchange contracts (Note 1b).............. 366,691
Investment adviser (Note 2)............................... 337,571
Capital shares redeemed................................... 95,012 2,070,255
----------
Accrued expenses and other liabilities...................... 121,572
------------
Total liabilities........................................... 2,191,827
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $875,063,982
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized+........................................ $ 2,277,348
Paid-in capital in excess of par............................ 600,627,564
Undistributed investment income--net........................ 8,054,505
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 114,755,946
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 149,348,619
------------
NET ASSETS.................................................. $875,063,982
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $875,063,982 and 22,773,482
shares outstanding........................................ $ 38.42
============
- ---------------------------------------------------------------------------------------
+ The Fund is authorized to issue 100,000,000 Class B Shares.
</TABLE>
See Notes to Financial Statements.
191
<PAGE> 402
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1d & 1e):
Dividends (net of $181,780 foreign withholding tax)......... $ 11,520,201
Interest and discount earned................................ 2,031,747
Other income................................................ 53,271
------------
Total income................................................ 13,605,219
------------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $ 3,629,013
Accounting services (Note 2)................................ 177,529
Professional fees........................................... 82,783
Custodian fees.............................................. 70,547
Directors' fees and expenses................................ 15,687
Transfer agent fees (Note 2)................................ 5,006
Pricing services............................................ 2,163
Other....................................................... 1,038
------------
Total expenses.............................................. 3,983,766
------------
Investment income--net...................................... 9,621,453
------------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET (NOTES 1b, 1c, 1e & 3):
Realized gain (loss) from:
Investments--net.......................................... 115,222,600
Foreign currency transactions--net........................ (1,566,938) 113,655,662
------------
Change in unrealized appreciation on:
Investments--net.......................................... 50,534,088
Foreign currency transactions--net........................ 7,462 50,541,550
------------ ------------
Net realized and unrealized gain on investments and foreign
currency transactions....................................... 164,197,212
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $173,818,665
============
- -----------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
192
<PAGE> 403
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 9,621,453 $ 13,443,795
Realized gain on investments and foreign currency
transactions--net......................................... 113,655,662 36,740,820
Change in unrealized appreciation on investments and foreign
currency transactions--net................................ 50,541,550 67,969,744
------------ ------------
Net increase in net assets resulting from operations........ 173,818,665 118,154,359
------------ ------------
- ----------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1g):
Investment income--net:
Class A................................................... (5,217,029) (14,235,069)
Realized gain on investments--net:
Class A................................................... (37,207,312) (84,325,410)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (42,424,341) (98,560,479)
------------ ------------
- ----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase (decrease) in net assets derived from capital
share transactions........................................ (50,605,570) 130,130,747
------------ ------------
- ----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 80,788,754 149,724,627
Beginning of year........................................... 794,275,228 644,550,601
------------ ------------
End of year*................................................ $875,063,982 $794,275,228
============ ============
- ----------------------------------------------------------------------------------------------
* Undistributed investment income--net (Note 1h)............ $ 8,054,505 $ 5,217,038
============ ============
- ----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
193
<PAGE> 404
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS A
FINANCIAL STATEMENTS. --------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997+ 1996+ 1995+ 1994+ 1993
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year...................... $ 32.83 $ 32.76 $ 27.74 $ 29.02 $ 25.48
-------- -------- -------- -------- --------
Investment income--net.................................. .41 .58 .58 .38 .24
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net.................... 6.94 4.44 5.48 (.74) 3.46
-------- -------- -------- -------- --------
Total from investment operations........................ 7.35 5.02 6.06 (.36) 3.70
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................ (.22) (.66) (.45) (.25) (.12)
Realized gain on investments--net..................... (1.54) (4.29) (.59) (.67) (.04)
-------- -------- -------- -------- --------
Total dividends and distributions....................... (1.76) (4.95) (1.04) (.92) (.16)
-------- -------- -------- -------- --------
Net asset value, end of year............................ $ 38.42 $ 32.83 $ 32.76 $ 27.74 $ 29.02
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share...................... 23.70% 17.90% 22.61% (1.20%) 14.57%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................ .48% .49% .51% .54% .62%
======== ======== ======== ======== ========
Investment income--net.................................. 1.16% 1.89% 1.94% 1.39% 1.07%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands).................. $875,064 $794,275 $644,551 $464,360 $309,420
======== ======== ======== ======== ========
Portfolio turnover...................................... 100.08% 88.30% 140.32% 60.57% 88.25%
======== ======== ======== ======== ========
Average commission rate paid++.......................... $ .0545 $ .0615 -- -- --
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
++ For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into US
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
See Notes to Financial Statements.
194
<PAGE> 405
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. Quality Equity Fund (the "Fund") is classified as "diversified",
as defined in the Investment Company Act of 1940. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Short-term securities are valued
at amortized cost, which approximates market value. Securities for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity, debt and currency markets. Losses may arise due
to changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts. Premium or discount is amortized over the life
of the contracts.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premium received is added to (or deducted from) the basis of the security
acquired or deducted from (or added to) the proceeds of the security sold. When
an option expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums received (or
gain or loss to the extent the cost of the closing transaction exceeds the
premium received).
Written options are non-income producing investments.
(c) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets and liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(d) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on
195
<PAGE> 406
- --------------------------------------------------------------------------------
the ex-dividend dates. Dividends from foreign securities where the ex-dividend
date may have passed are subsequently recorded when the Fund has determined the
ex-dividend date. Interest income (including amortization of premium and
discount) is recognized on the accrual basis. Realized gains and losses on
security transactions are determined on the identified cost basis.
(f) Prepaid registration fees--Prepaid registration fees are charged to
expense as the related shares are issued.
(g) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $1,566,957 have been reclassified between undistributed
net realized capital gains and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. MLAM is responsible for the management of the Company's
funds and provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the funds.
For such services, the Fund pays a monthly fee at the following annual rates:
0.500% of the Fund's average daily net assets not exceeding $250 million; 0.450%
of average daily net assets in excess of $250 million but not exceeding $300
million; 0.425% of average daily net assets in excess of $300 million but not
exceeding $400 million; and 0.400% of average daily net assets in excess of $400
million.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc., a subsidiary of ML & Co., earned $53,906 in commissions on the execution
of portfolio security transactions.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $796,781,044 and $859,557,465, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Realized Unrealized
Gains (Losses) Gains (Losses)
- ----------------------------------------------------------
<S> <C> <C>
Long-term investments.... $115,222,530 $149,341,157
Short-term investments... 70 --
Forward foreign exchange
contracts............... (1,476,958) 7,475
Foreign currency
transactions............ (89,980) (13)
------------ ------------
Total.................... $113,655,662 $149,348,619
============ ============
- ----------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $148,138,414, of which $176,983,429 related to appreciated
securities and $28,845,015 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$728,083,721.
