As filed with the Securities and Exchange Commission on July 30, 1997.
1933 Act File No. 2-75093
1940 Act File No. 811-3333
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 X
Pre-Effective Amendment No.
Post-Effective Amendment No. 26
--
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 X
Amendment No. 28
--
USAA TAX EXEMPT FUND, INC.
(Exact Name of Registrant as Specified in Charter)
9800 FREDERICKSBURG RD., SAN ANTONIO, TX 78288
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code (210) 498-0600
Michael D. Wagner, Secretary
USAA TAX EXEMPT FUND, INC.
9800 Fredericksburg Rd.
SAN ANTONIO, TX 78288-0227
(Name and Address of Agent for Service)
Approximate Date of Proposed Public Offering: As soon as practicable after the
effective date of this Registration Statement.
It is proposed that this filing will become effective under Rule 485
____ immediately upon filing pursuant to paragraph (b)
_X__ on August 1, 1997 pursuant to paragraph (b)
____ 60 days after filing pursuant to paragraph (a)(1)
____ on (date) pursuant to paragraph (a)(1)
____ 75 days after filing pursuant to paragraph (a)(2)
____ on (date) pursuant to paragraph (a)(2)
If appropriate, check the following box:
____ This post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
DECLARATION PURSUANT TO RULE 24f-2
The Registrant has heretofore registered an indefinite number of shares of the
Long-Term Fund, Intermediate-Term Fund, Short-Term Fund, Tax Exempt Money Market
Fund, California Bond Fund, California Money Market Fund, New York Bond Fund,
New York Money Market Fund, Virginia Bond Fund, and Virginia Money Market Fund
pursuant to Rule 24f-2 under the Investment Company Act of 1940. The Registrant
filed its Rule 24f-2 notice for the fiscal year ended March 31, 1997 on May 27,
1997.
Exhibit Index on Pages 240 - 242
Page 1 of 327
<PAGE>
USAA TAX EXEMPT FUND, INC.
CROSS REFERENCE SHEET
PART A
FORM N-1A ITEM NO. SECTION IN PROSPECTUS
1. Cover Page........................................ Same
2. Synopsis.......................................... Fees and Expenses
3. Condensed Financial Information................... Financial Highlights
Performance Information
4. General Description of Registrant................. Investment Objectives
and Policies
Other Investment
Information
Description of Shares
5. Management of the Fund............................ Management of the Company
Service Providers
6. Capital Stock and Other Securities................ Dividends, Distributions
and Taxes
Description of Shares
7. Purchase of Securities Being Offered.............. Purchase of Shares
Conditions of Purchase
and Redemption
Exchanges
Other Services
Share Price Calculation
8. Redemption or Repurchase.......................... Redemption of Shares
Conditions of Purchase
and Redemption
Exchanges
Other Services
9. Legal Proceedings................................. Not Applicable
<PAGE>
USAA TAX EXEMPT FUND, INC.
CROSS REFERENCE SHEET
PART B
FORM N-1A ITEM NO. SECTION IN STATEMENT OF
ADDITIONAL INFORMATION
10. Cover Page....................................... Same
11. Table of Contents................................ Same
12. General Information and History.................. Not Applicable
13. Investment Objectives and Policies............... Investment Policies
Investment Restrictions
Special Risk
Considerations
(California, New York,
and Virginia Funds SAIs
only)
Portfolio Transactions
14. Management of the Registrant..................... Directors and Officers of
the Company
15. Control Persons and Principal
Holders of Securities............................ Directors and Officers of
the Company
16. Investment Advisory and Other
Services......................................... Directors and Officers of
the Company
The Company's Manager
General Information
17. Brokerage Allocation and Other Practices......... Portfolio Transactions
18. Capital Stock and Other Securities............... Further Description of
Shares
19. Purchase, Redemption and Pricing
of Securities Being Offered...................... Valuation of Securities
Additional Information
Regarding Redemption
of Shares
Investment Plans
20. Tax Status....................................... Tax Considerations (Long-
Term, Intermediate-
Term, Short-Term and
Tax Exempt Money
Market Funds SAI only)
Certain Federal Income
Tax Considerations
(California, New York,
and Virginia Funds
SAIs only)
California Taxation
(California Funds SAI
only)
Virginia Taxation
(Virginia Funds SAI
only)
21. Underwriters.................................... The Company's Manager
22. Calculation of Performance Data................. Calculation of
Performance Data
23. Financial Statements............................ General Information
<PAGE>
PART A
Prospectuses for the
Long-Term, Intermediate-Term, Short-Term
and Tax Exempt Money Market Funds,
California Bond and California Money Market Funds,
New York Bond and New York Money Market Funds, and
Virginia Bond and Virginia Money Market Funds
are included herein
<PAGE>
Part A
Prospectus for the
Long-Term, Intermediate-Term, Short-Term
and Tax Exempt Money Market Funds
<PAGE>
USAA TAX EXEMPT FUND, INC.
AUGUST 1, 1997 PROSPECTUS
USAA LONG-TERM FUND, USAA INTERMEDIATE-TERM FUND, USAA SHORT-TERM FUND and USAA
TAX EXEMPT MONEY MARKET FUND (collectively, the Funds) are four of ten no-load
mutual funds offered by USAA Tax Exempt Fund, Inc. (the Company). The Funds are
managed by USAA Investment Management Company (the Manager).
WHAT ARE THE INVESTMENT OBJECTIVES AND POLICIES?
The Funds have a common objective of providing investors with interest income
that is exempt from federal income tax. The Tax Exempt Money Market Fund has a
further objective of preserving capital and maintaining liquidity.
The LONG-TERM, INTERMEDIATE-TERM, and SHORT-TERM FUNDS invest primarily in
investment grade tax-exempt securities differentiated by maturity limitations.
The average weighted portfolio maturity for the Long-Term Fund is 10 years or
more, the Intermediate-Term Fund is between 3 and 10 years, and the Short-Term
Fund is 3 years or less. Page 15.
The TAX EXEMPT MONEY MARKET FUND invests in high quality tax-exempt
securities with maturities of 397 days or less. The Manager will maintain a
dollar-weighted average portfolio maturity of no more than 90 days. The Fund
will endeavor to maintain a constant net asset value per share of $1.00. Page
16.
HOW DO YOU BUY?
Fund shares are sold on a continuous basis at the net asset value per share
without a sales charge. Make your initial investment directly with the Manager
by mail, in person, or in certain instances, by telephone. Page 19.
HOW DO YOU SELL?
You may redeem Fund shares by mail, telephone, fax, or telegraph on any day
that the net asset value is calculated. Page 21.
This Prospectus, which should be read and retained for future reference,
provides information regarding the Company and the Funds that you should know
before investing.
SHARES OF THE USAA FUNDS ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF, OR
GUARANTEED BY, THE USAA FEDERAL SAVINGS BANK, ARE NOT INSURED BY THE FDIC OR ANY
OTHER GOVERNMENT AGENCY, AND ARE SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE
LOSS OF THE PRINCIPAL AMOUNT INVESTED.
If you would like more information about the Funds, you may call
1-800-531-8181 to request a free copy of the most recent financial report and/or
the Funds' Statement of Additional Information (SAI), dated August 1, 1997. The
SAI has been filed with the Securities and Exchange Commission (SEC) and is
incorporated by reference into this Prospectus (meaning it is legally a part of
the Prospectus).
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
AN INVESTMENT IN THE TAX EXEMPT MONEY MARKET FUND IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT AND THERE CAN BE NO ASSURANCE THAT THE FUND
WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
SUMMARY DATA
Fees and Expenses.............................................. 3
Financial Highlights........................................... 4
Performance Information........................................ 12
USING MUTUAL FUNDS
USAA Family of No-Load Mutual Funds............................ 13
Using Mutual Funds in an Investment Program.................... 14
INVESTMENT PORTFOLIO INFORMATION
Investment Objectives and Policies............................. 15
Long-Term Fund............................................. 15
Intermediate-Term Fund..................................... 15
Short-Term Fund............................................ 15
Tax Exempt Money Market Fund............................... 16
Other Investment Information................................... 16
SHAREHOLDER INFORMATION
Purchase of Shares............................................. 19
Redemption of Shares........................................... 21
Conditions of Purchase and Redemption.......................... 23
Exchanges...................................................... 24
Other Services................................................. 24
Share Price Calculation........................................ 25
Dividends, Distributions and Taxes............................. 26
Management of the Company...................................... 27
Description of Shares.......................................... 28
Service Providers.............................................. 29
Telephone Assistance Numbers................................... 29
- --------------------------------------------------------------------------------
2
<PAGE>
FEES AND EXPENSES
The following summary, which is based on actual expenses and average net assets
(ANA) of each Fund for the year ended March 31, 1997, is provided to assist you
in understanding the expenses you will bear directly or indirectly as a Fund
investor.
SHAREHOLDER TRANSACTION EXPENSES (APPLICABLE TO EACH FUND)
- --------------------------------------------------------------------------------
Sales Load Imposed on Purchases.......................... None
Sales Load Imposed on Reinvested Dividends............... None
Deferred Sales Load...................................... None
Redemption Fee*.......................................... None
Exchange Fee............................................. None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE OF ANA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
INTERMEDIATE- TAX EXEMPT
LONG-TERM TERM SHORT-TERM MONEY MARKET
FUND FUND FUND FUND
Management Fees......................... .28% .28% .28% .28%
12b-1 Fees.............................. None None None None
Other Expenses
Transfer Agent Fees**............... .06% .06% .08% .06%
Custodian Fees...................... .01% .01% .02% .02%
All Other Expenses.................. .02% .02% .03% .03%
--- --- --- ---
Total Other Expenses.................... .09% .09% .13% .11%
--- --- --- ---
Total Fund Operating Expenses........... .37% .37% .41% .39%
=== === === ===
</TABLE>
- --------------
* A shareholder who requests delivery of redemption proceeds by wire transfer
will be subject to a $10 fee. See REDEMPTION OF SHARES - BANK WIRE.
** The Funds pay USAA Shareholder Account Services an annual fixed fee per
account for its services. See TRANSFER AGENT in the SAI, page 13.
EXAMPLE OF EFFECT OF FUND EXPENSES
- --------------------------------------------------------------------------------
You would pay the following expenses on a $1,000 investment in one of the Funds
below, assuming (1) 5% annual return and (2) redemption at the end of the
periods shown:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
Long-Term Fund............................ $4 $12 $21 $47
Intermediate-Term Fund.................... $4 $12 $21 $47
Short-Term Fund........................... $4 $13 $23 $52
Tax Exempt Money Market Fund.............. $4 $13 $22 $49
THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The following per share operating performance for a share outstanding throughout
each period in the ten-year period ended March 31, 1997, has been audited by
KPMG Peat Marwick LLP. This table should be read in conjunction with the Funds'
financial statements for the year ended March 31, 1997, and the auditors' report
thereon, that appear in the Funds' Annual Report. Further performance
information is contained in the Annual Report and is available upon request
without charge.
LONG-TERM FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 13.17 $ 12.96 $ 13.20 $ 14.21 $ 13.54
Net investment income .79 .79 .79 .81 .88
Net realized and
unrealized gain (loss) .05 .21 (.16) (.44) .75
Distributions from net
investment income (.79) (.79) (.78) (.82) (.88)
Distributions of realized
capital gains - - (.09) (.56) (.08)
---------- ---------- ---------- ---------- ---------
Net asset value at
end of period $ 13.22 $ 13.17 $ 12.96 $ 13.20 $ 14.21
========== ========== ========== ========== =========
Total return (%)* 6.51 7.88 5.07 2.36 12.46
Net assets at end of
period (000) $1,822,436 $1,804,116 $1,774,643 $1,831,693 $1,882,882
Ratio of expenses to
average net assets (%) .37 .37 .38 .38 .39
Ratio of net investment
income to average net
assets (%) 5.95 5.99 6.23 5.69 6.35
Portfolio turnover (%) 40.78 53.25 64.72 109.28 88.27
- ------------
</TABLE>
* Assumes reinvestment of all dividend income and capital gain distributions
during the period.
4
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
LONG-TERM FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1992 1991 1990 1989 1988
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 13.13 $ 13.01 $ 12.66 $ 12.44 $ 13.96
Net investment income .92 .94 .95 .96 .97
Net realized and
unrealized gain (loss) .41 .12 .35 .22 (1.30)
Distributions from net
investment income (.92) .94) (.95) (.96) (.97)
Distributions of realized
capital gains - - - - (.22)
---------- ---------- ---------- -------- --------
Net asset value at
end of period $ 13.54 $ 13.13 $ 13.01 $ 12.66 $ 12.44
========== ========== ========== ======== ========
Total return (%)* 10.39 8.46 10.44 9.72 (2.01)
Net assets at end of
period (000) $1,638,848 $1,355,321 $1,172,842 $975,285 $823,375
Ratio of expenses to
average net assets (%) .40 .40 .43 .45 .51
Ratio of net investment
income to average net
assets (%) 6.83 7.22 7.23 7.58 7.75
Portfolio turnover (%) 76.28 91.41 91.52 124.07 169.38
</TABLE>
5
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
INTERMEDIATE-TERM FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 12.77 $ 12.50 $ 12.48 $ 12.90 $ 12.29
Net investment income .72 .71 .69 .69 .74
Net realized and
unrealized gain (loss) - .27 .05 (.29) .61
Distributions from net
investment income (.72) (.71) (.69) (.69) (.74)
Distributions of realized
capital gains - - (.03) (.13) -
---------- ----------- ---------- ---------- ----------
Net asset value at
end of period $ 12.77 $ 12.77 $ 12.50 $ 12.48 $ 12.90
========== ========== ========== ========== ==========
Total return (%)* 5.80 7.97 6.16 3.06 11.29
Net assets at end of
period (000) $1,725,684 $1,660,039 $1,529,750 $1,559,183 $1,374,159
Ratio of expenses to
average net assets (%) .37 .38 .40 .40 .42
Ratio of net investment
income to average net
assets (%) 5.65 5.54 5.63 5.30 5.85
Portfolio turnover (%) 23.05 27.51 27.26 69.45 74.02
- ------------
</TABLE>
* Assumes reinvestment of all dividend income and capital gain distributions
during the period.
6
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
INTERMEDIATE-TERM FUND:
YEAR ENDED MARCH 31,
-------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1992 1991 1990 1989 1988
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 12.00 $ 11.87 $ 11.64 $ 11.78 $ 12.38
Net investment income .79 .82 .83 .83 .84
Net realized and
unrealized gain (loss) .29 .13 .23 (.14) (.58)
Distributions from net
investment income (.79) (.82) (.83) (.83) (.84)
Distributions of realized
capital gains - - - - (.02)
-------- -------- -------- --------- --------
Net asset value at
end of period $ 12.29 $ 12.00 $ 11.87 $ 11.64 $ 11.78
======== ======== ======== ======== ========
Total return (%)* 9.24 8.30 9.29 6.04 2.34
Net assets at end of
period (000) $893,874 $575,770 $471,381 $401,026 $345,997
Ratio of expenses to
average net assets (%) .44 .43 .46 .49 .56
Ratio of net investment
income to average net
assets (%) 6.45 6.91 6.95 7.10 7.16
Portfolio turnover (%) 66.57 66.26 62.28 112.69 138.82
</TABLE>
7
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
SHORT-TERM FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 10.57 $ 10.47 $ 10.48 $ 10.63 $ 10.48
Net investment income .49 .50 .47 .45 .50
Net realized and
unrealized gain (loss) - .10 (.01) (.15) .15
Distributions from net
investment income (.49) (.50) (.47) (.45) (.50)
Distributions of realized
capital gains - - - - -
-------- -------- -------- -------- --------
Net asset value at
end of period $ 10.57 $ 10.57 $ 10.47 $ 10.48 $ 10.63
======== ======== ======== ======== ========
Total return (%)* 4.70 5.83 4.51 2.87 6.37
Net assets at end of
period (000) $804,897 $774,020 $801,157 $995,624 $862,182
Ratio of expenses to
average net assets (%) .41 .42 .42 .43 .43
Ratio of net investment
income to average net
assets (%) 4.60 4.73 4.50 4.25 4.75
Portfolio turnover (%) 27.67 35.99 32.61 101.67 138.20
- ------------
</TABLE>
* Assumes reinvestment of all dividend income and capital gain distribution
during the period.
8
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
SHORT-TERM FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1992 1991 1990 1989 1988
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 10.35 $ 10.39 $ 10.27 $ 10.42 $ 10.70
Net investment income .59 .67 .67 .64 .61
Net realized and
unrealized gain (loss) .13 (.04) .12 (.15) (.24)
Distributions from net
investment income (.59) (.67) (.67) (.64) (.61)
Distributions of realized
capital gains - - - - (.04)
-------- -------- --------- -------- --------
Net asset value at
end of period $ 10.48 $ 10.35 $ 10.39 $ 10.27 $ 10.42
======== ======== ======== ======== ========
Total return (%)* 7.09 6.27 7.91 4.78 3.57
Net assets at end of
period (000) $680,075 $423,914 $279,028 $254,453 $244,703
Ratio of expenses to
average net assets (%) .48 .50 .52 .51 .56
Ratio of net investment
income to average net
assets (%) 5.59 6.48 6.47 6.14 5.81
Portfolio turnover (%) 107.35 96.10 87.23 146.28 147.69
</TABLE>
9
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
TAX EXEMPT MONEY MARKET FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .03 .04 .03 .02 .03
Distributions from net
investment income (.03) (.04) (.03) (.02) (.03)
---------- ---------- ---------- ---------- ----------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
========== ========== ========== ========== ==========
Total return (%)* 3.30 3.65 2.98 2.31 2.89
Net assets at end of
period (000) $1,565,634 $1,529,176 $1,456,747 $1,569,760 $1,501,098
Ratio of expenses to
average net assets (%) .39 .40 .39 .40 .40
Ratio of net investment
income to average net
assets (%) 3.25 3.59 2.93 2.29 2.85
- ------------
* Assumes reinvestment of all dividend income distributions during the period.
</TABLE>
10
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
TAX EXEMPT MONEY MARKET FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1992 1991 1990 1989 1988
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .04 .06 .06 .05 .05
Distributions from net
investment income (.04) (.06) (.06) (.05) (.05)
---------- ---------- -------- -------- --------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
========== ========== ======== ======== ========
Total return (%)* 4.30 5.94 6.24 5.57 4.69
Net assets at end of
period (000) $1,483,554 $1,508,862 $990,050 $802,233 $619,085
Ratio of expenses to
average net assets (%) .39 .40 .42 .43 .43
Ratio of net investment
income to average net
assets (%) 4.21 5.76 6.06 5.48 4.63
</TABLE>
11
<PAGE>
PERFORMANCE INFORMATION
Performance information should be considered in light of each Fund's investment
objective and policies and market conditions during the time periods for which
it is reported. Historical performance should not be considered as
representative of the future performance of any Fund.
The Company may quote a Fund's total return or yield in advertisements and
reports to shareholders or prospective investors. A Fund's performance may also
be compared to that of other mutual funds with similar investment objectives and
relevant indexes that are referenced in APPENDIX B to the SAI. Standard total
return and yield results reported by the Funds do not take into account
recurring and nonrecurring charges for optional services which only certain
shareholders elect and which involve nominal fees, such as the $10 fee for a
delivery of redemption proceeds by wire transfer.
Further information concerning yield and total return is included in the
SAI.
TOTAL RETURN - A Fund's average annual total return is computed by determining
the average annual compounded rate of return for a specified period which, when
applied to a hypothetical $1,000 investment in the Fund at the beginning of the
period, would produce the redeemable value of that investment at the end of the
period, assuming reinvestment of all dividends and distributions during the
period.
YIELD - LONG-TERM, INTERMEDIATE-TERM, AND SHORT-TERM FUNDS. These Funds may
advertise performance in terms of a 30-day yield quotation. The yield quotation
is computed by dividing the net investment income per share earned during the
period by the offering price per share on the last day of the period. This
income is then annualized. For purposes of the yield calculation, interest
income is computed based on the yield to maturity of each debt obligation in a
Fund's portfolio and all recurring charges are recognized.
YIELD - TAX EXEMPT MONEY MARKET FUND. The Fund may advertise its yield and
effective yield. The yield of the Fund refers to the income generated by an
investment in the Fund over a seven-day period (which period will be stated in
the advertisement). This income is then annualized, that is, the amount of
income generated by the investment during the week is assumed to be generated
each week over a 52-week period and is shown as a percentage of the investment.
The effective yield is calculated similarly but, when annualized, the
income earned by an investment in the Fund is assumed to be reinvested. The
effective yield will be slightly higher than the yield because of the
compounding effect of this assumed reinvestment.
