<PAGE> 1
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MERRILL LYNCH VARIABLE
-------------------------------------------------------------------------
SERIES FUNDS, INC.
-------------------------------------------------------------------------
Annual Report
December 31, 1997
<PAGE> 2
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, American Balanced Fund's Class A Shares
had a total investment return of +17.11%, based on a change in per share net
asset value from $16.01 to $16.59, and assuming reinvestment of $0.603 per share
income dividends and $1.229 per share capital gains distributions. For the six
months ended December 31, 1997, the Fund's Class A Shares had a total investment
return of +8.72%, based on a change in per share net asset value from $15.26 to
$16.59. (Additional performance information can be found on page 3 of this
report to shareholders.)
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and South
Korea initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth remains moderate
enough and inflationary pressures sufficiently contained to preclude an increase
in short-term interest rates in early 1998. The ongoing developments in Asia
will undoubtedly also influence the central bank's monetary policy decisions in
the new year.
FISCAL YEAR IN REVIEW
As of December 31, 1997, the Fund's asset allocation was: US bonds, 41% of net
assets; US stocks, 56%; and cash reserves, 3%.
During the fiscal year ended December 31, 1997, we increased the Fund's US
equity weighting, consistent with the increase of the maximum allowable level
from 50% of net assets to 65% as provided for in the Fund's prospectus. This
proved beneficial to the overall return of the Fund, given the significant
outperformance of US stocks as compared to bonds and cash. Among US stocks, the
strong performance of financial services equities had a positive impact on total
return because this sector had the largest portfolio weighting throughout the
year. We maintained the bond duration in excess of five years throughout most of
1997. This strategy enabled the Fund to benefit from a US bond market rally in
the second half of the year.
PORTFOLIO MATTERS
We increased the Fund's exposure to US equities from 53% of net assets to 56%
during the six months ended December 31, 1997. However, our concern over the
widening economic problems in Asia led to a cautious attitude toward US
equities. As a result, we kept our allocation to US stocks well below the
maximum allowable level of 65% of net assets. Consistent with our expectation of
further US interest rate declines, financial services equities continued to
account for the largest concentration of assets in the US stock sector. We
maintained significant representation in the areas of healthcare, technology and
energy. Overall, we are increasing emphasis on the shares of companies which, in
our view, have limited potential for earnings disappointments resulting from the
problems afflicting the Asian economies.
In the US bond sector, we maintained the Fund's average duration at 5.8 years
as of December 31, 1997. Our optimistic stance toward US bonds reflected
indications that inflationary pressures in the US economy were exceptionally
subdued. The problems in Asian economies and a resultant slowdown in the US
economy seemed likely to accentuate the trend toward lower inflation. At the
same time, the rapid shrinkage, if not outright elimination, of the Federal
budget deficit was expected to continue to reduce the supply of newly issued US
Government securities relative to demand.
1
<PAGE> 3
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IN CONCLUSION
We appreciate your investment in American Balanced Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Thomas R. Robinson
Thomas R. Robinson
Senior Vice President and Portfolio Manager
February 10, 1998
2
<PAGE> 4
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
[AMERICAN BALANCED FUND GRAPH]
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ American Balanced Fund invests in a balanced portfolio of fixed-income and equity securities.
++ This unmanaged broad-based Index is comprised of common stocks.
+++ This unmanaged Index, which is an equally weighted blend of the Three-Month Treasury Bill Index, the Merrill
Lynch B0A0 Index, and the S&P 500 Index, is comprised of US Treasury bills maturing in up to 3 months,
investment-grade bonds, and common stocks.
Past performance is not predictive of future performance.
</TABLE>
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +17.11%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/97 +11.04
- --------------------------------------------------------------------------------
Inception (6/01/88) through 12/31/97 +10.83
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3
<PAGE> 5
Merrill Lynch Variable Series Funds, Inc.
American Balanced Fund -- Class A Shares
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the S&P 500 Index and a Weighted Index.
Beginning and ending values are:
6/01/88** 12/97
--------- -----
American Balanced Fund+--
Class A Shares $10,000 $26,797
Standard & Poor's 500 Index++ $10,000 $47,894
Weighted Index+++ $10,000 $27,190
<PAGE> 6
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997
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<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>
4
<PAGE> 7
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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 TRUSTS 50,000 Glenborough Realty Trust
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>
5
<PAGE> 8
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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 OBLIGATIONS** Corp., Pool #10036, 7.50%
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.
6
<PAGE> 9
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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.
7
<PAGE> 10
- --------------------------------------------------------------------------------
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.
8
<PAGE> 11
- --------------------------------------------------------------------------------
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.
9
<PAGE> 12
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED 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....................... $ 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.
10
<PAGE> 13
- --------------------------------------------------------------------------------
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.
11
<PAGE> 14
- --------------------------------------------------------------------------------
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.
12
<PAGE> 15
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
AMERICAN BALANCED FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of American Balanced Fund 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 years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the 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 custodian and broker. 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 position of American Balanced
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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
13
<PAGE> 16
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
ANNUAL REPORT--DECEMBER 31, 1997
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, the total investment return on Basic
Value Focus Fund's Class A Shares was +20.62%, based on a change in per share
net asset value from $14.74 to $15.84, and assuming reinvestment of $0.667 per
share income dividends and $0.943 per share capital gain distributions. For the
six months ended December 31, 1997, the total investment return on Basic Value
Focus Fund's Class A Shares was +6.81%, based on a change in per share net asset
value from $14.83 to $15.84. Since inception (November 3, 1997) through December
31, 1997, the total investment return on the Fund's Class B Shares was -0.31%,
based on a change in per share net asset value from $15.89 to $15.84.
(Additional performance information can be found on page 16 of this report to
shareholders.)
FISCAL YEAR IN REVIEW
During 1997, the unmanaged Standard & Poor's 500 Index (S&P 500) total return
was +33.36%. This stellar performance was attributable to the continuation of
robust economic growth coupled with low inflation. Most of the market's gain was
achieved in the first several months of the year. In early October, the
uninterrupted climb in the major indexes came to an abrupt halt as investors
took notice of the economic dislocations taking place in the Southeast Asian
economies. The S&P 500 suffered a one-day 7% correction as investors concluded
that the problems in Asia would have a decidedly depressing impact on the US
economy and US corporate profits. Although the market eventually recouped these
losses, volatility characterized daily trading as investors attempted to
reconcile continued reports of potentially inflationary US economic data with
the dampening effect on the US economy of the "Asian contagion."
Against this backdrop, Basic Value Focus Fund's Class A Shares underperformed
the broad market indexes with a total return of +20.62%. The Fund's performance
reflected strict adherence to our value style of investing which dictated an
overweighting in cyclical and basic industry stocks. These sectors offered low
price/book and price/earnings multiples with generous dividend yields. However,
investors' appetite for stable, large-capitalization growth companies was
unabated during 1997, despite their rich valuation levels. The Fund's
underperformance came primarily in the fourth quarter of 1997 when the economic
problems of Asia widened.
PORTFOLIO MATTERS
The Asian crisis, which came to investors' attention early in October, drove
investors toward safe-haven, large-capitalization quality issues, thereby
shunning stocks whose earnings are tied to the economic cycle. Despite their
rich valuations, stocks such as Procter & Gamble Co., Merck & Co., Johnson &
Johnson, Walt Disney Co. and General Electric Co. all attained new highs after
the initial Asian stock market corrections. In contrast, Fund holdings such as
International Paper Company, Louisiana-Pacific Corporation and ASARCO Inc.
declined and never recovered. Additional damage was inflicted on retail,
technology and chemical holdings which were hard-hit given their cyclical nature
and, in some cases, direct exposures to Asia. This rotation is evidenced by the
dramatic decoupling of the unmanaged Morgan Stanley Consumer and the Morgan
Stanley Cyclical Indexes, as the Consumer Index rose an impressive 9.6% during
the fourth quarter while the Cyclical Index declined 9%. This substantial
divergence helps to explain Basic Value Focus Fund's performance relative to the
broader indexes.
Recent activity in the stock market has led to an even wider disparity in
"value" versus "growth" stock valuations. We believe that the underperformance
in groups such as paper and forest products and capital goods/technology is
overdone. The currency devaluations in Asia could have a positive impact on
these industries over the longer term, as it becomes less likely that new
capacity will be added in the foreseeable future. While end demand for paper and
technology products is expected to remain healthy, it is the supply side of the
equation that typically leads to market imbalances. Therefore, we continued to
add to our positions in International Paper Company, Louisiana-Pacific
Corporation and other cyclical stocks. Moreover, it is this thought process that
dictated our adding new positions in Stone Container Corporation, Texas
Instruments Inc. and Seagate Technology, Inc. Other additions to the Fund since
our June 30, 1997 report to shareholders included Aetna, Inc., Sears, Roebuck &
Co., Travelers Property Casualty Corp., Tupperware Corporation and Unocal
Corporation.
Aetna, Inc., one of the Fund's largest holdings as of December 31, 1997,
became attractive after the aggressive consolidation of claims-
14
<PAGE> 17
- --------------------------------------------------------------------------------
paying centers resulted in the company underpricing a majority of its book of
business. We believe that Aetna is likely to take steps to protect its profit
margins by reducing its cost structure. Moreover, the company generates
substantial free cash flow, and recently authorized a share repurchase program.
At ten times cash earnings per share, Aetna was an attractive addition to the
Fund. We purchased Sears, Roebuck & Co. when it fell 40% from its high as a
result of accelerated deterioration in its credit card business. We are
comfortable with the plan outlined by Sears' management to control the problem.
At 12 times earnings per share, Sears trades well below its peer group and its
merchandising offerings remain healthy.
Travelers Property Casualty Corp. is undergoing a cost reduction program which
we believe will extend beyond current expectations. It also appears likely that
the company will continue
to grow through accretive acquisitions. The company's track record for
assimilating new businesses is sound, and we believe its management can continue
to be astute buyers of property casualty assets. The company has $2 billion of
excess cash and is expected to generate an additional $1 billion annually.
Coupled with reserve redundancies estimated at over $2.5 billion, Travelers
Property Casualty is a welcome addition to the Fund, trading at 2.6 times book
value per share and 11 times earnings per share.
Tupperware Corporation has suffered from a confluence of short-term adverse
events. We believe the stock is likely to rebound as management takes corrective
actions to improve profitability. In the meantime, the company continues to
generate free cash flow and offers a generous safe 3.2% dividend yield. Unocal
Corporation has recently transformed itself from an integrated oil and gas
producer with downstream operations to an independent producer, with the sale of
its refining and marketing business. Achieving a group average multiple suggests
substantial upside potential for this holding is possible.
On the sell side, we eliminated positions in Computervision Corp., Dillards,
Inc., Eastman Chemical Company, Millennium Chemicals Inc., and Toys 'R' US, Inc.
Looking ahead, we understand that investors may continue to favor
large-capitalization growth stocks. However, we remain confident that through
our bottom-up approach to stock selection, our shareholders will be rewarded by
our commitment to undervalued, out-of-favor equities. We continue to invest in
equities where company-specific events are likely to unleash value, and do not
invest with specific forecasts of the direction of interest rates or the
economy. This strategy has been successful in the past, and we anticipate that
it will continue to lead to healthy performance in the future.
IN CONCLUSION
We appreciate your investment in Basic Value Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies with you in our upcoming report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Kevin M. Rendino
Kevin M. Rendino
Senior Vice President and Portfolio Manager
February 10, 1998
15
<PAGE> 18
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BASIC VALUE
MEASUREMENT PERIOD FOCUS-CLASS A
(FISCAL YEAR COVERED) SHARES* S&P 500++
<S> <C> <C>
7/01/93** 10000 10000
DEC-93 10950 10531
DEC-94 11209 10667
DEC-95 14065 14673
DEC-96 16976 18043
DEC-97 20476 24063
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ Basic Value Focus Fund invests primarily in equities that Fund management believes are undervalued.
++ This unmanaged broad-based Index is comprised of common stocks.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +20.62%
- --------------------------------------------------------------------------------
Inception (7/01/93) to 12/31/97 +17.26
================================================================================
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
AGGREGATE TOTAL RETURN--CLASS B SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Inception (11/03/97) to 12/31/97 - 0.31%
- --------------------------------------------------------------------------------
16
<PAGE> 19
Basic Value Focus Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Standard & Poor's 500 Index.
Beginning and ending values are:
7/01/93** 12/97
--------- -----
Basic Value Focus Fund+--
Class A Shares* $10,000 $20,476
Standard & Poor's 500 Index++ $10,000 $24,063
<PAGE> 20
- --------------------------------------------------------------------------------
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>
17
<PAGE> 21
- --------------------------------------------------------------------------------
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.
18
<PAGE> 22
- --------------------------------------------------------------------------------
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.
19
<PAGE> 23
- --------------------------------------------------------------------------------
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.
20
<PAGE> 24
- --------------------------------------------------------------------------------
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.
21
<PAGE> 25
- --------------------------------------------------------------------------------
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 FOR THE PERIOD
FINANCIAL STATEMENTS. 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.
22
<PAGE> 26
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
--------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM INFORMATION PROVIDED IN THE FOR THE PERIOD
FINANCIAL STATEMENTS. NOVEMBER 3, 1997+
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.
23
<PAGE> 27
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE FOCUS FUND
NOTES TO FINANCIALS 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
24
<PAGE> 28
- --------------------------------------------------------------------------------
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.
25
<PAGE> 29
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC. -- BASIC VALUE FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
BASIC VALUE FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Basic Value Focus Fund 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 years in the
two-year period then ended, and the financial highlights for each of the years
in the four-year period then ended and the period July 1, 1993 (commencement of
operations) to December 31, 1993. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the 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 custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Basic Value Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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 12, 1998
26
<PAGE> 30
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, the total investment return on
Developing Capital Markets Focus Fund's Class A Shares was -6.53%, based on a
change in per share net asset value from $10.05 to $9.22, and assuming
reinvestment of $0.186 per share income dividends. For the six months ended
December 31, 1997, the total investment return on Developing Capital Market's
Class A Shares was -20.31%, based on a change in per share net asset value from
$11.57 to $9.22. Since inception (November 3, 1997) through December 31, 1997,
the total investment return on the Fund's Class B Shares was -0.86%, based on a
change in per share net asset value from $9.30 to $9.22. (Additional performance
information can be found on page 30 of this report to shareholders.)
FISCAL YEAR IN REVIEW
During the 12-month period ended December 31, 1997, the total return for
Developing Capital Markets Focus Fund's Class A Shares was -6.53%. The unmanaged
Morgan Stanley Capital International (MSCI) Emerging Markets Free Index fell
11.59% during the same period. The Fund's outperformance was, in part,
attributable to the Fund's underweighted positions in many of the Asian markets,
including South Korea, Malaysia, the Philippines and Thailand, whose markets
fell 66.67%, 68.11%, 62.59% and 73.43%, respectively. During the year, we
reduced the Fund's weighting in the Pacific Basin/Asia from 35.4% of net assets
to 22.5%. This occurred partly as a result of market declines and partly through
further reduction of our already underweighted positions in these markets.
During the fiscal year ended December 31, 1997, the performance of the
emerging markets varied significantly. The Asian markets declined considerably,
while other markets--including Latin America, emerging Europe and the Middle
East--appreciated significantly. The two strongest markets during the 12-month
period were Russia and Turkey, both of which appreciated by more than 100% in US
dollar terms. Likewise, the weakest markets during the same period were Thailand
and Indonesia, both of which declined more than 70% when measured in US dollars.
Furthermore, considering market performance from a chronological perspective,
the year can be divided into two halves. The first half includes the period
through June 30, 1997, when many markets registered significant gains. In the
last six months, what began as sporadic market declines accelerated in October
and November into outright market panics in some countries.
In Asia, markets such as Malaysia, Indonesia, Thailand and South Korea
suffered US dollar-denominated declines of 68.11%, 74.06%, 73.43% and 66.67%,
respectively. Hong Kong, which has long been viewed as a relatively stable
market in the region, declined by 23.29% over the last 12 months, and witnessed
a drop of 10% in one day. Although each country's situation was somewhat unique,
many of the countries in the region suffered from one or more of the following
problems: slowing economic growth, high and unstable interest rates, poorly
funded current account deficits, and falling currencies.
The region's problems began in early summer in Thailand where losses in the
banking and property sectors pointed to other structural weaknesses in the Thai
economy. These concerns led to currency speculation on the Thai baht. Thailand
eventually was obliged to seek aid from the International Monetary Fund (IMF).