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital share transactions
were $(50,605,570) and $130,130,747 for the years
196
<PAGE> 407
- --------------------------------------------------------------------------------
ended December 31, 1997 and December 31, 1996, respectively.
Transactions in capital shares were as follows:
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold........................... 762,740 $ 26,562,888
Shares issued to shareholders in
reinvestment of dividends and
distributions........................ 1,378,757 42,424,341
---------- ------------
Total issued.......................... 2,141,497 68,987,229
Shares redeemed....................... (3,562,259) (119,592,799)
---------- ------------
Net decrease.......................... (1,420,762) $(50,605,570)
========== ============
- -----------------------------------------------------------------
</TABLE>
- ---------------------------------------------------------
<TABLE>
<CAPTION>
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -----------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 1,934,738 $ 58,210,337
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 3,478,605 98,560,479
--------- ------------
Total issued........................... 5,413,343 156,770,816
Shares redeemed........................ (895,337) (26,640,069)
--------- ------------
Net increase........................... 4,518,006 $130,130,747
========= ============
- -----------------------------------------------------------------
</TABLE>
5. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $1.133468 per Class A Share and a long-term capital
gains distribution in the amount of $4.312370 per Class A Share payable on
January 9, 1998 to shareholders of record as of December 31, 1997.
197
<PAGE> 408
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (NOTE 1A)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BANK NOTES--11.6% $ 100,000 Bank of America, N.T. & S.A............. 5.93% 6/24/98 $ 99,999
200,000 Bank of America, N.T. & S.A.+........... 6.10 6/30/98 199,921
100,000 Bank of New York, The................... 5.85 8/20/98 99,952
500,000 BankBoston, N.A......................... 5.69 3/16/98 499,893
150,000 FNB of Chicago.......................... 5.89 8/26/98 149,969
200,000 KeyBank, N.A.+.......................... 5.64... 5/06/98 199,967
100,000 KeyBank, N.A.+.......................... 5.62 8/20/98 99,954
500,000 KeyBank, N.A.+.......................... 5.62 8/28/98 499,780
200,000 Northern Trust Company.................. 5.96 6/17/98 200,019
400,000 PNC Bank, N.A.+......................... 5.60 10/01/98 399,798
- ------------------------------------------------------------------------------------------------------------------------
TOTAL BANK NOTES (COST--$2,449,277) 2,449,252
- ------------------------------------------------------------------------------------------------------------------------
CERTIFICATES OF 250,000 Chase Manhattan Bank USA, N.A. ......... 5.87 7/21/98 249,948
DEPOSIT--3.6% 500,000 Morgan Guaranty Trust Co. of NY......... 5.71 1/06/98 499,986
- ------------------------------------------------------------------------------------------------------------------------
TOTAL CERTIFICATES OF DEPOSIT (COST--$749,998) 749,934
- ------------------------------------------------------------------------------------------------------------------------
CERTIFICATES OF 100,000 ABN-AMRO Bank N.V....................... 5.77 7/28/98 99,930
DEPOSIT--YANKEE--2.6% 250,000 Bayerische Vereinsbank AG............... 5.71 10/06/98 249,592
100,000 Westdeutsche Landesbank Girozentrale.... 5.94 6/29/98 100,015
100,000 Westdeutsche Landesbank Girozentrale.... 5.83 8/03/98 99,946
- ------------------------------------------------------------------------------------------------------------------------
TOTAL CERTIFICATES OF DEPOSIT--YANKEE (COST--$549,825) 549,483
- ------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER--44.8% 1,000,000 Block Financial Corp.................... 5.67 4/03/98 985,718
1,000,000 CSW Credit, Inc......................... 5.62 2/13/98 993,152
500,000 Centric Capital Corp.................... 6.50 1/07/98 499,549
243,000 Countrywide Home Loans, Inc............. 5.90 1/07/98 242,801
1,000,000 Finova Capital Corp..................... 5.73 3/18/98 988,229
250,000 Ford Motor Credit Co.................... 5.60 3/30/98 246,586
100,000 General Motors Acceptance Corp.......... 5.56 3/30/98 98,635
530,000 International Securitization
Corporation............................. 5.80 3/20/98 523,595
300,000 Lehman Brothers Holdings, Inc........... 5.90 1/15/98 299,361
465,000 Lehman Brothers Holdings, Inc........... 5.78 1/21/98 463,589
197,000 Lehman Brothers Holdings, Inc........... 5.60 1/29/98 196,146
500,000 Lexington Parker Capital Co. LLC........ 5.92 2/20/98 496,005
225,000 Morgan Stanley, Dean Witter, Discover
& Co. .................................. 5.75 3/17/98 222,387
700,000 New Center Asset Trust.................. 5.68 3/18/98 691,761
764,000 Old Line Funding Corp................... 5.77 1/20/98 761,804
507,000 Park Avenue Receivables Corp............ 5.90 1/23/98 505,255
175,000 Toshiba International Finance (UK)
PLC..................................... 5.90 1/12/98 174,722
174,000 Toshiba International Finance (UK)
PLC..................................... 5.90 1/14/98 173,668
570,000 Windmill Funding Corp................... 5.80 2/13/98 566,097
330,000 Windmill Funding Corp................... 5.77 2/20/98 327,363
- ------------------------------------------------------------------------------------------------------------------------
TOTAL COMMERCIAL PAPER (COST--$9,456,339) 9,456,423
- ------------------------------------------------------------------------------------------------------------------------
CORPORATE NOTES--3.4% 722,915 LABS Trust Series 1996-4 Senior
Notes+++................................ 5.969 12/28/98 722,915
- ------------------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE NOTES (COST--$722,915) 722,915
- ------------------------------------------------------------------------------------------------------------------------
FUNDING AGREEMENTS--4.7% 1,000,000 Jackson National Life Insurance Co.+.... 5.72 5/01/98 1,000,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL FUNDING AGREEMENTS (COST--$1,000,000) 1,000,000
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
198
<PAGE> 409
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FACE INTEREST MATURITY VALUE
AMOUNT ISSUE RATE* DATE (NOTE 1A)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
MEDIUM-TERM NOTES--6.4% $ 200,000 CIT Group Holdings, Inc., The........... 6.50% 7/13/98 $ 200,660
100,000 CIT Group Holdings, Inc., The+.......... 5.58 8/17/98 99,946
250,000 IBM Credit Corp......................... 5.868 8/13/98 249,984
100,000 International Business Machines Corp.... 5.67 1/28/98 99,984
400,000 International Business Machines Corp.... 5.93 3/18/98 400,143
300,000 Norwest Corporation..................... 6.00 10/13/98 300,231
- ------------------------------------------------------------------------------------------------------------------------
TOTAL MEDIUM-TERM NOTES (COST--$1,350,659) 1,350,948
- ------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT, AGENCY & 50,000 Federal Home Loan Mortgage Corp. ....... 5.50 1/30/98 49,783
INSTRUMENTALITY 500,000 Federal National Mortgage Association... 5.44 8/05/98 483,818
OBLIGATIONS-- 250,000 US Treasury Bills....................... 5.08 1/15/98 249,535
DISCOUNT--3.7%
- ------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT, AGENCY & INSTRUMENTALITY
OBLIGATIONS--DISCOUNT (COST--$783,083) 783,136
- ------------------------------------------------------------------------------------------------------------------------
US GOVERNMENT, AGENCY & 300,000 Federal Home Loan Banks+................ 5.899 10/20/98 299,930
INSTRUMENTALITY 150,000 Federal Home Loan Banks................. 5.99 8/11/99 149,859
OBLIGATIONS-- 100,000 Federal Home Loan Mortgage Corp......... 5.685 8/21/98 99,906
NON-DISCOUNT--19.0% 100,000 Federal Home Loan Mortgage Corp......... 6.36 5/20/99 100,196
500,000 Federal National Mortgage
Association+............................ 5.629 3/27/98 499,922
500,000 Federal National Mortgage
Association+............................ 5.669 4/24/98 499,941
1,000,000 Federal National Mortgage
Association+............................ 6.00 5/14/98 1,000,000
300,000 Federal National Mortgage
Association+............................ 5.894 10/20/98 299,896