TAX EQUIVALENT YIELD - The Funds may also utilize tax equivalent yields with
adjustments for assumed income tax rates. See APPENDIX C - TAXABLE EQUIVALENT
YIELD TABLE in the SAI for illustrations of this
yield.
12
<PAGE>
USAA FAMILY OF NO-LOAD MUTUAL FUNDS
The USAA Family of No-Load Mutual Funds includes a variety of Funds, each with
different objectives and policies. In combination, these Funds are designed to
provide investors with the opportunity to formulate their own investment
program. You may exchange any shares you hold in any one USAA Fund for shares in
any other USAA Fund. For more complete information about the Funds in the USAA
Family of Funds, including charges and expenses, call the Manager for a
Prospectus. Read it carefully before you invest or send money.
USAA TAX EXEMPT FUND, INC.
Long-Term Fund
Intermediate-Term Fund
Short-Term Fund
Tax Exempt Money Market Fund
California Bond Fund*
California Money Market Fund*
New York Bond Fund*
New York Money Market Fund*
Virginia Bond Fund*
Virginia Money Market Fund*
USAA MUTUAL FUND, INC.
Aggressive Growth Fund
Science & Technology Fund
Growth Fund
First Start Growth Fund
S&P 500 Index Fund**
Growth & Income Fund
Income Stock Fund
Income Fund
Short-Term Bond Fund
Money Market Fund
USAA INVESTMENT TRUST
Income Strategy Fund
Growth and Tax Strategy Fund
Balanced Strategy Fund
Cornerstone Strategy Fund
Growth Strategy Fund
Emerging Markets Fund
Gold Fund
International Fund
World Growth Fund
GNMA Trust
Treasury Money Market Trust
USAA STATE TAX-FREE TRUST
Florida Tax-Free Income Fund*
Florida Tax-Free Money Market Fund*
Texas Tax-Free Income Fund*
Texas Tax-Free Money Market Fund*
* Available for sale only to residents of these specific states.
** S&P is a trademark of The McGraw-Hill Companies, Inc., and has been
licensed for use. The Product is not sponsored, sold or promoted by
Standard & Poor's and Standard & Poor's makes no representation regarding
the advisability of investing in the Product.
13
<PAGE>
USING MUTUAL FUNDS IN AN INVESTMENT PROGRAM
I. THE IDEA BEHIND MUTUAL FUNDS
Mutual funds provide small investors some of the advantages enjoyed by wealthy
investors. A relatively small investment can buy part of a widely diversified
portfolio. That portfolio is managed by investment professionals, relieving the
shareholder of the need to make individual stock or bond selections. The
investor also enjoys conveniences, such as daily pricing, liquidity, and in the
case of the USAA Family of Funds, no sales charge. The portfolio, because of its
size, has lower transaction costs on its trades than most individuals would
have. As a result each shareholder owns an investment that in earlier times
would have been available only to very wealthy people.
II. USING FUNDS IN AN INVESTMENT PROGRAM
In choosing a mutual fund as an investment vehicle, the shareholder is foregoing
some investment decisions, but must still make others. The decisions foregone
are those involved with choosing individual securities. The Fund Manager will
perform that function. In addition, the Manager will arrange for the safekeeping
of securities, auditing the annual financial statements, and daily valuation of
the Fund, as well as other functions.
The shareholder, however, retains at least part of the responsibility for
an equally important decision. This decision includes determining a portfolio of
mutual funds that balances the investor's investment goals with his or her
tolerance for risk. It is likely that this decision may involve the use of more
than one fund of the USAA Family of Funds.
For example, assume a shareholder wishes to pursue the higher yields
usually available in the long-term bond market, but is also concerned about the
possible price swings of the longer-term bonds. He or she could divide
investments between the Long- Term Fund and the Tax Exempt Money Market Fund.
This would create a portfolio with a higher yield than that of the money market
and less volatility than that of the long-term market. This is just one example
of how an individual could combine funds to create a portfolio tailored to his
or her own risk and reward goals.
III. USAA'S FAMILY OF FUNDS
The Manager offers investors another alternative in its asset strategy funds,
the Income Strategy, Growth and Tax Strategy, Balanced Strategy, Cornerstone
Strategy, and Growth Strategy Funds. These unique mutual funds provide a
professionally managed diversified investment portfolio within a mutual fund.
These Funds are designed for the shareholder who prefers to delegate the asset
allocation process to an investment manager. The Funds are structured to achieve
diversification across a number of investment categories.
Whether you prefer to create your own mix of mutual funds or use an asset
strategy fund, the USAA Family of Funds provides a broad range of choices
covering just about any investor's investment objectives. Our sales
representatives stand ready to inform you of your choices and to help you craft
a portfolio which meets your needs.
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INVESTMENT OBJECTIVES AND POLICIES
LONG-TERM FUND
INTERMEDIATE-TERM FUND
SHORT-TERM FUND
INVESTMENT OBJECTIVE
The Funds have a common investment objective of providing investors with
interest income that is exempt from federal income tax.
INVESTMENT POLICIES
The Manager will pursue this common objective by investing each Fund's assets in
tax-exempt securities, the interest from which, in the opinion of counsel, is
excluded from gross income for federal income tax purposes, but may be subject
to state and local taxes. It is a fundamental policy of each Fund that during
normal market conditions the Fund's assets will be invested so that at least 80%
of the Fund's annual income will be exempt from federal personal income tax and
excluded from the calculation of federal alternative minimum taxes for
individual taxpayers.
Under normal market conditions, the Manager will invest the assets of each
Fund so that at least 50% of the total market value of the tax-exempt securities
is rated within the three highest long-term rating categories (at least A) by
Moody's Investors Service, Inc. (Moody's), Standard & Poor's Ratings Group
(S&P), or Fitch Investors Service, Inc. (Fitch), in the highest short-term
rating category by Moody's, S&P, or Fitch, or, if a security is not rated by
those rating agencies, it must be of equivalent investment quality as determined
by the Manager. In no event will a security be purchased for a Fund unless it is
rated at least investment grade; i.e., rated by Moody's, S&P, or Fitch at least
in the fourth highest rating category for long-term securities, in the second
highest rating category for short-term securities, or, if not rated by those
rating agencies, determined by the Manager to be of equivalent investment
quality. Securities rated in the lowest level of investment grade have
speculative characteristics since adverse economic conditions and changing
circumstances are more likely to have an adverse impact on such securities.
If the rating of a security is downgraded, the Manager will determine
whether it is in the best interest of the Fund's shareholders to continue to
hold such security in the Fund's portfolio. Unless otherwise directed by the
Board of Directors, if downgrades result in more than 5% of a Fund's net assets
being invested in securities that are less than investment grade quality, the
Manager will take immediate action to reduce the Fund's holdings in such
securities to 5% or less of the Fund's net assets. For a more complete
description of tax-exempt securities and their ratings, see APPENDIX A to the
SAI.
FUND DIFFERENCES
These Funds are differentiated by their average weighted maturities of all the
securities in the portfolios. Generally, the longer the maturity, the higher the
yield and the greater the price volatility.
MATURITY LIMITS
PORTFOLIO WEIGHTED
FUND AVERAGE
---- ------------------
Long-Term 10 years or more
Intermediate-Term 3-10 years
Short-Term 3 years or less
Within these limitations, a Fund may purchase individual securities with
stated maturities greater than the Fund's weighted average maturity limits. In
determining a security's maturity for purposes of calculating a Fund's average
maturity, estimates of the expected time for its principal to be paid may be
used. This can be substantially shorter than its stated final maturity. For a
discussion of the method of calculating the average weighted maturities of these
Funds' portfolios, see INVESTMENT POLICIES in the SAI.
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TAX EXEMPT MONEY MARKET FUND
INVESTMENT OBJECTIVE
The Fund's investment objective is to provide investors with interest income
that is exempt from federal income tax while preserving capital and maintaining
liquidity.
INVESTMENT POLICIES
The Manager will pursue this objective by investing the Fund's assets in
tax-exempt securities, the interest from which, in the opinion of counsel, is
excluded from gross income for federal income tax purposes, but may be subject
to state and local taxes. It is a fundamental policy of the Fund that during
normal market conditions the Fund's assets will be invested so that at least 80%
of the Fund's annual income will be exempt from federal personal income tax and
excluded from the calculation of federal alternative minimum taxes for
individual taxpayers.
The Fund will purchase only high quality securities that qualify as
"eligible securities" under the SEC rules applicable to money market mutual
funds. These securities must also be determined by the Manager to present
minimal credit risk. In general, the category of eligible securities may include
a security that is:
(1) issued or guaranteed by the U.S. Government or any agency or
instrumentality thereof, including "prerefunded" and "escrowed to maturity"
tax-exempt securities;
(2) rated in one of the two highest categories for short-term securities by at
least two Nationally Recognized Statistical Rating Organizations (NRSROs),
or by one NRSRO if the security is rated by only one NRSRO;
(3) unrated but issued by an issuer or guaranteed by a guarantor that has
other comparable short-term debt obligations so rated; or
(4) unrated but determined to be of comparable quality by the Manager.
If a security is downgraded after purchase, the Manager will follow written
procedures adopted by the Company's Board of Directors and a determination will
be made as to whether it is in the best interest of the Fund's shareholders for
the Fund to continue to hold the security.
Current NRSROs include Moody's, S&P, Fitch, Duff & Phelps Inc., Thompson
BankWatch, Inc., and IBCA Inc. For a description of tax-exempt securities and
their ratings, see APPENDIX A to the SAI.
Consistent with regulatory requirements, the Manager will purchase
securities with remaining maturities of 397 days or less and will maintain a
dollar-weighted average portfolio maturity of no more than 90 days. The Fund
will endeavor to maintain a constant net asset value of $1.00 per share,
although there is no assurance that it will be able to do so.
The Fund will also comply with the diversification requirements applicable
to money market funds under regulations of the SEC. Generally, these
requirements limit the Fund's investments in the securities of any issuer to no
more than 5% of the Fund's assets, excluding securities issued or guaranteed by
the U.S. Government or its agencies and instrumentalities.
OTHER INVESTMENT INFORMATION
The investment objectives of the Funds may not be changed without shareholder
approval. In view of the risks inherent in all investments in securities, there
is no assurance that these objectives will be achieved. The investment policies
and techniques used to pursue the Funds' objectives may be changed without
shareholder approval, except as otherwise noted. Further information regarding
the Funds' investment policies and restrictions is provided in the SAI.
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TAX-EXEMPT SECURITIES
These securities include general obligation bonds, which are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest; revenue bonds, which are payable from the revenue
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise tax or other specific revenue source, but
not from the general taxing power; lease obligations backed by the
municipality's covenant to budget for the payments due under the lease
obligation; and certain types of industrial development bonds issued by or on
behalf of public authorities to obtain funds for privately-operated facilities,
provided that the interest paid on such securities qualifies as exempt from
federal income taxes.
The value of the securities in which a Fund will invest generally
fluctuates inversely with changes in prevailing interest rates. Changes in the
creditworthiness of issuers and changes in other market factors such as the
relative supply of and demand for tax-exempt bonds also create value
fluctuations. Moreover, because each Fund invests in securities backed by banks
and other financial institutions, changes in the credit quality of these
institutions could cause losses to a Fund and affect its share price.
Each Fund may on a temporary basis due to market or other conditions invest
up to 100% of its assets in short-term securities whether or not exempt from
federal income tax. Such taxable securities may consist of obligations of the
U.S. Government, its agencies or instrumentalities, and repurchase agreements
secured by such instruments; certificates of deposit of domestic banks having
capital, surplus and undivided profits in excess of $100 million; banker's
acceptances of similar banks; commercial paper; and other corporate debt
obligations.
INVESTMENT TECHNIQUES
VARIABLE RATE SECURITIES - Each Fund may invest in tax-exempt securities that
bear interest at rates which are adjusted periodically to market rates. These
interest rate adjustments can both raise and lower the income generated by such
securities. These changes will have the same effect on the income earned by a
Fund depending on the proportion of such securities held.
The market value of fixed coupon securities fluctuates with changes in
prevailing interest rates, increasing in value when interest rates decline and
decreasing in value when interest rates rise. The value of variable rate
securities, however, is less affected by changes in prevailing interest rates
because of the periodic adjustment of their coupons to a market rate. The
shorter the period between adjustments, the smaller the impact of interest rate
fluctuations on the value of these securities. The market value of tax-exempt
variable rate securities usually tends toward par (100% of face value) at
interest rate adjustment time.
In the case of the Tax Exempt Money Market Fund only, any variable rate
instrument with a demand feature will be deemed to have a maturity equal to
either the date on which the underlying principal amount may be recovered
through demand or the next rate adjustment date consistent with applicable
regulatory requirements.
PUT BONDS - Each Fund may invest in tax-exempt securities (including securities
with variable interest rates) which may be redeemed or sold back (put) to the
issuer of the security or a third party prior to stated maturity (put bonds).
Such securities will normally trade as if maturity is the earlier put date, even
though stated maturity is longer. For the Long-Term, Intermediate- Term, and
Short-Term Funds, maturity for put bonds is deemed to be the date on which
17
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the put becomes exercisable. Generally, maturity for put bonds for the Tax
Exempt Money Market Fund is determined as stated under Variable Rate Securities.
ZERO COUPON BONDS - Each Fund may invest in zero coupon bonds. A zero coupon
bond is a security that is sold at a deep discount from its face value, makes no
periodic interest payments, and is redeemed at face value when it matures. The
lump sum payment at maturity increases the price volatility of the zero coupon
bond to changes in interest rates when compared to a bond that distributes a
semiannual coupon payment. In calculating its dividend, each Fund records as
income the daily amortization of the purchase discount.
WHEN-ISSUED SECURITIES - Each Fund may invest in new issues of tax-exempt
securities offered on a when-issued basis; that is, delivery and payment take
place after the date of the commitment to purchase, normally within 45 days.
Both price and interest rate are fixed at the time of commitment. The Funds do
not earn interest on the securities until settlement, and the market value of
the securities may fluctuate between purchase and settlement. Such securities
can be sold before settlement date.
Cash or high quality liquid debt securities equal to the amount of the
when-issued commitments are segregated at the Fund's custodian bank. The
segregated securities are valued at market, and daily adjustments are made to
keep the value of the cash and segregated securities at least equal to the
amount of such commitments by the Fund. On the settlement date, the Fund will
meet its obligations from then available cash, sale of segregated securities,
sale of other securities, or sale of the when-issued securities themselves.
MUNICIPAL LEASE OBLIGATIONS - Each Fund may invest in municipal lease
obligations and certificates of participation in such obligations (collectively,
lease obligations). A lease obligation does not constitute a general obligation
of the municipality for which the municipality's taxing power is pledged,
although the lease obligation is ordinarily backed by the municipality's
covenant to budget for the payments due under the lease obligation.
Certain lease obligations contain "non-appropriation" clauses which
provide that the municipality has no obligation to make lease obligation
payments in future years unless money is appropriated for such purpose on a
yearly basis. Although "non-appropriation" lease obligations are secured by the
leased property, disposition of the property in the event of foreclosure might
prove difficult. In evaluating a potential investment in such a lease
obligation, the Manager will consider: (1) the credit quality of the obligor,
(2) whether the underlying property is essential to a governmental function, and
(3) whether the lease obligation contains covenants prohibiting the obligor from
substituting similar property if the obligor fails to make appropriations for
the lease obligation.
LIQUIDITY - Each of the Long-Term, Intermediate-Term and Short-Term Funds may
invest up to 15% (10% with respect to the Tax Exempt Money Market Fund) of their
net assets in illiquid securities.
Lease obligations and certain put bonds that are subject to restrictions on
transfer may be determined to be liquid in accordance with the guidelines
established by the Board of Directors.
In determining the liquidity of a lease obligation, the Manager will
consider: (1) the frequency of trades and quotes for the lease obligation, (2)
the number of dealers willing to purchase or sell the lease obligation and the
number of other potential purchasers, (3) dealer undertakings to make a market
in the lease obligation, (4) the nature of the marketplace trades, including the
time needed to dispose of the lease obligation, the method of soliciting offers,
and the mechanics
18
<PAGE>
of transfer, (5) whether the lease obligation is of a size that will be
attractive to institutional investors, (6) whether the lease obligation contains
a non-appropriation clause and the likelihood that the obligor will fail to make
an appropriation therefor, and (7) such other factors as the Manager may
determine to be relevant to such determination.
In determining the liquidity of put bonds with restrictions on transfer,
the Manager will evaluate the credit quality of the party (the Put Provider)
issuing (or unconditionally guaranteeing performance on) the unconditional put
or demand feature of the put bond.
INVESTMENT RESTRICTIONS
The following restrictions may not be changed without shareholder approval:
(1) No Fund may borrow money, except for temporary or emergency purposes in an
amount not exceeding 33 1/3% of its total assets (including the amount
borrowed) less liabilities (other than borrowings).
(2) No Fund may invest more than 25% of its total assets in securities of
issuers conducting their principal activities in the same state or
securities issued in connection with the financing of projects with similar
characteristics, such as toll road revenue bonds, housing revenue bonds or
electric power project revenue bonds.
(3) No Fund may, with respect to 75% of its total assets, purchase the
securities of any issuer (except Government Securities, as such term is
defined in the Investment Company Act of 1940, as amended (1940 Act)) if,
as a result, the Fund would have more than 5% of the value of its total
assets invested in the securities of such issuer.
PURCHASE OF SHARES
OPENING AN ACCOUNT
You may open an account and make an investment by any of the following methods.
A complete, signed application is required together with a check for each new
account.
TAX ID NUMBER
We require that each shareholder named on the account provide the Company with a
social security number or tax identification number to avoid possible tax
withholding requirements.
EFFECTIVE DATE
When you make a purchase, your purchase price will be the net asset value (NAV)
per share next determined after the Fund receives your request in proper form.
The NAV of each Fund is determined at the close of the regular trading session
of the New York Stock Exchange (NYSE) each day the Exchange is open. If a Fund
receives your request prior to that time, your purchase price will be the NAV
per share determined for that day. If a Fund receives your request after the NAV
per share is calculated, the purchase will be effective on the next business
day.
Because of the more lengthy clearing process and the need to convert
foreign currency, a check drawn on a foreign bank will not be deemed received
for the purchase of shares until such time as the check has cleared and the
Manager has received good funds, which may take up to four to six weeks.
Furthermore, a bank charge may be assessed in the clearing process, which will
be deducted from the amount of the purchase. To avoid a delay in the
effectiveness of your purchase, the Manager suggests that you convert your
foreign check to U.S. dollars prior to investment in the Funds.
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PURCHASE OF SHARES
MINIMUM INVESTMENTS
- -------------------
Initial Purchase: $3,000
Additional Purchases: $50 - (Except transfers from brokerage accounts into
the Tax Exempt Market Fund, which are exempt from
minimum)
HOW TO PURCHASE:
- ---------------
MAIL o To open an account, send your application and check to:
USAA Investment Management Company
9800 Fredericksburg Rd., San Antonio, TX 78288
o To add to your account, send your check and the "Invest by
Mail" stub that accompanies your fund's transaction
confirmation to the Transfer Agent:
USAA Shareholder Account Services
9800 Fredericksburg Rd., San Antonio, TX 78288
o To exchange by mail, call 1-800-531-8448 for instructions.
IN PERSON o To open an account, bring your application and check to:
USAA Investment Management Company
USAA Federal Savings Bank
10750 Robert F. McDermott Freeway, San Antonio
AUTOMATICALLY o Additional purchases on a regular basis can be deducted
VIA from a bank account, paycheck, income-producing investment
ELECTRONIC or from a USAA money market account. Sign up for these
FUNDS services when opening an account or call 1-800-531-8448 to
TRANSFER add these services.
o Purchases through payroll deduction ($25 minimum each pay
period with (EFT) no initial investment) can be made by any
employee of USAA, its subsidiaries or affiliated companies.
BANK WIRE o To add to an account, instruct your bank (which may
charge a fee for the service) to wire the specified amount
to the Fund as follows:
State Street Bank and Trust Company, Boston, MA 02101
ABA#011000028
Attn: USAA [Fund Name]
USAA AC-69384998
Shareholder(s) Name(s)_________________
Shareholder(s) Account Number___________________
PHONE o If you have an existing USAA account and would like to
1-800-531-8448 open a new account or if you would like to exchange to
another USAA fund, call for instructions. The new account
must have the same registration as your existing account.
o To add to an account, intermittent (as-needed) purchases
can be deducted from your bank account through our Buy/Sell
Service. Call for instructions.
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REDEMPTION OF SHARES
You may redeem shares of a Fund by any of the following methods on any day the
NAV per share is calculated. Redemptions will be effective on the day
instructions are received in accordance with the requirements set forth below.