The next country to falter was the Philippines, where the banking sector
experienced a sharp rise in non-performing loans and the currency also came
under attack. In order to defend the peso, the Philippine government raised
interest rates sharply. The Malaysian currency, the ringgit, also came under
attack. However, the Malaysian government's initial response to the economic
crisis was to lay the blame on currency speculators and then implement short-
lived measures to limit capital outflows. In Indonesia, the outlook is
complicated by speculation about President Suharto's health and the issues of
succession and political stability.
South Korea is the world's eleventh-largest economy, and the economic problems
facing the country evoked a high level of concern. As far back as 1996, many
large industrial conglomerates in South Korea experienced financial difficulties
and began declaring bankruptcy. As the number of these bankruptcies grew during
1997, foreign banks, suffering through problems in Thailand and Indonesia, took
preemptive actions and withdrew support from South Korea. This prompted a
liquidity crisis, since South Korea had come to rely on short-term foreign
borrowings to finance its economic expansion. Although most of the external bank
debt was incurred by the South Korean private sector, the liquidity crisis
pointed out how quickly massive private sector problems can become the
government's problems as well. The withdrawal of
27
<PAGE> 31
- --------------------------------------------------------------------------------
foreign bank support in the fall of 1997 wreaked havoc on the country's
international reserves. The possibilities of massive devaluation of the South
Korean won and outright default on bank debt loomed large. The South Korean
government, after failing to obtain direct aid from the United States and Japan,
was forced to agree to an IMF-sponsored program. In early December, a US$55
billion IMF-backed rescue package was hurriedly announced for South Korea, with
major contributions scheduled from the IMF, other multilateral agencies and
major economies.
Speculation that Hong Kong would devalue its currency pulled the stock market
down sharply in late October. Hong Kong has had to defend its currency with high
interest rates, which have depressed both the stock and property markets. The
Chinese stock market declined by 25.25% during the 12 months ended December 31,
1997.
To a certain extent India remained insulated from the problems in the rest of
Asia for a long time. Its currency is basically non-convertible and therefore
not prey to speculation. The Indian market appreciated by 11.27% during the
12-month period.
In Asia we continue to hold several stocks in key sectors such as
telecommunications. For example, in the Philippines, our main holding is in
Philippine Long Distance Telephone Co., a company which we believe should
actually benefit from the devaluation of the Philippine peso because more than
half of its revenues are generated from overseas tolls. In Indonesia, a major
holding is P.T. Indonesian Satellite Corp. (Indosat), a provider of
international telephone services. In China, we hold China Telecom (Hong Kong)
Ltd., a cellular telecommunications company, and Eastern Communications Co.,
Ltd., a telecommunications equipment company
During the 12-month period ended December 31, 1997, performance of Latin
American markets was relatively strong, particularly during the first half of
the year. Mexico was the star performer, with its market appreciating by almost
54% on a 12-month basis as investors began to pay more attention to the positive
economic news coming out in Mexico. Month after month, positive news on
industrial activity, declining interest rates and a stable currency gradually
buoyed the market. The Brazilian market appreciated more than 27% for the
12-month period. This market was buoyed for the first half of the year by
progress in privatizations. Argentina's situation was similar to Mexico's in
that as positive news on the continuing economic recovery and strong tax
collections became more widely known, the market strengthened. The Argentine
market appreciated by almost 25% for the 12-month period.
However, the strong performance of the Latin American markets made an
about-face once the crisis in Asia began. The sudden fall of the Hong Kong
market prompted investors to become impatient with the slow pace of reforms and
the growing current account deficit in Brazil. Rumors of a possible devaluation
of the Brazilian real led to panic selling during October. In the neighboring
Argentine market, concern over a possible devaluation of the real weighed
heavily because of the negative implications for Argentine exports to Brazil.
Even the Mexican market, despite the very positive economic news, could not
escape the general sell-off in the region.
As mentioned, throughout the 12-month period the Mexican domestic economy
continued to improve, with the construction and retail sectors showing sharp
growth. In Mexico, we established a position in Cementos Mexicanos, S.A. de C.V.
(Cemex), a major cement company.
The performance of the major markets in the Middle East/Africa region varied
widely during the last 12 months with South Africa declining by 8.18%, Israel
appreciating by 25.02%, and Turkey experiencing a strong rally of 118% for the
year. The Fund's largest weighting was in South African stocks where the market
was negatively affected not only by the sell-off in emerging markets in general,
but also by weak gold prices. Despite these two factors, the underlying economy
in South Africa has remained relatively sound with inflation slowing and the
current account deficit decreasing. The outlook is for a continued decline in
interest rates, which we believe should, in turn, stimulate growth and benefit
Nedcor Ltd. and First National Bank Holdings Ltd., two bank stocks the Fund
holds.
The emerging European markets were also strong during the 12-month period.
Market leaders were Russia (+118.05%) and Hungary (+95.21%). Portugal
appreciated by 47.5%. The Hungarian market posted strong gains because of good
corporate earnings and the Hungarian government's decision to proceed with the
Magyar TavKozlesi Reszvenytarsasag, Ltd. (MATAV) initial public offering.
Portugal graduated to developed market status as the market became included in
the unmanaged MSCI developed market indexes on December 31, 1997. The Portuguese
economy has recently been characterized by a combination of strong gross
domestic product growth, lower unemployment and low inflation. For most of the
year, the Russian market advanced as new investors
28
<PAGE> 32
- --------------------------------------------------------------------------------
entered the market. However, like Brazil the market was badly shaken by the
crisis in Asia. In Russia, investors became concerned that reserves were being
run down to defend the ruble and that the liquidity problems in South Korea
would lead to a massive sell-off of Russian debt instruments. Speculation about
President Yeltsin's health also added to the uncertainty characterizing the
Russian market. Our Fund's major holdings in Russia included Lukoil Oil Company,
the blue-chip petroleum company, and AO Mosenergo, the electric power
distributor in Moscow.
IN CONCLUSION
We would caution our investors that the volatility exhibited during the last
12 months is very much a part of investing in the emerging markets. We would
therefore remind you that it is advisable to take a long-term view when
investing in these markets.
We appreciate your ongoing interest in Developing Capital Markets Focus Fund
of Merrill Lynch Variable Series Funds, Inc., and we look forward to reviewing
our outlook with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Grace Pineda
Grace Pineda
Senior Vice President and Portfolio Manager
February 10, 1998
29
<PAGE> 33
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
[DEVELOPING CAPITAL MARKETS FOCUS FUND GRAPH]
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ Developing Capital Markets Focus Fund invests in securities, principally equities, of issuers in countries having
smaller capital markets.
++ This unmanaged Index measures the total returns of developed foreign stock markets in Europe, Asia and the Far
East, calculated in US dollars.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 -6.53%
- --------------------------------------------------------------------------------
Inception (5/02/94) through 12/31/97 -0.76
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
AGGREGATE TOTAL RETURN--CLASS B SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Inception (11/03/97) through 12/31/97 -0.86%
- --------------------------------------------------------------------------------
30
<PAGE> 34
Developing Capital Markets Focus Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Morgan Stanley Capital International
EAFE Index. Beginning and ending values are:
5/02/94** 12/97
--------- -----
Developing Capital Markets
Focus Fund+--Class A Shares* $10,000 $9,724
Morgan Stanley Capital
International EAFE Index++ $10,000 $11,991
<PAGE> 35
- --------------------------------------------------------------------------------
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 SERVICES 94,740 First National Bank Holdings
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 & TOBACCO 736,377 Delta Corporation Ltd. ..... 733,883 504,368 0.4
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
ZIMBABWE 733,883 504,368 0.4
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
AFRICA 10,588,218 9,111,328 6.5
- ---------------------------------------------------------------------------------------------------------------------
<CAPTION>
EUROPE
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
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>
31
<PAGE> 36
- --------------------------------------------------------------------------------
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>
32
<PAGE> 37
- --------------------------------------------------------------------------------
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 PRODUCERS 77,672 Yacimientos Petroliferos
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 NATIONAL US$ 174,459 Republic of Brazil, 7.06%
BONDS--FOREIGN due 4/15/2014(i).......... 123,188 136,514 0.1
-----------------------------------------------------------------------------------------------------
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>
33
<PAGE> 38
- --------------------------------------------------------------------------------
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 MATERIALS 182,200 +Cementos Mexicanos, S.A. de
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 GOVERNMENT US$ 640,000 United Mexican States,
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 GOVERNMENT US$ 153,000 Republic of Venezuela,
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>
34
<PAGE> 39
- --------------------------------------------------------------------------------
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 & TOBACCO 890,000 +Tsingtao Brewery Company
Ltd. ..................... 323,608 207,925 0.2
-----------------------------------------------------------------------------------------------------
CELLULAR TELEPHONES 294,625 +Smartone
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>
35
<PAGE> 40
- --------------------------------------------------------------------------------
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 & FINANCIAL 80,100 State Bank of India Ltd.
(GDR)(b).................. 1,633,340 1,457,820 1.0
-----------------------------------------------------------------------------------------------------
BUILDING MATERIALS 70,500 Gujarat Ambuja Cement
& COMPONENTS Limited (GDR)(b).......... 608,302 502,313 0.4
-----------------------------------------------------------------------------------------------------
ENERGY SOURCES 19,747 +Bombay Suburban Electric
Supply Co. Ltd.
(GDR)(b).................. 408,565 345,572 0.2
-----------------------------------------------------------------------------------------------------
FINANCIAL SERVICES 78,064 Industrial Credit &
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>
36
<PAGE> 41
- --------------------------------------------------------------------------------
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 TRADE 106,250 +International Container
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 & FINANCIAL 99,256 +Kookmin Bank
(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 SERVICES 756,000 +Yang Ming Marine
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>
37
<PAGE> 42
- --------------------------------------------------------------------------------
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.
38
<PAGE> 43
- --------------------------------------------------------------------------------
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.
39
<PAGE> 44
- --------------------------------------------------------------------------------
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.
40
<PAGE> 45
- --------------------------------------------------------------------------------
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.
41
<PAGE> 46
- --------------------------------------------------------------------------------
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 FOR THE YEAR ENDED DECEMBER 31, FOR THE PERIOD
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. 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.
42
<PAGE> 47
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE CLASS B
BEEN DERIVED FROM INFORMATION PROVIDED IN THE ---------------
FINANCIAL STATEMENTS. FOR THE PERIOD
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.
43
<PAGE> 48
- --------------------------------------------------------------------------------
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
44
<PAGE> 49
- --------------------------------------------------------------------------------
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--Trans-actions 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.
45
<PAGE> 50
- --------------------------------------------------------------------------------
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.
46
<PAGE> 51
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DEVELOPING CAPITAL MARKETS FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
DEVELOPING CAPITAL MARKETS FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Developing Capital Markets Focus Fund 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 years in the two-year period then ended, and the financial
highlights for each of the years in the three-year period then ended and the
period May 2, 1994 (commencement of operations) to December 31, 1994. These
financial statements and the financial highlights are the responsibility of the
Fund's management. Our responsibility is to express an opinion on these
financial statements and the 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 custodian 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 position of Developing Capital
Markets Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of December
31, 1997, the results of its operations, the changes in its 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 12, 1998
47
<PAGE> 52
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, the Domestic Money Market Fund's Class A
Shares had a net annualized yield of 5.11%*. For the six-month period ended
December 31, 1997, the Fund's Class A Shares had a net annualized yield of
5.17%*. The Fund's Class A Shares' 7-day yield as of December 31, 1997 was
5.33%*. The average portfolio maturity was 72 days at December 31, 1997,
compared to 68 days at June 30, 1997.
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and South
Korea initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth remains moderate
enough and inflationary pressures sufficiently contained to preclude an increase
in short-term interest rates in early 1998. The ongoing developments in Asia
will undoubtedly also influence the central bank's monetary policy decisions in
the new year.
Our market exposure during this period was consistent with our belief that the
Federal Reserve Board would leave monetary policy unchanged. However, we were
slightly cautious in the structure of the portfolio, favoring securities with
maturities of under one year. The Fund's composition at the end of December and
as of our last report is detailed below:
<TABLE>
<CAPTION>
- -------------------------------------------------------
Issue 12/31/97 6/30/97
- -------------------------------------------------------
<S> <C> <C>
Bank Notes...................... 11.1% 6.1%
Certificates of Deposit......... 3.4 3.2
Commercial Paper................ 55.5 56.5
Corporate Notes................. 10.2 7.8
Funding Agreements.............. 1.6 1.6
Master Notes.................... 2.5 0.9
US Government Agency &
Instrumentality
Obligations--Discount......... 3.5 0.1
US Government Agency &
Instrumentality
Obligations--Non-Discount..... 15.3 23.1
(Liabilities in Excess of Other
Assets)/Other Assets Less
Liabilities................... (3.1) 0.7
----- -----
Total........................... 100.0% 100.0%
===== =====
</TABLE>
IN CONCLUSION
We appreciate your investment in Domestic Money Market Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook with you in our upcoming semi-annual report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Jacqueline Rogers
Jacqueline Rogers
Vice President and Portfolio Manager
February 10, 1998
- ---------------
* Based on a constant investment throughout the period, with dividends
compounded daily, and reflecting a net return to the investor after all
expenses.
48
<PAGE> 53
- --------------------------------------------------------------------------------
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>
49
<PAGE> 54
- --------------------------------------------------------------------------------
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 OBLIGATIONS-- 3,000,000 Federal National Mortgage
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.
50
<PAGE> 55
- --------------------------------------------------------------------------------
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.
51
<PAGE> 56
- --------------------------------------------------------------------------------
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.
52
<PAGE> 57
- --------------------------------------------------------------------------------
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.
53
<PAGE> 58
- --------------------------------------------------------------------------------
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 FOR THE YEAR ENDED
FROM INFORMATION PROVIDED IN THE FINANCIAL 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 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.
54
<PAGE> 59
- --------------------------------------------------------------------------------
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 share-holders--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.
55
<PAGE> 60
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
DOMESTIC MONEY MARKET FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Domestic Money Market Fund 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
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
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 custodian and broker. 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 position of Domestic Money
Market Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31,
1997, the results of its operations, the changes in its 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 12, 1998
56
<PAGE> 61
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, Global Bond Focus Fund's Class A Shares
had a total investment return of +1.95%, based on a change in per share net
asset value from $9.76 to $9.32, and assuming reinvestment of $0.603 per share
income dividends. For the six months ended December 31, 1997, the Fund's Class A
Shares had a total investment return of +4.97%, based on a change in per share
net asset value from $9.15 to $9.32, and assuming reinvestment of $0.277 per
share income dividends. (Additional performance information can be found on page
59 of this report to shareholders.)
FISCAL YEAR IN REVIEW
During the fiscal year ended December 31, 1997, the Fund's total returns were
in line with the total return of the unmanaged JP Morgan Global Government Bond
Index. Enhancing the Fund's performance relative to the Index were the long
duration we maintained since the beginning of the second quarter of 1997 along
with our focus on US dollar-denominated investments. However, even though the
Fund had a greater-than-index exposure to US dollar-denominated securities, we
retained some exposure to non-US dollar investments. With the US dollar's
substantial appreciation in 1997, these non-dollar positions limited the Fund's
total returns for the fiscal year. Given the Fund's investment objective and
policies, we do not believe it is appropriate to heavily underweight--or
overweight--US dollar-denominated investments. The portfolio's composition of
more global corporate debt versus sovereign government positions enhanced total
return, since corporate debt offered a higher current income flow than generally
available on government obligations.
ECONOMIC REVIEW
During the second half of the year investor attention was focused on the lack
of inflationary pressure in the world's major economies. Europe, except for the
United Kingdom, and the United States reflected very low inflationary pressures
as expectations continued to recede. By the end of the six-month period ended
December 31, 1997, Asia was the focus of investor concern. What continues to
unfold in Asia is a new kind of global deflationary force: competitive
deflationary currency devaluation. The overcapacity in a group of economies
accustomed to fast growth in sales to industrialized nations--as is currently
the case in Asia-- appears to have triggered competitive currency devaluation.
Such devaluations have led to even faster growth in the export of deflation to
the industrial world.
As this deflation has gotten out of control, banking systems have felt
pressure. As a result, equity investors have devalued banking shares in the Asia
region. In most cases, these banks were overextended in asset-based lending. The
value of assets underlying these loans has eroded because of outright asset
deflation (for example, real estate) or the wrong kind of industrial capacity
(as seen in South Korea, Japan and Germany). Global consumers should be expected
to have greater leverage in price and selection as the competition for market
share increases.