560,000 Federal National Mortgage
Association+............................ 5.609 5/25/99 555,690
200,000 Student Loan Marketing Association...... 5.86 6/10/98 200,104
100,000 Student Loan Marketing Association+..... 5.877 10/06/98 99,952
200,000 US Treasury Notes....................... 5.625 11/30/98 200,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL US GOVERNMENT, AGENCY & INSTRUMENTALITY
OBLIGATIONS--NON-DISCOUNT (COST--$4,004,903) 4,005,396
- ------------------------------------------------------------------------------------------------------------------------
REPURCHASE 350,000 HSBC Holdings Inc., purchased on
AGREEMENTS**--1.7% 12/31/1997 to yield 6.25% to
1/02/1998............................. 350,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS (COST--$350,000) 350,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$21,416,999)--101.5%............. 21,417,487
LIABILITIES IN EXCESS OF OTHER
ASSETS--(1.5%).......................... (315,265)
-----------
NET ASSETS--100.0%...................... $21,102,222
===========
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper and certain US Government, Agency & Instrumentality
Obligations are traded on a discount basis; the interest rates shown are the
discount rates paid at the time of purchase by the Fund. Other securities bear
interest rate at the rates shown, payable at fixed dates or upon maturity. The
interest rates on variable rate securities are adjusted periodically based
upon appropriate indexes; the interest rates shown are the rates in effect at
December 31, 1997.
** Repurchase Agreements are fully collateralized by US Government Obligations.
+ Variable Rate Notes.
++ Subject to principal paydowns.
See Notes to Financial Statements.
199
<PAGE> 410
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost $21,416,999*) (Note
1a)....................................................... $21,417,487
Cash........................................................ 3,397
Receivables:
Interest.................................................. $147,290
Capital shares sold....................................... 36,288 183,578
--------
Prepaid expenses and other assets........................... 289
-----------
Total assets................................................ 21,604,751
-----------
- ------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 483,755
Investment adviser (Note 2)............................... 9,228
Capital shares redeemed................................... 4,957 497,940
--------
Accrued expenses and other liabilities...................... 4,589
-----------
Total liabilities........................................... 502,529
-----------
- ------------------------------------------------------------------------------------
NET ASSETS.................................................. $21,102,222
===========
- ------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 500,000,000
shares authorized+........................................ $ 2,110,173
Paid-in capital in excess of par............................ 18,991,561
Unrealized appreciation on investments--net................. 488
-----------
NET ASSETS.................................................. $21,102,222
===========
- ------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $21,102,222 and 21,101,733
shares outstanding........................................ $ 1.00
===========
- ------------------------------------------------------------------------------------
</TABLE>
* Cost for Federal income tax purposes. As of December 31, 1997, net unrealized
appreciation for Federal income tax purposes amounted to $488, of which $1,772
related to appreciated securities and $1,284 related to depreciated
securities.
+ The Fund is authorized to issue 500,000,000 Class B Shares.
See Notes to Financial Statements.
200
<PAGE> 411
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTE 1d):
Interest and discount earned................................ $1,213,769
- -----------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $107,029
Custodian fees.............................................. 8,362
Professional fees........................................... 6,996
Transfer agent fees (Note 2)................................ 4,979
Accounting services (Note 2)................................ 4,316
Directors' fees and expenses................................ 328
--------
Total expenses.............................................. 132,010
----------
Investment income--net...................................... 1,081,759
----------
- -----------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN ON INVESTMENTS--NET (NOTE 1d):
Realized gain on investments--net........................... 1,873
Change in unrealized depreciation on investments--net....... 740
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $1,084,372
==========
- -----------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
201
<PAGE> 412
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 1,081,759 $ 1,179,223
Realized gain on investments--net........................... 1,873 3,049
Change in unrealized appreciation/depreciation on
investments--net.......................................... 740 (14,201)
------------ ------------
Net increase in net assets resulting from operations........ 1,084,372 1,168,071
------------ ------------
- --------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1E):
Investment income--net:
Class A................................................... (1,081,759) (1,179,223)
Realized capital gain on investments--net:
Class A................................................... (1,873) (3,049)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................... (1,083,632) (1,182,272)
------------ ------------
- --------------------------------------------------------------------------------------------
CLASS A CAPITAL SHARE TRANSACTIONS (NOTE 3):
Net proceeds from sale of shares............................ 8,423,689 6,967,844
Net asset value of shares issued to shareholders in
reinvestment of dividends and distributions (Note 1e)..... 1,083,837 1,182,349
------------ ------------
9,507,526 8,150,193
Cost of shares redeemed..................................... (11,291,415) (10,800,490)
------------ ------------
Net decrease in net assets derived from capital share
transactions.............................................. (1,783,889) (2,650,297)
------------ ------------
- --------------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (1,783,149) (2,664,498)
Beginning of year........................................... 22,885,371 25,549,869
------------ ------------
End of year................................................. $ 21,102,222 $ 22,885,371
============ ============
- --------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
202
<PAGE> 413
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM CLASS A
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. ---------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year........................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
------- ------- ------- ------- -------
Investment income--net....................................... .0506 .0501 .0543 .0371 .0268
Realized and unrealized gain (loss) on investments--net...... .0001 (.0005) .0018 (.0009) .0005
------- ------- ------- ------- -------
Total from investment operations............................. .0507 .0496 .0561 .0362 .0273
------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net..................................... (.0506) (.0501) (.0543) (.0362) (.0268)
Realized gain on investments--net.......................... (.0001) (.0001) (.0004) --+ (.0005)
------- ------- ------- ------- -------
Total dividends and distributions............................ (.0507) (.0502) (.0547) (.0362) (.0273)
------- ------- ------- ------- -------
Net asset value, end of year................................. $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share........................... 5.19% 5.13% 5.61% 3.79% 2.77%
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses..................................................... .62% .61% .61% .65% .70%
======= ======= ======= ======= =======
Investment income and realized gain on investments--net...... 5.06% 4.96% 5.47% 3.75% 2.73%
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands)....................... $21,102 $22,885 $25,550 $32,196 $30,168
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Amount is less than $.0001 per share.