However, if instructions are received after the NAV per share calculation,
redemption will be effective on the next business day.
REDEMPTION PROCEEDS
Redemption proceeds are distributed within seven days after the effective date
of redemption. Payment for redemption of shares purchased by check or electronic
funds transfer will not be disbursed until the purchase check or electronic
funds transfer has cleared, which could take up to 15 days from the purchase
date. If you are considering redeeming shares soon after purchase, you should
purchase by bank wire or certified check to avoid delay.
In addition, the Company may elect to suspend the redemption of shares or
postpone the date of payment during any period that the NYSE is closed, or
trading in the markets the Company normally utilizes is restricted, or during
any period that redemption is otherwise permitted to be suspended by the SEC.
HOW TO REDEEM:
- -------------
WRITTEN, o Send your written instructions to:
FAX, OR USAA Shareholder Account Services
TELEGRAPH 9800 Fredericksburg Rd., San Antonio, TX 78288
o Send a signed fax to 1-800-292-8177, or send a telegraph to
USAA Shareholder Account Services.
Written redemption requests must include the following: (1) a letter of
instruction or stock assignment, and stock certificate (if issued), specifying
the Fund and the number of shares or dollar amount to be redeemed; (2)
signatures of all owners of the shares exactly as their names appear on the
account; (3) other supporting legal documents, if required, as in the case of
estates, trusts, guardianships, custodianships, partnerships, corporations, and
pension and profit-sharing plans; and (4) method of payment.
PHONE o Call toll free 1-800-531-8448, in San Antonio, 456-7202.
Telephone redemption is automatically established when you complete your
application. The Fund will employ reasonable procedures to confirm that
instructions communicated by telephone are genuine, and if it does not, it may
be liable for any losses due to unauthorized or fraudulent instructions.
Information is obtained prior to any discussion regarding an account including:
(1) USAA number or account number, (2) the name(s) on the account registration,
and (3) social security number or tax identification number for the account
registration. In addition, all telephone communications with a shareholder are
recorded, and confirmations of all account transactions are sent to the address
of record.
Redemption by telephone, fax, or telegraph is not available for shares
represented by stock certificates.
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<PAGE>
METHODS OF PAYMENT:
- ------------------
BANK WIRE o Allows redemptions to be sent directly to your bank account.
Establish this service when you apply for your account, or later upon
request. Please obtain precise wiring instructions from your financial
institution. USAA Shareholder Account Services (Transfer Agent) deducts a wire
fee from the account for the redemption by wire. The fee as of the date of this
Prospectus is $10 ($25 for wires to a foreign bank) and is subject to change at
any time. The fee is paid to State Street Bank and Trust Company (SSB) and the
Transfer Agent for their services in connection with the wire redemption. Your
financial institution may also charge a fee for receiving funds by wire.
AUTOMATICALLY o Systematic (regular) or intermittent (as-needed) redemptions
VIA EFT can be credited to your bank account.
Establish any of our electronic investing services when you apply for your
account, or later upon request.
CHECK o A check payable to the registered shareholder(s) will be
REDEMPTION mailed to the address of record.
This check redemption privilege is automatically established when your
application is completed and accepted. There is a 15-day waiting period before a
check redemption can be processed following a telephone address change. Should
you wish to redeem shares within the 15 days following a telephone address
change, you may do so by providing written instructions by mail or facsimile.
CHECKWRITING o Checks can be issued for your Short-Term Fund or Tax
Exempt Money Market Fund accounts.
To establish your checkwriting privilege (CWP), complete the signature card
which accompanies the application form or Shareholder Services Guide, or request
and complete the signature card separately. There is no charge for the use of
checks nor for subsequent reorders. This privilege is subject to SSB's rules and
regulations governing checking accounts. Checks must be written for an amount of
at least $250. Checks written for less than $250 will be returned. Checkwriting
may not be used to close an account because the value of the account changes
daily as dividends are accrued.
When a check is presented to the Transfer Agent for payment, a sufficient
number of full and fractional shares in the investor's account will be redeemed
to cover the amount of the check. Checks will be returned if there are
insufficient shares to cover the amount of the check. Presently, there is a $15
processing fee assessed against an account for any redemption check not honored
by a clearing or paying agent. A check paid during the month will be returned to
the shareholder by separate mail. Checkwriting fees are subject to change at any
time. The Company, the Transfer Agent and SSB each reserve the right to change
or suspend the checkwriting privilege upon 30 days' written notice to
participating shareholders. See the SAI for further information.
You may request that the Transfer Agent stop payment on a check. The
Transfer Agent will use its best efforts to execute stop payment instructions,
but does not guarantee that such efforts will be effective. A $10 charge will be
made for each stop payment requested by a shareholder.
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<PAGE>
CONDITIONS OF PURCHASE AND REDEMPTION
NONPAYMENT
If any order to purchase shares is cancelled due to nonpayment or if the Company
does not receive good funds either by check or electronic funds transfer, the
Transfer Agent will treat the cancellation as a redemption of shares purchased,
and you will be responsible for any resulting loss incurred by the Fund or the
Manager. If you are a shareholder, the Transfer Agent can redeem shares from any
of your account(s) as reimbursement for all losses. In addition, you may be
prohibited or restricted from making future purchases in any of the USAA Family
of Funds. A $15 fee is charged for all returned items, including checks and
electronic funds transfers.
TRANSFER OF SHARES
You may transfer Fund shares to another person by sending written instructions
to the Transfer Agent. The account must be clearly identified, and you must
include the number of shares to be transferred, the signatures of all registered
owners, and all stock certificates, if any, which are the subject of transfer.
You also need to send written instructions signed by all registered owners and
supporting documents to change an account registration due to events such as
divorce, marriage, or death. If a new account needs to be established, you must
complete and return an application to the Transfer Agent.
ACCOUNT BALANCE
Beginning in September 1998, and occurring each September thereafter, the
Transfer Agent will assess a small balance account fee of $12 to each
shareholder account with a balance, at the time of assessment, of less than
$2,000. The fee will be used to reduce total transfer agency fees paid by each
Fund to the Transfer Agent. Accounts exempt from the fee include: (1) any
account regularly purchasing additional shares each month through an automatic
investment plan; (2) any account registered under the Uniform Gifts/Transfers to
Minors Act (UGMA or UTMA); (3) all (non IRA) money market fund accounts; (4) any
account whose registered owner has an aggregate balance of $50,000 or more
invested in USAA mutual funds; and (5) all IRA accounts (for the first year the
account is open).
COMPANY RIGHTS The Company reserves the right to:
(1) reject purchase or exchange orders when in the best interest of the
Company;
(2) limit or discontinue the offering of shares of any portfolio of the Company
without notice to the shareholders;
(3) impose a redemption charge of up to 1% of the net asset value of shares
redeemed if circumstances indicate a charge is necessary for the protection
of remaining investors (for example, if excessive market-timing share
activity unfairly burdens long-term investors); provided, however, this 1%
charge will not be imposed upon shareholders unless authorized by the Board
of Directors and the required notice has been given to shareholders;
(4) require a signature guarantee for purchases, redemptions, or changes in
account information in those instances where the appropriateness of a
signature authorization is in question. The section ADDITIONAL INFORMATION
REGARDING REDEMPTION OF SHARES in the SAI contains information on
acceptable guarantors;
(5) redeem an account with a balance of less than 50 full shares, subject to
certain limitations described in ADDITIONAL INFORMATION REGARDING
REDEMPTION OF SHARES in the SAI.
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EXCHANGES
EXCHANGE PRIVILEGE
The Exchange Privilege is automatically established when you complete your
application. You may exchange shares among Funds in the USAA Family of Funds,
provided you do not hold these shares in stock certificate form and that the
shares to be acquired are offered in your state of residence. Exchange
redemptions and purchases will be processed simultaneously at the share prices
next determined after the exchange order is received. For federal income tax
purposes, an exchange between Funds is a taxable event. Accordingly, when
exchanging shares, you may realize a capital gain or loss.
The Funds have undertaken certain procedures regarding telephone
transactions. See REDEMPTION OF SHARES - PHONE.
EXCHANGE LIMITATIONS, EXCESSIVE TRADING
To minimize Fund costs and to protect the Funds and their shareholders from
unfair expense burdens, the Funds restrict excessive exchanges. Exchanges out of
any Fund in the USAA Family of Funds are limited for each account to six per
calendar year except that there is no limitation on exchanges out of the Tax
Exempt Short- Term Fund, Short-Term Bond Fund, or any of the money market funds
in the USAA Family of Funds.
OTHER SERVICES
INVESTMENT PLANS
AUTOMATIC INVESTMENT PLANS - You may establish an automatic investment plan by
completing the appropriate forms, if any. At the time you sign up for any of the
following investment plans that utilize the electronic funds transfer service,
you will choose the day of the month (the effective date) on which you would
like to regularly purchase shares. When this day falls on a weekend or holiday,
the electronic transfer will take place on the last business day before the
effective date. Call the Manager to obtain instructions. More information about
these preauthorized plans is contained in the SAI.
o INVESTRONIC(R) - The regular purchase of additional shares through electronic
funds transfer from a checking or savings account. You may invest as little as
$50 per month.
o DIRECT PURCHASE SERVICE - The periodic purchase of shares through electronic
funds transfer from an employer (including government allotments), an
income-producing investment, or an account with a participating financial
institution.
o AUTOMATIC PURCHASE PLAN - The periodic transfer of funds from a USAA money
market fund to purchase shares in another non-money market USAA mutual fund.
o BUY/SELL SERVICE - The intermittent purchase or redemption of shares through
electronic funds transfer to or from a checking or savings account.
o SYSTEMATIC WITHDRAWAL PLAN - The periodic redemption of shares from one of
your accounts permitting you to receive a fixed amount of money monthly or
quarterly.
o DIRECTED DIVIDENDS - If you own shares in more than one of the Funds in the
USAA Family of Funds, you may direct that dividends and/or capital gain
distributions earned in one fund be used to purchase shares automatically in
another fund.
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SHAREHOLDER STATEMENTS AND REPORTS
You will receive a confirmation after each account transaction in your Long-Term
Fund, Intermediate-Term Fund and Short-Term Fund except:
(1) a reinvested dividend;
(2) a payment you make under the InvesTronic(R), Direct Purchase Service,
Automatic Purchase Plan, or Directed Dividends investment plans; or
(3) a redemption you make under the Systematic Withdrawal Plan.
If you own shares in the Tax Exempt Money Market Fund, you will receive a
confirmation for purchases or redemptions by check and exchanges. If that money
market fund account had activity other than reinvested dividends, such as wire
purchases or redemptions or purchases under the InvesTronic(R), Direct Purchase
Service, Automatic Purchase Plan or Directed Dividends investment plans, you
will receive a monthly statement that will reflect quarter-to-date account
activity.
At the end of each quarter, you will receive a consolidated statement for
all of your mutual fund accounts, regardless of account activity. The fourth
quarter consolidated statement will reflect all account activity for the prior
tax year. There will be a $10 fee charged for copies of historical statements
for other than the prior tax year for any one account. You will receive a Fund's
financial statements with a summary of its investments and performance at least
semiannually.
In an effort to reduce expenses and respond to shareholders' requests to
reduce mail, the Company intends to consolidate mailings of Annual and
Semiannual Reports to households having multiple accounts with the same address
of record. One copy of each report will be furnished to that address. You may
request additional reports by notifying the Company.
TELEPHONE ASSISTANCE
Call our telephone assistance numbers for specific forms, a copy of the SAI, the
most recent Annual Report and/or Semiannual Report, or if you have any questions
concerning any of the services offered.
SHARE PRICE CALCULATION
The price at which shares of the Funds are purchased and redeemed by
shareholders is equal to the NAV per share determined on the effective date of
the purchase or redemption.
WHEN
The NAV per share for each Fund is calculated at the close of the regular
trading session of the NYSE, which is usually 4:00 p.m. Eastern Time. You may
buy and sell Fund shares at the NAV per share without a sales charge.
HOW
The NAV per share is calculated by adding the value of all securities and other
assets in a Fund, deducting liabilities, and dividing by the number of shares
outstanding. Securities of the Long-Term, Intermediate-Term, and Short-Term
Funds are valued each business day at their current market value as determined
by a pricing service approved by the Board of Directors. Securities which cannot
be valued by the pricing service, and all other assets, are valued in good faith
at fair value using methods determined by the Manager under the general
supervision of the Board of Directors. In addition, securities purchased with
maturities of 60 days or less and all securities of the Tax Exempt Money Market
Fund are stated at amortized cost.
For additional information, see VALUATION OF SECURITIES in the SAI.
25
<PAGE>
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
Net investment income of each Fund is accrued daily and distributed to
shareholders on the last business day of each month. Net capital gains, if any,
generally will be distributed at least annually. The Funds intend to make such
additional distributions as may be necessary to avoid the imposition of any
federal excise tax.
All shares purchased will begin accruing dividends on the day following the
effective date of the purchase and will receive dividends through the effective
date of redemption.
All income dividends and capital gain distributions are automatically
reinvested, unless the shareholder specifies otherwise. The share price will be
the net asset value of the Fund shares computed on the ex- dividend date. Any
capital gain distribution paid by a Fund (other than the Tax Exempt Money Market
Fund) will reduce the NAV per share by the amount of the distribution. An
investor should consider carefully the effects of purchasing shares of a Fund
shortly before any capital gain distribution. Although in effect a return of
capital, these distributions are subject to taxes.
Any dividend or distribution payment returned to the Manager as not
deliverable will be invested in the shareholder's Fund account at the
then-current NAV per share. If any check for the payment of dividends or
distributions is not cashed within six months from the date on the check, it
becomes void. The amount of the check will then be invested in the shareholder's
Fund account at the then-current NAV per share.
FEDERAL TAXES
The exemption of interest income for federal income tax purposes does not
necessarily result in exemption under the income or other tax laws of any state
or local taxing authority. The following discussion relates only to generally
applicable federal income tax provisions in effect as of the date of this
Prospectus. Therefore, shareholders are urged to consult their own tax advisers
about the status of distributions from a Fund in their own states and
localities.
FUND - Each Fund intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the Code). By
complying with the applicable provisions of the Code, none of the Funds will be
subject to federal income tax on its net investment income and net capital gains
(capital gains in excess of capital losses) distributed to shareholders.
SHAREHOLDER - Dividends of net tax-exempt interest income paid by a Fund are
excluded from a shareholder's gross income for federal income tax purposes.
Dividends from taxable net investment income and distributions of net short-term
capital gains are taxable to shareholders as ordinary income, whether received
in cash or reinvested in additional shares. However, it is expected that any
taxable net investment income will be minimal in relation to the tax-exempt
interest generated by a Fund.
26
<PAGE>
Distributions of net long-term capital gains are taxable as long-term
capital gains whether received in cash or reinvested in additional shares, and
regardless of the length of time the investor has held the shares of a Fund.
Redemptions, including exchanges, are subject to income tax, based on the
difference between the cost of shares when purchased and the price received upon
redemption or exchange.
Tax-exempt interest from private activity bonds (for example, industrial
development revenue bonds) issued after August 7, 1986, although otherwise
exempt from federal tax, is treated as a tax preference item for purposes of the
alternative minimum tax. For corporations, all tax-exempt interest will be
considered in calculating the alternative minimum tax as part of the adjusted
current earnings.
WITHHOLDING - Each Fund is required by federal law to withhold and remit to the
U.S. Treasury a portion of the income dividends and capital gain distributions
and proceeds of redemptions paid to any non-corporate shareholder who fails to
furnish the Fund with a correct tax identification number, who underreports
dividend or interest income, or who fails to certify that he is not subject to
withholding. To avoid this withholding requirement, you must certify on your
application, or on a separate Form W-9 supplied by the Transfer Agent, that your
tax identification number is correct and that you are not currently subject to
backup withholding.
REPORTING - Each Fund will report annually to its shareholders the federal tax
status of dividends and distributions paid or declared by each Fund during the
preceding calendar year, including the portion of the dividends constituting
interest on private activity bonds, and the percentage and source, on a
state-by-state basis, of interest income earned on tax-exempt securities held by
the Fund during the preceding year.
MANAGEMENT OF THE COMPANY
The business affairs of the Company are subject to the supervision of the Board
of Directors.
The Manager, USAA Investment Management Company (IMCO), was organized in
May 1970 and is an affiliate of United Services Automobile Association (USAA), a
large diversified financial services institution. As of the date of this
Prospectus, the Manager had approximately $35 billion in total assets under
management. The Manager's mailing address is 9800 Fredericksburg Rd., San
Antonio, TX 78288.
Officers and employees of the Manager are permitted to engage in personal
securities transactions subject to restrictions and procedures set forth in the
Joint Code of Ethics adopted by the Company and the Manager. Such restrictions
and procedures include substantially all of the recommendations of the Advisory
Group of the Investment Company Institute and comply with SEC rules and
regulations.
ADVISORY AGREEMENT
The Manager serves as the manager and investment adviser of the Company,
providing services under an Advisory Agreement. Under the Advisory Agreement,
the Manager is responsible for the management of the business affairs,
investment portfolios and placement of brokerage orders, subject to the
authority of and supervision by the Board of Directors.
For its services under the Advisory Agreement, each Fund pays the Manager
an annual fee which is computed as a percentage of that Fund's ANA, accrued
daily, and paid monthly. The fee for each Fund was computed and paid at
twenty-eight one-hundredths of one percent (.28%) of ANA for the fiscal year
ended March 31, 1997.
27
<PAGE>
OPERATING EXPENSES
For the fiscal year ended March 31, 1997, the total operating expenses for each
Fund as a percentage of that Fund's ANA equaled .37% for the Long-Term Fund,
.37% for the Intermediate-Term Fund, .41% for the Short-Term Fund, and .39% for
the Tax Exempt Money Market Fund.
PORTFOLIO MANAGERS
The following individuals are primarily responsible for managing the Funds.
LONG-TERM FUND
Kenneth E. Willmann, Vice President of Fixed Income Investments since December
1986, has managed the Fund since its inception in March 1982. He has 23 years
investment management experience and has worked for IMCO for 20 years. Mr.
Willmann earned the Chartered Financial Analyst (CFA) designation in 1978 and is
a member of the Association for Investment Management and Research (AIMR), San
Antonio Financial Analysts Society, Inc. (SAFAS), and the National Federation of
Municipal Analysts (NFMA). He holds an MBA and a BA from the University of
Texas.
INTERMEDIATE-TERM AND SHORT-TERM FUNDS
Clifford A. Gladson, Assistant Vice President of Fixed Income Investments since
November 1994, has managed the Funds since April 1993 and April 1994,
respectively. He has ten years investment management experience and has worked
for IMCO for seven years where he has held various positions in Fixed Income
Investments. Mr. Gladson earned the CFA designation in 1990 and is a member of
the AIMR, SAFAS and NFMA. He holds an MS from the University of Wisconsin,
Milwaukee and a BS from Marquette University.
TAX EXEMPT MONEY MARKET FUND
Thomas G. Ramos, Vice President of Money Market Funds since September 1996, has
managed the Fund since August 1994. Mr. Ramos has 19 years investment management
experience and has worked for IMCO for 15 years where he has held various
positions in Fixed Income Investments. Mr. Ramos earned the CFA designation in
1983 and is a member of the AIMR, SAFAS, and NFMA. He holds an MBA from the
University of California, an MA from St. Mary's University and a BA from Yale
University.
DESCRIPTION OF SHARES
The Company is an open-end management investment company incorporated under the
laws of the State of Maryland on November 16, 1981. The Company is authorized to
issue shares in separate portfolios. Ten such portfolios have been established,
four of which are described in this Prospectus. Each of the four Funds is
classified as diversified. Under the Company's charter, the Board of Directors
is authorized to create new portfolios in addition to those already existing
without the approval of the shareholders of the Company.
Under the provisions of the Bylaws of the Company, no annual meeting of
shareholders is required. Ordinarily, no shareholder meeting will be held unless
required by the 1940 Act. The Directors may fill vacancies on the Board or
appoint new Directors provided that immediately after such action at least
two-thirds of the Directors have been elected by shareholders.
Shareholders are entitled to one vote per share (with proportionate voting
for fractional shares) irrespective of the relative net asset value of the
shares. For matters affecting an individual portfolio, a separate vote of the
shareholders of that portfolio is required.
28
<PAGE>
SERVICE PROVIDERS
UNDERWRITER/ USAA Investment Management Company
DISTRIBUTOR 9800 Fredericksburg Rd., San Antonio, Texas 78288.
TRANSFER USAA Shareholder Account Services
AGENT 9800 Fredericksburg Rd., San Antonio, Texas 78288.
CUSTODIAN State Street Bank and Trust Company
P.O. Box 1713, Boston, Massachusetts 02105.