In Europe, the Bundesbank made good on its promise to raise base rates by
increasing short-term borrowing by 30 basis points (0.30%) in early October.
This move reflected not the strength of the economy, but more of a support
measure for the currency, which has continued to weaken throughout the last
three months. We believe this monetary policy tightening is a one-time event,
and the German central bank may not consider increasing base rates until well
into 1998. Subsequent inflation data has reflected a lack of inflationary
pressure as a result of the weaker Deutschemark at the manufacturing level as
well as the consumer level.
The United Kingdom has continued to reinforce the independence of the Bank of
England. Base rates have increased by 50 basis points, reflecting the
continuation of the strong consumer spending habits of the past two years. This
has forced the sterling to stronger levels against both the US dollar and the
Deutschemark. We believe that the economy is beginning to show signs of slowing,
and that additional interest rate hikes will not materialize soon.
The Fund continues to have no exposure to the Japanese market for a number of
reasons. Current yield continues to be below 2% on ten-year government issues.
In addition, the yen continues to slide toward an equilibrium point that seems
to be at even weaker levels. Finally, as of the date of this report, the
financial rescue package does not give us confidence that the Bank of Japan will
be able to make the necessary fiscal shifts needed for recovery. There have been
five long years of near depression-like conditions in Japan.
57
<PAGE> 62
- --------------------------------------------------------------------------------
PORTFOLIO COMPOSITION
During the six-month period ended December 31, 1997, the most significant
shift within the portfolio was to establish a more market-neutral position
within the core European markets. This was accomplished by reducing some of the
dollar-bloc investments in favor of Germany and Denmark. The interest rate
spread was clearly in favor of the United States for most of the early part of
1997. The yield spread between Europe and US securities was at its maximum-- 120
basis points--in early June. At this point, we decided to shift assets toward
the US corporate sector. By late November, the spread had reduced to just 32
basis points. This reduction, along with genuinely favorable inflation data out
of Germany, has benefited the Fund's total return.
We continue to favor longer-duration exposure to most bond markets and
investing in the bond markets with the steepest yield curves (that is, those
markets in which longer-term yields are highest relative to shorter-term
yields).
These markets have higher interest rates priced into them, yet we believe
there is an increasing likelihood that global deflationary trends will result in
lower interest rates. The countries with steep yield curves were Germany,
Denmark and the United States. Our long duration positions in the United Kingdom
were profitable as these issues outperformed almost 40 basis points more than
the short end.
CURRENCY OUTLOOK
Since most of the world's currencies have devalued so decisively against the
dollar in the past three months, it is likely that the US trade deficit will
progressively deteriorate over the next 18 months, unless the United States were
to fall into recession and its trading partners' economies were to strengthen.
Since we believe this development is unlikely, it seems probable that a
continuous weakening of the US trade balance will slow the US economy. This
would add to the deflationary pressures on the prices of tradable goods and make
foreign dollar holders increasingly concerned about their exposure.
Our strategy has been overwhelmingly pro-dollar for some time, with the bulk
of the Fund's non-US dollar positions hedged back into the US dollar. This has
enhanced the Fund's yield, since short-term interest rates are very low in
Denmark, Canada and Germany. However, the outlook for the dollar currently is
not as clear. As of December month-end, the bulk of the Fund's assets in
non-dollar investments has been hedged back to the US dollar, while our exposure
to the sterling has not been hedged. We have reduced some hedges over the past
few weeks as investors reassess the outlook for the dollar. With recent economic
indicators showing strength in the United States and a possible weakening of the
German economy, our near-term expectations for the Deutschemark are for slightly
stronger levels of about DM1.82/US$1 but with little potential to go much
higher.
IN CONCLUSION
We appreciate your investment in Global Bond Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Paolo Valle
Paolo Valle
Senior Vice President and Portfolio Manager
February 10, 1998
- ---------------------------------------------------------
Effective January 15, 1998, Paolo Valle became responsible for the management of
the Fund. Mr. Valle has served as First Vice President and Portfolio Manager of
Merrill Lynch Asset Management, L.P. (MLAM) since 1997 and as Vice President and
Portfolio Manager of MLAM from 1992 to 1997.
- ---------------------------------------------------------
58
<PAGE> 63
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
GLOBAL BOND
FOCUS
MEASUREMENT PERIOD FUND'CLASS A MERRILL LYNCH WEIGHTED
(FISCAL YEAR COVERED) SHARES* G5AO INDEX" INDEX"'
<S> <C> <C> <C>
7/01/93** 10000 10000 10000
DEC-93 10590 10227 10344
DEC-94 10144 10062 10315
DEC-95 11837 11526 12452
DEC-96 12787 11987 13472
DEC-97 13036 12918 14344
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ Global Bond Focus Fund invests in US and foreign government and corporate bonds.
++ This unmanaged Index is comprised of intermediate-term Government bonds maturing in one to ten years.
+++ The weighted Index consists of 40% High Yield Master Index MLJOAO and 60% JP Morgan Global Government Bond Index
(Ex-Japan).
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +1.95%
- --------------------------------------------------------------------------------
Inception (7/01/93) through 12/31/97 +6.07
- --------------------------------------------------------------------------------
59
<PAGE> 64
Global Bond Focus Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Merrill Lynch G5A0 Index and the
Weighted Index. Beginning and ending values are:
7/01/93** 12/97
--------- -----
Global Bond Focus Fund+--Class A
Shares* $10,000 $13,036
Merrill Lynch G5A0 Index++ $10,000 $12,918
Weighted Index+++ $10,000 $14,344
<PAGE> 65
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (IN US DOLLARS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NORTH FACE VALUE PERCENT OF
AMERICA INDUSTRY AMOUNT FIXED-INCOME INVESTMENTS COST (NOTE 1A) NET ASSETS
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
CANADA FOREIGN Canadian Government
GOVERNMENT Bonds:
OBLIGATIONS C$ 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>
60
<PAGE> 66
- --------------------------------------------------------------------------------
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>
61
<PAGE> 67
- --------------------------------------------------------------------------------
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>
62
<PAGE> 68
- --------------------------------------------------------------------------------
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>
FOREIGN UNREALIZED
CURRENCY APPRECIATION
SOLD EXPIRATION DATE (NOTE 1B)
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dkr 28,000,000............................................................... 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.
63
<PAGE> 69
- --------------------------------------------------------------------------------
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.
64
<PAGE> 70
- --------------------------------------------------------------------------------
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.
65
<PAGE> 71
- --------------------------------------------------------------------------------
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.
66
<PAGE> 72
- --------------------------------------------------------------------------------
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 FOR THE PERIOD
FINANCIAL STATEMENTS. 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.
67
<PAGE> 73
- --------------------------------------------------------------------------------
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
68
<PAGE> 74
- --------------------------------------------------------------------------------
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.
69
<PAGE> 75
- --------------------------------------------------------------------------------
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.
70
<PAGE> 76
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL BOND FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GLOBAL BOND FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Global Bond Focus Fund 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 years in the
two-year period then ended, and the financial highlights for each of the years
in the four-year period then ended and the period July 1, 1993 (commencement of
operations) to December 31, 1993. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the 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 custodian. 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 position of Global Bond Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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
71
<PAGE> 77
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, Global Strategy Focus Fund's Class A
Shares had a total investment return of +11.94%, based on a change in per share
net asset value from $13.87 to $14.71, and assuming reinvestment of $0.433 per
share income dividends and $0.290 per share capital gains distributions. For the
six months ended December 31, 1997, the Fund's Class A Shares had a total
investment return of -2.32%, based on a change in per share net asset value from
$15.06 to $14.71. (Additional performance information can be found on page 74 of
this report to shareholders.)
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and South
Korea initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth will moderate enough
and inflationary pressures will be sufficiently contained to preclude an
increase in short-term interest rates in early 1998. The ongoing developments in
Asia will undoubtedly also influence the central bank's monetary policy
decisions in the new year.
FISCAL YEAR IN REVIEW
As of December 31, 1997, the Fund's asset allocation was: foreign equities,
30% of net assets; US equities, 30%; foreign bonds, 15%; US bonds, 15%; and cash
reserves, 10%.
During the year ended December 31, 1997, the overall return of the Fund was
held down by the laggard performance of foreign equities and bonds relative to
the performance of their US counterparts. The negative impact of foreign
equities was limited by the reduction of that sector during the second half of
1997. The decision to limit representation in Asian markets and to remain
underweighted in Japanese equities further reduced the negative impact of
foreign equities. As for foreign bonds, the maintenance of hedges against the
European fixed-income positions during much of the year improved the Fund's
return by limiting the negative impact of a strong US dollar versus European
currencies. US equities continued to be a positive net contributor to overall
Fund returns during 1997. The strong overall performance in the financial
services sector, which was the largest single group represented among US
equities, offset less-favorable performance among technology, healthcare and
economically sensitive equities.
PORTFOLIO MATTERS
As mentioned above, during the second half of 1997 we became more cautious
toward foreign stocks. Our concerns over the widening economic problems in Asia,
particularly in South Korea, Japan and Southeast Asia, led us to reduce our
allocation to foreign equities from 55% of net assets as of June 30, 1997 to 30%
as of December 31, 1997. In decreasing our foreign equity representation,
Japan's relative position was reduced from an already underweighted position. We
are concerned that the uncertainties surrounding the Japanese financial
structure and economy will limit the recovery potential in the Japanese stock
market in the coming months. Our representation in Asia was further reduced. On
the other hand, meaningful representation was maintained in Latin America and
Europe where prospects appear more attractive.
72
<PAGE> 78
- --------------------------------------------------------------------------------
During the six months ended December 31, 1997, we directed the newly available
assets from the reduction of the foreign equity representation to US equities,
US bonds and cash reserves, while the weighting in foreign bonds was little
changed. Consistent with our expectation of further US interest rate declines,
financial services equities continued to account for the largest concentration
of assets in the US stock sector. We maintained significant representation in
the areas of healthcare, technology and energy. Overall, we are increasing
emphasis on the shares of companies, which, in our view, have limited potential
for earnings disappointments resulting from the problems afflicting the Asian
economies.
The bulk of our foreign bond weighting remains concentrated in Europe,
including Germany, France, Italy, Sweden, Denmark, Spain and the United Kingdom.
During October, we became less confident that US dollar strength would continue
against the European currencies. Given this changed assessment, we lifted the
hedges against commitments in European stocks and bonds. In the Pacific Basin,
our residual commitment to Japanese equities remains hedged back to the US
dollar, since we expect yen weakness to continue in the coming months.
In the US bond sector, we maintained the Fund's average duration at 5.9 years
as of December 31, 1997. Our optimistic stance toward US bonds reflected
indications that inflationary pressures in the US economy were exceptionally
subdued. The problems in Asian economies and a resultant slowdown in the US
economy seemed likely to accentuate the trend toward lower inflation. At the
same time, the rapid shrinkage, if not outright elimination, of the Federal
budget deficit was expected to continue to reduce the supply of newly issued US
Government securities relative to demand.
IN CONCLUSION
We appreciate your investment in Global Strategy Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Thomas R. Robinson
Thomas R. Robinson
Senior Vice President and Portfolio Manager
February 10, 1998
73
<PAGE> 79
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MORGAN STANLEY
GLOBAL STRATEGY CAPITAL
MEASUREMENT PERIOD FOCUS FUND'- INTERNATIONAL WEIGHTED INDEX
(FISCAL YEAR COVERED) CLASS A SHARES* WORLD INDEX " "'
<S> <C> <C> <C>
2/28/92** 10000 10000 10000
DEC-92 10262 9832 10382
DEC-93 12240 12045 11759
DEC-94 12239 12656 12541
DEC-95 13537 15278 14627
DEC-96 15320 17337 15407
DEC-97 17149 20070 15948
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ Global Strategy Focus Fund invests primarily in a portfolio of equity and fixed-income securities of US and
foreign issuers.
++ This unmanaged market capitalization-weighted Index is comprised of a representative sampling of stocks of
large-, medium-, and small-capitalization companies in 22 countries, including the United States.
+++ This unmanaged Index, which is an equally weighted blend of the Morgan Stanley World Index, the Salomon Brothers
World Government Bond Index and the Salomon Brothers World Money Market Index, is comprised of a representative
sampling of stocks of large-, medium-, and small-capitalization companies in 22 countries, government bonds and
money market securities in the major markets, including the United States.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +11.94%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/97 +10.82%
- --------------------------------------------------------------------------------
Inception (2/28/92) to 12/31/97 + 9.67%
- --------------------------------------------------------------------------------
74
<PAGE> 80
Global Strategy Focus Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Morgan Stanley Capital International
World Index and a Weighted Index. Beginning and ending values are:
2/28/92** 12/97
--------- -----
Global Strategy
Focus Fund+--Class A Shares* $10,000 $17,149
Morgan Stanley Capital
International World Index++ $10,000 $20,070
Weighted Index+++ $10,000 $15,948
<PAGE> 81
- --------------------------------------------------------------------------------
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
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
75
<PAGE> 82
- --------------------------------------------------------------------------------
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>
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
- ---------------------------------------------------------------------------------------------------------------------
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
TRUSTS Inc. .................... 2,650,000 3,140,250 0.4
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>
76
<PAGE> 83
- --------------------------------------------------------------------------------
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>
77
<PAGE> 84
- --------------------------------------------------------------------------------
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 Dkr 72,500,000 Government of Denmark, 7%
due 11/15/2007
(15)..................... 11,582,614 11,628,616 1.3
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
78
<PAGE> 85
- --------------------------------------------------------------------------------
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>
FRANCE Fim 73,700,000 Government of France, 5.50%
due 10/25/2007 (15)...... $ 12,134,726 $ 12,391,494 1.4%
- ---------------------------------------------------------------------------------------------------------------------
GERMANY
Bundesrepublik Deutschland
(15):
DM 7,900,000 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 Lit 30,000,000,000 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 Skr 98,200,000 Government of Sweden, 8%
due 8/15/2007 (15)....... 14,051,805 14,157,770 1.6
- ---------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM L 11,000,000 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>
79
<PAGE> 86
- --------------------------------------------------------------------------------
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.
80
<PAGE> 87
- --------------------------------------------------------------------------------
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.
81
<PAGE> 88
- --------------------------------------------------------------------------------
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.
82
<PAGE> 89
- --------------------------------------------------------------------------------
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.
83
<PAGE> 90
- --------------------------------------------------------------------------------
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 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.......................... $ 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.
84
<PAGE> 91
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
NOTES TO FINANCIALS 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
85
<PAGE> 92
- --------------------------------------------------------------------------------
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.
86
<PAGE> 93
- --------------------------------------------------------------------------------
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.
87
<PAGE> 94
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL STRATEGY FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GLOBAL STRATEGY FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Global Strategy Focus Fund 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
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
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 custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Global Strategy
Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997,
the results of its operations, the changes in its 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 12, 1998
88
<PAGE> 95
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, Global Utility Focus Fund's Class A
Shares had a total investment return of +25.90%, based on a change in per share
net asset value from $12.19 to $14.84, and assuming reinvestment of $0.436 per
share income dividends. For the six months ended December 31, 1997, the Fund's
Class A Shares had a total investment return of +13.73%, based on a change in
per share net asset value from $13.28 to $14.84, and assuming reinvestment of
$0.242 per share income dividends. (Additional performance information can be
found on page 91 of this report to shareholders.)
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and Korea
initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth remains moderate
enough and inflationary pressures sufficiently contained to preclude an increase
in short-term interest rates in early 1998. The ongoing developments in Asia
will undoubtedly also influence the central bank's monetary policy decisions in
the new year.
FISCAL YEAR IN REVIEW
The primary investment objective of Global Utility Focus Fund is to seek both
capital appreciation and current income through investment of at least 65% of
its assets in the utility sector. During the fiscal year ended December 31,
1997, we continued to seek out new opportunities in both existing companies and
newly privatized entities within the utility sector. Reductions and eliminations
were made when, in our view, the risk/reward ratios became unfavorable, while
new positions and additions were made as opportunities arose. For example, the
perceived increased likelihood of restructuring in the German electric utility
sector resulted in our adding two securities to the electric sector of the
Fund--RWE AG and Viag AG. We maintained the Fund's overweighted position in the
US utility sector. While in the first half of 1997 this stance was not a
significant positive to overall performance, valuation levels and the
fundamental outlook for the utility sector became attractive as the concerns
regarding competition and deregulation that had surrounded the sector in 1996
and into 1997 had become overdone. Therefore, investors returned to the group in
the second half of 1997. As a result, the utility sector outperformed the broad
market, as measured by the unmanaged Standard & Poor's 500 Index in the fourth
quarter.