See Notes to Financial Statements.
203
<PAGE> 414
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A Shares and each fund began offering Class B Shares. Both classes of shares
have equal voting, dividend, liquidation and other rights, except that only
shares of the respective classes are entitled to vote on matters concerning only
that class and Class B Shares bear certain expenses related to the distribution
of such shares. Reserve Assets Fund (the "Fund") is classified as "diversified"
as defined in the Investment Company Act of 1940. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Investments maturing more than sixty days after
the valuation date are valued at the most recent bid price or yield equivalent
as obtained from dealers that make markets in such securities. When such
securities are valued with sixty days or less to maturity, the difference
between the valuation existing on the sixty-first day before maturity and
maturity value is amortized on a straight-line basis to maturity. Investments
maturing within sixty days from their date of acquisition are valued at
amortized cost, which approximates market value. For purposes of valuation, the
maturity of a variable rate security is deemed to be the next coupon date on
which the interest rate is to be adjusted. Securities for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Board of Directors of the Company.
(b) Repurchase agreements--The Fund invests in US Government securities
pursuant to repurchase agreements with a member bank of the Federal Reserve
System or a primary dealer in US Government securities. Under such agreements,
the bank or primary dealer agrees to repurchase the security at a mutually
agreed upon time and price. The Fund takes possession of the underlying
securities, marks to market such securities and, if necessary, receives
additional securities daily to ensure that the contract is fully collateralized.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute all of its taxable income to its shareholders. Therefore, no Federal
income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income (including amortization of discount) is recognized on the
accrual basis. Realized gains and losses on security transactions are determined
on the identified cost basis.
(e) Dividends and distributions--The Fund declares dividends daily and
reinvests monthly such dividends (net of non-resident alien tax and back-up
withholding tax) in additional shares of beneficial interest at net asset value.
Dividends and distributions are declared from the total of net investment income
and net realized gain or loss on investments.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the following annual rates: 0.500% of the Fund's average daily net assets not
exceeding $500 million; 0.425% of average daily net assets in excess of $500
million but not exceeding $750 million; 0.375% of average daily net assets in
excess of $750 million but not exceeding $1 billion; 0.350% of average daily net
assets in excess of $1 billion but not exceeding $1.5 billion; 0.325% of average
daily net assets in excess of $1.5 billion but not exceeding $2 billion; 0.300%
of average daily net assets in excess of $2 billion but not exceeding $2.5
billion and 0.275% of average daily net assets in excess of $2.5 billion.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement
204
<PAGE> 415
- --------------------------------------------------------------------------------
which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, Merrill Lynch Funds Distributor, Inc., a wholly-owned
subsidiary of Merrill Lynch Group, Inc., which is the Fund's distributor, and/or
ML & Co.
3. CAPITAL SHARE TRANSACTIONS:
The number of shares sold and redeemed during the periods corresponds to the
amounts included in the Statements of Changes in Net Assets with respect to net
proceeds from sale of shares and cost of shares redeemed, respectively, since
shares are recorded at $1.00 per share.
205
<PAGE> 416
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ADVERTISING 161,000 +HA-LO Industries, Inc........ $ 3,433,385 $ 4,186,000 0.9%
- -----------------------------------------------------------------------------------------------------------------------
AIR TRANSPORTATION 158,500 Air Express International
Corporation................. 3,871,000 4,774,813 1.0
- -----------------------------------------------------------------------------------------------------------------------
APPLIED TECHNOLOGY 200 +QuickResponse Services,
Inc......................... 6,882 7,300 0.0
- -----------------------------------------------------------------------------------------------------------------------
AUTO--RELATED 170,000 Meritor Automotive, Inc....... 3,738,124 3,580,625 0.7
- -----------------------------------------------------------------------------------------------------------------------
AUTOMOBILE PARTS 225,900 Walbro Corp................... 4,338,063 2,993,175 0.6
- -----------------------------------------------------------------------------------------------------------------------
BANKS & FINANCE 102,680 Charter One Financial, Inc.... 4,987,896 6,443,170 1.3
- -----------------------------------------------------------------------------------------------------------------------
BIOTECHNOLOGY 107,300 +COR Therapeutics, Inc........ 1,219,200 2,400,838 0.5
160,000 +Cephalon, Inc................ 1,645,909 1,820,000 0.4
41,000 +Gilead Sciences, Inc......... 1,008,477 1,568,250 0.3
------------ ------------ -----
3,873,586 5,789,088 1.2
- -----------------------------------------------------------------------------------------------------------------------
BROADCAST 773,900 +Paxson Communications
Corp........................ 8,351,931 5,707,513 1.2
- -----------------------------------------------------------------------------------------------------------------------
BUILDING & CONSTRUCTION 150,000 Ryland Group, Inc. (The)...... 2,438,380 3,543,750 0.7
123,000 +Toll Brothers, Inc........... 2,347,248 3,290,250 0.7
------------ ------------ -----
4,785,628 6,834,000 1.4
- -----------------------------------------------------------------------------------------------------------------------
BUILDING MATERIALS 51,800 Apogee Enterprises, Inc....... 533,209 615,125 0.1
- -----------------------------------------------------------------------------------------------------------------------
CABLE 193,400 General Cable Corp............ 4,591,335 6,998,663 1.5
- -----------------------------------------------------------------------------------------------------------------------
CEMENT 172,000 +Giant Cement Holdings,
Inc......................... 3,519,024 3,956,000 0.8
- -----------------------------------------------------------------------------------------------------------------------
COMMUNICATION EQUIPMENT 396,000 +Network Equipment
Technologies, Inc........... 6,175,879 5,791,500 1.2
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES 136,300 +BISYS Group, Inc. (The)...... 4,441,761 4,531,975 0.9
178,000 +Boole & Babbage, Inc......... 3,765,250 5,317,750 1.1
67,000 National Data Corporation..... 2,547,874 2,420,375 0.5
------------ ------------ -----
10,754,885 12,270,100 2.5
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER SOFTWARE 277,400 +Business Objects S.A.
(ADR)**..................... 3,480,686 2,843,350 0.6
156,900 +Cylink Corporation........... 2,251,288 1,529,775 0.3
145,935 +Harbinger Corporation........ 3,233,946 4,067,938 0.8
185,600 +Learning Company, Inc.