LEGAL Goodwin, Procter & Hoar LLP
COUNSEL Exchange Place, Boston, Massachusetts 02109.
INDEPENDENT KPMG Peat Marwick LLP
AUDITORS 112 East Pecan, Suite 2400, San Antonio, Texas 78205.
TELEPHONE ASSISTANCE
(Call toll free - Central Time)
Monday-Friday 8:00 a.m. to 8:00 p.m.
Saturday 8:30 a.m. to 5:00 p.m.
For further information on mutual funds:
1-800-531-8181
In San Antonio 456-7211
For account servicing, exchanges or redemptions:
1-800-531-8448
In San Antonio 456-7202
RECORDED 24 HOUR SERVICE
MUTUAL FUND PRICE QUOTES
(From any phone)
1-800-531-8066
In San Antonio 498-8066
MUTUAL FUND TOUCHLINE(R)
(From Touchtone phones only)
For account balance, last transaction or fund prices:
1-800-531-8777
In San Antonio 498-8777
29
<PAGE>
Part A
Prospectus for the
California Bond and
California Money Market Funds
<PAGE>
USAA CALIFORNIA FUNDS
AUGUST 1, 1997 PROSPECTUS
USAA CALIFORNIA BOND FUND and USAA CALIFORNIA MONEY MARKET FUND (collectively,
the Funds or the California Funds) are two of ten no-load mutual funds offered
by USAA Tax Exempt Fund, Inc. (the Company). The Funds are managed by USAA
Investment Management Company (the Manager).
WHAT ARE THE INVESTMENT OBJECTIVES AND POLICIES?
The Funds have a common objective of providing California investors with a
high level of current interest income that is exempt from federal and California
state income taxes. The California Money Market Fund has a further objective of
preserving capital and maintaining liquidity. Each Fund has separate investment
policies to achieve its objective.
The CALIFORNIA BOND FUND invests primarily in long-term investment grade
California tax-exempt securities. The Fund's average portfolio maturity is not
restricted, but is expected to be greater than 10 years.
Page 11.
The CALIFORNIA MONEY MARKET FUND invests in high quality California
tax-exempt securities with maturities of 397 days or less. The Manager will
maintain a dollar-weighted average portfolio maturity of no more than 90 days.
The Fund will endeavor to maintain a constant net asset value per share of
$1.00. Page 11.
HOW DO YOU BUY?
Fund shares are sold on a continuous basis at the net asset value per share
without a sales charge. Make your initial investment directly with the Manager
by mail, in person, or in certain instances, by telephone. Page 15.
HOW DO YOU SELL?
You may redeem Fund shares by mail, telephone, fax, or telegraph on any day that
the net asset value is calculated. Page 17.
Shares of the California Funds are authorized for sale only to residents of
the State of California. The delivery of this Prospectus shall not constitute an
offer in any state in which shares of the California Funds may not lawfully be
made.
SHARES OF THE USAA CALIFORNIA FUNDS ARE NOT DEPOSITS OR OTHER OBLIGATIONS
OF, OR GUARANTEED BY, THE USAA FEDERAL SAVINGS BANK, ARE NOT INSURED BY THE FDIC
OR ANY OTHER GOVERNMENT AGENCY, AND ARE SUBJECT TO INVESTMENT RISKS, INCLUDING
POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED.
This Prospectus, which should be read and retained for future reference,
provides information regarding the Company and the California Funds that you
should know before investing.
If you would like more information about the Funds, you may call
1-800-531-8181 to request a free copy of the most recent financial report and/or
the Funds' Statement of Additional Information (SAI), dated August 1, 1997. The
SAI has been filed with the Securities and Exchange Commission (SEC) and is
incorporated by reference into this Prospectus (meaning it is legally a part of
the Prospectus).
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
AN INVESTMENT IN THE CALIFORNIA MONEY MARKET FUND IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT AND THERE CAN BE NO ASSURANCE THAT THE FUND
WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE. THIS FUND
MAY INVEST A SIGNIFICANT PERCENTAGE OF ITS ASSETS IN A SINGLE ISSUER, AND
THEREFORE AN INVESTMENT IN THE FUND MAY BE RISKIER THAN AN INVESTMENT IN OTHER
TYPES OF MONEY MARKET FUNDS.
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
SUMMARY DATA
Fees and Expenses.............................................. 3
Financial Highlights........................................... 4
Performance Information........................................ 8
USING MUTUAL FUNDS
USAA Family of No-Load Mutual Funds............................ 9
Using Mutual Funds in an Investment Program.................... 10
INVESTMENT PORTFOLIO INFORMATION
Investment Objectives and Policies............................. 11
California Bond Fund......................................... 11
California Money Market Fund................................. 11
Other Investment Information................................... 12
SHAREHOLDER INFORMATION
Purchase of Shares............................................. 15
Redemption of Shares........................................... 17
Conditions of Purchase and Redemption.......................... 19
Exchanges...................................................... 20
Other Services................................................. 20
Share Price Calculation........................................ 21
Dividends, Distributions and Taxes............................. 22
Management of the Company...................................... 24
Description of Shares.......................................... 25
Service Providers.............................................. 25
Telephone Assistance Numbers................................... 25
- --------------------------------------------------------------------------------
2
<PAGE>
FEES AND EXPENSES
The following summary, which is based on actual expenses and average net assets
(ANA) of each Fund for the year ended March 31, 1997, is provided to assist you
in understanding the expenses you will bear directly or indirectly as a Fund
investor.
SHAREHOLDER TRANSACTION EXPENSES (APPLICABLE TO EACH FUND)
- --------------------------------------------------------------------------------
Sales Load Imposed on Purchases.......................... None
Sales Load Imposed on Reinvested Dividends............... None
Deferred Sales Load...................................... None
Redemption Fee*.......................................... None
Exchange Fee............................................. None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE OF ANA)
- --------------------------------------------------------------------------------
CALIFORNIA CALIFORNIA
BOND MONEY MARKET
FUND FUND
Management Fees.................................... .32% .32%
12b-1 Fees......................................... None None
Other Expenses
Transfer Agent Fees**.......................... .05% .07%
Custodian Fees................................. .02% .03%
All Other Expenses............................. .02% .03%
--- ---
Total Other Expenses............................... .09% .13%
--- ---
Total Fund Operating Expenses...................... .41% .45%
=== ===
- --------------
* A shareholder who requests delivery of redemption proceeds by wire transfer
will be subject to a $10 fee. See REDEMPTION OF SHARES - BANK WIRE.
** The Funds pay USAA Shareholder Account Services an annual fixed fee per
account for its services. See TRANSFER AGENT in the SAI, page 17.
EXAMPLE OF EFFECT OF FUND EXPENSES
- --------------------------------------------------------------------------------
You would pay the following expenses on a $1,000 investment in one of the Funds
below, assuming (1) 5% annual return and (2) redemption at the end of the
periods shown:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
California Bond Fund...................... $4 $13 $23 $52
California Money Market Fund.............. $5 $14 $25 $57
THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The following per share operating performance for a share outstanding throughout
each period in the eight-year period ended March 31, 1997, has been audited by
KPMG Peat Marwick LLP. This table should be read in conjunction with the Funds'
financial statements for the year ended March 31, 1997, and the auditors' report
thereon, that appear in the Funds' Annual Report. Further performance
information is contained in the Annual Report and is available upon request
without charge.
CALIFORNIA BOND FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 10.43 $ 10.10 $ 10.03 $ 10.75 $ 10.25
Net investment income .61 .60 .59 .59 .62
Net realized and
unrealized gain (loss) .07 .33 .07 (.52) .62
Distributions from net
investment income (.61) (.60) (.59) (.59) (.62)
Distributions of realized
capital gains - - - (.20) (.12)
-------- -------- -------- -------- --------
Net asset value at
end of period $ 10.50 $ 10.43 $ 10.10 $ 10.03 $ 10.75
======== ======== ======== ======== ========
Total return (%)** 6.60 9.35 6.89 .31 12.56
Net assets at end of
period (000) $440,231 $409,180 $372,877 $382,766 $386,933
Ratio of expenses to
average net assets (%) .41 .42 .44 .44 .46
Ratio of net investment
income to average net
assets (%) 5.74 5.74 5.98 5.40 5.94
Portfolio turnover (%) 23.72 23.09 28.86 102.85 86.53
- --------------
</TABLE>
* Fund commenced operations August 1, 1989.
** Assumes reinvestment of all dividend income and capital gains
distributions during the period.
(a) Based on actual expenses for the period, after giving effect to
reimbursements of expenses by the Manager. Absent such reimbursements
the Fund's ratios would have been:
YEAR ENDED MARCH 31,
-------------------
1991 1990*
---- -----
Ratio of expenses to
average net assets (%) .54 .74(b)
Ratio of net investment
income to average net
assets (%) 6.69 6.57(b)
(b) Annualized. The ratio is not necessarily indicative of 12 months of
operations.
4
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
CALIFORNIA BOND FUND:
YEAR ENDED MARCH 31,
--------------------
1992 1991 1990*
---- ---- -----
Net asset value at
beginning of period $ 9.98 $ 9.75 $ 10.00
Net investment income .66 .66 .44
Net realized and
unrealized gain (loss) .27 .23 (.25)
Distributions from net
investment income (.66) (.66) (.44)
Distributions of realized
capital gains - - -
-------- -------- --------
Net asset value at
end of period $ 10.25 $ 9.98 $ 9.75
======== ======== ========
Total return (%)** 9.52 9.46 1.97
Net assets at end of
period (000) $305,834 $192,344 $107,539
Ratio of expenses to
average net assets (%) .48 .50(a) .50(a)(b)
Ratio of net investment
income to average net
assets (%) 6.44 6.73(a) 6.81(a)(b)
Portfolio turnover (%) 50.61 72.67 135.61
5
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
CALIFORNIA MONEY MARKET FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .03 .04 .03 .02 .03
Distributions from net
investment income (.03) (.04) (.03) (.02) (.03)
-------- -------- -------- -------- --------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======== ======== ======== ======== ========
Total return (%)** 3.23 3.58 2.94 2.22 2.66
Net assets at end of
period (000) $341,128 $296,349 $266,764 $247,303 $219,097
Ratio of expenses to
average net assets (%) .45 .47 .47 .49 .50
Ratio of net investment
income to average net
assets (%) 3.19 3.52 2.91 2.19 2.63
</TABLE>
- --------------
* Fund commenced operations August 1, 1989.
** Assumes reinvestment of all dividend income distributions during the period.
(a) Based on actual expenses for the period, after giving effect to
reimbursements of expenses by the Manager. Absent such reimbursements the
Fund's ratios would have been:
YEAR ENDED MARCH 31,
-------------------
1991 1990*
---- -----
Ratio of expenses to
average net assets (%) .55 .76(b)
Ratio of net investment
income to average net
assets (%) 5.21 5.25(b)
(b) Annualized. The ratio is not necessarily indicative of 12 months of
operations.
6
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
CALIFORNIA MONEY MARKET FUND:
YEAR ENDED MARCH 31,
--------------------
1992 1991 1990*
---- ---- -----
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00
Net investment income .04 .05 .04
Distributions from net
investment income (.04) (.05) (.04)
-------- -------- -------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00
======== ======== =======
Total return (%)** 4.03 5.44 3.70
Net assets at end of
period (000) $229,328 $197,254 $97,782
Ratio of expenses to
average net assets (%) .50 .50(a) .50(a)(b)
Ratio of net investment
income to average net
assets (%) 3.94 5.26(a) 5.51(a)(b)
7
<PAGE>
PERFORMANCE INFORMATION
Performance information should be considered in light of each Fund's investment
objective and policies and market conditions during the time periods for which
it is reported. Historical performance should not be considered as
representative of the future performance of either Fund.
The Company may quote a Fund's total return or yield in advertisements and
reports to shareholders or prospective investors. A Fund's performance may also
be compared to that of other mutual funds with similar investment objectives and
relevant indexes that are referenced in APPENDIX B to the SAI. Standard total
return and yield results reported by the Funds do not take into account
recurring and nonrecurring charges for optional services which only certain
shareholders elect and which involve nominal fees, such as the $10 fee for a
delivery of redemption proceeds by wire transfer.
Further information concerning yield and total return is included in the
SAI.
TOTAL RETURN - CALIFORNIA BOND FUND. The Fund's average annual total return is
computed by determining the average annual compounded rate of return for a
specified period which, when applied to a hypothetical $1,000 investment in the
Fund at the beginning of the period, would produce the redeemable value of that
investment at the end of the period, assuming reinvestment of all dividends and
distributions during the period.
YIELD - CALIFORNIA BOND FUND. The Fund may advertise performance in terms of a
30- day yield quotation. The yield quotation is computed by dividing the net
investment income per share earned during the period by the offering price per
share on the last day of the period. This income is then annualized. For
purposes of the yield calculation, interest income is computed based on the
yield to maturity of each debt obligation in a Fund's portfolio and all
recurring charges are recognized.
YIELD - CALIFORNIA MONEY MARKET FUND. The Fund may advertise its yield and
effective yield. The yield of the Fund refers to the income generated by an
investment in the Fund over a seven-day period (which period will be stated in
the advertisement). This income is then annualized, that is, the amount of
income generated by the investment during the week is assumed to be generated
each week over a 52-week period and is shown as a percentage of the investment.
The effective yield is calculated similarly but, when annualized, the income
earned by an investment in the Fund is assumed to be reinvested. The effective
yield will be slightly higher than the yield because of the compounding effect
of this assumed reinvestment.
TAX EQUIVALENT YIELD - The Funds may also utilize tax equivalent yields with
adjustments for assumed income tax rates. See APPENDIX C - TAXABLE EQUIVALENT
YIELD TABLE in the SAI for illustrations of this
yield.
8
<PAGE>
USAA FAMILY OF NO-LOAD MUTUAL FUNDS
The USAA Family of No-Load Mutual Funds includes a variety of Funds, each with
different objectives and policies. In combination, these Funds are designed to
provide investors with the opportunity to formulate their own investment
program. You may exchange any shares you hold in any one USAA Fund for shares in
any other USAA Fund. For more complete information about the Funds in the USAA
Family of Funds, including charges and expenses, call the Manager for a
Prospectus. Read it carefully before you invest or send money.
USAA TAX EXEMPT FUND, INC.
Long-Term Fund
Intermediate-Term Fund
Short-Term Fund
Tax Exempt Money Market Fund
California Bond Fund*
California Money Market Fund*
New York Bond Fund*
New York Money Market Fund*
Virginia Bond Fund*
Virginia Money Market Fund*
USAA MUTUAL FUND, INC.
Aggressive Growth Fund
Science & Technology Fund
Growth Fund
First Start Growth Fund
S&P 500 Index Fund**
Growth & Income Fund
Income Stock Fund
Income Fund
Short-Term Bond Fund
Money Market Fund
USAA INVESTMENT TRUST
Income Strategy Fund
Growth and Tax Strategy Fund
Balanced Strategy Fund
Cornerstone Strategy Fund
Growth Strategy Fund
Emerging Markets Fund
Gold Fund
International Fund
World Growth Fund
GNMA Trust
Treasury Money Market Trust
USAA STATE TAX-FREE TRUST
Florida Tax-Free Income Fund*
Florida Tax-Free Money Market Fund*
Texas Tax-Free Income Fund*
Texas Tax-Free Money Market Fund*
* Available for sale only to residents of these specific states.
** S&P is a trademark of The McGraw-Hill Companies, Inc., and has been
licensed for use. The Product is not sponsored, sold or promoted by
Standard & Poor's and Standard & Poor's makes no representation regarding
the advisability of investing in the Product.
9
<PAGE>
USING MUTUAL FUNDS IN AN INVESTMENT PROGRAM
I. THE IDEA BEHIND MUTUAL FUNDS
Mutual funds provide small investors some of the advantages enjoyed by wealthy
investors. A relatively small investment can buy part of a widely diversified
portfolio. That portfolio is managed by investment professionals, relieving the
shareholder of the need to make individual stock or bond selections. The
investor also enjoys conveniences, such as daily pricing, liquidity, and in the
case of the USAA Family of Funds, no sales charge. The portfolio, because of its
size, has lower transaction costs on its trades than most individuals would
have. As a result each shareholder owns an investment that in earlier times
would have been available only to very wealthy people.
II. USING FUNDS IN AN INVESTMENT PROGRAM
In choosing a mutual fund as an investment vehicle, the shareholder is foregoing
some investment decisions, but must still make others. The decisions foregone
are those involved with choosing individual securities. The Fund Manager will
perform that function. In addition, the Manager will arrange for the safekeeping
of securities, auditing the annual financial statements, and daily valuation of
the Fund, as well as other functions.
The shareholder, however, retains at least part of the responsibility for
an equally important decision. This decision includes determining a portfolio of
mutual funds that balances the investor's investment goals with his or her
tolerance for risk. It is likely that this decision may involve the use of more
than one fund of the USAA Family of Funds.
For example, assume a shareholder wishes to pursue the higher yields
usually available in the long-term bond market, but is also concerned about the
possible price swings of the long-term bonds. He or she could divide investments
between the California Bond Fund and the California Money Market Fund. This
would create a portfolio with a higher yield than that of the money market and
less volatility than that of the long-term market. This is just one example of
how an individual could combine funds to create a portfolio tailored to his or
her own risk and reward goals.
III. USAA'S FAMILY OF FUNDS
The Manager offers investors another alternative in its asset strategy funds,
the Income Strategy, Growth and Tax Strategy, Balanced Strategy, Cornerstone
Strategy and Growth Strategy Funds. These unique mutual funds provide a
professionally managed diversified investment portfolio within a mutual fund.
These Funds are designed for the shareholder who prefers to delegate the asset
allocation process to an investment manager. The Funds are structured to achieve
diversification across a number of investment categories.
Whether you prefer to create your own mix of mutual funds or use an asset
strategy fund, the USAA Family of Funds provides a broad range of choices
covering just about any investor's investment objectives. Our sales
representatives stand ready to inform you of your choices and to help you craft
a portfolio which meets your needs.
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INVESTMENT OBJECTIVES AND POLICIES
INVESTMENT OBJECTIVES
The Funds have a common investment objective of providing California investors
with a high level of current interest income that is exempt from federal and
California state income taxes. The California Money Market Fund has a further
objective of preserving capital and maintaining liquidity.
INVESTMENT POLICIES
The Manager will pursue this common objective by investing each Fund's assets in
tax-exempt securities, the interest from which, in the opinion of counsel, is
excluded from gross income for federal income tax purposes and is exempt from
California state income taxes. It is a fundamental policy of each Fund that
during normal market conditions at least 80% of the Fund's net assets will
consist of California tax-exempt securities and at least 80% of the Fund's
annual income will be exempt from federal and California state income taxes and
excluded from the calculation of federal alternative minimum taxes for
individual taxpayers.
CALIFORNIA BOND FUND. Under normal market conditions, the Manager will invest
the assets of the Fund so that at least 50% of the total market value of the
tax-exempt securities is rated within the three highest long-term rating
categories (at least A) by Moody's Investors Service, Inc. (Moody's), Standard &
Poor's Ratings Group (S&P), or Fitch Investors Service, Inc. (Fitch), in the
highest short-term rating category by Moody's, S&P, or Fitch, or, if a security
is not rated by those rating agencies, it must be of equivalent investment
quality as determined by the Manager. In no event will a security be purchased
for the Fund unless it is rated at least investment grade; i.e., rated by
Moody's, S&P, or Fitch at least in the fourth highest rating category for
long-term securities, in the second highest rating category for short-term
securities, or, if not rated by those rating agencies, determined by the Manager
to be of equivalent investment quality. Securities rated in the lowest level of
investment grade have speculative characteristics since adverse economic
conditions and changing circumstances are more likely to have an adverse impact
on such securities.
If the rating of a security is downgraded, the Manager will determine
whether it is in the best interest of the Fund's shareholders to continue to
hold such security in the Fund's portfolio. Unless otherwise directed by the
Board of Directors, if downgrades result in more than 5% of a Fund's net assets
being invested in securities that are less than investment grade quality, the
Manager will take immediate action to reduce the Fund's holdings in such
securities to 5% or less of the Fund's net assets. For a more complete
description of tax-exempt securities and their ratings, see APPENDIX A to the
SAI.
The Fund's average portfolio maturity is not restricted, but is expected to
be greater than ten years. In determining a security's maturity for purposes of
calculating the Fund's average maturity, estimates of the expected time for its
principal to be paid may be used. This can be substantially shorter than its
stated final maturity. For a discussion of the method of calculating the average
weighted maturity of the Fund's portfolio, see INVESTMENT POLICIES in the SAI.