For the fiscal year ended December 31, 1997, Global Utility Focus Fund's Class
A Shares had a total return of +25.90%. The unmanaged Financial Times/Standard &
Poor's--Actuaries World Utility Index had a total return of +26.03%. The modest
difference in return between the Fund and the Index can be attributed to the
higher weighting of domestic telephone stocks in the Index. Overall, the Fund
benefited throughout the year from its significant weighting in European
utilities, its underweighted position in the Asia/Pacific region and its strong
presence in US-based utility stocks.
PORTFOLIO MATTERS
For the six-month period ended December 31, 1997, the total return for the
Fund's Class A Shares was +13.73% as compared to +13.09% for the unmanaged
Financial Times/Standard & Poor's--Actuaries World Utility Index.
The Fund's performance was significantly enhanced by its overweighting in
US-based utility stocks. There were several factors that contributed to the
strong performance of the
89
<PAGE> 96
- --------------------------------------------------------------------------------
domestic utility sector. First, there were
declining long-term interest rates. These enhanced the attractiveness of the
yields in the domestic utility sector and in particular, the electric component.
Second, the overall stock market, which had reached new highs earlier in the
year, became more volatile as a result of the Asian currency crisis. This
resulted in investors seeking less volatile and more defensive investments that
had not participated in the broad market rally. Third, the fundamental outlook
for both the electric and telecommunications sectors improved during the second
half of 1997. More specifically, domestic electric utility companies began the
process of selling some generating assets as regulatory changes permitted. These
assets were sold at above book value prices that were higher than most investors
and industry experts predicted. Thus, a valuation argument was made for the
electric utility group. On the other hand, the telecommunications sector
continued to deliver growth in terms of volume, new access lines and enhanced
services. Moreover, the regional bell holding companies remained out of the
long-distance business because of legal constraints, and AT&T Corporation
remained out of the local telephone business because of the high cost of entry.
Therefore, the regulatory status quo was maintained in the telephone business
through much of 1997, but massive consolidations were announced which created
continued investor enthusiasm. The net result was that we maintained our
holdings in the local telephone business and purchased shares of AT&T
Corporation, the largest US-based long distance company, and WorldCom, Inc., the
fourth largest US-based long distance carrier.
Turning to the international side of the Fund's portfolio, which was
underweighted relative to the domestic utility sector, we reduced our exposure
to some of the emerging markets such as Thailand, Chile and Malaysia. The
currency crisis which erupted in Asia during the six-month period ended December
31, 1997 had spillover effects in South America. While we eliminated our
holdings in Thailand and Malaysia, which gave us an even further underweighted
position in the Asia/Pacific region, we chose to reduce our holdings in Chile
and keep our holdings in Brazil, Argentina, Peru and Mexico. From our
perspective, the Chilean market had a greater exposure to the Asian crisis
because of its huge exports of copper to Asia. The remaining markets within the
Latin American region did not have the same level of risk as Chile. In Europe,
where the Fund has a significant presence, we modestly reduced our holdings in
Italy and Spain as a result of overweighted positions.
IN CONCLUSION
We appreciate your investment in Global Utility Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Walter D. Rogers
Walter D. Rogers
Senior Vice President and Portfolio Manager
February 10, 1998
90
<PAGE> 97
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
FINANCIAL FINANCIAL
TIMES/STANDARD TIMES/STANDARD
GLOBAL UTILITY & POOR'S- & POOR'S-
MEASUREMENT PERIOD FOCUS FUND' - ACTUARIES WORLD ACTUARIES WORLD
(FISCAL YEAR COVERED) CLASS A SHARES* INDEX " UTILITY INDEX"'
<S> <C> <C> <C>
7/01/93** 10000 10000 10000
DEC-93 10685 10613 10464
DEC-94 9776 11232 9772
DEC-95 12154 13434 11928
DEC-96 13729 15209 12931
DEC-97 17285 17550 16297
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ Global Utility Focus Fund invests at least 65% of total assets in equity and debt securities of domestic and
foreign firms involved in electricity, telecommunications, gas or water.
++ This unmanaged market capitalization-weighted Index is comprised of nearly 2,200 equities from 24 countries in 12
regions, including the United States. Performance data is as of June 30, 1993.
+++ This unmanaged market capitalization-weighted Index is comprised of utility stocks from any of the 24 countries
that make up the Financial Times/Standard & Poor's--Actuaries World Index.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +25.90%
- --------------------------------------------------------------------------------
Inception (7/01/93) through 12/31/97 +12.93
- --------------------------------------------------------------------------------
91
<PAGE> 98
Global Utility Focus Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Financial Times/Standard &
Poor's-Actuaries World Index and the Financial Times/Standard & Poor's-Actuaries
World Utility Index. Beginning and ending values are:
7/01/93** 12/97
--------- -----
Global Utility
Focus Fund+--Class A Shares* $10,000 $17,285
Financial Times/Standard & Poor's-
Actuaries World Index++ $10,000 $17,550
Financial Times/Standard & Poor's-
Actuaries World Utility Index+++ $10,000 $16,297
<PAGE> 99
- --------------------------------------------------------------------------------
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>
92
<PAGE> 100
- --------------------------------------------------------------------------------
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>
93
<PAGE> 101
- --------------------------------------------------------------------------------
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>
94
<PAGE> 102
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED) (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 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.
95
<PAGE> 103
- --------------------------------------------------------------------------------
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.
96
<PAGE> 104
- --------------------------------------------------------------------------------
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.
97
<PAGE> 105
- --------------------------------------------------------------------------------
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.
98
<PAGE> 106
- --------------------------------------------------------------------------------
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 YEAR ENDED DECEMBER 31, FOR THE PERIOD
DERIVED FROM INFORMATION PROVIDED IN THE FINANCIAL 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.
99
<PAGE> 107
- --------------------------------------------------------------------------------
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
100
<PAGE> 108
- --------------------------------------------------------------------------------
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--Trans-actions 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.
101
<PAGE> 109
- --------------------------------------------------------------------------------
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.
102
<PAGE> 110
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL UTILITY FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GLOBAL UTILITY FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Global Utility Focus Fund 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
years in the two-year period then ended, and the financial highlights for each
of the years in the four-year period then ended and the period July 1, 1993
(commencement of operations) to December 31, 1993. These financial statements
and the financial highlights are the responsibility of the Fund's management.
Our responsibility is to express an opinion on these financial statements and
the 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 custodian. 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 position of Global Utility Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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
103
<PAGE> 111
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, Government Bond Fund's Class A Shares
had a total investment return of +8.88%, based on a change in per share net
asset value from $10.40 to $10.60, and assuming reinvestment of $0.673 per share
income dividends and $0.011 per share capital gains distributions. For the six
months ended December 31, 1997, the Fund's Class A Shares had a total investment
return of +6.45%, based on a change in per share net asset value from $10.31 to
$10.60, and assuming reinvestment of $0.352 per share income dividends and
$0.011 per share capital gains distributions. (Additional performance
information can be found on page 106 of this report to shareholders.)
FISCAL YEAR IN REVIEW
During the first quarter of the Fund's fiscal year, fixed-income markets fell
on concerns of growing inflationary pressures. We shortened the duration of the
Fund to 4.2 years by increasing the Fund's cash reserves to 17% of net assets.
At the end of March, the Federal Reserve Board launched a preemptive strike
against inflationary pressures by raising the Federal Funds rate by 25 basis
points (0.25%). Interest rates peaked in mid-April, then dropped through the
second quarter. This rally was fueled by a significant change in expectations
regarding the economy and more optimistic outlook for inflation. At this time,
we decided to maintain a duration-neutral strategy for the Fund, based on the
volatility that characterized the market. Accordingly, we set a range of 4.5
years - 4.6 years for the Fund's duration. The Fund's performance was hurt by
the relatively high percentage (12%) of the Fund's net assets in cash reserves
in response to our concerns regarding volatility.
The market continued to rally until the middle of the summer. We extended the
upper limit of our duration range to 4.7 years and lengthened our positions
accordingly, primarily by reducing the Fund's cash reserve position to 9% of net
assets. The market fell sharply in August as a result of stronger-than-expected
employment and purchasing manager reports. These data suggested substantially
more robust consumer spending in the third quarter. The market rallied again in
September on the belief that the Federal Reserve Board would not move to tighten
interest rates again in 1997. Prices then began to fall in early October in
response to concern about employment and wage pressure, but reversed direction
and rose sharply in the middle of the month because of concerns about the Asian
currency crisis. The US Treasury market has been viewed as a "safe haven" for
assets. By the end of the fiscal year, bond yields were at their lowest levels
of the year. We extended the Fund's duration to 5.06 years in order to seek to
participate in this rally. This strategy enhanced the Fund's performance, so
that total return on the Fund's Class A Shares rose to +8.88% for the year ended
December 31, 1997.
PORTFOLIO MATTERS
A strong rally in bond prices in September, which was encouraged by low
inflation data, brought the yield on the 30-year Treasury bond to 6.23% by the
beginning of October. This rally lasted from the middle of September through the
first week of October, and was mirrored by the gains of the stock market, which
soared from 7660 to 8178 as measured by the Dow Jones Industrial Average. On
October 8, 1997, Federal Reserve Board Chairman Alan Greenspan expressed concern
before the House Budget Committee that the demand for labor was outpacing the
supply, with the resulting pressure likely to push up wages and prices. Mr.
Greenspan suggested that the Federal Reserve Board would tighten monetary policy
before it would allow this to happen. Bond prices slumped, and the yield on the
long-term Treasury bond jumped from 6.23% to 6.43% in three days. Then, on
October 23, 1997, the Thai baht collapsed and the Asian currency markets
declined rapidly. On the following Monday, the New York Stock Exchange saw the
DJIA fall 554 points on a record volume of 1.2 billion shares. A worldwide
flight to quality caused both foreign and domestic investors to seek shelter in
the US Treasury market.
The yield on the long-term bond fell from 6.43% to 6.15% during the third
quarter. Gross domestic product (GDP) figures for the third calendar quarter of
1997 were released indicating a slightly larger-than-expected increase of 3.5%
as compared to 3.3% in the second calendar quarter. The GDP price deflator rose
only 1.4% for the third calendar quarter against a 1.8% increase in the second
calendar quarter. This was the lowest quarterly increase since the second
quarter of 1964. The long-term bond finished December with a 6.16% yield.
November
104
<PAGE> 112
- --------------------------------------------------------------------------------
and December witnessed a continuation of the flight to quality into US bonds.
The Treasury yield curve flattened from 53 basis points to 28 basis points
between 2-year-- 30-year issues. This suggested some foreign central bank
selling of issues with short-term maturities to shore up weak currencies and
private sector purchasing of the long-term issues to increase dollar-denominated
investments. By the end of the year, the yield on the long-term Treasury bond
was 5.92%.
IN CONCLUSION
We appreciate your investment in Government Bond Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Jay C. Harbeck
Jay C. Harbeck
Senior Vice President and Portfolio Manager
February 10, 1998
105
<PAGE> 113
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
GOVERNMENT BOND
MEASUREMENT PERIOD FUND'CLASS A MERRILL LYNCH G402
(FISCAL YEAR COVERED) SHARES* INDEX
<S> <C> <C>
5/02/94** 10000 10000
DEC-94 10179 10007
DEC-95 11688 12309
DEC-96 12023 12477
DEC-97 13091 13785
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ Government Bond Fund invests in only debt securities issued or guaranteed by the US Government, its agencies or
instrumentalities.
++ This unmanaged Index is comprised of intermediate-term US Government bonds and US Treasury securities maturing in
7-10 years.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +8.88%
- --------------------------------------------------------------------------------
Inception (5/02/94) through 12/31/97 +7.62
- --------------------------------------------------------------------------------
106
<PAGE> 114
Government Bond Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Merrill Lynch G402 Index. Beginning
and ending values are:
5/02/94** 12/97
--------- -----
Government Bond
Fund+--Class A Shares* $10,000 $13,091
Merrill Lynch G402 Index++ $10,000 $13,785
<PAGE> 115
- --------------------------------------------------------------------------------
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
CORPORATION--12.8%
10,000,000 7.125% due 7/21/1999..................... 10,212,200 10,195,300
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
ASSOCIATION--13.9%
2,000,000 8.90% due 6/12/2000...................... 2,171,480 2,124,060
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> 116
- --------------------------------------------------------------------------------
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> 117
- --------------------------------------------------------------------------------
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> 118
- --------------------------------------------------------------------------------
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> 119
- --------------------------------------------------------------------------------
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> 120
- --------------------------------------------------------------------------------
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 FOR THE PERIOD
INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. 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> 121
- --------------------------------------------------------------------------------
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> 122
- --------------------------------------------------------------------------------
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
<PAGE> 123
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
GOVERNMENT BOND FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Government Bond Fund 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 years in the
two-year period then ended, and the financial highlights for each of the years
in the three-year period then ended and the period May 2, 1994 (commencement of
operations) to December 31, 1994. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the 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 custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Government Bond Fund
of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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
115
<PAGE> 124
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, High Current Income Fund's Class A
Shares had a net annualized yield of 9.02%. The Fund's Class A Shares had a
total investment return for the year ended December 31, 1997 of +11.00%, based
on a change in per share net asset value from $11.39 to $11.52, and assuming
reinvestment of $1.059 per share income dividends and $0.006 per share capital
gains distributions. For the six months ended December 31, 1997, the Fund's
Class A Shares had a total investment return of +4.59%, based on a change in per
share net asset value from $11.54 to $11.52, and assuming reinvestment of $0.534
per share income dividends and $0.006 per share capital gains distributions.
(Additional performance information can be found on page 118 of this report to
shareholders.)
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and South
Korea initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth remains moderate
enough and inflationary pressures sufficiently contained to preclude an increase
in short-term interest rates in early 1998. The ongoing developments in Asia
will undoubtedly also influence the central bank's monetary policy decisions in
the new year.
FISCAL YEAR IN REVIEW
For the year ended December 31, 1997, the high-yield market posted a return of
+12.63% as measured by the unmanaged CS First Boston High Yield Index, outpacing
a strong US Treasury bond performance of +11.10%. Yield spreads widened on
average only 40 basis points--50 basis points (0.40%--0.50%) from their highest
levels at mid-year. Returns on high-yield issues reflected continued cash
inflows to the market and favorable equity markets, but were dampened somewhat
by concerns over potential erosion in future corporate earnings as well as a
heavy new-issue calendar. The Fund's results were hindered by large average cash
positions (10%--12% of total long-term investments) throughout the year and a
relatively high exposure (12.6%) to emerging market issues that were hard hit by
the Asian currency turmoil. However, our investments in media and communication
sectors (22.8%) outperformed other industries, benefiting Fund returns.
Despite recent market volatility, we believe that prospects for the high-yield
market are generally favorable. The economic environment remains benign. Trends
in credit quality remain positive. Merger and acquisition activity and equity
issuance have strengthened credit quality for many high-yield issuers. Portfolio
holdings benefiting from this trend included Brooks Fiber Properties Inc., which
has agreed to be acquired by WorldCom Inc., as well as Sinclair Broadcasting
Group Inc. and Del Monte Corp., which tapped the equity markets in recent
months. During the past six months, market technicals continued to favor modest
yields obtained elsewhere. Heavy supply has been and is likely to be offset in
part by the yield pick up obtained from investing in high-yield securities
relative to US Treasury issues. The yield spread to Treasury issues, despite
some widening, continues to suggest that much of the good news is priced into
the market.
Our approach to the market continues to be selective, favoring companies with
strong fundamentals whose bonds we believe represent good value. As an example,
in recent months
116
<PAGE> 125
- --------------------------------------------------------------------------------
we added positions in several healthcare names at attractive levels. These names
included Vencor Inc., Paragon Health Network, Inc. and Extendicare Inc.
Healthcare had been significantly underrepresented in the portfolio because of
previously full valuations. The emerging markets sector, despite its volatility,
also represents above-average relative value, in our opinion. We believe that
the magnitude of these wide yield spreads already discounts the worst credit
scenario.
Communications and media remained our largest broad industry category,
totaling 22.8% of total long-term investments. Of the more narrowly classified
sectors, the largest industries were: energy, 8.7%; domestic cable, 6.2%;
utilities, 5.7%; and paper/forest products, 3.9%. Non-US bonds totaled 20.5% of
the portfolio, with emerging markets issues accounting for 12.6% of long-term
investments. At December 31, 1997, the average portfolio maturity was 6 years, 8
months.