(The)....................... 2,288,113 2,981,200 0.6
349,700 +Metromail Corporation........ 7,735,051 6,250,888 1.3
300,300 +Phoenix Technologies Ltd..... 4,196,485 3,641,138 0.8
93,500 +Sterling Commerce, Inc....... 3,154,307 3,593,906 0.7
96,700 +Vanstar Corporation.......... 986,591 1,093,919 0.2
163,500 +Wonderware Corp.............. 2,857,683 2,309,438 0.5
------------ ------------ -----
30,184,150 28,311,552 5.8
- -----------------------------------------------------------------------------------------------------------------------
COMPUTER TECHNOLOGY 113,700 +Platinum Technology, Inc..... 1,806,315 3,212,025 0.7
- -----------------------------------------------------------------------------------------------------------------------
COMPUTERS 100,800 +Axiom, Inc................... 1,210,521 403,200 0.1
289,700 +IKOS Systems, Inc............ 2,545,130 1,774,413 0.4
1,207,600 +Physician Computer Network,
Inc......................... 7,225,977 4,830,400 1.0
488,000 +Sybase, Inc.................. 7,472,994 6,496,500 1.3
325,100 Telxon Corporation............ 7,048,773 7,761,763 1.6
------------ ------------ -----
25,503,395 21,266,276 4.4
- -----------------------------------------------------------------------------------------------------------------------
COMPUTERS & PERIPHERALS 398,000 +Planar Systems, Inc.......... 4,727,044 4,079,500 0.8
- -----------------------------------------------------------------------------------------------------------------------
DEFENSE 186,000 +ESCO Electronics
Corporation................. 3,277,736 3,138,750 0.7
- -----------------------------------------------------------------------------------------------------------------------
DIVERSIFIED 237,100 +ACX Technologies, Inc........ 5,517,998 5,794,131 1.2
- -----------------------------------------------------------------------------------------------------------------------
DIVERSIFIED MANUFACTURING 258,400 +Figgie International, Inc.
(Class A)................... 3,597,088 3,391,500 0.7
- -----------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 21,122 Emerson Electric Co........... 1,014,993 1,192,073 0.2
- -----------------------------------------------------------------------------------------------------------------------
ELECTRONIC COMPONENTS 285,400 +Alpha Industries, Inc........ 4,316,675 4,602,075 1.0
87,000 +Triumph Group, Inc........... 2,484,720 2,892,750 0.6
------------ ------------ -----
6,801,395 7,494,825 1.6
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
206
<PAGE> 417
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ELECTRONICS DISTRIBUTION 464,000 +DII Group, Inc............... $ 9,959,944 $ 12,470,000 2.6%
183,200 +ITI Technologies, Inc........ 4,425,974 4,007,500 0.8
------------ ------------ -----
14,385,918 16,477,500 3.4
- -----------------------------------------------------------------------------------------------------------------------
ENGINEERING & CONSTRUCTION 347,800 +Insituform Technologies, Inc.
(Class A)................... 2,996,006 2,651,975 0.6
- -----------------------------------------------------------------------------------------------------------------------
ENTERTAINMENT 68,000 Dover Downs Entertainment
Inc......................... 1,439,910 1,559,750 0.3
- -----------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 132,200 +FirstFed Financial Corp...... 4,046,032 5,122,750 1.1
- -----------------------------------------------------------------------------------------------------------------------
FINANCIAL SERVICES-- 66,046 Reliastar Financial Corp...... 2,230,089 2,720,270 0.6
CONSUMER
- -----------------------------------------------------------------------------------------------------------------------
GAMING 248,500 +Sodak Gaming, Inc............ 3,051,238 1,584,188 0.3
250,300 +WMS Industries, Inc.......... 5,270,197 5,287,587 1.1
------------ ------------ -----
8,321,435 6,871,775 1.4
- -----------------------------------------------------------------------------------------------------------------------
HEALTH SERVICES 57,000 +Sierra Health Services,
Inc......................... 1,774,125 1,916,625 0.4
- -----------------------------------------------------------------------------------------------------------------------
HEALTHCARE--PHARMACEUTICALS 242,850 +Magainin Pharmaceuticals,
Inc......................... 2,567,638 1,957,978 0.4
- -----------------------------------------------------------------------------------------------------------------------
HEALTHCARE--PRODUCTS & 192,900 +Bell Industries, Inc......... 3,111,508 2,652,375 0.6
SERVICES
- -----------------------------------------------------------------------------------------------------------------------
HOSPITAL MANAGEMENT 165,000 +Magellan Health Services,
Inc......................... 5,018,308 3,547,500 0.7
- -----------------------------------------------------------------------------------------------------------------------
HOSPITALS 110,300 +Veterinary Centers of
America, Inc................ 1,550,090 1,468,369 0.3
- -----------------------------------------------------------------------------------------------------------------------
INDUSTRIAL 55,000 +C.P. Clare Corporation....... 712,500 708,125 0.1
- -----------------------------------------------------------------------------------------------------------------------
INDUSTRIAL--SERVICES 119,000 +Cuno Incorporated............ 1,693,969 1,814,750 0.4
- -----------------------------------------------------------------------------------------------------------------------
INSTRUMENTS/PHOTO-OPTICAL 3,800 +Identix, Inc................. 31,540 36,575 0.0
- -----------------------------------------------------------------------------------------------------------------------
INSURANCE 101,000 AGCO Corp..................... 3,164,545 2,954,250 0.6
47,350 American National Insurance
Co.......................... 4,420,316 4,403,550 0.9
150,000 +DONCASTERS PLC (ADR)**...... 3,921,500 3,168,750 0.7
209,000 PXRE Corp..................... 5,518,647 6,936,187 1.4
------------ ------------ -----
17,025,008 17,462,737 3.6
- -----------------------------------------------------------------------------------------------------------------------
MACHINERY 129,150 Applied Industrial
Technologies, Inc........... 3,183,262 3,454,762 0.7
308,000 Stewart & Stevenson Services,
Inc......................... 7,700,088 7,854,000 1.6
------------ ------------ -----
10,883,350 11,308,762 2.3
- -----------------------------------------------------------------------------------------------------------------------
MACHINERY & MACHINE TOOLS 89,100 Cincinnati Milacron, Inc...... 2,370,641 2,311,031 0.5
64,000 Kennametal Inc................ 2,875,932 3,316,000 0.7
------------ ------------ -----
5,246,573 5,627,031 1.2
- -----------------------------------------------------------------------------------------------------------------------
MANUFACTURED HOUSING 116,000 Oakwood Homes Corporation..... 2,396,774 3,849,750 0.8
- -----------------------------------------------------------------------------------------------------------------------
MARKETING 9,900 +Catalina Marketing
Corporation................. 334,719 457,875 0.1
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL 217,000 +Genome Therapeutics
Corporation................. 1,852,452 1,383,375 0.3
102,100 +Sequana Therapeutics Inc..... 1,360,557 1,116,719 0.2
------------ ------------ -----
3,213,009 2,500,094 0.5
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL SERVICES 291,000 +NABI, Inc.................... 2,103,909 1,000,312 0.2
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL SPECIALTIES 622,300 +VISX, Inc.................... 13,849,057 13,535,025 2.8
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL SUPPLIES 80,900 +Biomatrix, Inc............... 2,537,850 2,346,100 0.5
351,900 +Vivus, Inc................... 8,502,046 3,738,937 0.8
------------ ------------ -----
11,039,896 6,085,037 1.3
- -----------------------------------------------------------------------------------------------------------------------
MEDICAL TECHNOLOGY 140,000 +HCIA Inc..................... 1,749,249 1,662,500 0.3
222,000 +Scios Inc.................... 1,524,798 2,220,000 0.5
------------ ------------ -----
3,274,047 3,882,500 0.8
- -----------------------------------------------------------------------------------------------------------------------