The net asset value (NAV) per share of the California Bond Fund will fluctuate
with portfolio maturity, the quality of securities held, and inversely to
interest rate levels.
CALIFORNIA MONEY MARKET FUND. The Fund will purchase only high quality
securities that qualify as "eligible securities" under the SEC rules applicable
to money market mutual funds. These securities must also be determined by the
Manager to present minimal credit risk. In general, the category of eligible
securities may include a security that is:
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(1) issued or guaranteed by the U.S. Government or any agency or
instrumentality thereof, including "prerefunded" and "escrowed to maturity"
tax-exempt securities;
(2) rated in one of the two highest categories for short-term securities by at
least two Nationally Recognized Statistical Rating Organizations (NRSROs),
or by one NRSRO if the security is rated by only one NRSRO;
(3) unrated but issued by an issuer or guaranteed by a guarantor that has other
comparable short-term debt obligations so rated; or
(4) unrated but determined to be of comparable quality by the Manager.
If a security is downgraded after purchase, the Manager will follow written
procedures adopted by the Company's Board of Directors and a determination will
be made as to whether it is in the best interest of the Fund's shareholders for
the Fund to continue to hold the security.
Current NRSROs include Moody's, S&P, Fitch, Duff & Phelps Inc., Thompson
BankWatch, Inc., and IBCA Inc. For a description of tax-exempt securities and
their ratings, see APPENDIX A to the SAI.
Consistent with regulatory requirements, the Manager will purchase
securities with remaining maturities of 397 days or less and will maintain a
dollar-weighted average portfolio maturity of no more than 90 days. The Fund
will endeavor to maintain a constant net asset value of $1.00 per share,
although there is no assurance that it will be able to do so.
OTHER INVESTMENT INFORMATION
The investment objectives of the Funds may not be changed without shareholder
approval. In view of the risks inherent in all investments in securities, there
is no assurance that these objectives will be achieved. The investment policies
and techniques used to pursue the Funds' objectives may be changed without
shareholder approval, except as otherwise noted. Further information regarding
the Funds' investment policies and restrictions is provided in the SAI.
TAX-EXEMPT SECURITIES
These securities include general obligation bonds, which are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest; revenue bonds, which are payable from the revenue
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise tax or other specific revenue source, but
not from the general taxing power; lease obligations backed by the
municipality's covenant to budget for the payments due under the lease
obligation; and certain types of industrial development bonds issued by or on
behalf of public authorities to obtain funds for privately-operated facilities,
provided that the interest paid on such securities qualifies as exempt from
federal and California state income taxes.
The value of the securities in which a Fund will invest generally
fluctuates inversely with changes in prevailing interest rates. Changes in the
creditworthiness of issuers and changes in other market factors such as the
relative supply of and demand for tax-exempt bonds also create value
fluctuations.
Each Fund may on a temporary basis due to market or other conditions invest
up to 100% of its assets in short-term securities whether or not exempt from
federal and California state income taxes. Such taxable securities may consist
of obligations of the U.S. Government, its agencies or instrumentalities, and
repurchase agreements secured by such instruments; certificates of deposit of
domestic banks having capital, surplus and undivided
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profits in excess of $100 million; banker's acceptances of similar banks;
commercial paper; and other corporate debt obligations.
INVESTMENT TECHNIQUES
VARIABLE RATE SECURITIES - Each Fund may invest in tax-exempt securities that
bear interest at rates which are adjusted periodically to market rates. These
interest rate adjustments can both raise and lower the income generated by such
securities. These changes will have the same effect on the income earned by a
Fund depending on the proportion of such securities held.
The market value of fixed coupon securities fluctuates with changes in
prevailing interest rates, increasing in value when interest rates decline and
decreasing in value when interest rates rise. The value of variable rate
securities, however, is less affected by changes in prevailing interest rates
because of the periodic adjustment of their coupons to a market rate. The
shorter the period between adjustments, the smaller the impact of interest rate
fluctuations on the value of these securities. The market value of tax-exempt
variable rate securities usually tends toward par (100% of face value) at
interest rate adjustment time.
In the case of the California Money Market Fund only, any variable rate
instrument with a demand feature will be deemed to have a maturity equal to
either the date on which the underlying principal amount may be recovered
through demand or the next rate adjustment date consistent with applicable
regulatory requirements.
PUT BONDS - Each Fund may invest in tax-exempt securities (including securities
with variable interest rates) which may be redeemed or sold back (put) to the
issuer of the security or a third party prior to stated maturity (put bonds).
Such securities will normally trade as if maturity is the earlier put date, even
though stated maturity is longer. For the California Bond Fund, maturity for put
bonds is deemed to be the date on which the put becomes exercisable. Generally,
maturity for put bonds for the California Money Market Fund is determined as
stated under Variable Rate Securities.
ZERO COUPON BONDS - Each Fund may invest in zero coupon bonds. A zero coupon
bond is a security that is sold at a deep discount from its face value, makes no
periodic interest payments, and is redeemed at face value when it matures. The
lump sum payment at maturity increases the price volatility of the zero coupon
bond to changes in interest rates when compared to a bond that distributes a
semiannual coupon payment. In calculating its dividend, each Fund records as
income the daily amortization of the purchase discount.
WHEN-ISSUED SECURITIES - Each Fund may invest in new issues of tax-exempt
securities offered on a when-issued basis; that is, delivery and payment take
place after the date of the commitment to purchase, normally within 45 days.
Both price and interest rate are fixed at the time of commitment. The Funds do
not earn interest on the securities until settlement, and the market value of
the securities may fluctuate between purchase and settlement. Such securities
can be sold before settlement date.
Cash or high quality liquid debt securities equal to the amount of the
when-issued commitments are segregated at the Fund's custodian bank. The
segregated securities are valued at market, and daily adjustments are made to
keep the value of the cash and segregated securities at least equal to the
amount of such commitments by the Fund. On the settlement date, the Fund will
meet its obligations from then available cash, sale of segregated securities,
sale of other securities, or sale of the when-issued securities themselves.
MUNICIPAL LEASE OBLIGATIONS - Each Fund may invest in municipal lease
obligations and certificates of participation in such obligations (collectively,
lease obligations). A
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lease obligation does not constitute a general obligation of the municipality
for which the municipality's taxing power is pledged, although the lease
obligation is ordinarily backed by the municipality's covenant to budget for the
payments due under the lease obligation.
Certain lease obligations contain "non-appropriation" clauses which provide
that the municipality has no obligation to make lease obligation payments in
future years unless money is appropriated for such purpose on a yearly basis.
Although "non-appropriation" lease obligations are secured by the leased
property, disposition of the property in the event of foreclosure might prove
difficult. In evaluating a potential investment in such a lease obligation, the
Manager will consider: (1) the credit quality of the obligor, (2) whether the
underlying property is essential to a governmental function, and (3) whether the
lease obligation contains covenants prohibiting the obligor from substituting
similar property if the obligor fails to make appropriations for the lease
obligation.
LIQUIDITY - The California Bond Fund and California Money Market Fund may invest
up to 15% and 10%, respectively, of their net assets in illiquid securities.
Lease obligations and certain put bonds that are subject to restrictions on
transfer may be determined to be liquid in accordance with the guidelines
established by the Board of Directors.
In determining the liquidity of a lease obligation, the Manager will
consider: (1) the frequency of trades and quotes for the lease obligation, (2)
the number of dealers willing to purchase or sell the lease obligation and the
number of other potential purchasers, (3) dealer undertakings to make a market
in the lease obligation, (4) the nature of the marketplace trades, including the
time needed to dispose of the lease obligation, the method of soliciting offers,
and the mechanics of transfer, (5) whether the lease obligation is of a size
that will be attractive to institutional investors, (6) whether the lease
obligation contains a non-appropriation clause and the likelihood that the
obligor will fail to make an appropriation therefor, and (7) such other factors
as the Manager may determine to be relevant to such determination.
In determining the liquidity of put bonds with restrictions on transfer,
the Manager will evaluate the credit quality of the party (the Put Provider)
issuing (or unconditionally guaranteeing performance on) the unconditional put
or demand feature of the put bond.
INVESTMENT RESTRICTIONS
The following restrictions may not be changed without shareholder approval:
(1) Neither Fund may borrow money, except for temporary or emergency purposes
in an amount not exceeding 33 1/3% of its total assets (including the
amount borrowed) less liabilities (other than borrowings).
(2) Neither Fund may invest more than 25% of its total assets in securities
issued in connection with the financing of projects with similar
characteristics, such as toll road revenue bonds, housing revenue bonds or
electric power project revenue bonds or in industrial revenue bonds which
are based, directly or indirectly, on the credit of private entities of
any one industry. However, each Fund reserves the right to invest more than
25% of its total assets in tax- exempt industrial revenue bonds.
(3) Neither Fund will invest more than 25% of its total assets in the
securities of a single issuer, and neither Fund will, with respect to 75%
of its total assets, invest more than 5% of its total assets in securities
of a single issuer.
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RISK FACTORS
Each Fund is subject to credit and market risks, which will be intensified by
concentration in California issues. Because the Funds' portfolios concentrate
their investments in California tax-exempt securities, the Funds are affected by
political, economic, regulatory or other developments which constrain the taxing
and spending authority of California issuers or otherwise affect the ability of
California issuers to pay interest or repay principal. AN INVESTMENT IN THE
CALIFORNIA MONEY MARKET FUND MAY BE RISKIER THAN AN INVESTMENT IN OTHER TYPES OF
MONEY MARKET FUNDS BECAUSE OF THIS CONCENTRATION.
In addition, because each Fund invests in securities backed by banks and
other financial institutions, changes in the credit quality of these
institutions could cause losses to a Fund and affect its share price.
Other considerations affecting the Funds' investments in California
obligations are summarized in the SAI under SPECIAL RISK CONSIDERATIONS.
PURCHASE OF SHARES
OPENING AN ACCOUNT
You may open an account and make an investment by any of the following methods.
A complete, signed application is required together with a check for each new
account.
TAX ID NUMBER
We require that each shareholder named on the account provide the Company with a
social security number or tax identification number to avoid possible tax
withholding requirements.
EFFECTIVE DATE
When you make a purchase, your purchase price will be the NAV per share next
determined after the Fund receives your request in proper form. The NAV of each
Fund is determined at the close of the regular trading session of the New York
Stock Exchange (NYSE) each day the Exchange is open. If a Fund receives your
request prior to that time, your purchase price will be the NAV per share
determined for that day. If a Fund receives your request after the NAV per share
is calculated, the purchase will be effective on the next business day.
Because of the more lengthy clearing process and the need to convert
foreign currency, a check drawn on a foreign bank will not be deemed received
for the purchase of shares until such time as the check has cleared and the
Manager has received good funds, which may take up to four to six weeks.
Furthermore, a bank charge may be assessed in the clearing process, which will
be deducted from the amount of the purchase. To avoid a delay in the
effectiveness of your purchase, the Manager suggests that you convert your
foreign check to U.S. dollars prior to investment in the Funds.
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PURCHASE OF SHARES
MINIMUM INVESTMENTS
- -------------------
Initial Purchase: $3,000
Additional Purchases: $50 - (Except transfers from brokerage accounts into
the California Money Market Fund, which are exempt
from minimum)
HOW TO PURCHASE:
- ---------------
MAIL o To open an account, send your application and check to:
USAA Investment Management Company
9800 Fredericksburg Rd., San Antonio, TX 78288
o To add to your account, send your check and the "Invest by
Mail" stub that accompanies your fund's transaction
confirmation to the Transfer Agent:
USAA Shareholder Account Services
9800 Fredericksburg Rd., San Antonio, TX 78288
o To exchange by mail, call 1-800-531-8448 for instructions.
IN PERSON o To open an account, bring your application and check to:
USAA Investment Management Company
USAA Federal Savings Bank
10750 Robert F. McDermott Freeway, San Antonio
AUTOMATICALLY o Additional purchases on a regular basis can be deducted
VIA from a bank account, paycheck, income-producing investment
ELECTRONIC or from a USAA money market account. Sign up for these
FUNDS services when opening an account or call 1-800-531-8448 to
TRANSFER add these services.
o Purchases through payroll deduction ($25 minimum each pay
period with (EFT) no initial investment) can be made by any
employee of USAA, its subsidiaries or affiliated companies.
BANK WIRE o To add to an account, instruct your bank (which may
charge a fee for the service) to wire the specified amount
to the Fund as follows:
State Street Bank and Trust Company, Boston, MA 02101
ABA#011000028
Attn: USAA [Fund Name]
USAA AC-69384998
Shareholder(s) Name(s)_________________
Shareholder(s) Account Number___________________
PHONE o If you have an existing USAA account and would like to open
1-800-531-8448 to open account or if you would like to exchange to another
USAA fund, call for instructions. The new account must have
the same registration as your existing account.
o To add to an account, intermittent (as-needed) purchases
can be deducted from your bank account through our Buy/Sell
Service. Call for instructions.
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REDEMPTION OF SHARES
You may redeem shares of a Fund by any of the following methods on any day the
NAV per share is calculated. Redemptions will be effective on the day
instructions are received in accordance with the requirements set forth below.
However, if instructions are received after the NAV per share calculation,
redemption will be effective on the next business day.
REDEMPTION PROCEEDS
Redemption proceeds are distributed within seven days after the effective date
of redemption. Payment for redemption of shares purchased by check or electronic
funds transfer will not be disbursed until the purchase check or electronic
funds transfer has cleared, which could take up to 15 days from the purchase
date. If you are considering redeeming shares soon after purchase, you should
purchase by bank wire or certified check to avoid delay.
In addition, the Company may elect to suspend the redemption of shares or
postpone the date of payment during any period that the NYSE is closed, or
trading in the markets the Company normally utilizes is restricted, or during
any period that redemption is otherwise permitted to be suspended by the SEC.
HOW TO REDEEM:
- -------------
WRITTEN, o Send your written instructions to:
FAX, OR USAA Shareholder Account Services
TELEGRAPH 9800 Fredericksburg Rd., San Antonio, TX 78288
o Send a signed fax to 1-800-292-8177, or send a telegraph to
USAA Shareholder Account Services.
Written redemption requests must include the following: (1) a letter of
instruction or stock assignment, and stock certificate (if issued), specifying
the Fund and the number of shares or dollar amount to be redeemed; (2)
signatures of all owners of the shares exactly as their names appear on the
account; (3) other supporting legal documents, if required, as in the case of
estates, trusts, guardianships, custodianships, partnerships, corporations, and
pension and profit-sharing plans; and (4) method of payment.
PHONE o Call toll free 1-800-531-8448, in San Antonio, 456-7202.
Telephone redemption is automatically established when you complete your
application. The Fund will employ reasonable procedures to confirm that
instructions communicated by telephone are genuine, and if it does not, it may
be liable for any losses due to unauthorized or fraudulent instructions.
Information is obtained prior to any discussion regarding an account including:
(1) USAA number or account number, (2) the name(s) on the account registration,
and (3) social security number or tax identification number for the account
registration. In addition, all telephone communications with a shareholder are
recorded, and confirmations of all account transactions are sent to the address
of record.
Redemption by telephone, fax, or telegraph is not available for shares
represented by stock certificates.
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METHODS OF PAYMENT:
- ------------------
BANK WIRE o Allows redemptions to be sent directly to your bank account.
Establish this service when you apply for your account, or later upon
request. Please obtain precise wiring instructions from your financial
institution. USAA Shareholder Account Services (Transfer Agent) deducts a wire
fee from the account for the redemption by wire. The fee as of the date of this
Prospectus is $10 ($25 for wires to a foreign bank) and is subject to change at
any time. The fee is paid to State Street Bank and Trust Company (SSB) and the
Transfer Agent for their services in connection with the wire redemption. Your
financial institution may also charge a fee for receiving funds by wire.
AUTOMATICALLY o Systematic (regular) or intermittent (as-needed) redemptions
VIA EFT can be credited to your bank account.
Establish any of our electronic investing services when you apply for your
account, or later upon request.
CHECK o A check payable to the registered shareholder(s) will be
REDEMPTION mailed to the address of record.
This check redemption privilege is automatically established when your
application is completed and accepted. There is a 15-day waiting period before a
check redemption can be processed following a telephone address change. Should
you wish to redeem shares within the 15 days following a telephone address
change, you may do so by providing written instructions by mail or facsimile.
CHECKWRITING o Checks can be issued for your California Money Market Fund
account.
To establish your checkwriting privilege (CWP), complete the signature card
which accompanies the application form or Shareholder Services Guide, or request
and complete the signature card separately. There is no charge for the use of
checks nor for subsequent reorders. This privilege is subject to SSB's rules and
regulations governing checking accounts. Checks must be written for an amount of
at least $250. Checks written for less than $250 will be returned. Checkwriting
may not be used to close an account because the value of the account changes
daily as dividends are accrued.
When a check is presented to the Transfer Agent for payment, a sufficient
number of full and fractional shares in the investor's account will be redeemed
to cover the amount of the check. Checks will be returned if there are
insufficient shares to cover the amount of the check. Presently, there is a $15
processing fee assessed against an account for any redemption check not honored
by a clearing or paying agent. A check paid during the month will be returned to
the shareholder by separate mail. Checkwriting fees are subject to change at any
time. The Company, the Transfer Agent and SSB each reserve the right to change
or suspend the checkwriting privilege upon 30 days' written notice to
participating shareholders. See the SAI for further information.
You may request that the Transfer Agent stop payment on a check. The
Transfer Agent will use its best efforts to execute stop payment instructions,
but does not guarantee that such efforts will be effective. A $10 charge will be
made for each stop payment requested by a shareholder.
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<PAGE>
CONDITIONS OF PURCHASE AND REDEMPTION
NONPAYMENT
If any order to purchase shares is cancelled due to nonpayment or if the Company
does not receive good funds either by check or electronic funds transfer, the
Transfer Agent will treat the cancellation as a redemption of shares purchased,
and you will be responsible for any resulting loss incurred by the Fund or the
Manager. If you are a shareholder, the Transfer Agent can redeem shares from any
of your account(s) as reimbursement for all losses. In addition, you may be
prohibited or restricted from making future purchases in any of the USAA Family
of Funds. A $15 fee is charged for all returned items, including checks and
electronic funds transfers.
TRANSFER OF SHARES
You may transfer Fund shares to another person by sending written instructions
to the Transfer Agent. The account must be clearly identified, and you must
include the number of shares to be transferred, the signatures of all registered
owners, and all stock certificates, if any, which are the subject of transfer.
You also need to send written instructions signed by all registered owners and
supporting documents to change an account registration due to events such as
divorce, marriage, or death. If a new account needs to be established, you must
complete and return an application to the Transfer Agent.
ACCOUNT BALANCE
Beginning in September 1998, and occurring each September thereafter, the
Transfer Agent will assess a small balance account fee of $12 to each
shareholder account with a balance, at the time of assessment, of less than
$2,000. The fee will be used to reduce total transfer agency fees paid by each
Fund to the Transfer Agent. Accounts exempt from the fee include: (1) any
account regularly purchasing additional shares each month through an automatic
investment plan; (2) any account registered under the Uniform Gifts/Transfers to
Minors Act (UGMA or UTMA); (3) all (non IRA) money market fund accounts; (4) any
account whose registered owner has an aggregate balance of $50,000 or more
invested in USAA mutual funds; and (5) all IRA accounts (for the first year the
account is open).
COMPANY RIGHTS The Company reserves the right to:
(1) reject purchase or exchange orders when in the best interest of the
Company;
(2) limit or discontinue the offering of shares of any portfolio of the Company
without notice to the shareholders;
(3) impose a redemption charge of up to 1% of the net asset value of shares
redeemed if circumstances indicate a charge is necessary for the protection
of remaining investors (for example, if excessive market-timing share
activity unfairly burdens long-term investors); provided, however, this 1%
charge will not be imposed upon shareholders unless authorized by the Board
of Directors and the required notice has been given to shareholders;
(4) require a signature guarantee for purchases, redemptions, or changes in
account information in those instances where the appropriateness of a
signature authorization is in question. The section ADDITIONAL INFORMATION
REGARDING REDEMPTION OF SHARES in the SAI contains information on
acceptable guarantors;
(5) redeem an account with a balance of less than 50 full shares of either
Fund, subject to certain limitations described in ADDITIONAL INFORMATION
REGARDING REDEMPTION OF SHARES in the SAI.
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EXCHANGES
EXCHANGE PRIVILEGE
The Exchange Privilege is automatically established when you complete your
application. You may exchange shares among Funds in the USAA Family of Funds,
provided you do not hold these shares in stock certificate form and that the
shares to be acquired are offered in your state of residence. Only California
residents may exchange into a California Fund. Exchange redemptions and
purchases will be processed simultaneously at the share prices next determined
after the exchange order is received. For federal income tax purposes, an
exchange between Funds is a taxable event. Accordingly, when exchanging shares,
you may realize a capital gain or loss.