IN CONCLUSION
We thank you for your continued interest in High Current Income Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to sharing our
investment outlook and strategies with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Aldona A. Schwartz
Aldona A. Schwartz
Vice President and Portfolio Manager
February 10, 1998
117
<PAGE> 126
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MEASUREMENT PERIOD HIGH CURRENT INCOME FIRST BOSTON HIGH
(FISCAL YEAR COVERED) FUND'CLASS A SHARES YIELD INDEX"
<S> <C> <C>
DEC-87 10000 10000
DEC-88 11387 11365
DEC-89 12086 11410
DEC-90 11164 10682
DEC-91 15965 15356
DEC-92 19165 17913
DEC-93 22584 21301
DEC-94 21774 21093
DEC-95 25521 24760
DEC-96 28397 27835
DEC-97 31521 31349
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
+ High Current Income 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.
++ This unmanaged market-weighted Index of high-yield debt securities is comprised of 423 securities rated BBB or
lower.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +11.00%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/97 +10.46
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/97 +12.17
- --------------------------------------------------------------------------------
118
<PAGE> 127
High Current Income Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the First Boston High Yield Index.
Beginning and ending values are:
12/87 12/97
----- -----
High Current Income Fund+
- --Class A Shares* $10,000 $31,521
First Boston High Yield Index++ $10,000 $31,349
<PAGE> 128
- --------------------------------------------------------------------------------
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>
119
<PAGE> 129
- --------------------------------------------------------------------------------
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>
120
<PAGE> 130
- --------------------------------------------------------------------------------
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>
121
<PAGE> 131
- --------------------------------------------------------------------------------
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 & PUBLISHING--1.9% B+ B1 4,000,000 Garden State Newspapers, 8.75%
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 DISTRIBUTION--0.8% B- B3 4,000,000 AmeriServe Food Distribution,
Inc., 10.125% due
7/15/2007................... 4,000,000 4,200,000
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
122
<PAGE> 132
- --------------------------------------------------------------------------------
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>
123
<PAGE> 133
- --------------------------------------------------------------------------------
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 & PUBLISHING--0.3% NR* NR* 15,704 Primedia Inc. (Series B)(a)... 1,557,630 1,692,110
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
124
<PAGE> 134
- --------------------------------------------------------------------------------
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.
125
<PAGE> 135
- --------------------------------------------------------------------------------
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.
126
<PAGE> 136
- --------------------------------------------------------------------------------
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.
127
<PAGE> 137
- --------------------------------------------------------------------------------
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.
128
<PAGE> 138
- --------------------------------------------------------------------------------
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.
129
<PAGE> 139
- --------------------------------------------------------------------------------
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 FROM INFORMATION PROVIDED IN THE FINANCIAL FOR THE YEAR ENDED DECEMBER 31,
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.
130
<PAGE> 140
- --------------------------------------------------------------------------------
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.
131
<PAGE> 141
- --------------------------------------------------------------------------------
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.
132
<PAGE> 142
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
HIGH CURRENT INCOME FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of High Current Income Fund 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
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
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 custodian. 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 position of High Current Income
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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 12, 1998
133
<PAGE> 143
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, Index 500 Fund's Class A Shares had a
total investment return of +32.81%, based on a change in per share net asset
value from $10.17 to $13.48, and assuming reinvestment of $0.018 per share
income dividends and $0.003 per share capital gains distributions. For the six
months ended December 31, 1997, the Fund's Class A Shares had a total investment
return of +10.42%, based on a change in per share net asset value from $12.21 to
$13.48. (Additional performance information can be found on page 136 of this
report to shareholders.)
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and South
Korea initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth remains moderate
enough and inflationary pressures sufficiently contained to preclude an increase
in short-term interest rates in early 1998. The ongoing developments in Asia
will undoubtedly also influence the central bank's monetary policy decisions in
the new year.
FISCAL YEAR IN REVIEW
High levels of volatility within the US equity market have, to some extent,
overshadowed the remarkable performance turned in by the Standard & Poor's 500
Index (S&P 500) during 1997. The Index continued its trend of extraordinary
returns that has turned the last 16 years into a bull market of historic
proportions. The year ended December 31, 1997 became the third straight year in
which the unmanaged S&P 500 produced a total return in excess of 20%. It also
became the seventh straight year of positive total returns for the S&P 500,
which last produced a negative total return in 1990. Since 1982, the S&P 500
recorded a negative return only in 1990. For the three-year period ended
December 31, 1997, the S&P 500 had a total return of +125.56%.
The third quarter of 1997 began on a strong note for the S&P 500 as it gained
7.98% in July, easily the best month of the year. Having ended June at a level
of 885.14, the Index finished July at an all-time high of 954.29. Concerns over
stronger-than-expected economic growth and rising inflationary pressures led to
the market's decline in August, with that month becoming only the second month
of 1997 in which the S&P 500 posted a loss. These concerns were alleviated as
lower interest rates fueled a powerful rebound in September and resulted in an
overall third quarter total return of +7.49% for the S&P 500.
By October 7, 1997, the S&P 500 had posted a new all-time high of 983.12.
However, during October, turmoil in the financial and currency markets of the
Far East led to significant and rapid declines in most markets of the world,
with the S&P 500 and Dow Jones Industrial Average suffering their biggest
one-day point declines in history on October 27, 1997. Although the S&P 500 lost
nearly 65 points that day, the rebound on the following day saw it regain much
of that loss, as the S&P 500 climbed by nearly 45 points, and posted a loss of
3.30% for the month of October. Inflationary concerns and worries about the
situation in Asia appeared to be muted during November, with the S&P 500
rebounding strongly with a total return of +4.59%. This momentum continued into
December as long-term interest rates continued their descent toward, and finally
through, the 6% level. With the background of a strong bond market rally and
continuing inflows into equity mutual funds, the S&P 500 reached a new all-
134
<PAGE> 144
- --------------------------------------------------------------------------------
time high of 983.79 on December 5, 1997, which it did not exceed by the end of
the year.
Although small-capitalization stocks did show signs of strength during certain
periods of 1997, the rally late in the year was heavily concentrated in the
larger-capitalization stocks which have powered the S&P 500 advance during most
of the last three years. While the total return produced by the Index during the
second half of the year was a sizeable +10.59%, much of this six-month period
had the S&P 500 fluctuating, sometimes rapidly, in a range between 925 and 965.
The gains produced during the first half of 1997 were far stronger at +20.59%.
Having ended 1996 at 740.74, the S&P 500 closed 1997 at 970.43, a gain of nearly
230 points for the year. This advance resulted in a total return for 1997 of
+33.36%.
For the year ended December 31, 1997, the Fund's Class A Shares total return
was +32.81%, compared to the unmanaged S&P 500 total return of +33.36% for the
same period. The Fund's objective is to provide investment results that seek to
replicate the total return (before expenses) of the S&P 500 Index. Therefore,
the cumulative tracking deviation for the year, relative to the total return of
the S&P 500, was -0.55%.
PORTFOLIO MATTERS
We added several new equity positions to the Fund during the second half of
1997, as Standard & Poor's Corp. revised the composition of the Index in
response to merger and acquisition activity affecting many of its constituents.
Among the new equity positions initiated in the second half of 1997 were:
SunAmerica Inc. on July 16; Apache Corporation, Anadarko Petroleum Corporation
and NextLevel Systems, Inc. on July 25; Owens-Illinois, Inc. and Progressive
Corporation on August 1; Huntington Bancshares, Inc. and Mirage Resorts, Inc. on
August 5 and 6, respectively; State Street Corporation on August 15; Clear
Channel Communications, Inc. on August 29; KLA-Tencor Corporation on September
12; HBO & Company on October 22; Synovus Financial Corp. on November 26; BB&T
Corporation on December 3; Cincinnati Financial Corporation on December 17; and
Omnicom Group, Inc. on December 23.
Net assets of the Fund continued to grow rapidly during the second half of
1997, increasing from $144.6 million on June 30, 1997 to $215.2 million on
December 31, 1997. This represents a gain of 48.8% for net assets during the
six-month period ended December 31, 1997. Nearly all of the Fund's assets are
held in the form of a fully replicating portfolio of all 500 stocks which
comprise the S&P 500. In addition, the Fund held a long position in futures
contracts, which are used to equitize most daily cash flows into the Fund. At
the end of December, the Fund's equity portfolio was valued at $209,586,482. In
addition, the Fund held a long position of 25 S&P March 1998 futures contracts.
Many of the Fund's futures contracts were converted into equity prior to the
expiration of the December 1997 futures contracts, since it had been
uneconomical to roll these contracts into the March contract during this period.
The Fund seeks to be 100% invested in the S&P 500 at all times.
IN CONCLUSION
We appreciate your investment in Index 500 Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to sharing our investment outlook and
strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Eric Mitofsky
Eric Mitofsky
Senior Vice President and Portfolio Manager
February 10, 1998
135
<PAGE> 145
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INDEX 500
MEASUREMENT PERIOD FUND'CLASS A
(FISCAL YEAR COVERED) SHARES* S&P 500 INDEX++
<S> <C> <C>
12/13/96** 10000 10000
DEC-96 10168 10175
DEC-97 13505 13570
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ The Fund may invest in all 500 stocks in the S&P 500 Index in approximately the same proportions as in the
S&P 500 Index, in a statistically selected sample of the 500 stocks in the S&P 500 Index, or in related options
and futures contracts.
++ This unmanaged market-weighted Index is comprised 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
United States.
Past performance is not predictive of future results.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +32.81%
- --------------------------------------------------------------------------------
Inception (12/13/96) to 12/31/97 +33.16
- --------------------------------------------------------------------------------
136
<PAGE> 146
Index 500 Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the S&P 500 Index. Beginning and ending
values are:
12/13/96** 12/97
---------- -----
Index 500
Fund+--Class A Shares* $10,000 $13,505
S&P 500 Index++ $10,000 $13,570
<PAGE> 147
- --------------------------------------------------------------------------------
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
<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>
137
<PAGE> 148
- --------------------------------------------------------------------------------
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
SHARES VALUE
COMMON STOCKS HELD (NOTE 1a)
- -------------------------------------------------------
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>
138
<PAGE> 149
- --------------------------------------------------------------------------------
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
SHARES VALUE
COMMON STOCKS HELD (NOTE 1a)
- -------------------------------------------------------
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>
139
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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
SHARES VALUE
COMMON STOCKS HELD (NOTE 1a)
- -------------------------------------------------------
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>
140
<PAGE> 151
- --------------------------------------------------------------------------------
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
<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.
141
<PAGE> 152
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
SCHEDULE OF INVESTMENTS AS OF DECEMBER 31, 1997 (CONCLUDED)
- --------------------------------------------------------------------------------
* 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.
** 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.
142
<PAGE> 153
- --------------------------------------------------------------------------------
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.
143
<PAGE> 154
- --------------------------------------------------------------------------------
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.
144
<PAGE> 155
- --------------------------------------------------------------------------------
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.
145
<PAGE> 156
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
------------------------------
FOR THE
PERIOD
FOR THE YEAR DEC. 13,
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED FROM INFORMATION ENDED 1996+
PROVIDED 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.
146
<PAGE> 157
- --------------------------------------------------------------------------------
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.
147
<PAGE> 158
- --------------------------------------------------------------------------------
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.
148
<PAGE> 159
- --------------------------------------------------------------------------------
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, Dollar
1996+ 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.
149
<PAGE> 160
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
INDEX 500 FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Index 500 Fund 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 and the financial highlights for
the year then ended and the period December 13, 1996 (commencement of
operations) to December 31, 1996. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the 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 custodian 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 position of Index 500 Fund of
Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the results
of its operations, the changes in its 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
150
<PAGE> 161
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, International Equity Focus Fund's Class
A Shares had a total investment return of -4.55%, based on a change in per share
net asset value from $11.63 to $10.80, and assuming reinvestment of $0.226 per
share income dividends and $0.087 per share capital gains distributions. For the
six months ended December 31, 1997, the Fund's Class A Shares had a total
investment return of -16.67%, based on a change in per share net asset value
from $12.96 to $10.80. (Additional performance information can be found on page
154 of this report to shareholders.)
FISCAL YEAR IN REVIEW
International equity markets provided poor returns in 1997. In particular,
emerging markets declined by more than 16% in US dollar terms, according to the
unmanaged International Finance Corporation's Asian Investables Index, as the
Asian currency crisis severely impacted both liquidity and the intermediate-term
outlook for earnings growth. However, among the major markets returns differed
significantly. Japanese equities declined by more than 25% in US dollar terms,
according to the unmanaged S&P World Japan Index, while European equities
returned almost +24%, according to the unmanaged Financial Times/Standard &
Poor's (FT/S&P) -- Actuaries European Index. However, even European returns
failed to match the continued rally in US stocks which, according to the
unmanaged S&P 500 Composite Index, provided a total return of +33.36% for the 12
months ended December 31, 1997.
As outlined in our June semi-annual report, the investment process for
International Equity Focus Fund changed during 1997. The Fund's new investment
strategy seeks to add value over the intermediate term by conducting strategic
allocations between countries and generally maintaining an overweighted stance
in smaller and emerging markets. During 1997, our strategy of overweighting
emerging markets negatively affected the return to shareholders.
Performance in the second half of 1997 reflected positive contributions from
underweighted positions in Japan and some Asian markets, together with currency
hedges into US dollars, and negative contributions from underweighted positions
in Germany, Switzerland and Holland. Overall, stock selection was a slightly
negative factor in the second half of 1997 as the Fund remained overweighted in
cyclical securities and underweighted in financial sectors.
PORTFOLIO MATTERS
The Fund's effective cash position continued to rise in the second half of
1997 as we reduced our exposure to Japan and Asian markets. As of December 31,
1997, the Fund's effective cash position was approximately 18% of net assets.
The Fund had approximately 37% invested in European equities, with overweighted
positions in some peripheral markets and the United Kingdom, but underweighted
positions in Germany, Holland and Switzerland. The Fund had 21% invested in
Japan at year-end, down significantly from six months earlier. Other major
investments were in Latin America, Canada and Australia.
During the second half of 1997, we implemented new stock selection strategies
in the United Kingdom, Germany, Australia and France. These investment
strategies were designed to enhance stock selection in those countries by
employing quantitative screening techniques which seek to highlight attractive
stock opportunities. One consequence of implementing these new strategies was an
increased level of turnover activity associated with the restructuring. Other
portfolio activity concentrated on reducing exposure to Asian financial stocks.
ECONOMIC AND INVESTMENT ENVIRONMENT
The consensus expectation for global economic growth in 1998 fell sharply in
recent months as a result of the turmoil in the Asian markets and economies.
Whereas a few months ago many analysts were expecting global growth in 1998 to
match or exceed 1997's rise of about 4%, few now expect growth to exceed 3.25%
in 1998. Against this backdrop, analysts have begun reducing earnings forecasts.
However, to the extent that weaker economic growth allows global real bond
yields to ease, we believe the impact on equity markets of slower earnings
growth is likely to be softened. At this point, global equity returns in 1998
look unlikely to reach the double-digit levels of 1995--1996, but in our view a
widespread bear market probably requires a rise in global inflationary
pressures.
Not surprisingly, the sharpest economic growth downgrades for 1998 have come
in Asia. While the region has seen its currencies depreciate against the rest of
the world in nominal terms, it remains to be seen how much higher inflation
expected in 1998 may reduce the real depreciation. Meanwhile, many countries are
151
<PAGE> 162
- --------------------------------------------------------------------------------
entering 1998 with much tighter interest rate and fiscal policies as well as
weaker financial systems. We have no plans to overweight Asia as a region until
current account positions improve, the cyclical growth outlook brightens and
structural improvements are delivered. There is also the problem that many Asian
countries' stock markets have large weightings in property and/ or financial
stocks that are vulnerable to asset price deflation. However, some markets do
appear to offer attractive intermediate-term returns, notably India, Taiwan and,
to a lesser extent, the Philippines.
Latin America has withstood the initial impact of the Asian crisis relatively
well. Our favored markets in the region are Mexico and Argentina, in light of
sound economic management and recent noninflationary rises in domestic demand
which have enhanced the prospect for earnings growth in 1998. Furthermore, after
a period of sharp equity price increases, the recent correction in equity prices
has restored the attractiveness of Latin American markets from a valuation
perspective.