MERCHANDISING 290,000 Heilig-Meyers Company......... 4,441,136 3,480,000 0.7
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
207
<PAGE> 418
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
METAL FABRICATING 150,000 +Miller Industries, Inc....... $ 1,800,438 $ 1,612,500 0.3%
75,000 Quanex Corp................... 2,057,512 2,109,375 0.4
80,000 +Ryerson Tull, Inc............ 1,281,539 1,110,000 0.2
------------ ------------ -----
5,139,489 4,831,875 0.9
- -----------------------------------------------------------------------------------------------------------------------
METAL PROCESSING 138,000 +Wolverine Tube, Inc.......... 4,059,788 4,278,000 0.9
- -----------------------------------------------------------------------------------------------------------------------
METALS 109,400 Castle (A.M.) & Company....... 2,456,274 2,502,525 0.5
411,400 Commonwealth Industries
Inc......................... 7,950,098 6,016,725 1.3
308,000 +Shiloh Industries, Inc....... 6,067,867 5,852,000 1.2
------------ ------------ -----
16,474,239 14,371,250 3.0
- -----------------------------------------------------------------------------------------------------------------------
OFFICE--RELATED 295,000 +Wang Laboratories, Inc....... 5,879,941 6,526,875 1.4
- -----------------------------------------------------------------------------------------------------------------------
OIL 312,100 +Benton Oil & Gas Co.......... 4,636,227 4,037,794 0.8
- -----------------------------------------------------------------------------------------------------------------------
OIL & GAS PRODUCERS 133,900 +Louis Dreyfus Natural Gas
Corp........................ 2,569,424 2,502,256 0.5
135,000 +Brown (Tom) Inc.............. 3,068,126 2,598,750 0.5
------------ ------------ -----
5,637,550 5,101,006 1.0
- -----------------------------------------------------------------------------------------------------------------------
PETROLEUM 50,000 +Plains Resources, Inc........ 748,212 859,375 0.2
- -----------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 160,000 +NeoRx Corp................... 1,034,843 880,000 0.2
73,400 +Neurogen Corporation......... 979,256 990,900 0.2
193,600 +Pharmaceutical Product
Development, Inc............ 2,525,568 2,976,600 0.6
35,000 +Sano Corporation............. 391,562 1,159,375 0.2
------------ ------------ -----
4,931,229 6,006,875 1.2
- -----------------------------------------------------------------------------------------------------------------------
RENTAL SERVICES 231,900 Unitog Company................ 5,649,579 5,130,787 1.1
- -----------------------------------------------------------------------------------------------------------------------
RESTAURANTS 9,200 +Cheesecake Factory, Inc...... 207,000 276,575 0.1
- -----------------------------------------------------------------------------------------------------------------------
RETAIL 186,900 +Department 56, Inc........... 4,140,354 5,373,375 1.1
- -----------------------------------------------------------------------------------------------------------------------
RETAIL--MAIL ORDER 69,900 +Global DirectMail Corp....... 1,556,007 1,210,144 0.3
259,500 +Viking Office Products,
Inc. ....................... 5,334,462 5,660,344 1.2
------------ ------------ -----
6,890,469 6,870,488 1.5
- -----------------------------------------------------------------------------------------------------------------------
RETAIL SPECIALTY 442,000 +Micro Warehouse, Inc......... 7,323,468 6,160,375 1.3
- -----------------------------------------------------------------------------------------------------------------------
RETAIL STORES 138,300 Baker (J.) Inc................ 1,075,200 777,937 0.2
- -----------------------------------------------------------------------------------------------------------------------
SAVINGS & LOAN 210,200 Haven Bancorp, Inc............ 3,806,800 4,676,950 1.0
- -----------------------------------------------------------------------------------------------------------------------
SOFTWARE--COMPUTER 632,900 +Mentor Graphics Corporation.. 6,367,041 6,131,219 1.3
750,000 +Structural Dynamics Research
Corporation................. 17,349,976 16,875,000 3.5
------------ ------------ -----
23,717,017 23,006,219 4.8
- -----------------------------------------------------------------------------------------------------------------------
STEEL 197,800 +Citation Corp. .............. 3,030,695 3,214,250 0.7
46,600 +Novamerican Steel Inc........ 504,450 524,250 0.1
------------ ------------ -----
3,535,145 3,738,500 0.8
- -----------------------------------------------------------------------------------------------------------------------
TECHNOLOGY 276,600 +Applied Digital Access,
Inc. ....................... 2,162,998 1,607,737 0.3
116,200 +Storage Technology Corp...... 5,283,728 7,197,137 1.5
------------ ------------ -----
7,446,726 8,804,874 1.8
- -----------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 230,000 +APAC Teleservices, Inc....... 3,138,534 3,105,000 0.6
140,050 +Brite Voice Systems, Inc..... 1,158,250 1,365,487 0.3
206,000 +MasTec, Inc.................. 4,993,312 4,712,250 1.0
584,300 +Metromedia International
Group, Inc.................. 7,058,163 5,550,850 1.2
252,900 +SITEL Corp................... 2,362,764 2,307,712 0.5
------------ ------------ -----
18,711,023 17,041,299 3.6
- -----------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS & 100,700 +Allen Telecom Inc............ 1,783,426 1,856,656 0.4
EQUIPMENT 310,600 +DSP Communications, Inc...... 5,867,665 3,727,200 0.8
------------ ------------ -----
7,651,091 5,583,856 1.2
- -----------------------------------------------------------------------------------------------------------------------
TEXTILES 200,000 +Dan River Inc. (Class A)..... 3,009,997 3,287,500 0.7
- -----------------------------------------------------------------------------------------------------------------------
TOOLS 248,200 +Brown & Sharpe Manufacturing
Company (Class A)........... 3,380,927 2,528,537 0.5
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
208
<PAGE> 419
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE PERCENT OF
INDUSTRY HELD COMMON STOCKS COST (NOTE 1A) NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
TRANSPORT--TRUCK 252,200 +Landair Services, Inc........ $ 5,156,567 $ 5,800,600 1.2%
- -----------------------------------------------------------------------------------------------------------------------
TRANSPORTATION--FREIGHT 222,500 Circle International Group
Inc......................... 5,883,836 5,103,594 1.1
- -----------------------------------------------------------------------------------------------------------------------
UTILITIES--GAS 148,100 +Primark Corp................. 4,048,554 6,025,819 1.2
- -----------------------------------------------------------------------------------------------------------------------
WHOLESALE & INTERNATIONAL 497,600 +CHS Electronics, Inc......... 9,469,780 8,334,800 1.7
TRADE
- -----------------------------------------------------------------------------------------------------------------------
WIRELESS COMMUNICATIONS 279,000 +Anixter International Inc.... 4,817,958 4,603,500 1.0
- -----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS 442,505,653 435,661,779 90.4
- -----------------------------------------------------------------------------------------------------------------------
FACE AMOUNT
SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER* $ 4,000,000 Countrywide Home Loans, 6.02%
due 1/09/1998............... 3,993,980 3,993,980 0.8
21,176,000 General Motors Acceptance
Corp., 6.75% due 1/02/1998.. 21,168,059 21,168,059 4.4
Lexington Parker Capital:
6,000,000 5.88% due 1/07/1998........... 5,993,140 5,993,140 1.3
4,000,000 5.90% due 1/09/1998........... 3,994,100 3,994,100 0.8
10,000,000 WCP Funding Inc., 5.85% due
1/16/1998................... 9,974,000 9,974,000 2.1
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES 45,123,279 45,123,279 9.4
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS............. $487,628,932 480,785,058 99.8
============
OTHER ASSETS LESS
LIABILITIES................. 1,076,661 0.2
------------ -----
NET ASSETS.................... $481,861,719 100.0%
============ =====
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commercial Paper is traded on a discount basis; the interest rates shown are
the discount rates paid at the time of purchase by the Fund.