The Funds have undertaken certain procedures regarding telephone
transactions. See REDEMPTION OF SHARES - PHONE.
EXCHANGE LIMITATIONS, EXCESSIVE TRADING
To minimize Fund costs and to protect the Funds and their shareholders from
unfair expense burdens, the Funds restrict excessive exchanges. Exchanges out of
any Fund in the USAA Family of Funds are limited for each account to six per
calendar year except that there is no limitation on exchanges out of the Tax
Exempt Short-Term Fund, Short-Term Bond Fund, or any of the money market funds
in the USAA Family of Funds.
OTHER SERVICES
INVESTMENT PLANS
AUTOMATIC INVESTMENT PLANS - You may establish an automatic investment plan by
completing the appropriate forms, if any. At the time you sign up for any of the
following investment plans that utilize the electronic funds transfer service,
you will choose the day of the month (the effective date) on which you would
like to regularly purchase shares. When this day falls on a weekend or holiday,
the electronic transfer will take place on the last business day before the
effective date. Call the Manager to obtain instructions. More information about
these preauthorized plans is contained in the SAI.
o INVESTRONIC(R) - The regular purchase of additional shares through electronic
funds transfer from a checking or savings account. You may invest as little as
$50 per month.
o DIRECT PURCHASE SERVICE - The periodic purchase of shares through electronic
funds transfer from an employer (including government allotments), an
income-producing investment, or an account with a participating financial
institution.
o AUTOMATIC PURCHASE PLAN - The periodic transfer of funds from a USAA money
market fund to purchase shares in another non-money market USAA mutual fund.
o BUY/SELL SERVICE - The intermittent purchase or redemption of shares through
electronic funds transfer to or from a checking or savings account.
o SYSTEMATIC WITHDRAWAL PLAN - The periodic redemption of shares from one of
your accounts permitting you to receive a fixed amount of money monthly or
quarterly.
o DIRECTED DIVIDENDS - If you own shares in more than one of the Funds in the
USAA Family of Funds, you may direct that dividends and/or capital gain
distributions earned in one fund be used to purchase shares automatically in
another fund.
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SHAREHOLDER STATEMENTS AND REPORTS
You will receive a confirmation after each transaction in your California Bond
Fund account except:
(1) a reinvested dividend;
(2) a payment you make under the InvesTronic(R), Direct Purchase Service,
Automatic Purchase Plan, or Directed Dividends investment plans; or
(3) a redemption you make under the Systematic Withdrawal Plan.
If you own shares in the California Money Market Fund, you will receive a
confirmation for purchases or redemptions by check and exchanges. If that money
market fund account had activity other than reinvested dividends, such as wire
purchases or redemptions or purchases under the InvesTronic(R), Direct Purchase
Service, Automatic Purchase Plan or Directed Dividends investment plans, you
will receive a monthly statement that will reflect quarter-to-date account
activity.
At the end of each quarter, you will receive a consolidated statement for
all of your mutual fund accounts, regardless of account activity. The fourth
quarter consolidated statement will reflect all account activity for the prior
tax year. There will be a $10 fee charged for copies of historical statements
for other than the prior tax year for any one account. You will receive a Fund's
financial statements with a summary of its investments and performance at least
semiannually.
In an effort to reduce expenses and respond to shareholders' requests to
reduce mail, the Company intends to consolidate mailings of Annual and
Semiannual Reports to households having multiple accounts with the same address
of record. One copy of each report will be furnished to that address. You may
request additional reports by notifying the Company.
TELEPHONE ASSISTANCE
Call our telephone assistance numbers for specific forms, a copy of the SAI, the
most recent Annual Report and/or Semiannual Report, or if you have any questions
concerning any of the services offered.
SHARE PRICE CALCULATION
The price at which shares of the Funds are purchased and redeemed by
shareholders is equal to the NAV per share determined on the effective date of
the purchase or redemption.
WHEN
The NAV per share for each Fund is calculated at the close of the regular
trading session of the NYSE, which is usually 4:00 p.m. Eastern Time. You may
buy and sell Fund shares at the NAV per share without a sales charge.
HOW
The NAV per share is calculated by adding the value of all securities and other
assets in a Fund, deducting liabilities, and dividing by the number of shares
outstanding. Securities of the California Bond Fund are valued each business day
at their current market value as determined by a pricing service approved by the
Board of Directors. Securities which cannot be valued by the pricing service,
and all other assets, are valued in good faith at fair value using methods
determined by the Manager under the general supervision of the Board of
Directors. In addition, securities purchased with maturities of 60 days or less
and all securities of the California Money Market Fund are stated at amortized
cost.
For additional information, see VALUATION OF SECURITIES in the SAI.
21
<PAGE>
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
Net investment income of each Fund is accrued daily and distributed to
shareholders on the last business day of each month. Net capital gains, if any,
generally will be distributed at least annually. The Funds intend to make such
additional distributions as may be necessary to avoid the imposition of any
federal excise tax.
All shares purchased will begin accruing dividends on the day following the
effective date of the purchase and will receive dividends through the effective
date of redemption.
All income dividends and capital gain distributions are automatically
reinvested, unless the shareholder specifies otherwise. The share price will be
the net asset value of the Fund shares computed on the ex-dividend date. Any
capital gain distribution paid by the California Bond Fund will reduce the NAV
per share by the amount of the distribution. An investor should consider
carefully the effects of purchasing shares of the California Bond Fund shortly
before any capital gain distribution. Although in effect a return of capital,
these distributions are subject to taxes. If a shareholder becomes a resident of
a state other than California, a check for proceeds of income dividends will be
mailed to such shareholder monthly, and a check for any capital gain
distribution will be mailed after the distribution is paid.
Any dividend or distribution payment returned to the Manager as not
deliverable will be invested in the shareholder's Fund account at the
then-current NAV per share. If any check for the payment of dividends or
distributions is not cashed within six months from the date on the check, it
becomes void. The amount of the check will then be invested in the shareholder's
Fund account at the then-current NAV per share.
FEDERAL TAXES
The exemption of interest income for federal income tax purposes does not
necessarily result in exemption under the income or other tax laws of any state
or local taxing authority. The following discussion relates only to generally
applicable federal income tax provisions in effect as of the date of this
Prospectus. Therefore, shareholders are urged to consult their own tax advisers
about the status of distributions from a Fund in their own states and
localities.
FUND - Each Fund intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the Code). By
complying with the applicable provisions of the Code, neither Fund will be
subject to federal income tax on its net investment income and net capital gains
(capital gains in excess of capital losses) distributed to shareholders.
SHAREHOLDER - Dividends of net tax-exempt interest income paid by a Fund are
excluded from a shareholder's gross income for federal income tax purposes.
Dividends from taxable net investment income and distributions of net short-term
capital gains are taxable to shareholders as ordinary income, whether received
in cash or reinvested in additional shares. However, it is expected that any
taxable net investment income will be minimal in relation to the tax-exempt
interest generated by a Fund.
Distributions of net long-term capital gains are taxable as long-term
capital gains whether received in cash or reinvested in additional shares, and
regardless of the length of time the investor has held the shares of a Fund.
Redemptions, including exchanges, are subject to income tax, based on the
difference between the cost of shares when purchased and the price received upon
redemption or exchange.
Tax-exempt interest from private activity bonds (for example, industrial
22
<PAGE>
development revenue bonds) issued after August 7, 1986, although otherwise
exempt from federal tax, is treated as a tax preference item for purposes of the
alternative minimum tax. For corporations, all tax-exempt interest will be
considered in calculating the alternative minimum tax as part of the adjusted
current earnings.
WITHHOLDING - Each Fund is required by federal law to withhold and remit to the
U.S. Treasury a portion of the income dividends and capital gain distributions
and proceeds of redemptions paid to any non-corporate shareholder who fails to
furnish the Fund with a correct tax identification number, who underreports
dividend or interest income, or who fails to certify that he is not subject to
withholding. To avoid this withholding requirement, you must certify on your
application, or on a separate Form W-9 supplied by the Transfer Agent, that your
tax identification number is correct and that you are not currently subject to
backup withholding.
REPORTING - Each Fund will report annually to its shareholders the federal tax
status of dividends and distributions paid or declared by each Fund during the
preceding calendar year, including the portion of the dividends constituting
interest on private activity bonds, and the percentage and source, on a
state-by-state basis, of interest income earned on tax-exempt securities held by
the Fund during the preceding year.
CALIFORNIA TAXATION
California law relating to the taxation of regulated investment companies was
generally conformed to federal law effective January 1, 1993. Any portion of the
dividends paid by the Funds and derived from interest on obligations that pay
interest (when such obligations are held by an individual) which is excludable
from California personal income under California law including obligations of
certain territories and possessions of the United States such as Puerto Rico,
the Virgin Islands, and Guam will be exempt from California personal income tax
(although not from the California franchise tax). To the extent a portion of the
dividends are derived from interest on debt obligations other than those
described directly above, such portion will be subject to the California
personal and corporate income tax even though it may be excludable from gross
income for federal income tax purposes. In addition, distributions of short-term
capital gains realized by the Funds will be taxable to the shareholders as
ordinary income. Distributions of long-term capital gains will be taxable as
such to the shareholders regardless of how long they have held their shares. If
shares of the Funds that are sold at a loss have been held six months or less,
the loss will be disallowed to the extent of any exempt-interest dividends
received on such shares.
With respect to non-corporate shareholders, California does not treat
tax-exempt interest as a tax preference item for purposes of its alternative
minimum tax. To the extent a corporate shareholder receives dividends which are
exempt from California taxation, a portion of such dividends may be subject to
the alternative minimum tax. Interest on indebtedness incurred to purchase or
carry shares of an investment company paying exempt-interest dividends, such as
the Fund, will not be deductible by the shareholder for California personal
income tax purposes.
The foregoing is only a summary of some of the important California
personal income tax considerations generally affecting the Funds and their
shareholders. This discussion is not intended as a substitute for careful
planning. Potential investors in the Funds should consult their tax advisers
with specific reference to their own tax situations.
23
<PAGE>
MANAGEMENT OF THE COMPANY
The business affairs of the Company are subject to the supervision of the Board
of Directors.
The Manager, USAA Investment Management Company (IMCO), was organized in
May 1970 and is an affiliate of United Services Automobile Association (USAA), a
large diversified financial services institution. As of the date of this
Prospectus, the Manager had approximately $35 billion in total assets under
management. The Manager's mailing address is 9800 Fredericksburg Rd., San
Antonio, TX 78288.
Officers and employees of the Manager are permitted to engage in personal
securities transactions subject to restrictions and procedures set forth in the
Joint Code of Ethics adopted by the Company and the Manager. Such restrictions
and procedures include substantially all of the recommendations of the Advisory
Group of the Investment Company Institute and comply with SEC rules and
regulations.
ADVISORY AGREEMENT
The Manager serves as the manager and investment adviser of the Company,
providing services under an Advisory Agreement. Under the Advisory Agreement,
the Manager is responsible for the management of the business affairs,
investment portfolios, and placement of brokerage orders, subject to the
authority of and supervision by the Board of Directors.
For its services under the Advisory Agreement, each Fund pays the Manager
an annual fee which is computed as a percentage of the aggregate ANA of both
Funds combined. The fee is accrued daily, paid monthly, and allocated between
the Funds based on the relative net assets of each. The fee is computed at .50%
of the first $50,000,000 ANA, .40% of that portion over $50,000,000 and not over
$100,000,000 ANA, and .30% of that portion over $100,000,000 ANA. For the fiscal
year ended March 31, 1997, the fees paid to the Manager were .32% of ANA for the
California Bond Fund and .32% of ANA for the California Money Market Fund.
OPERATING EXPENSES
For the fiscal year ended March 31, 1997, the total operating expenses for each
Fund as a percentage of that Fund's ANA equaled .41% for the California Bond
Fund and .45% for the California Money Market Fund.
PORTFOLIO MANAGERS
The following individuals are primarily responsible for managing the Funds.
CALIFORNIA BOND FUND
Robert R. Pariseau, Assistant Vice President of Fixed Income Investments since
June 1995, has managed the Fund since May 1995. He has 13 years investment
management experience working for IMCO, where he has held various positions in
Fixed Income and Equity Investments. Mr. Pariseau earned the Chartered Financial
Analyst (CFA) designation in 1987 and is a member of the Association for
Investment Management and Research (AIMR), San Antonio Financial Analysts
Society, Inc. (SAFAS), and the National Federation of Municipal Analysts (NFMA).
He holds an MBA from Lindenwood College and a BS from the U.S. Naval Academy.
CALIFORNIA MONEY MARKET FUND
John C. Bonnell, Executive Director of Money Market Funds since May 1996, has
managed the Fund since May 1996. He has eight years investment management
experience working for IMCO, where he has held various positions in Fixed Income
Investments. Mr. Bonnell earned the CFA designation in 1994 and is a member of
the AIMR, the SAFAS, the NFMA and the Southern Municipal Finance Society. He
holds an MBA from St. Mary's University and a BBA from the University of Texas
at San Antonio.
24
<PAGE>
DESCRIPTION OF SHARES
The Company is an open-end management investment company incorporated under the
laws of the State of Maryland on November 16, 1981. The Company is authorized to
issue shares in separate portfolios. Ten such portfolios have been established,
two of which are described in this Prospectus. Each of the two Funds is
classified as diversified. Under the Company's charter, the Board of Directors
is authorized to create new portfolios in addition to those already existing
without the approval of the shareholders of the Company.
Under the provisions of the Bylaws of the Company, no annual meeting of
shareholders is required. Ordinarily, no shareholder meeting will be held unless
required by the 1940 Act. The Directors may fill vacancies on the Board or
appoint new Directors provided that immediately after such action at least
two-thirds of the Directors have been elected by shareholders.
Shareholders are entitled to one vote per share (with proportionate voting
for fractional shares) irrespective of the relative net asset value of the
shares. For matters affecting an individual portfolio, a separate vote of the
shareholders of that portfolio is required.
SERVICE PROVIDERS
UNDERWRITER/ USAA Investment Management Company
DISTRIBUTOR 9800 Fredericksburg Rd., San Antonio, Texas 78288.
TRANSFER USAA Shareholder Account Services
AGENT 9800 Fredericksburg Rd., San Antonio, Texas 78288.
CUSTODIAN State Street Bank and Trust Company
P.O. Box 1713, Boston, Massachusetts 02105.
LEGAL Goodwin, Procter & Hoar LLP
COUNSEL Exchange Place, Boston, Massachusetts 02109.
INDEPENDENT KPMG Peat Marwick LLP
AUDITORS 112 East Pecan, Suite 2400, San Antonio, Texas 78205.
TELEPHONE ASSISTANCE
(Call toll free - Central Time)
Monday-Friday 8:00 a.m. to 8:00 p.m.
Saturday 8:30 a.m. to 5:00 p.m.
For further information on mutual funds:
1-800-531-8181
In San Antonio 456-7211
For account servicing, exchanges or redemptions:
1-800-531-8448
In San Antonio 456-7202
RECORDED 24 HOUR SERVICE
MUTUAL FUND PRICE QUOTES
(From any phone)
1-800-531-8066
In San Antonio 498-8066
MUTUAL FUND TOUCHLINE(R)
(From Touchtone phones only)
For account balance, last transaction or fund prices:
1-800-531-8777
In San Antonio 498-8777
25
<PAGE>
Part A
Prospectus for the
New York Bond and
New York Money Market Funds
<PAGE>
USAA NEW YORK FUNDS
AUGUST 1, 1997 PROSPECTUS
USAA NEW YORK BOND FUND and USAA NEW YORK MONEY MARKET FUND (collectively, the
Funds or the New York Funds) are two of ten no-load mutual funds offered by USAA
Tax Exempt Fund, Inc. (the Company). The Funds are managed by USAA Investment
Management Company (the Manager).
WHAT ARE THE INVESTMENT OBJECTIVES AND POLICIES?
The Funds have a common objective of providing New York investors with a
high level of current interest income that is exempt from federal income taxes
and New York State and New York City personal income taxes. The New York Money
Market Fund has a further objective of preserving capital and maintaining
liquidity. Each Fund has separate investment policies to achieve its objective.
The NEW YORK BOND FUND invests primarily in long-term investment grade New
York tax-exempt securities. The Fund's average portfolio maturity is not
restricted, but is expected to be greater than 10 years. Page 11.
The NEW YORK MONEY MARKET FUND invests in high quality New York tax-exempt
securities with maturities of 397 days or less. The Manager will maintain a
dollar-weighted average portfolio maturity of no more than 90 days. The Fund
will endeavor to maintain a constant net asset value per share of $1.00. Page
11.
HOW DO YOU BUY?
Fund shares are sold on a continuous basis at the net asset value per share
without a sales charge. Make your initial investment directly with the Manager
by mail, in person, or in certain instances, by telephone. Page 16.
HOW DO YOU SELL?
You may redeem Fund shares by mail, telephone, fax, or telegraph on any day that
the net asset value is calculated. Page 18.
Shares of the New York Funds are authorized for sale only to residents of
the State of New York. The delivery of this Prospectus shall not constitute an
offer in any state in which shares of the New York Funds may not lawfully be
made.
SHARES OF THE USAA NEW YORK FUNDS ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF,
OR GUARANTEED BY, THE USAA FEDERAL SAVINGS BANK, ARE NOT INSURED BY THE FDIC OR
ANY OTHER GOVERNMENT AGENCY, AND ARE SUBJECT TO INVESTMENT RISKS, INCLUDING
POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED.
This Prospectus, which should be read and retained for future reference,
provides information regarding the Company and the New York Funds that you
should know before investing.
If you would like more information about the Funds, you may call
1-800-531-8181 to request a free copy of the most recent financial report and/or
the Funds' Statement of Additional Information (SAI), dated August 1, 1997. The
SAI has been filed with the Securities and Exchange Commission (SEC) and is
incorporated by reference into this Prospectus (meaning it is legally a part of
the Prospectus).
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
AN INVESTMENT IN THE NEW YORK MONEY MARKET FUND IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT AND THERE CAN BE NO ASSURANCE THAT THE FUND
WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE. THIS FUND
MAY INVEST A SIGNIFICANT PERCENTAGE OF ITS ASSETS IN A SINGLE ISSUER, AND
THEREFORE AN INVESTMENT IN THE FUND MAY BE RISKIER THAN AN INVESTMENT IN OTHER
TYPES OF MONEY MARKET FUNDS.
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
SUMMARY DATA
Fees and Expenses.............................................. 3
Financial Highlights........................................... 4
Performance Information........................................ 8
USING MUTUAL FUNDS
USAA Family of No-Load Mutual Funds............................ 9
Using Mutual Funds in an Investment Program.................... 10
INVESTMENT PORTFOLIO INFORMATION
Investment Objectives and Policies............................. 11
New York Bond Fund......................................... 11
New York Money Market Fund................................. 11
Other Investment Information................................... 12
SHAREHOLDER INFORMATION
Purchase of Shares............................................. 16
Redemption of Shares........................................... 18
Conditions of Purchase and Redemption.......................... 20
Exchanges...................................................... 21
Other Services................................................. 21
Share Price Calculation........................................ 22
Dividends, Distributions and Taxes............................. 23
Management of the Company...................................... 25
Description of Shares.......................................... 26
Service Providers.............................................. 27
Telephone Assistance Numbers................................... 27
- --------------------------------------------------------------------------------
2
<PAGE>
FEES AND EXPENSES
The following summary, which is based on actual expenses and average net assets
(ANA) of each Fund for the year ended March 31, 1997, is provided to assist you
in understanding the expenses you will bear directly or indirectly as a Fund
investor.
SHAREHOLDER TRANSACTION EXPENSES (APPLICABLE TO EACH FUND)
- --------------------------------------------------------------------------------
Sales Load Imposed on Purchases.......................... None
Sales Load Imposed on Reinvested Dividends............... None
Deferred Sales Load...................................... None
Redemption Fee*.......................................... None
Exchange Fee............................................. None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE OF ANA)
- --------------------------------------------------------------------------------
NEW YORK NEW YORK
BOND MONEY MARKET
FUND FUND
Management Fees, net of reimbursements................. .29% .26%
12b-1 Fees............................................. None None
Other Expenses, net of reimbursements
Transfer Agent Fees**............................. .08% .07%
Custodian Fees.................................... .07% .09%
All Other Expenses................................ .06% .08%
--- ---
Total Other Expenses................................... .21% .24%
--- ---
Total Fund Operating Expenses, net of reimbursements... .50% .50%
=== ===
- ---------------
* A shareholder who requests delivery of redemption proceeds by wire transfer
will be subject to a $10 fee. See REDEMPTION OF SHARES - BANK WIRE.