Our intermediate-term expected equity returns for Japan remain among the
highest for developed markets. However, the near-term growth outlook is poor,
and a sustained rally in the equity market probably would require a package of
measures to address the structural impediments to growth (such as a weak
financial system and an inefficient property market) as well as providing a
boost to cyclical prospects (for example, corporate tax cuts).
The economic recovery in continental Europe has begun to spread from exports
to domestic demand, even in Germany and France. In contrast to most regions,
12-month forward earnings estimates have been revised upward over the past six
months. Exposure to the slowdown in Asia is likely to be relatively limited,
which may allow the region to remain in what is often viewed as a "sweetspot"
for equity markets where there is above-par economic growth with sufficient
spare capacity to permit stable or even falling inflation. While two of the
larger markets, Switzerland and the Netherlands, already appear significantly
overvalued on an intermediate-term basis, better value appears to lie in France,
Italy and Spain. European Monetary Union will be a major focus in 1998. Interest
rate convergence is largely complete, but tax reform, corporate restructuring
and merger and acquisition activity should be durable themes next year. The UK
stock market looks to us well-positioned from both a value and flow of funds
viewpoints to benefit in the near term from a downturn in interest rate
expectations for 1998. Recent indicators have suggested that consumer spending
growth has peaked and that net exports have finally begun to deteriorate in
response to sterling's overvaluation.
The US economy continues to exhibit late business cycle pressures. Delivery
lags and labor market indicators are above thresholds that previously have
coincided with higher inflation. The rally in the stock market since the sharp
decline in October may reflect an increasingly accepted view that the slowdown
in Asia will feed through into lower economic growth in the US in 1998, allowing
the Federal Reserve Board to either leave interest rates unchanged for a
prolonged period or reduce them slightly. However, we find it difficult to see
how such a scenario remains consistent with analysts' long-term earnings growth
forecasts, which remain around 15% per year. US profit margins already appear to
be under some pressure from rising labor costs, notwithstanding the impact of
increased competition from Asian imports and a generally stronger US dollar. If
US economic growth continues to be robust, corporate earnings could surprise on
the upside in 1998. But in such an environment, interest rates would appear
likely to move higher than is currently discounted. In contrast,
intermediate-term stock market return prospects in Canada and Australia look
relatively attractive, notwithstanding the recent weakening in commodity prices.
The US dollar is currently supported relative to the Deutschemark and yen by
significant interest rate differentials. However, a risk to the dollar in 1998
is that the US current account deficit becomes a more significant factor. While
economists have been busy revising Asian current account forecasts for 1998 in a
favorable direction, reflecting currency depreciations and tighter policy
stances, it is notable that this has not yet found its full counterpart in
downward revisions to developed countries' current account estimates. It is
conceivable that the US current account deficit could exceed 3% of gross
domestic product in 1998, which would leave the US currency vulnerable to a
change in relative interest rate trends.
IN CONCLUSION
International equity markets provided significantly dispersed returns in the
year ended December 31, 1997, as the Asian currency crisis impacted global
markets, and Pacific Basin
152
<PAGE> 163
- --------------------------------------------------------------------------------
equity markets in particular. Much of this volatility occurred in the latter
half of 1997. The Fund remains defensively positioned with overweighted
positions in Canada, Australia, India, Mexico and some European markets.
Effective cash weights are likely to remain between 10%--20% of net assets
during the coming months.
We appreciate your investment in International Equity Focus Fund of Merrill
Lynch Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Andrew Bascand
Andrew Bascand
Vice President and Portfolio Manager
February 12, 1998
153
<PAGE> 164
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
[Graph]
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ International Equity Focus Fund invests in a portfolio of securities of foreign countries, both developed and
developing, throughout the world.
++ This unmanaged capitalization-weighted Index is comprised of over 1,800 companies in 24 countries, excluding the
United States.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 -4.55%
- --------------------------------------------------------------------------------
Inception (7/01/93) through 12/31/97 +3.95
- --------------------------------------------------------------------------------
154
<PAGE> 165
International Equity Focus Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Financial Times/Standard &
Poor's-Actuaries World (Ex-US) Index. Beginning and ending values are:
7/01/93** 12/97
--------- -----
International Equity
Focus Fund+--Class A Shares* $10,000 $11,904
Financial Times/Standard & Poor's --
Actuaries World (Ex-US) Index++ $10,000 $13,771
<PAGE> 166
- --------------------------------------------------------------------------------
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
- ---------------------------------------------------------------------------------------------------------------------
<CAPTION>
LATIN AMERICA
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
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 PRODUCERS 3,500,000 Petroleo Brasileiro
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>
155
<PAGE> 167
- --------------------------------------------------------------------------------
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 PRODUCERS 19,000 Imperial Oil Ltd. ....... 1,109,952 1,221,438 0.3
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 48,000 BC Telecom, Inc. ........ 1,275,260 1,492,558 0.4
-----------------------------------------------------------------------------------------------------
</TABLE>
156
<PAGE> 168
- --------------------------------------------------------------------------------
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 SERVICES 25,000 Mayne Nickless Ltd. ..... 142,510 131,990 0.0
-----------------------------------------------------------------------------------------------------
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>
157
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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 PRODUCERS 38,900 Australian Gas Light Co.,
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>
158
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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>
159
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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>
160
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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>
161
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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>
162
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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 & DEFENSE 1,400 Labinal S.A.............. 420,805 360,060 0.1
-----------------------------------------------------------------------------------------------------
AGRICULTURAL 3,400 Eridania Beghin-Say
OPERATIONS S.A.................... 503,228 531,550 0.1
-----------------------------------------------------------------------------------------------------
</TABLE>
163
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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>
164
<PAGE> 176
- --------------------------------------------------------------------------------
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>
165
<PAGE> 177
- --------------------------------------------------------------------------------
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>
166
<PAGE> 178
- --------------------------------------------------------------------------------
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 PRODUCERS 29,758 Saga Petroleum A.S.
(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>
167
<PAGE> 179
- --------------------------------------------------------------------------------
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%
EQUIPMENT
(CONTINUED) -----------------------------------------------------------------------------------------------------
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>
168
<PAGE> 180
- --------------------------------------------------------------------------------
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.
PLC.................... $ 997,073 $ 865,926 0.2%
(CONCLUDED)
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>
169
<PAGE> 181
- --------------------------------------------------------------------------------
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 WRITTEN 1,868,261 Thailand Index, expiring
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%
============ =====
- ---------------------------------------------------------------------------------------------------------------------
(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.
</TABLE>
170
<PAGE> 182
- --------------------------------------------------------------------------------
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>
VALUE
NUMBER OF EXPIRATION (NOTES 1a &
CONTRACTS ISSUE EXCHANGE DATE 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:
---------------------------------------------------------------------------------------------------------------------
<CAPTION>
NUMBER OF EXPIRATION VALUE
CONTRACTS ISSUE EXCHANGE DATE (NOTES 1a & 1b)
- ---------------------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
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
===============
- ---------------------------------------------------------------------------------------------------------------------
See Notes to Financial Statements.
</TABLE>
171
<PAGE> 183
- --------------------------------------------------------------------------------
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.
172
<PAGE> 184
- --------------------------------------------------------------------------------
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.
173
<PAGE> 185
- --------------------------------------------------------------------------------
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.
174
<PAGE> 186
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
-----------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN FOR THE PERIOD
DERIVED FROM INFORMATION PROVIDED IN THE FINANCIAL JULY 1, 1993+ TO
STATEMENTS. INCREASE (DECREASE) IN NET ASSET DECEMBER 31,
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.
175
<PAGE> 187
- --------------------------------------------------------------------------------
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
176
<PAGE> 188
- --------------------------------------------------------------------------------
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.
177
<PAGE> 189
- --------------------------------------------------------------------------------
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
Gains
(Losses)
Unrealized
Gains
(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 Written Premiums
Call Options 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.
178
<PAGE> 190
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL EQUITY FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
INTERNATIONAL EQUITY FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of International Equity Focus Fund 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
years in the two-year period then ended, and the financial highlights for each
of the years in the four-year period then ended and the period July 1, 1993
(commencement of operations) to December 31, 1993. These financial statements
and the financial highlights are the responsibility of the Fund's management.
Our responsibility is to express an opinion on these financial statements and
the 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 custodian 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 position of International Equity
Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997,
the results of its operations, the changes in its 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
179
<PAGE> 191
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, Natural Resources Focus Fund's Class A
Shares had a total investment return of -12.52%, based on a change in per share
net asset value from $13.12 to $10.66, and assuming reinvestment of $0.206 per
share income dividends and $0.724 per share capital gains distributions. For the
six months ended December 31, 1997, the Fund's Class A Shares had a total
investment return of -15.73%, based on a change in per share net asset value
from $12.65 to $10.66. (Additional performance information can be found on page
183 of this report to shareholders.)
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and South
Korea initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth remains moderate
enough and inflationary pressures sufficiently contained to preclude an increase
in short-term interest rates in early 1998. The ongoing developments in Asia
will undoubtedly also influence the central bank's monetary policy decisions in
the new year.
FISCAL YEAR IN REVIEW
The environment for investments in the natural resources sector was generally
mixed for the year ended December 31, 1997. This environment reflected increased
commodity demand arising from continued moderate global economic growth, led by
strong business activity in the United States. The combination of moderate
global economic growth and continued modest inflationary pressures had positive
implications for basic materials demand.
The Fund was heavily weighted in base metal stocks, with a particular emphasis
on copper stocks. Strong economic growth in North America and a budding recovery
in Europe helped copper prices strengthen during the first half of 1997. We had
expected rising demand for base metals to lead to declining inventories and
improved metal prices and company earnings. However, copper inventories rose on
the London Metals Exchange from distressed sales of producer stocks and as Far
East consumers pared inventories. Combined with concerns of an impending
economic slowdown in Asia during the second half of 1997, the price of copper
declined to as low as $0.76 per pound by the end of the year from its summer
peak which exceeded $1.20 per pound. Given that many mines produce gold as well
as other mineral by-products in association with copper production, the share
price declines were leveraged to the fall in prices across the metals sector. A
significant number of the Fund's holdings in the base metals area were in
Australian- and Canadian-domiciled companies. To the extent that the currencies
of these commodity-exposed nations declined, currency translations negatively
impacted certain companies in the Fund's portfolio and the Fund's performance as
a result.
The Fund's performance was also hurt by our significant exposure to the gold
sector during the fiscal year. After trending downward since early 1996, the
price of gold collapsed on the third-quarter announcement that Australia's
central bank had sold two-thirds of its gold holdings. The price of gold
continued to fall as inflation reports consistently came in at or below
estimates, and the metal price reached lows not seen in nearly 18 years as
deflationary fears became more prominent in economic forecasts. Exacerbating the
decline was additional central
180
<PAGE> 192
- --------------------------------------------------------------------------------
bank selling as speculation clouded gold's role as a reserve asset backing the
European Monetary Unit. The failure of gold to perform as a store of value in
time of currency crisis may undermine the premium multiples that have
traditionally been awarded to the shares of gold-mining stocks.
For the fiscal year ended December 31, 1997, the Fund's largest investment
representation was in the energy sector, with particular emphasis on exploration
and production companies. The shares of independent oil companies initially
appreciated on rising natural gas prices and as merger activity ignited takeover
fever involving several companies in the group. Investment returns benefited in
the second half of the year as two holdings, The Louisiana Land and Exploration
Co. and Chauvco Resources Ltd., were acquired by Burlington Resources Inc. and
Pioneer Natural Resources Co., respectively. However, gains in the sector were
short-lived as energy prices fell in response to the combined impact of politics
and weather. In November, the Organization of Petroleum Exporting Countries
(OPEC) raised quota levels for the first time in four years. Since OPEC had
already been producing well above its quota, the incremental barrels added to
the market were marginal. However, the quota increase coincided with the
slowdown in Asian consumption and with the emergence of mild weather conditions
arising from the El Nino climatic phenomenon. The increased oil production and
declining demand, coupled with ample worldwide inventories, drove oil prices
down to their lowest levels in over two years. Oil service companies' stock
prices were particularly strong early in the summer and fall months, as pricing
for oil services continued to escalate and as early announcements of oil company
capital spending plans continued to show double-digit gains in oil services
spending. Given the strong appreciation of the oil service sector, new holdings
in the area were concentrated in companies that we believed would benefit from
the later stages of the capital spending cycle.
During the fiscal year, chemical investments were solid performers, as
declining feedstock costs supported earning forecasts despite rising capacity in
many product areas. The Fund was severely underexposed to this sector, with only
4% of net assets in chemical stocks compared to the Morgan Stanley Capital
International Natural Resources Index's 20% representation. While the chemical
sector did not appreciate significantly in absolute terms, the Fund's
underweighting in the sector negatively impacted Fund performance.
We increased the Fund's holdings of paper and forest product shares during the
first half of 1997 because it appeared that the two-year slide in commodity
prices had ended. The poor pricing environment had curtailed plans for new
capacity in some grades, and a trend for consolidation in the group had emerged.
The shares of forest product companies aborted their rally as currency collapses
led to concerns of lower Southeast Asian demand. While the group suffered
significant declines in the second half, the outlook for some paper products
appeared favorable, and we began to concentrate the Fund's holdings in those
companies.
During the final months of the year, the collapse of Asian currencies and
consequent deterioration of financial conditions played havoc with the
investment thesis on which the portfolio was structured. Growth estimates for
Far Eastern economies were sharply reduced, with economic contraction now
possible for several nations in the region. Investors increasingly focused on
the potential for commodity price deflation, and speculation shifted to the
impact that the Asian debacle could have on Western economies. The Fund's
returns suffered as lower demand forecasts and declining commodity prices led to
earnings estimate reductions across a broad spectrum of natural resource
companies.
INVESTMENT ACTIVITIES
During the six-month period ended December 31, 1997, there were no significant
geographic or industry allocation changes made in the Fund. The Fund was fully
invested during the second half of the year, with a cash position of about 3% of
net assets at year-end. We have begun to raise the cash position to seek to
limit the Fund's exposure to broad-based selling of resource stocks, as well as
to seek to take advantage of opportunities that arise from share price declines.
We established a new position in TransCoastal Marine Services Inc., Stolt Comex
Seaway Inc. and McDermott International, Inc. in the oil sector, and took
profits in the shares of Louisiana Land and Exploration Co. and Chauvco
Resources Ltd. after their share prices rose following acquisition bids. We made
modest reductions in gold shares as the commodity continued to be pressured from
central bank sales. We reduced our positions in Japanese industrial and mining
shares, given the risk of reduced exports to trading partners in the Pacific
Rim.
181
<PAGE> 193
- --------------------------------------------------------------------------------
The problems facing the economies of Asia have created severe uncertainty in
the outlook for natural resource stocks. Commodity prices continue to decline,
and resource-related companies are experiencing earnings estimate reductions and
a contraction of price/earnings and price/cash flow multiples. The Fund had been
constructed with leverage to continued global expansion. Looking ahead, we plan
to take a number of steps to position the portfolio toward the value end of the
spectrum. The Fund will be reviewed to ascertain that all holdings are
inexpensive in terms of absolute and relative valuations of price/earnings,
price/book and price/cash flow multiples. The review also will include financial
structures and cash operating costs of each enterprise to assess prospects for
ongoing operations in worst-case economic conditions. Exposure to commodities
with rising capacity utilization trends, a key driver of natural resource
stocks, will be emphasized in portfolio construction. Commodities in
supply/demand balance are likely to appreciate in economic expansions, while
mitigating downside price risk in economic contractions.
We plan to create a more focused Fund by reducing the number of stock
positions from the current 111 holdings. We expect to increase concentration in
the companies in which we have high confidence concerning company fundamentals
and where valuation levels appear attractive given uncertain economic
conditions. In addition, geographic representation of Fund positions will be
examined to seek to enhance exposure to markets perceived to have sound growth
outlooks, as well as to diversify currency risks to the Fund.
The collapse of currencies and stock markets in the Far East is likely to
dramatically reduce natural resource use in those countries. The duration of the
downturn, as well as its potential spread to North American and European
markets, could exacerbate declines in production and pricing across a broad
spectrum of commodities. However, the recent declines in resource equities have
been indiscriminate. We believe opportunities exist in many of the commodity
companies that are users of feedstocks with declining costs, as well as in
energy commodities where positive trends have been masked by mild weather
conditions. Investments in companies whose operations can exploit lower input
costs, or whose shares discount the economic turmoil, could provide satisfactory
returns in the coming year. We expect the changes outlined above to position the
Fund to provide favorable returns relative to the commodity markets.