** American Depositary Receipts (ADR).
+ Non-income producing security.
See Notes to Financial Statements.
209
<PAGE> 420
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (identified cost $487,628,932) (Note
1a)....................................................... $480,785,058
Cash........................................................ 294
Receivables:
Securities sold........................................... $4,376,852
Capital shares sold....................................... 53,705
Dividends................................................. 38,355 4,468,912
----------
Prepaid expenses and other assets........................... 28,983
------------
Total assets................................................ 485,283,247
------------
- ---------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 2,906,960
Investment adviser (Note 2)............................... 323,590
Capital shares redeemed................................... 111,342
Distributor (Note 2)...................................... 34 3,341,926
----------
Accrued expenses and other liabilities...................... 79,602
------------
Total liabilities........................................... 3,421,528
------------
- ---------------------------------------------------------------------------------------
NET ASSETS.................................................. $481,861,719
============
- ---------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class A Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... $ 1,735,544
Class B Shares of Common Stock, $0.10 par value, 100,000,000
shares authorized......................................... 894
Paid-in capital in excess of par............................ 375,938,739
Undistributed investment income--net........................ 1,476,774
Undistributed realized capital gains on investments--net.... 109,553,642
Unrealized depreciation on investments--net................. (6,843,874)
------------
NET ASSETS.................................................. $481,861,719
============
- ---------------------------------------------------------------------------------------
NET ASSET VALUE:
Class A--Based on net assets of $481,613,827 and 17,355,445
shares outstanding........................................ $ 27.75
============
Class B--Based on net assets of $247,892 and 8,936 shares
outstanding............................................... $ 27.74
============
- ---------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
210
<PAGE> 421
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME (NOTES 1c & 1d):
Interest and discount earned................................ $ 3,096,138
Dividends (net of $1,276 foreign withholding tax)........... 2,061,070
Other income................................................ 11,658
------------
Total income................................................ 5,168,866
------------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees (Note 2)........................... $3,466,085
Accounting services (Note 2)................................ 101,058
Custodian fees.............................................. 60,209
Professional fees........................................... 50,998
Directors' fees and expenses................................ 8,686
Transfer agent fees (Note 2)................................ 5,005
Distribution fees--Class B (Note 2)*........................ 34
----------
Total expenses.............................................. 3,692,075
------------
Investment income--net...................................... 1,476,791
------------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET (NOTES
1b, 1d & 3):
Realized gain on investments--net........................... 109,665,458
Change in unrealized appreciation/depreciation on
investments--net.......................................... (60,400,517)
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 50,741,732
============
- ---------------------------------------------------------------------------------------
</TABLE>
* Class B Shares commenced operations on October 23, 1997.
See Notes to Financial Statements.
211
<PAGE> 422
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------------
INCREASE (DECREASE) IN NET ASSETS: 1997 1996
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Investment income--net...................................... $ 1,476,791 $ 2,025,368
Realized gain on investments--net........................... 109,665,458 22,199,518
Change in unrealized appreciation/depreciation on
investments--net.......................................... (60,400,517) 5,970,999
------------ ------------
Net increase in net assets resulting from operations........ 50,741,732 30,195,885
------------ ------------
- --------------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS (NOTE 1e):
Investment income--net:
Class A................................................... (1,422,649) (1,882,603)
Realized gain on investments--net:
Class A................................................... (22,153,543) (43,561,906)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (23,576,192) (45,444,509)
------------ ------------
- --------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4):
Net increase in net assets derived from capital share
transactions.............................................. 1,666,914 128,356,735
------------ ------------
- --------------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 28,832,454 113,108,111
Beginning of year........................................... 453,029,265 339,921,154
------------ ------------
End of year*................................................ $481,861,719 $453,029,265
============ ============
- --------------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 1,476,774 $ 1,422,632
============ ============
- --------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
212
<PAGE> 423
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN
DERIVED FROM INFORMATION PROVIDED IN THE FINANCIAL CLASS A+
STATEMENTS. -------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year...................... $ 26.22 $ 27.98 $ 19.26 $ 20.96 $ 17.80
-------- -------- -------- -------- -------
Investment income (loss)--net........................... .09 .13 .17 .05 (.01)
Realized and unrealized gain (loss) on
investments--net........................................ 2.80 1.84 8.64 (1.56) 3.17
-------- -------- -------- -------- -------
Total from investment operations........................ 2.89 1.97 8.81 (1.51) 3.16
-------- -------- -------- -------- -------
Less dividends and distributions:
Investment income--net................................ (.08) (.14) (.09) -- --#
Realized gain on investments--net..................... (1.28) (3.59) -- (.19) --
-------- -------- -------- -------- -------
Total dividends and distributions....................... (1.36) (3.73) (.09) (.19) --
-------- -------- -------- -------- -------
Net asset value, end of year............................ $ 27.75 $ 26.22 $ 27.98 $ 19.26 $ 20.96
======== ======== ======== ======== =======
- ------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
Based on net asset value per share...................... 11.72% 8.11% 45.90% (7.27%) 17.78%
======== ======== ======== ======== =======
- ------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................ .80% .81% .81% .83% .96%
======== ======== ======== ======== =======
Investment income (loss)--net........................... .32% .50% .72% .27% (.05%)
======== ======== ======== ======== =======
- ------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands).................. $481,614 $453,029 $339,921 $170,044 $98,976
======== ======== ======== ======== =======
Portfolio turnover...................................... 147.06% 80.84% 96.79% 88.48% 131.75%
======== ======== ======== ======== =======
Average commission rate paid++.......................... $ .0555 $ .0598 -- -- --
======== ======== ======== ======== =======
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
++ For the fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities.