** The Funds pay USAA Shareholder Account Services an annual fixed fee per
account for its services. See TRANSFER AGENT in the SAI, page 21.
During the year, the Manager voluntarily limited each Fund's annual
expenses to .50% of its ANA and reimbursed the Funds for all expenses in excess
of the limitation. The Management Fees, Other Expenses, and Total Fund Operating
Expenses reflect all such expense reimbursements by the Manager. Absent such
reimbursements, the amount of the Management Fees, Other Expenses, and Total
Fund Operating Expenses as a percentage of ANA for each of the Funds would have
been as follows: New York Bond Fund, .45%, .21%, and .66%; and New York Money
Market Fund, .45%, .24%, and .69%. The Manager has voluntarily agreed to
continue to limit each Fund's annual expenses until August 1, 1998, to .50% of
its ANA and will reimburse the Funds for all expenses in excess of the
limitation.
EXAMPLE OF EFFECT OF FUND EXPENSES
- --------------------------------------------------------------------------------
You would pay the following expenses on a $1,000 investment in one of the Funds
below, assuming (1) 5% annual return and (2) redemption at the end of the
periods shown:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------- ------- ------- --------
New York Bond Fund.................... $5 $16 $28 $63
New York Money Market Fund............ $5 $16 $28 $63
THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The following per share operating performance for a share outstanding throughout
each period in the seven-year period ended March 31, 1997, has been audited by
KPMG Peat Marwick LLP. This table should be read in conjunction with the Funds'
financial statements for the year ended March 31, 1997, and the auditors'
reports thereon, that appear in the Funds' Annual Report. Further performance
information is contained in the Annual Report and is available upon request
without charge.
NEW YORK BOND FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 10.95 $ 10.77 $ 10.83 $ 11.62 $ 10.94
Net investment income .64 .63 .62 .62 .65
Net realized and
unrealized gain (loss) (.01) .18 (.06) (.50) .80
Distributions from net
investment income (.64) (.63) (.62) (.62) (.65)
Distributions of realized
capital gains - - - (.29) (.12)
------- -------- ------- ------- -------
Net asset value at
end of period $ 10.94 $ 10.95 $ 10.77 $ 10.83 $ 11.62
======= ======= ======= ======= =======
Total return (%)** 5.89 7.67 5.42 .68 13.74
Net assets at end of
period (000) $58,035 $53,987 $50,507 $56,912 $48,925
Ratio of expenses to
average net assets (%) .50(a) .50(a) .50(a) .50(a) .50(a)
Ratio of net investment
income to average net
assets (%) 5.83(a) 5.75(a) 5.83(a) 5.24(a) 5.79(a)
Portfolio turnover (%) 41.42 74.80 74.74 124.40 107.12
</TABLE>
- --------------
* Fund commenced operations October 15, 1990.
** Assumes reinvestment of all dividend income and capital gains distributions
during the period.
(a) Based on actual expenses for the period, after giving effect to
reimbursements of expenses by the Manager. Absent such reimbursements,
the Fund's ratios would have been:
YEAR ENDED MARCH 31,
--------------------
1997 1996 1995 1994 1993 1992 1991*
---- ---- ---- ---- ---- ---- ----
Ratio of expenses to
average net assets (%) .66 .69 .71 .69 .80 1.07 1.73(b)
Ratio of net investment
income to average net
assets (%) 5.67 5.56 5.62 5.05 5.49 5.75 5.50(b)
(b) Annualized. The ratio is not necessarily indicative of 12 months of
operations.
4
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
NEW YORK BOND FUND:
YEAR ENDED MARCH 31,
--------------------
1992 1991*
---- -----
Net asset value at
beginning of period $ 10.50 $ 10.00
Net investment income .69 .32
Net realized and
unrealized gain (loss) .44 .50
Distributions from net
investment income (.69) (.32)
Distributions of realized
capital gains - -
-------- -------
Net asset value at
end of period $ 10.94 $ 10.50
======= =======
Total return (%)** 11.00 8.22
Net assets at end of
period (000) $28,022 $11,635
Ratio of expenses to
average net assets (%) .50(a) .50(a)(b)
Ratio of net investment
income to average net
assets (%) 6.32(a) 6.73(a)(b)
Portfolio turnover (%) 110.77 128.04
5
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
NEW YORK MONEY MARKET FUND:
YEAR ENDED MARCH 31,
---------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .03 .04 .03 .02 .03
Distributions from net
investment income (.03) (.04) (.03) (.02) (.03)
------- -------- ------- ------- -------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======= ======= ======= ======= =======
Total return (%)** 3.16 3.56 2.76 2.00 2.51
Net assets at end of
period (000) $49,996 $45,554 $27,525 $24,513 $19,428
Ratio of expenses to
average net assets (%) .50(a) .50(a) .50(a) .50(a) .50(a)
Ratio of net investment
income to average net
assets (%) 3.12(a) 3.47(a) 2.74(a) 1.98(a) 2.46(a)
- --------------
</TABLE>
* Fund commenced operations October 15, 1990.
** Assumes reinvestment of all dividend income distributions during the period.
(a) Based on actual expenses for the period, after giving effect to
reimbursements of expenses by the Manager. Absent such reimbursements, the
Fund's ratios would have been:
YEAR ENDED MARCH 31,
--------------------
1997 1996 1995 1994 1993 1992 1991*
---- ---- ---- ---- ---- ---- ----
Ratio of expenses to
average net assets (%) .69 .78 .85 .98 1.06 1.26 1.65(b)
Ratio of net investment
income to average net
assets (%) 2.93 3.19 2.39 1.50 1.90 2.85 3.60(b)
(b) Annualized. The ratio is not necessarily indicative of 12 months of
operations.
6
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
NEW YORK MONEY MARKET FUND:
YEAR ENDED MARCH 31,
--------------------
1992 1991*
---- -----
Net asset value at
beginning of period $ 1.00 $ 1.00
Net investment income .04 .02
Distributions from net
investment income (.04) (.02)
-------- --------
Net asset value at
end of period $ 1.00 $ 1.00
======= =======
Total return (%)** 3.72 2.23
Net assets at end of
period (000) $16,788 $12,684
Ratio of expenses to
average net assets (%) .50(a) .50(a)(b)
Ratio of net investment
income to average net
assets (%) 3.61(a) 4.75(a)(b)
7
<PAGE>
PERFORMANCE INFORMATION
Performance information should be considered in light of each Fund's investment
objective and policies and market conditions during the time periods for which
it is reported. Historical performance should not be considered as
representative of the future performance of either Fund.
The Company may quote a Fund's total return or yield in advertisements and
reports to shareholders or prospective investors. A Fund's performance may also
be compared to that of other mutual funds with similar investment objectives and
relevant indexes that are referenced in APPENDIX B to the SAI. Standard total
return and yield results reported by the Funds do not take into account
recurring and nonrecurring charges for optional services which only certain
shareholders elect and which involve nominal fees, such as the $10 fee for a
delivery of redemption proceeds by wire transfer.
Further information concerning yield and total return is included in the
SAI.
TOTAL RETURN - NEW YORK BOND FUND. The Fund's average annual total return is
computed by determining the average annual compounded rate of return for a
specified period which, when applied to a hypothetical $1,000 investment in the
Fund at the beginning of the period, would produce the redeemable value of that
investment at the end of the period, assuming reinvestment of all dividends and
distributions during the period.
YIELD - NEW YORK BOND FUND. The Fund may advertise performance in terms of a 30-
day yield quotation. The yield quotation is computed by dividing the net
investment income per share earned during the period by the offering price per
share on the last day of the period. This income is then annualized. For
purposes of the yield calculation, interest income is computed based on the
yield to maturity of each debt obligation in a Fund's portfolio and all
recurring charges are recognized.
YIELD - NEW YORK MONEY MARKET FUND. The Fund may advertise its yield and
effective yield. The yield of the Fund refers to the income generated by an
investment in the Fund over a seven-day period (which period will be stated in
the advertisement). This income is then annualized, that is, the amount of
income generated by the investment during the week is assumed to be generated
each week over a 52-week period and is shown as a percentage of the investment.
The effective yield is calculated similarly but, when annualized, the income
earned by an investment in the Fund is assumed to be reinvested. The effective
yield will be slightly higher than the yield because of the compounding effect
of this assumed reinvestment.
TAX EQUIVALENT YIELD - The Funds may also utilize tax equivalent yields with
adjustments for assumed income tax rates. See APPENDIX C - TAXABLE EQUIVALENT
YIELD TABLES in the SAI for illustrations of this
yield.
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USAA FAMILY OF NO-LOAD MUTUAL FUNDS
The USAA Family of No-Load Mutual Funds includes a variety of Funds, each with
different objectives and policies. In combination, these Funds are designed to
provide investors with the opportunity to formulate their own investment
program. You may exchange any shares you hold in any one USAA Fund for shares in
any other USAA Fund. For more complete information about the Funds in the USAA
Family of Funds, including charges and expenses, call the Manager for a
Prospectus. Read it carefully before you invest or send money.
USAA TAX EXEMPT FUND, INC.
Long-Term Fund
Intermediate-Term Fund
Short-Term Fund
Tax Exempt Money Market Fund
California Bond Fund*
California Money Market Fund*
New York Bond Fund*
New York Money Market Fund*
Virginia Bond Fund*
Virginia Money Market Fund*
USAA MUTUAL FUND, INC.
Aggressive Growth Fund
Science & Technology Fund
Growth Fund
First Start Growth Fund
S&P 500 Index Fund**
Growth & Income Fund
Income Stock Fund
Income Fund
Short-Term Bond Fund
Money Market Fund
USAA INVESTMENT TRUST
Income Strategy Fund
Growth and Tax Strategy Fund
Balanced Strategy Fund
Cornerstone Strategy Fund
Growth Strategy Fund
Emerging Markets Fund
Gold Fund
International Fund
World Growth Fund
GNMA Trust
Treasury Money Market Trust
USAA STATE TAX-FREE TRUST
Florida Tax-Free Income Fund*
Florida Tax-Free Money Market Fund*
Texas Tax-Free Income Fund*
Texas Tax-Free Money Market Fund*
* Available for sale only to residents of these specific states.
** S&P is a trademark of The McGraw-Hill Companies, Inc., and has been
licensed for use. The Product is not sponsored, sold or promoted by
Standard & Poor's and Standard & Poor's makes no representation regarding
the advisability of investing in the Product.
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USING MUTUAL FUNDS IN AN INVESTMENT PROGRAM
I. THE IDEA BEHIND MUTUAL FUNDS
Mutual funds provide small investors some of the advantages enjoyed by wealthy
investors. A relatively small investment can buy part of a widely diversified
portfolio. That portfolio is managed by investment professionals, relieving the
shareholder of the need to make individual stock or bond selections. The
investor also enjoys conveniences, such as daily pricing, liquidity, and in the
case of the USAA Family of Funds, no sales charge. The portfolio, because of its
size, has lower transaction costs on its trades than most individuals would
have. As a result each shareholder owns an investment that in earlier times
would have been available only to very wealthy people.
II. USING FUNDS IN AN INVESTMENT PROGRAM
In choosing a mutual fund as an investment vehicle, the shareholder is foregoing
some investment decisions, but must still make others. The decisions foregone
are those involved with choosing individual securities. The Fund Manager will
perform that function. In addition, the Manager will arrange for the safekeeping
of securities, auditing the annual financial statements, and daily valuation of
the Fund, as well as other functions.
The shareholder, however, retains at least part of the responsibility for
an equally important decision. This decision includes determining a portfolio of
mutual funds that balances the investor's investment goals with his or her
tolerance for risk. It is likely that this decision may involve the use of more
than one fund of the USAA Family of Funds.
For example, assume a shareholder wishes to pursue the higher yields
usually available in the long-term bond market, but is also concerned about the
possible price swings of the long-term bonds. He or she could divide investments
between the New York Bond Fund and the New York Money Market Fund. This would
create a portfolio with a higher yield than that of the money market and less
volatility than that of the long-term market. This is just one example of how an
individual could combine funds to create a portfolio tailored to his or her own
risk and reward goals.
III. USAA'S FAMILY OF FUNDS
The Manager offers investors another alternative in its asset strategy funds,
the Income Strategy, Growth and Tax Strategy, Balanced Strategy, Cornerstone
Strategy and Growth Strategy Funds. These unique mutual funds provide a
professionally managed diversified investment portfolio within a mutual fund.
These Funds are designed for the shareholder who prefers to delegate the asset
allocation process to an investment manager. The Funds are structured to achieve
diversification across a number of investment categories.
Whether you prefer to create your own mix of mutual funds or use an asset
strategy fund, the USAA Family of Funds provides a broad range of choices
covering just about any investor's investment objectives. Our sales
representatives stand ready to inform you of your choices and to help you craft
a portfolio which meets your needs.
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INVESTMENT OBJECTIVES AND POLICIES
INVESTMENT OBJECTIVES
The Funds have a common investment objective of providing New York investors
with a high level of current interest income that is exempt from federal income
taxes and New York State and New York City personal income taxes. The New York
Money Market Fund has a further objective of preserving capital and maintaining
liquidity.
INVESTMENT POLICIES
The Manager will pursue this common objective by investing each Fund's assets in
debt obligations issued by New York State, its political subdivisions,
municipalities and public authorities and by other governmental entities if, in
the opinion of counsel, the interest from such obligations is excluded from
gross income for federal income tax purposes and is exempt from New York State
and New York City personal income taxes. It is a fundamental policy of each Fund
that during normal market conditions at least 80% of the Fund's net assets will
consist of New York tax-exempt securities and at least 80% of the Fund's annual
income will be exempt from federal and New York State and New York City personal
income taxes and excluded from the calculation of federal alternative minimum
taxes for individual taxpayers.
NEW YORK BOND FUND. Under normal market conditions, the Manager will invest the
assets of the Fund so that at least 50% of the total market value of the
tax-exempt securities is rated within the three highest long-term rating
categories (at least A) by Moody's Investors Service, Inc. (Moody's), Standard &
Poor's Ratings Group (S&P), or Fitch Investors Service, Inc. (Fitch), in the
highest short-term rating category by Moody's, S&P, or Fitch, or, if a security
is not rated by those rating agencies, it must be of equivalent investment
quality as determined by the Manager. In no event will a security be purchased
for the Fund unless it is rated at least investment grade; i.e., rated by
Moody's, S&P, or Fitch at least in the fourth highest rating category for
long-term securities, in the second highest rating category for short-term
securities, or, if not rated by those rating agencies, determined by the Manager
to be of equivalent investment quality. Securities rated in the lowest level of
investment grade have speculative characteristics since adverse economic
conditions and changing circumstances are more likely to have an adverse impact
on such securities.
If the rating of a security is downgraded, the Manager will determine
whether it is in the best interest of the Fund's shareholders to continue to
hold such security in the Fund's portfolio. Unless otherwise directed by the
Board of Directors, if downgrades result in more than 5% of a Fund's net assets
being invested in securities that are less than investment grade quality, the
Manager will take immediate action to reduce the Fund's holdings in such
securities to 5% or less of the Fund's net assets. For a more complete
description of tax-exempt securities and their ratings, see APPENDIX A to the
SAI.
The Fund's average portfolio maturity is not restricted, but is expected to
be greater than ten years. In determining a security's maturity for purposes of
calculating the Fund's average maturity, estimates of the expected time for its
principal to be paid may be used. This can be substantially shorter than its
stated final maturity. For a discussion of the method of calculating the average
weighted maturity of the Fund's portfolio, see INVESTMENT POLICIES in the SAI.
The net asset value (NAV) per share of the New York Bond Fund will fluctuate
with portfolio maturity, the quality of securities held, and inversely to
interest rate levels.
NEW YORK MONEY MARKET FUND. The Fund will purchase only high quality securities
that qualify as "eligible securities" under the
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<PAGE>
SEC rules applicable to money market mutual funds. These securities must also be
determined by the Manager to present minimal credit risk. In general, the
category of eligible securities may include a security that is:
(1) issued or guaranteed by the U.S. Government or any agency or
instrumentality thereof, including "prerefunded" and "escrowed to maturity"
tax-exempt securities;
(2) rated in one of the two highest categories for short-term securities by at
least two Nationally Recognized Statistical Rating Organizations (NRSROs),
or by one NRSRO if the security is rated by only one NRSRO;
(3) unrated but issued by an issuer or guaranteed by a guarantor that has other
comparable short-term debt obligations so rated; or
(4) unrated but determined to be of comparable quality by the Manager.
If a security is downgraded after purchase, the Manager will follow written
procedures adopted by the Company's Board of Directors and a determination will
be made as to whether it is in the best interest of the Fund's shareholders for
the Fund to continue to hold the security.
Current NRSROs include Moody's, S&P, Fitch, Duff & Phelps Inc., Thompson
BankWatch, Inc., and IBCA Inc. For a description of tax-exempt securities and
their ratings, see APPENDIX A to the SAI.
Consistent with regulatory requirements, the Manager will purchase
securities with remaining maturities of 397 days or less and will maintain a
dollar-weighted average portfolio maturity of no more than 90 days. The Fund
will endeavor to maintain a constant net asset value of $1.00 per share,
although there is no assurance that it will be able to do so.
OTHER INVESTMENT INFORMATION
The investment objectives of the Funds may not be changed without shareholder
approval. In view of the risks inherent in all investments in securities, there
is no assurance that these objectives will be achieved. The investment policies
and techniques used to pursue the Funds' objectives may be changed without
shareholder approval, except as otherwise noted. Further information regarding
the Funds' investment policies and restrictions is provided in the SAI.
TAX-EXEMPT SECURITIES
These securities include general obligation bonds, which are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest; revenue bonds, which are payable from the revenue
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise tax or other specific revenue source, but
not from the general taxing power; lease obligations backed by the
municipality's covenant to budget for the payments due under the lease
obligation; and certain types of industrial development bonds issued by or on
behalf of public authorities to obtain funds for privately-operated facilities,
provided that the interest paid on such securities is excluded from gross income
for federal income tax purposes and is exempt from New York State and New York
City personal income taxes.
The value of the securities in which a Fund will invest generally fluctuates
inversely with changes in prevailing interest rates. Changes in the
creditworthiness of issuers and changes in other market factors such as the
relative supply of and demand for tax-exempt bonds also create value
fluctuations.
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Each Fund may on a temporary basis due to market or other conditions invest
up to 100% of its assets in short-term securities whether or not exempt from
federal and New York State and New York City income taxes. Such taxable
securities may consist of obligations of the U.S. Government, its agencies or
instrumentalities, and repurchase agreements secured by such instruments;
certificates of deposit of domestic banks having capital, surplus and undivided
profits in excess of $100 million; banker's acceptances of similar banks;
commercial paper; and other corporate debt obligations.
INVESTMENT TECHNIQUES
VARIABLE RATE SECURITIES - Each Fund may invest in tax-exempt securities that
bear interest at rates which are adjusted periodically to market rates. These
interest rate adjustments can both raise and lower the income generated by such
securities. These changes will have the same effect on the income earned by a
Fund depending on the proportion of such securities held.
The market value of fixed coupon securities fluctuates with changes in
prevailing interest rates, increasing in value when interest rates decline and
decreasing in value when interest rates rise. The value of variable rate
securities, however, is less affected by changes in prevailing interest rates
because of the periodic adjustment of their coupons to a market rate. The
shorter the period between adjustments, the smaller the impact of interest rate
fluctuations on the value of these securities. The market value of tax-exempt
variable rate securities usually tends toward par (100% of face value) at
interest rate adjustment time.
In the case of the New York Money Market Fund only, any variable rate
instrument with a demand feature will be deemed to have a maturity equal to
either the date on which the underlying principal amount may be recovered
through demand or the next rate adjustment date consistent with applicable
regulatory requirements.
PUT BONDS - Each Fund may invest in tax-exempt securities (including securities
with variable interest rates) which may be redeemed or sold back (put) to the
issuer of the security or a third party prior to stated maturity (put bonds).
Such securities will normally trade as if maturity is the earlier put date, even
though stated maturity is longer. For the New York Bond Fund, maturity for put
bonds is deemed to be the date on which the put becomes exercisable. Generally,
maturity for put bonds for the New York Money Market Fund is determined as
stated under Variable Rate Securities.
ZERO COUPON BONDS - Each Fund may invest in zero coupon bonds. A zero coupon
bond is a security that is sold at a deep discount from its face value, makes no
periodic interest payments, and is redeemed at face value when it matures. The
lump sum payment at maturity increases the price volatility of the zero coupon
bond to changes in interest rates when compared to a bond that distributes a
semiannual coupon payment. In calculating its dividend, each Fund records as
income the daily amortization of the purchase discount.