IN CONCLUSION
We appreciate your investment in Natural Resources Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies with you in our upcoming semi-annual report to
shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Robert M. Shearer
Robert M. Shearer
Vice President and Portfolio Manager
February 10, 1998
- --------------------------------------------------------------------------------
We are pleased to announce that effective December 10, 1997 Robert M. Shearer
has been appointed Senior Portfolio Manager, and is responsible for the
day-to-day management of Natural Resources Focus Fund. Mr. Shearer has been
employed by Merrill Lynch Asset Management, L.P. since 1997 as Associate
Portfolio Manager of the Fund. Prior thereto, he was a Vice President and an
Assistant Portfolio Manager at David L. Babson and Company, Inc. from 1996 to
1997, and was a Vice President/Sector Manager at Concert Capital Management from
1993 to 1996. From 1988 to 1993, he was the Senior Energy Analyst at Fiduciary
Trust Company International.
- --------------------------------------------------------------------------------
182
<PAGE> 194
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LIPPER
NATURAL S*P NATURAL
MEASUREMENT PERIOD RESOURCES INDUSTRIALS RESOURCES CONSUMER
(FISCAL YEAR COVERED) FOCUS FUND* INDEX AVERAGE PRICE INDEX
<S> <C> <C> <C> <C>
6/01/88** 10000 10000 10000 10000
12/88 9580 10615 9928 10272
12/89 11326 13997 13125 10748
12/90 10622 13870 12050 11420
12/91 10766 18144 12225 11760
12/92 10913 19180 12456 12109
12/93 12056 20914 15741 12449
12/94 12230 21709 15145 12780
12/95 13778 29220 17668 13104
12/96 15641 35947 23329 13537
12/97 13683 47107 23343 13767
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Commencement of operations.
+ Natural Resources Focus Fund invests primarily in a portfolio of equity securities of domestic and foreign
companies with substantial natural resource assets.
++ This unmanaged Index measures the pattern of movements of the common stocks of 400 large industrial companies
and their weighting by capitalization.
+++ This unmanaged Index is comprised of all US mutual funds classified by Lipper Analytical Services as natural
resource-related funds.
++++ This unmanaged Index is the most widely used Index of price changes over time and is designed to measure changes
in the typical market basket of purchases by urban consumers.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 -12.52%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/97 +4.63
- --------------------------------------------------------------------------------
Inception (6/01/88) through 12/31/97 +3.33
- --------------------------------------------------------------------------------
183
<PAGE> 195
Natural Resources Focus Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Standard & Poor's Industrials Index,
the Lipper Natural Resources Average and the Consumer Price Index. Beginning and
ending values are:
6/01/88** 12/97
--------- -----
Natural Resources Focus Fund+--
Class A Shares* $10,000 $13,683
Standard & Poor's Industrials
Index++ $10,000 $47,107
Lipper Natural Resources
Average+++ $10,000 $23,343
Consumer Price Index++++ $10,000 $13,767
<PAGE> 196
- --------------------------------------------------------------------------------
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>
184
<PAGE> 197
- --------------------------------------------------------------------------------
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>
185
<PAGE> 198
- --------------------------------------------------------------------------------
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
- ---------------------------------------------------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT SHORT-TERM INVESTMENTS
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
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.
186
<PAGE> 199
- --------------------------------------------------------------------------------
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.
187
<PAGE> 200
- --------------------------------------------------------------------------------
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.
188
<PAGE> 201
- --------------------------------------------------------------------------------
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.
189
<PAGE> 202
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES 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 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.
190
<PAGE> 203
- --------------------------------------------------------------------------------
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
191
<PAGE> 204
- --------------------------------------------------------------------------------
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.
192
<PAGE> 205
- --------------------------------------------------------------------------------
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.
193
<PAGE> 206
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--NATURAL RESOURCES FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
NATURAL RESOURCES FOCUS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Natural Resources Focus Fund 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
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
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 custodian. 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 position of Natural Resources
Focus Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997,
the results of its operations, the changes in its 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
194
<PAGE> 207
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, Prime Bond Fund's Class A Shares had a
total investment return of +8.64%, based on a change in per share net asset
value from $11.91 to $12.11, and assuming reinvestment of $0.784 per share
income dividends. For the six months ended December 31, 1997, the Fund's Class A
Shares had a total investment return of +5.83%, based on a change in per share
net asset value from $11.82 to $12.11, and assuming reinvestment of $0.388 per
share income dividends. (Additional performance information can be found on page
197 of this report to shareholders.)
FISCAL YEAR IN REVIEW
During the first quarter of the Fund's fiscal year, fixed-income markets fell
on concerns of growing inflationary pressures. We shortened the duration of the
Fund to 4.4 years by increasing the Fund's cash reserves to 8% of net assets. At
the end of March, the Federal Reserve Board launched a preemptive strike against
inflationary pressures by raising the Federal Funds rate by 25 basis points
(0.25%). Interest rates peaked in mid-April, then dropped through the second
quarter. This rally was fueled by a significant change in expectations regarding
the economy and more optimistic outlook for inflation. At this time, we decided
to maintain a duration-neutral strategy for the Fund, based on the volatility
that characterized the market. Accordingly, we set a range of 4.5 years--4.6
years for the Fund's duration. The Fund's performance was hurt by the relatively
high percentage (9%) of the Fund's net assets in cash reserves in response to
our concerns regarding volatility.
The market continued to rally until the middle of the summer. We extended the
upper limit of our duration range to 4.7 years and lengthened our positions
accordingly, primarily by reducing the Fund's cash reserve position to 7% of net
assets. Our industrial sector and quality mixes remained neutral to the Index.
The market fell sharply in August as a result of stronger-than-expected
employment and purchasing manager reports. These data suggested substantially
more robust consumer spending in the third quarter. The market rallied again in
September on the belief that the Federal Reserve Board would not move to tighten
interest rates again in 1997. Prices then began to fall in early October in
response to concerns about employment and wage pressures, but reversed direction
and rose sharply in the middle of the month because of concerns about the Asian
currency crisis. The US Treasury market was viewed as a safe haven for assets.
By the end of the fiscal year, bond yields were at their lowest levels of the
year. We extended the Fund's duration to 5.8 years in order to seek to
participate in this rally. This strategy enhanced the Fund's performance, so
that the total return on the Fund's Class A Shares rose to +8.64% for the year
by December 31, 1997.
PORTFOLIO MATTERS
A strong rally in bond prices in September, which was encouraged by low
inflation data, brought the yield on the 30-year Treasury bond to 6.23% by the
beginning of October. This rally lasted from the middle of September through the
first week of October, and was mirrored by the gains of the stock market, which
soared from 7660 to 8178 as measured by the Dow Jones Industrial Average. On
October 8, 1997, Federal Reserve Board Chairman Alan Greenspan expressed concern
before the House Budget Committee that the demand for labor was outpacing the
supply, with the resulting pressure likely to push up wages and prices. He
suggested that the Federal Reserve Board would tighten monetary policy before it
would allow this to happen. Bond prices slumped, and the yield on the long-term
Treasury bond jumped from 6.23% to 6.43% in three days. Then, on October 23,
1997, the Thai baht collapsed and the Asian currency markets declined rapidly.
On the following Monday, the New York Stock Exchange saw the DJIA fall 554
points on a record volume of 1.2 billion shares. A worldwide flight to quality
caused both foreign and domestic investors to seek shelter in the US Treasury
market.
The yield on the long-term bond fell from 6.43% to 6.15% during the third
quarter. Gross domestic product (GDP) data for the third calendar quarter of
1997 were released indicating a slightly larger-than-expected increase of 3.5%
as compared to 3.3% in the second calendar quarter. The GDP price deflator rose
only 1.4% for the third calendar quarter against a 1.8% increase in the second
calendar quarter. This was the lowest quarterly increase since the second
quarter of 1964. The long-term bond finished December with a 6.16% yield.
November and December witnessed a continuation of the flight to quality into US
bonds. The Treasury yield curve flattened from 53 basis points to 28 basis
points between 2-year--30-year issues. This suggested some foreign central bank
selling of issues with short-term maturities to shore
195
<PAGE> 208
- --------------------------------------------------------------------------------
up weak currencies and private sector purchasing of the long-term issues to
increase dollar-denominated investments. By the end of the year, the yield on
the long-term Treasury bond was 5.92%.
IN CONCLUSION
We appreciate your investment in Prime Bond Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to sharing our investment outlook and
strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Jay C. Harbeck
Jay C. Harbeck
Senior Vice President and Portfolio Manager
February 10, 1998
196
<PAGE> 209
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRIME BOND
MEASUREMENT PERIOD FUND'CLASS A MERRILL LYNCH COAO
(FISCAL YEAR COVERED) SHARES* INDEX"
<S> <C> <C>
DEC-87 10000 10000
DEC-88 10675 10976
DEC-89 12094 12526
DEC-90 12956 13448
DEC-91 15082 15901
DEC-92 16179 17351
DEC-93 18123 19507
DEC-94 17253 18856
DEC-95 20728 22919
DEC-96 21186 23696
DEC-97 23017 26157
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
+ Prime Bond Fund invests primarily in long-term corporate bonds rated A or better by either Standard & Poor's
Corp. or Moody's Investors Service, Inc.
++ This unmanaged broad-based Index is comprised of all industrialized bonds rated BBB3 of higher, of all
maturities.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +8.64%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/97 +7.31
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/97 +8.70
- --------------------------------------------------------------------------------
197
<PAGE> 210
Prime Bond Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Merrill Lynch C0A0 Index. Beginning
and ending values are:
12/87 12/97
----- -----
Prime Bond Fund+--
Class A Shares $10,000 $23,017
Merrill Lynch C0A0 Index++ $10,000 $26,157
<PAGE> 211
- --------------------------------------------------------------------------------
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 PROVINCES*--2.6% Province of Quebec (Canada)(2):
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>
198
<PAGE> 212
- --------------------------------------------------------------------------------
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>
199
<PAGE> 213
- --------------------------------------------------------------------------------
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>
200
<PAGE> 214
- --------------------------------------------------------------------------------
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>
201
<PAGE> 215
- --------------------------------------------------------------------------------
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.
202
<PAGE> 216
- --------------------------------------------------------------------------------
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.
203
<PAGE> 217
- --------------------------------------------------------------------------------
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.
204
<PAGE> 218
- --------------------------------------------------------------------------------
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.
205
<PAGE> 219
- --------------------------------------------------------------------------------
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 ------------------------------------------------------------
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....................... $ 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.
206
<PAGE> 220
- --------------------------------------------------------------------------------
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
207
<PAGE> 221
- --------------------------------------------------------------------------------
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.
208
<PAGE> 222
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--PRIME BOND FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
PRIME BOND FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Prime Bond Fund 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 years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the 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 custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Prime Bond Fund of
Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the results
of its operations, the changes in its 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
209
<PAGE> 223
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, Quality Equity Fund's Class A Shares had
a total investment return of +23.70%, based on a change in per share net asset
value from $32.83 to $38.42, and assuming reinvestment of $1.196 per share
income dividends and $0.558 per share capital gains distributions. For the six
months ended December 31, 1997, the Fund's Class A Shares had a total investment
return of +6.57%, based on a change in per share net asset value from $36.05 to
$38.42. (Additional performance information can be found on page 212 of this
report to shareholders.)
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and South
Korea initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth remains moderate
enough and inflationary pressures sufficiently contained to preclude an increase
in short-term interest rates in early 1998. The ongoing developments in Asia
will undoubtedly also influence the central bank's monetary policy decisions in
the new year.
FISCAL YEAR IN REVIEW
As of December 31, 1997, the Fund's asset allocation was: US equities, 91% of
net assets; foreign equities, 7%; and cash reserves, 2%.
During the year ended December 31, 1997, the overall return of the Fund was
held down by the laggard performance of foreign equities and bonds relative to
the performance of their US counterparts. The negative impact of foreign
equities was limited by our reducing investments in that sector during the
second half of 1997.
In the United States, the strong performance of financial service equities
during the year proved to be a positive influence on the Fund's total return.
The financial services sector accounted for the largest portion of US equities
held in the Fund throughout the fiscal year. Strength in financial services
equities offset disappointing returns for selected technology and healthcare
issues, among others, which had a negative impact on the Fund's total return.
PORTFOLIO MATTERS
During the second half of 1997 we became more cautious toward foreign stocks.
Our concerns over the widening economic problems in Asia, including South Korea,
Japan and Southeast Asia, led us to reduce our allocation to foreign equities
from 11% of net assets as of June 30, 1997 to 7% at December 31, 1997. We now
seek to limit representation to foreign equities which we believe offer
potential to add value to a primarily US portfolio.
In the US equity sector, consistent with our expectation of further US
interest rate declines, financial services equities continued to account for the
largest concentration of assets in the US stock sector. We maintained
significant representation in the areas of healthcare, technology and energy.
Overall, we are increasing emphasis on the shares of companies which, in our
view, have limited potential for earnings disappointments resulting from the
problems afflicting the Asian economies. On the other hand, we are reducing
positions in shares of companies which appear vulnerable to earnings
disappointments resulting from problems affect-
210
<PAGE> 224
- --------------------------------------------------------------------------------
ing developing economies. We eliminated Oracle Corp. on this basis.
IN CONCLUSION
We appreciate your investment in Quality Equity Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to sharing our investment outlook and
strategies again with you in our next report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Thomas R. Robinson
Thomas R. Robinson
Senior Vice President and Portfolio Manager
February 10, 1998
211
<PAGE> 225
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
QUALITY EQUITY
MEASUREMENT PERIOD FUND'CLASS A STANDARD & POOR'S
(FISCAL YEAR COVERED) SHARES* 500 INDEX"++
<S> <C> <C>
DEC-87 10000 10000
DEC-88 11354 11688
DEC-89 14848 15391
DEC-90 14946 14903
DEC-91 19456 19441
DEC-92 19980 20922
DEC-93 22891 23028
DEC-94 22616 23326
DEC-95 27729 32085
DEC-96 32690 39454
DEC-97 40441 52616
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
+ Quality Equity Fund, which uses a fully managed investment policy, invests primarily in common stocks of large-
capitalization companies, as well as investment-grade debt and convertible securities.
++ This unmanaged broad-based Index is comprised of common stocks.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +23.70%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/97 +15.14
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/97 +14.99
- --------------------------------------------------------------------------------
212
<PAGE> 226
Quality Equity Fund
Total Return Based on a $10,000 Investment
A line graph depicting the growth of an investment in the Fund's Class A Shares
compared to growth of an investment in the Standard & Poor's 500 Index.
Beginning and ending values are:
12/87 12/97
----- -----
Quality Equity Fund+--
Class A Shares* $10,000 $40,441
Standard & Poor's 500 Index++ $10,000 $52,616
<PAGE> 227
- --------------------------------------------------------------------------------
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>
213
<PAGE> 228
- --------------------------------------------------------------------------------
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>
214
<PAGE> 229
- --------------------------------------------------------------------------------
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 TRUSTS 350,000 Glenborough Realty Trust,
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.
215
<PAGE> 230
- --------------------------------------------------------------------------------
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.
216
<PAGE> 231
- --------------------------------------------------------------------------------
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.
217
<PAGE> 232
- --------------------------------------------------------------------------------
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.
218
<PAGE> 233
- --------------------------------------------------------------------------------
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.
219
<PAGE> 234
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY 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...................... $ 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.
220
<PAGE> 235
- --------------------------------------------------------------------------------
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
221
<PAGE> 236
- --------------------------------------------------------------------------------
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
222
<PAGE> 237
- --------------------------------------------------------------------------------
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.
223
<PAGE> 238
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--QUALITY EQUITY FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
QUALITY EQUITY FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Quality Equity Fund 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 years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the 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 custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Quality Equity Fund
of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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
224
<PAGE> 239
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the year ended December 31, 1997, the Reserve Assets Fund's Class A Shares
had a net annualized yield of 5.07%*. For the six-month period ended December
31, 1997, the Reserve Assets Fund's Class A Shares had a net annualized yield of
5.12%*. The Fund's Class A Shares' 7-day yield as of December 31, 1997 was
5.20%*. The average portfolio maturity was 70 days at December 31, 1997,
compared to 69 days at June 30, 1997.
THE ENVIRONMENT
Volatility highlighted stock and bond markets worldwide during the six months
ended December 31, 1997. The initial focus of investor concerns was the widening
financial crisis in Asia. In the wake of a series of currency devaluations, many
emerging economies are facing the challenges of higher interest rates, slowing
economic growth and declining corporate earnings. Although the announcement of
International Monetary Fund (IMF) loan packages to Thailand, Indonesia and South
Korea initially reassured investors, the stringent terms of the loans and their
potential negative impact on these already beleaguered economies are now being
called into question. In Japan, the failure of several major financial
institutions has undermined the prospects for economic recovery.