# Amount is less than $.01 per share.
See Notes to Financial Statements.
213
<PAGE> 424
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B#
--------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FOR THE PERIOD
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. OCTOBER 23, 1997+ TO
INCREASE (DECREASE) IN NET ASSET VALUE: DECEMBER 31, 1997
- -----------------------------------------------------------------------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 31.23
-------
Investment loss--net........................................ (.01)
Realized and unrealized loss on investments--net............ (3.48)
-------
Total from investment operations............................ (3.49)
-------
Net asset value, end of period.............................. $ 27.74
=======
- -----------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... (11.18%)++
=======
- -----------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... .96%*
=======
Investment loss--net........................................ (.24%)*
=======
- -----------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 248
=======
Portfolio turnover.......................................... 147.06%
=======
Average commission rate paid................................ $ .0555
=======
- -----------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Aggregate total investment return.
# Based on average shares outstanding.
See Notes to Financial Statements.
214
<PAGE> 425
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers two classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Effective
September 17, 1997, each fund's existing class of shares was designated as Class
A and each fund began offering Class B Shares. Both classes of shares have equal
voting, dividend, liquidation and other rights, except that only shares of the
respective classes are entitled to vote on matters concerning only that class
and Class B Shares bear certain expenses related to the distribution of such
shares. Special Value Focus Fund (the "Fund"), formerly known as Equity Growth
Fund, is classified as "diversified", as defined in the Investment Company Act
of 1940. The following is a summary of significant accounting policies followed
by the Fund.
(a) Valuation of investments--Portfolio securities which are traded on stock
exchanges are valued at the last sale price as of the close of business on the
day the securities are being valued, or lacking any sales, at the closing bid
price. Securities traded in the over-the-counter market are valued at the last
available bid price prior to the time of valuation. Portfolio securities which
are traded both in the over-the-counter market and on a stock exchange are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the
over-the-counter market, the last asked price. Short-term securities are valued
at amortized cost, which approximates market value. Securities for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Board of Directors of the Company.
(b) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the equity and debt markets. Losses may arise due to
changes in the value of the contract or if the counterparty does not perform
under the contract.
- - Options--The Fund may write covered call options. When the Fund writes an
option, an amount equal to the premium received by the Fund is reflected as an
asset and an equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the related
premium received is added to (or deducted from) the basis of the security
acquired or deducted from (or added to) the proceeds of the security sold. When
an option expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums received (or
gain or loss to the extent the cost of the closing transaction exceeds the
premium received).
Written options are non-income producing investments.
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amortization of premium and discount) is recognized on the accrual basis.
Realized gains and losses on security transactions are determined on the
identified cost basis.
(e) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Asset Management, L.P. ("MLAM"). The general partner of MLAM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with Merrill Lynch Funds Distributor, Inc.
("MLFD" or "Distributor"), a wholly-owned subsidiary of Merrill Lynch Group,
Inc.
215
<PAGE> 426
- --------------------------------------------------------------------------------
MLAM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of 0.75% of the average daily value of the Fund's net assets.
Pursuant to the Distribution Plan adopted by the Company, in accordance with
Rule 12b-1 under the Investment Company Act of 1940, the Fund pays the
Distributor an ongoing distribution fee each month at the annual rate of 0.15%
of the average daily value of the Fund's Class B net assets.
MLAM and Merrill Lynch Life Agency, Inc. ("MLLA") have entered into an
agreement which limits the operating expenses paid by the Fund, exclusive of any
distribution fees imposed on Class B Shares, to 1.25% of its average daily net
assets. Any such expenses in excess of 1.25% of average daily net assets will be
reimbursed to the Fund by MLAM which, in turn, will be reimbursed by MLLA.
For the year ended December 31, 1997, Merrill Lynch, Pierce, Fenner & Smith
Inc. a subsidiary of ML & Co., earned $46,686 in commissions on the execution of
portfolio security transactions.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-owned
subsidiary of ML & Co., is the Company's transfer agent.
Accounting services are provided to the Fund by MLAM at cost.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLFDS, MLFD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1997 were $599,008,608 and $606,308,267, respectively.
Net realized and unrealized gains (losses) as of December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Realized
Gains Unrealized
(Losses) Losses
- ------------------------------------------------------------------
<S> <C> <C>
Long-term investments................. $109,667,199 $(6,843,874)
Short-term investments................ (1,741) --
------------ -----------
Total................................. $109,665,458 $(6,843,874)
============ ===========
- ------------------------------------------------------------------
</TABLE>
At December 31, 1997, net unrealized depreciation for Federal income tax
purposes aggregated $7,138,521, of which $36,068,841 related to appreciated
securities and $43,207,362 related to depreciated securities. At December 31,
1997, the aggregate cost of investments for Federal income tax purposes was
$487,923,579.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$1,666,914 and $128,356,735 for the years ended December 31, 1997 and December
31, 1996, respectively.
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1997 Shares Amount
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold............................ 2,566,273 $ 68,132,882
Shares issued to shareholders in
reinvestment of dividends and
distributions.......................... 960,725 23,576,192
---------- ------------
Total issued........................... 3,526,998 91,709,074
Shares redeemed........................ (3,446,348) (90,294,889)
---------- ------------
Net increase........................... 80,650 $ 1,414,185
========== ============
- --------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
Class A Shares for the Year Ended Dollar
December 31, 1996 Shares Amount
- -------------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 3,897,758 $ 99,038,352
Shares issued to shareholders in
reinvestment of dividends and
distributions........................ 1,870,190 45,444,509
---------- ------------
Total issued......................... 5,767,948 144,482,861
Shares redeemed...................... (639,891) (16,126,126)
---------- ------------
Net increase......................... 5,128,057 $128,356,735
========== ============
- -------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
Class B Shares for the Period Dollar
October 23, 1997+ to December 31, 1997 Shares Amount
- --------------------------------------------------------------------
<S> <C> <C>
Shares sold.......................... 10,276 $ 291,595
Shares redeemed...................... (1,340) (38,866)
---------- ------------
Net increase......................... 8,936 $ 252,729
========== ============
- --------------------------------------------------------------------
+ Commencement of operations.
</TABLE>
5. SUBSEQUENT EVENT:
On January 2, 1998, the Company's Board of Directors declared an ordinary income
dividend in the amount of $2.963143 per Class A Share, and $2.959330 per Class B
Share, and a long-term capital gains distribution in the amount of $3.447977 per
share for each of the two classes, payable on January 9, 1998 to shareholders of
record as of December 31, 1997.
216