As developments in Asia continue to unfold, US equity investors are trying to
gauge the impact of poorer Asian economic prospects on multinational
corporations. Although there have been periods of rising share prices, investor
confidence has not been definitively restored. The US bond market benefited from
a "flight to quality" as investors anticipated slower economic growth, but the
release of stronger-than-expected economic statistics also prompted periods of
declining bond prices.
As 1998 begins, investors are likely to continue to focus on the prospects for
the US economy within the context of international developments. Although the
Federal Reserve Board did not tighten monetary policy at its November 12, 1997
meeting, it remains to be seen whether US economic growth remains moderate
enough and inflationary pressures sufficiently contained to preclude an increase
in short-term interest rates in early 1998. The ongoing developments in Asia
will undoubtedly also influence the central bank's monetary policy decisions in
the new year.
Our market exposure during this period was consistent with our belief that the
Federal Reserve Board would leave monetary policy unchanged. However, we were
slightly cautious in the structure of the portfolio, favoring securities with
maturities of under one year. The Fund's composition at the end of December and
as of our last report is detailed below:
<TABLE>
<CAPTION>
- -------------------------------------------------------
Issue 12/31/97 6/30/97
- -------------------------------------------------------
<S> <C> <C>
Bank Notes...................... 11.6% 5.2%
Certificates of Deposit......... 3.6 4.8
Certificates of Deposit--
Yankee........................ 2.6 0.5
Commercial Paper................ 44.8 47.1
Corporate Notes................. 3.4 4.2
Funding Agreements.............. 4.7 4.8
Master Notes.................... -- 4.8
Medium-Term Notes............... 6.4 3.6
Repurchase Agreements........... 1.7 --
US Government Agency &
Instrumentality Obligations--
Discount...................... 3.7 2.8
US Government Agency &
Instrumentality Obligations--
Non-Discount.................. 19.0 21.7
Liabilities in Excess of Other
Assets........................ (1.5) --
Other Assets Less Liabilities... -- 0.5
----- -----
Total........................... 100.0% 100.0%
===== =====
</TABLE>
IN CONCLUSION
We appreciate your investment in Reserve Assets Fund of Merrill Lynch Variable
Series Funds, Inc., and we look forward to sharing our investment outlook with
you in our upcoming semi-annual report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Jacqueline Rogers
Jacqueline Rogers
Vice President and Portfolio Manager
February 10, 1998
- ---------------
* Based on a constant investment throughout the period, with dividends
compounded daily, and reflecting a net return to the investor after all
expenses.
225
<PAGE> 240
- --------------------------------------------------------------------------------
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>
226
<PAGE> 241
- --------------------------------------------------------------------------------
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
OBLIGATIONS-- 500,000 Federal National Mortgage Association... 5.44 8/05/98 483,818
DISCOUNT--3.7% 250,000 US Treasury Bills....................... 5.08 1/15/98 249,535
- ---------------------------------------------------------------------------------------------------------------------
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
OBLIGATIONS-- 150,000 Federal Home Loan Banks................. 5.99 8/11/99 149,859
NON-DISCOUNT--19.0% 100,000 Federal Home Loan Mortgage Corp......... 5.685 8/21/98 99,906
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.
227
<PAGE> 242
- --------------------------------------------------------------------------------
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.
228
<PAGE> 243
- --------------------------------------------------------------------------------
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.
229
<PAGE> 244
- --------------------------------------------------------------------------------
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.
230
<PAGE> 245
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS 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......................................... .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.
231
<PAGE> 246
- --------------------------------------------------------------------------------
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
232
<PAGE> 247
- --------------------------------------------------------------------------------
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.
233
<PAGE> 248
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--RESERVE ASSETS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
RESERVE ASSETS FUND OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Reserve Assets Fund 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 years in the
two-year period then ended, and the financial highlights for each of the years
in the five-year period then ended. These financial statements and the financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and the 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 custodian and broker. 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 position of Reserve Assets Fund
of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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
234
<PAGE> 249
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
DECEMBER 31, 1997--ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
Effective August 15, 1997, Equity Growth Fund changed its name to Special
Value Focus Fund. The change in the Fund's name does not connote a change in its
investment objective and policies, which remain the same: to achieve long-term
capital growth by investing primarily in common shares of small companies and
emerging growth companies regardless of size.
For the year ended December 31, 1997, the total investment return on Special
Value Focus Fund's Class A Shares was +11.72%, based on a change in per share
net asset value from $26.22 to $27.75, and assuming reinvestment of $0.533 per
share income dividends and $0.832 per share capital gains distributions. For the
six months ended December 31, 1997, the total investment return on Special Value
Focus Fund's Class A Shares was +4.17%, based on a change in per share net asset
value from $26.64 to $27.75. Since inception (October 23, 1997) through December
31, 1997, the total investment return on the Fund's Class B Shares was -11.18%,
based on a change in per share net asset value from $31.23 to $27.74.
(Additional performance information can be found on page 237 of this report to
shareholders.)
PORTFOLIO MATTERS
During the six months ended December 31, 1997, Special Value Focus Fund
underperformed the unmanaged Russell 2000 Index. For the six months ended
December 31, 1997, the total return for the Fund's Class A Shares was +4.17%,
compared to a total return of +11.04% for the Russell 2000 Index. The Fund's
underperformance resulted primarily from adverse sector positioning as specific
stock holdings performed in line with their respective Russell 2000 economic
sectors.
Small-capitalization stocks rallied early in the third quarter of 1997, as
investors focused on the positive outlook for corporate profits. The Russell
2000 Index set an all-time high on October 13, 1997, then abruptly changed
course. Turmoil in Southeast Asian financial markets provided the catalyst for
sharp stock price declines late in the year as investors abandoned small stocks
in favor of more liquid large-capitalization issues. Small-capitalization stocks
have less overseas exposure than large company stocks. Yet, despite this seeming
contradiction, the resulting investor behavior was not surprising, since
liquidity often diminishes during periods of market uncertainty.
Within the benchmark Russell 2000 Index, the financial services, integrated
oils and consumer staples sectors posted high double-digit returns, while the
technology, materials processing and healthcare sectors posted returns in the
low single-digits. Adverse sector positioning hindered Special Value Focus
Fund's investment performance during the six-month period. The Fund was heavily
weighted in technology stocks, and had only limited exposure to the financial
services and consumer staples sectors. Technology stocks in the Russell 2000
Index advanced only 1.3% compared to an advance of 18% for the Fund's specific
technology holdings. We have not reduced the Fund's weighting in technology
stocks since many of our established holdings and new purchases appear both
attractive on valuation and fundamental measures.
As we enter the new year, the US economy remains strong and earnings growth
expectations favor small company stocks over large company stocks, while
valuations based on price/book value, price/sales and price/earnings ratios are
well below historical averages relative to large company stocks. Any
stabilization of events in Southeast Asia could cause investors to refocus on
the favorable fundamentals underpinning US small capitalization stocks. The
Fund's allocation strategy, while adverse to performance in the second half of
1997, positions the portfolio to seek to take advantage of growth in the
technology sector where stock valuations appear low, and seeks to limit exposure
to the financial services sector where earnings may have peaked and current
valuations appear high.
FISCAL YEAR IN REVIEW
For the 12-month period ended December 31, 1997, Special Value Focus Fund
underperformed the unmanaged Russell 2000 Index. For the year ended December 31,
1997, the Fund's Class A Shares had a total return of +11.72%, compared to a
total return of +22.36% for the Russell 2000 Index. The Fund's performance was
hindered by adverse sector positioning and company-specific factors that
impacted certain large investment positions. The Fund was heavily weighted in
technology stocks, and had limited exposure to the consumer staples and
financial
235
<PAGE> 250
- --------------------------------------------------------------------------------
services sectors. Technology stocks in the Russell 2000 Index advanced only
+0.99% in the year ended December 31, 1997, compared to advances of +36.12% and
+29.93% for the consumer staples and financial services sectors, respectively.
Company-specific events pertaining to individual Fund holdings also hindered
Fund performance during the fiscal year ended December 31, 1997. Shares of
Vivus, Inc. abruptly declined as the company encountered manufacturing problems
and concerns over competing therapies surfaced. The company provides products to
treat erectile dysfunction. Shares of Fisher Scientific International were also
weak as sales to clinical laboratories slowed and the company experienced
medical reimbursement pressures. Fisher Scientific International manufactures
precision medical instruments. We eliminated this position in the first half of
the year.
Fund performance benefited from investments in Platinum Technology, Inc. and
Storage Technology Corp. Shares of Platinum Technology, Inc., a provider of
distributed software solutions, were strong as revenue growth accelerated and
the company announced a key strategic alliance with Intel Corp. Shares of
Storage Technology Corp., a manufacturer of computer tape and disk storage
products, also advanced sharply based on improved earnings and the announcement
of a substantial corporate stock repurchase program.
Stock purchases for the year ended December 31, 1997 spanned a variety of
areas, although we emphasized telemarketing services, biotechnology and
telecommunication equipment stocks. We took advantage of volatility in the
biotechnology industry to purchase stocks where we believed that a temporary
setback in the development process caused the stocks to trade at exceptionally
low absolute valuations based on the companies' drugs under development.
Telemarketing services stocks also presented an attractive investment
opportunity. These stocks have suffered in recent months as a result of
increased price competition and high customer concentrations that are common in
the industry. SITEL Corp. and APAC Teleservices, Inc. are two recent Fund
purchases in this area. Both companies provide outsourced telephone customer
service. We anticipate that these companies will experience profit margin
recovery along with continued strong revenue growth.
IN CONCLUSION
We appreciate your investment in Special Value Focus Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to sharing our investment
outlook and strategies with you in our upcoming report to shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ Daniel V. Szemis
Daniel V. Szemis
Vice President and Co-Portfolio Manager
/s/ R. Elise Baum
R. Elise Baum
Vice President and Co-Portfolio Manager
February 10, 1998
- --------------------------------------------------------------------------------
We are pleased to announce that effective January 15, 1998, R. Elise Baum will
serve as Co-Portfolio Manager of the Fund along with Daniel V. Szemis. Together,
Mr. Szemis and Ms. Baum will be primarily responsible for the day-to-day
management of the Fund. Ms. Baum has been employed by Merrill Lynch Asset
Management, L.P. since 1995 as Vice President. From 1994 to 1995, she was Senior
Fund Analyst and from 1993 to 1994 was Fund Analyst.
- --------------------------------------------------------------------------------
236
<PAGE> 251
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND**
TOTAL RETURN BASED ON A $10,000 INVESTMENT--CLASS A SHARES
- --------------------------------------------------------------------------------
[SPECIAL VALUE FOCUS FUND GRAPH]
<TABLE>
<C> <S>
* Assuming transaction costs and other operating expenses, including advisory fees. Does not include
insurance-related fees and expenses.
** Equity Growth Fund's name changed as of August 15, 1997 to Special Value Focus Fund.
+ Special Value Focus Fund invests primarily in common stocks of small companies and emerging growth companies
regardless of size.
++ This unmanaged index is comprised of approximately 2,000 smaller-capitalization common stocks from various
industrial sectors. During the 1997 calendar year, the Fund's primary performance benchmark was changed from the
Russell 1000 Growth Index and Russell 2000 Growth Index to the Russell 2000 Small Stock Index to reflect the
Fund's current focus on small-capitalization stocks and lowered emphasis on mid-capitalization issues. The
Fund's median market capitalization declined from approximately $770 million in January to $395 million on
December 31, 1997.
+++ This unmanaged broad-based Index is comprised of a representative sampling of the common stocks of 1,000 of the
largest publicly traded companies domiciled in the United States.
++++ This unmanaged broad-based Index is comprised of the common stocks of the bottom two-thirds of the largest 3,000
publicly traded companies domiciled in the United States.
Past performance is not predictive of future performance.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS A SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Year Ended 12/31/97 +11.72%
- --------------------------------------------------------------------------------
Five Years Ended 12/31/97 +13.99
- --------------------------------------------------------------------------------
Ten Years Ended 12/31/97 +11.81
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
AGGREGATE TOTAL RETURN--CLASS B SHARES
- --------------------------------------------------------------------------------
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------------
Inception (10/23/97) through 12/31/97 -11.18%
- --------------------------------------------------------------------------------
237
<PAGE> 252
- --------------------------------------------------------------------------------
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>
238
<PAGE> 253
- --------------------------------------------------------------------------------
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-- CONSUMER 66,046 Reliastar Financial Corp...... 2,230,089 2,720,270 0.6
- ---------------------------------------------------------------------------------------------------------------------
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>
239
<PAGE> 254
- --------------------------------------------------------------------------------
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>
240
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- --------------------------------------------------------------------------------
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.
241
<PAGE> 256
- --------------------------------------------------------------------------------
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.
242
<PAGE> 257
- --------------------------------------------------------------------------------
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.
243
<PAGE> 258
- --------------------------------------------------------------------------------
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.
244
<PAGE> 259
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL 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 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.
245
<PAGE> 260
- --------------------------------------------------------------------------------
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 --------------------
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE PERIOD
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.
246
<PAGE> 261
- --------------------------------------------------------------------------------
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.
247
<PAGE> 262
- --------------------------------------------------------------------------------
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
October 23, 1997+ to December 31, Dollar
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.
248
<PAGE> 263
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SPECIAL VALUE FOCUS FUND
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
SPECIAL VALUE FOCUS FUND (FORMERLY EQUITY GROWTH FUND) OF
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Special Value Focus Fund 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
years in the two-year period then ended, and the financial highlights for each
of the years in the five-year period then ended. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
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 custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Special Value Focus
Fund of Merrill Lynch Variable Series Funds, Inc. as of December 31, 1997, the
results of its operations, the changes in its 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 12, 1998
249
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- --------------------------------------------------------------------------------
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<PAGE> 265
- --------------------------------------------------------------------------------
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<PAGE> 266
- --------------------------------------------------------------------------------
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<PAGE> 267
- ---------------------------------------------------------
MERRILL LYNCH
VARIABLE SERIES FUNDS, INC.
- ---------------------------------------------------------
PRINCIPAL OFFICE OF THE FUNDS
Box 9011
Princeton, NJ 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
CUSTODIAN
For all Funds except Developing Capital
Markets Focus Fund:
The Bank of New York
110 Washington Street
New York, NY 10286
For Developing Capital Markets Focus Fund:
Chase Manhattan Bank N.A.
Chase Metro Tech Center
Brooklyn, NY 11245
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
DIRECTORS AND OFFICERS
Arthur Zeikel Grace Pineda
President Senior Vice President
Joe Grills Kevin M. Rendino
Director Senior Vice President
Walter Mintz Thomas R. Robinson
Director Senior Vice President
Robert S. Salomon Jr. Walter D. Rogers
Director Senior Vice President
Melvin R. Seiden Daniel V. Szemis
Director Senior Vice President
Stephen B. Swensrud Paolo Valle
Director Senior Vice President
Terry K. Glenn Andrew Bascand
Executive Vice President Vice President
Jay C. Harbeck Donald C. Burke
Senior Vice President Vice President
Norman R. Harvey Jacqueline Rogers
Senior Vice President Vice President
Vincent T. Lathbury III Aldona A. Schwartz
Senior Vice President Vice President
Kevin J. McKenna Robert M. Shearer
Senior Vice President Vice President
Eric S. Mitofsky Gerald M. Richard
Senior Vice President Treasurer
Joseph T. Monagle Jr. Jennifer L. Sawin
Senior Vice President Secretary
<PAGE> 268
- --------------------------------------------------------------------------------
This report is not authorized for use as an offer of sale or a solicitation of
an offer to buy shares of the Funds unless accompanied or preceded by the Funds'
current prospectus. Past performance results shown in this report should not be
considered a representation of future performance. Investment return and
principal value of non-money market fund shares will fluctuate so that shares,
when redeemed, may be worth more or less than their original cost. The Domestic
Money Market Fund and Reserve Assets Fund seek to maintain a consistent $1.00
net asset value per share, although this cannot be assured. An investment in the
Funds is neither insured nor guaranteed by the US Government. Statements and
other information herein are as dated and are subject to change.
Merrill Lynch Variable Series Funds, Inc.
Box 9011
Princeton, NJ
08543-9011
#16897-12/97