WHEN-ISSUED SECURITIES - Each Fund may invest in new issues of tax-exempt
securities offered on a when-issued basis; that is, delivery and payment take
place after the date of the commitment to purchase, normally within 45 days.
Both price and interest rate are fixed at the time of commitment. The Funds do
not earn interest on the securities until settlement, and the market value of
the securities may fluctuate between purchase and settlement. Such securities
can be sold before settlement date.
Cash or high quality liquid debt securities equal to the amount of the
when-issued commitments are segregated at the Fund's custodian bank. The
segregated securities are valued at market, and daily adjustments are made to
keep the value of
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<PAGE>
the cash and segregated securities at least equal to the amount of such
commitments by the Fund. On the settlement date, the Fund will meet its
obligations from then available cash, sale of segregated securities, sale of
other securities, or sale of the when-issued securities themselves.
MUNICIPAL LEASE OBLIGATIONS - Each Fund may invest in municipal lease
obligations and certificates of participation in such obligations (collectively,
lease obligations). A lease obligation does not constitute a general obligation
of the municipality for which the municipality's taxing power is pledged,
although the lease obligation is ordinarily backed by the municipality's
covenant to budget for the payments due under the lease obligation.
Certain lease obligations contain "non- appropriation" clauses which
provide that the municipality has no obligation to make lease obligation
payments in future years unless money is appropriated for such purpose on a
yearly basis. Although "non- appropriation" lease obligations are secured by the
leased property, disposition of the property in the event of foreclosure might
prove difficult. In evaluating a potential investment in such a lease
obligation, the Manager will consider: (1) the credit quality of the obligor,
(2) whether the underlying property is essential to a governmental function, and
(3) whether the lease obligation contains covenants prohibiting the obligor from
substituting similar property if the obligor fails to make appropriations for
the lease obligation.
LIQUIDITY - The New York Bond Fund and New York Money Market Fund may invest up
to 15% and 10%, respectively, of their net assets in illiquid securities.
Lease obligations and certain put bonds that are subject to restrictions on
transfer may be determined to be liquid in accordance with the guidelines
established by the Board of Directors.
In determining the liquidity of a lease obligation, the Manager will
consider: (1) the frequency of trades and quotes for the lease obligation, (2)
the number of dealers willing to purchase or sell the lease obligation and the
number of other potential purchasers, (3) dealer undertakings to make a market
in the lease obligation, (4) the nature of the marketplace trades, including the
time needed to dispose of the lease obligation, the method of soliciting offers,
and the mechanics of transfer, (5) whether the lease obligation is of a size
that will be attractive to institutional investors, (6) whether the lease
obligation contains a non-appropriation clause and the likelihood that the
obligor will fail to make an appropriation therefor, and (7) such other factors
as the Manager may determine to be relevant to such determination.
In determining the liquidity of put bonds with restrictions on transfer,
the Manager will evaluate the credit quality of the party (the Put Provider)
issuing (or unconditionally guaranteeing performance on) the unconditional put
or demand feature of the put bond.
INVESTMENT RESTRICTIONS
The following restrictions may not be changed without shareholder approval:
(1) Neither Fund may borrow money, except for temporary or emergency purposes
in an amount not exceeding 33 1/3% of its total assets (including the
amount borrowed) less liabilities (other than borrowings).
(2) Neither Fund may invest 25% or more of its total assets in securities
issued in connection with the financing of projects with similar
characteristics, such as toll road revenue bonds, housing revenue bonds or
electric power project revenue bonds or in industrial revenue bonds which
are based, directly or indirectly, on the credit of private entities of any
one industry. However, each Fund
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<PAGE>
reserves the right to invest more than 25% of its total assets in
tax-exempt industrial revenue bonds.
(3) Neither Fund will invest 25% or more of its total assets in the securities
of a single issuer, and neither Fund will, with respect to 75% of its total
assets, invest more than 5% of its total assets in securities of a single
issuer.
RISK FACTORS
Each Fund is subject to credit and market risks, which will be intensified by
concentration in New York issues. Each Fund's ability to achieve its investment
objective is dependent upon the ability of the issuers of New York Municipal
Obligations to meet their continuing obligations for the payment of principal
and interest. New York State and New York City face long-term economic problems
that could seriously affect their ability and that of other issuers of New York
Municipal Obligations to meet their financial obligations. AN INVESTMENT IN THE
NEW YORK MONEY MARKET FUND MAY BE RISKIER THAN AN INVESTMENT IN OTHER TYPES OF
MONEY MARKET FUNDS BECAUSE OF THE FUND'S CONCENTRATION IN NEW YORK ISSUES.
Certain substantial issuers of New York Municipal Obligations (including
issuers whose obligations may be acquired by the Funds) have experienced serious
financial difficulties in recent years. These difficulties have at times
jeopardized the credit standing and impaired the borrowing abilities of all New
York issuers and have generally contributed to higher interest costs for their
borrowings and fewer markets for their outstanding debt obligations. In recent
years, several different issues of municipal securities of New York State and
its agencies and instrumentalities and of New York City have been downgraded by
S&P and Moody's. On the other hand, strong demand for New York Municipal
Obligations has at times had the effect of permitting New York Municipal
Obligations to be issued with yields relatively lower, and after issuance, to
trade in the market at prices relatively higher, than comparably rated municipal
obligations issued by other jurisdictions. A recurrence of the financial
difficulties previously experienced by certain issuers of New York Municipal
Obligations could result in defaults or declines in the market values of those
issuers' existing obligations and, possibly, in the obligations of other issuers
of New York Municipal Obligations. Although as of the date of this prospectus,
no issuers of New York Municipal Obligations are in default with respect to the
payment of their municipal obligations, the occurrence of any such default could
affect adversely the market values and marketability of all New York Municipal
Obligations and, consequently, the net asset value of the Funds' portfolio.
Other considerations affecting the Funds' investments in New York Municipal
Obligations are summarized in the SAI under SPECIAL RISK CONSIDERATIONS.
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PURCHASE OF SHARES
OPENING AN ACCOUNT
You may open an account and make an investment by any of the following methods.
A complete, signed application is required together with a check for each new
account.
TAX ID NUMBER
We require that each shareholder named on the account provide the Company with a
social security number or tax identification number to avoid possible tax
withholding requirements.
EFFECTIVE DATE
When you make a purchase, your purchase price will be the NAV per share next
determined after the Fund receives your request in proper form. The NAV of each
Fund is determined at the close of the regular trading session of the New York
Stock Exchange (NYSE) each day the Exchange is open. If a Fund receives your
request prior to that time, your purchase price will be the NAV per share
determined for that day. If a Fund receives your request after the NAV per share
is calculated, the purchase will be effective on the next business day.
Because of the more lengthy clearing process and the need to convert
foreign currency, a check drawn on a foreign bank will not be deemed received
for the purchase of shares until such time as the check has cleared and the
Manager has received good funds, which may take up to four to six weeks.
Furthermore, a bank charge may be assessed in the clearing process, which will
be deducted from the amount of the purchase. To avoid a delay in the
effectiveness of your purchase, the Manager suggests that you convert your
foreign check to U.S. dollars prior to investment in the Funds.
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PURCHASE OF SHARES
MINIMUM INVESTMENTS
- -------------------
Initial Purchase: $3,000
Additional Purchases: $50 - (Except transfers from brokerage accounts
into the New York Money Market Fund, which are
exempt from minimum)
HOW TO PURCHASE:
- ---------------
MAIL o To open an account, send your application and check to:
USAA Investment Management Company
9800 Fredericksburg Rd., San Antonio, TX 78288
o To add to your account, send your check and the "Invest by
Mail" stub that accompanies your fund's transaction
confirmation to the Transfer Agent:
USAA Shareholder Account Services
9800 Fredericksburg Rd., San Antonio, TX 78288
o To exchange by mail, call 1-800-531-8448 for instructions.
IN PERSON o To open an account, bring your application and check to:
USAA Investment Management Company
USAA Federal Savings Bank
10750 Robert F. McDermott Freeway, San Antonio
AUTOMATICALLY o Additional purchases on a regular basis can be deducted
VIA from a bank account, paycheck, income-producing investment
ELECTRONIC or from a USAA money market account. Sign up for these
FUNDS services when opening an account or call 1-800-531-8448 to
TRANSFER add these services.
o Purchases through payroll deduction ($25 minimum each pay
period with (EFT) no initial investment) can be made by any
employee of USAA, its subsidiaries or affiliated companies.
BANK WIRE o To add to an account, instruct your bank (which may
charge a fee for the service) to wire the specified amount
to the Fund as follows:
State Street Bank and Trust Company, Boston, MA 02101
ABA#011000028
Attn: USAA [Fund Name]
USAA AC-69384998
Shareholder(s) Name(s)_________________
Shareholder(s) Account Number___________________
PHONE o If you have an existing USAA account and would like to open
1-800-531-8448 a new account or if you would like to exchange to another
USAA fund, call for instructions. The new account must have
the same registration as your existing account.
o To add to an account, intermittent (as-needed) purchases
can be deducted from your bank account through our Buy/Sell
Service. Call for instructions.
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REDEMPTION OF SHARES
You may redeem shares of a Fund by any of the following methods on any day the
NAV per share is calculated. Redemptions will be effective on the day
instructions are received in accordance with the requirements set forth below.
However, if instructions are received after the NAV per share calculation,
redemption will be effective on the next business day.
REDEMPTION PROCEEDS
Redemption proceeds are distributed within seven days after the effective date
of redemption. Payment for redemption of shares purchased by check or electronic
funds transfer will not be disbursed until the purchase check or electronic
funds transfer has cleared, which could take up to 15 days from the purchase
date. If you are considering redeeming shares soon after purchase, you should
purchase by bank wire or certified check to avoid delay.
In addition, the Company may elect to suspend the redemption of shares or
postpone the date of payment during any period that the NYSE is closed, or
trading in the markets the Company normally utilizes is restricted, or during
any period that redemption is otherwise permitted to be suspended by the SEC.
HOW TO REDEEM:
- -------------
WRITTEN, o Send your written instructions to:
FAX, OR USAA Shareholder Account Services
TELEGRAPH 9800 Fredericksburg Rd., San Antonio, TX 78288
o Send a signed fax to 1-800-292-8177, or send a telegraph to
USAA Shareholder Account Services.
Written redemption requests must include the following: (1) a letter of
instruction or stock assignment, and stock certificate (if issued), specifying
the Fund and the number of shares or dollar amount to be redeemed; (2)
signatures of all owners of the shares exactly as their names appear on the
account; (3) other supporting legal documents, if required, as in the case of
estates, trusts, guardianships, custodianships, partnerships, corporations, and
pension and profit-sharing plans; and (4) method of payment.
PHONE o Call toll free 1-800-531-8448, in San Antonio, 456-7202.
Telephone redemption is automatically established when you complete your
application. The Fund will employ reasonable procedures to confirm that
instructions communicated by telephone are genuine, and if it does not, it may
be liable for any losses due to unauthorized or fraudulent instructions.
Information is obtained prior to any discussion regarding an account including:
(1) USAA number or account number, (2) the name(s) on the account registration,
and (3) social security number or tax identification number for the account
registration. In addition, all telephone communications with a shareholder are
recorded, and confirmations of all account transactions are sent to the address
of record.
Redemption by telephone, fax, or telegraph is not available for shares
represented by stock certificates.
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<PAGE>
METHODS OF PAYMENT:
- ------------------
BANK WIRE o Allows redemptions to be sent directly to your bank account.
Establish this service when you apply for your account, or later upon
request. Please obtain precise wiring instructions from your financial
institution. USAA Shareholder Account Services (Transfer Agent) deducts a wire
fee from the account for the redemption by wire. The fee as of the date of this
Prospectus is $10 ($25 for wires to a foreign bank) and is subject to change at
any time. The fee is paid to State Street Bank and Trust Company (SSB) and the
Transfer Agent for their services in connection with the wire redemption. Your
financial institution may also charge a fee for receiving funds by wire.
AUTOMATICALLY o Systematic (regular) or intermittent (as-needed) redemptions
VIA EFT can be credited to your bank account.
Establish any of our electronic investing services when you apply for your
account, or later upon request.
CHECK o A check payable to the registered shareholder(s) will be
REDEMPTION mailed to the address of record.
This check redemption privilege is automatically established when your
application is completed and accepted. There is a 15-day waiting period before a
check redemption can be processed following a telephone address change. Should
you wish to redeem shares within the 15 days following a telephone address
change, you may do so by providing written instructions by mail or facsimile.
CHECKWRITING o Checks can be issued for your New York Money Market Fund
account.
To establish your checkwriting privilege (CWP), complete the signature card
which accompanies the application form or Shareholder Services Guide, or request
and complete the signature card separately. There is no charge for the use of
checks nor for subsequent reorders. This privilege is subject to SSB's rules and
regulations governing checking accounts. Checks must be written for an amount of
at least $250. Checks written for less than $250 will be returned. Checkwriting
may not be used to close an account because the value of the account changes
daily as dividends are accrued.
When a check is presented to the Transfer Agent for payment, a sufficient
number of full and fractional shares in the investor's account will be redeemed
to cover the amount of the check. Checks will be returned if there are
insufficient shares to cover the amount of the check. Presently, there is a $15
processing fee assessed against an account for any redemption check not honored
by a clearing or paying agent. A check paid during the month will be returned to
the shareholder by separate mail. Checkwriting fees are subject to change at any
time. The Company, the Transfer Agent and SSB each reserve the right to change
or suspend the checkwriting privilege upon 30 days' written notice to
participating shareholders. See the SAI for further information.
You may request that the Transfer Agent stop payment on a check. The
Transfer Agent will use its best efforts to execute stop payment instructions,
but does not guarantee that such efforts will be effective. A $10 charge will be
made for each stop payment requested by a shareholder.
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<PAGE>
CONDITIONS OF PURCHASE AND REDEMPTION
NONPAYMENT
If any order to purchase shares is cancelled due to nonpayment or if the Company
does not receive good funds either by check or electronic funds transfer, the
Transfer Agent will treat the cancellation as a redemption of shares purchased,
and you will be responsible for any resulting loss incurred by the Fund or the
Manager. If you are a shareholder, the Transfer Agent can redeem shares from any
of your account(s) as reimbursement for all losses. In addition, you may be
prohibited or restricted from making future purchases in any of the USAA Family
of Funds. A $15 fee is charged for all returned items, including checks and
electronic funds transfers.
TRANSFER OF SHARES
You may transfer Fund shares to another person by sending written instructions
to the Transfer Agent. The account must be clearly identified, and you must
include the number of shares to be transferred, the signatures of all registered
owners, and all stock certificates, if any, which are the subject of transfer.
You also need to send written instructions signed by all registered owners and
supporting documents to change an account registration due to events such as
divorce, marriage, or death. If a new account needs to be established, you must
complete and return an application to the Transfer Agent.
ACCOUNT BALANCE
Beginning in September 1998, and occurring each September thereafter, the
Transfer Agent will assess a small balance account fee of $12 to each
shareholder account with a balance, at the time of assessment, of less than
$2,000. The fee will be used to reduce total transfer agency fees paid by each
Fund to the Transfer Agent. Accounts exempt from the fee include: (1) any
account regularly purchasing additional shares each month through an automatic
investment plan; (2) any account registered under the Uniform Gifts/Transfers to
Minors Act (UGMA or UTMA); (3) all (non IRA) money market fund accounts; (4) any
account whose registered owner has an aggregate balance of $50,000 or more
invested in USAA mutual funds; and (5) all IRA accounts (for the first year the
account is open).
COMPANY RIGHTS The Company reserves the right to:
(1) reject purchase or exchange orders when in the best interest of the
Company;
(2) limit or discontinue the offering of shares of any portfolio of the Company
without notice to the shareholders;
(3) impose a redemption charge of up to 1% of the net asset value of shares
redeemed if circumstances indicate a charge is necessary for the protection
of remaining investors (for example, if excessive market-timing share
activity unfairly burdens long-term investors); provided, however, this 1%
charge will not be imposed upon shareholders unless authorized by the Board
of Directors and the required notice has been given to shareholders;
(4) require a signature guarantee for purchases, redemptions, or changes in
account information in those instances where the appropriateness of a
signature authorization is in question. The section ADDITIONAL INFORMATION
REGARDING REDEMPTION OF SHARES in the SAI contains information on
acceptable guarantors;
(5) redeem an account with a balance of less than 50 full shares of either
Fund, subject to certain limitations described in ADDITIONAL INFORMATION
REGARDING Redemption of Shares in the SAI.
20
<PAGE>
EXCHANGES
EXCHANGE PRIVILEGE
The Exchange Privilege is automatically established when you complete your
application. You may exchange shares among Funds in the USAA Family of Funds,
provided you do not hold these shares in stock certificate form and that the
shares to be acquired are offered in your state of residence. Only New York
residents may exchange into a New York Fund. Exchange redemptions and purchases
will be processed simultaneously at the share prices next determined after the
exchange order is received. For federal income tax purposes, an exchange between
Funds is a taxable event. Accordingly, when exchanging shares, you may realize a
capital gain or loss.
The Funds have undertaken certain procedures regarding telephone
transactions. See REDEMPTION OF SHARES - PHONE.
EXCHANGE LIMITATIONS, EXCESSIVE TRADING
To minimize Fund costs and to protect the Funds and their shareholders from
unfair expense burdens, the Funds restrict excessive exchanges. Exchanges out of
any Fund in the USAA Family of Funds are limited for each account to six per
calendar year except that there is no limitation on exchanges out of the Tax
Exempt Short- Term Fund, Short-Term Bond Fund, or any of the money market funds
in the USAA Family of Funds.
OTHER SERVICES
INVESTMENT PLANS
AUTOMATIC INVESTMENT PLANS - You may establish an automatic investment plan by
completing the appropriate forms, if any. At the time you sign up for any of the
following investment plans that utilize the electronic funds transfer service,
you will choose the day of the month (the effective date) on which you would
like to regularly purchase shares. When this day falls on a weekend or holiday,
the electronic transfer will take place on the last business day before the
effective date. Call the Manager to obtain instructions. More information about
these preauthorized plans is contained in the SAI.
o INVESTRONIC(R) - The regular purchase of additional shares through electronic
funds transfer from a checking or savings account. You may invest as little as
$50 per month.
o DIRECT PURCHASE SERVICE - The periodic purchase of shares through electronic
funds transfer from an employer (including government allotments), an
income-producing investment, or an account with a participating financial
institution.
o AUTOMATIC PURCHASE PLAN - The periodic transfer of funds from a USAA money
market fund to purchase shares in another non-money market USAA mutual fund.
o BUY/SELL SERVICE - The intermittent purchase or redemption of shares through
electronic funds transfer to or from a checking or savings account.
o SYSTEMATIC WITHDRAWAL PLAN - The periodic redemption of shares from one of
your accounts permitting you to receive a fixed amount of money monthly or
quarterly.
o DIRECTED DIVIDENDS - If you own shares in more than one of the Funds in the
USAA Family of Funds, you may direct that dividends and/or capital gain
distributions earned in one fund be used to purchase shares automatically in
another fund.
21
<PAGE>
SHAREHOLDER STATEMENTS AND REPORTS
You will receive a confirmation after each transaction in your New York Bond
Fund account except:
(1) a reinvested dividend;
(2) a payment you make under the InvesTronic(R), Direct Purchase Service,
Automatic Purchase Plan, or Directed Dividends investment plans; or
(3) a redemption you make under the Systematic Withdrawal Plan.
If you own shares in the New York Money Market Fund, you will receive a
confirmation for purchases or redemptions by check and exchanges. If that money
market fund account had activity other than reinvested dividends, such as wire
purchases or redemptions or purchases under the InvesTronic(R), Direct Purchase
Service, Automatic Purchase Plan or Directed Dividends investment plans, you
will receive a monthly statement that will reflect quarter-to-date account
activity.
At the end of each quarter, you will receive a consolidated statement for
all of your mutual fund accounts, regardless of account activity. The fourth
quarter consolidated statement will reflect all account activity for the prior
tax year. There will be a $10 fee charged for copies of historical statements
for other than the prior tax year for any one account. You will receive a Fund's
financial statements with a summary of its investments and performance at least
semiannually.
In an effort to reduce expenses and respond to shareholders' requests to
reduce mail, the Company intends to consolidate mailings of Annual and
Semiannual Reports to households having multiple accounts with the same address
of record. One copy of each report will be furnished to that address. You may
request additional reports by notifying the Company.
TELEPHONE ASSISTANCE
Call our telephone assistance numbers for specific forms, a copy of the SAI, the
most recent Annual Report and/or Semiannual Report, or if you have any questions
concerning any of the services offered.
SHARE PRICE CALCULATION
The price at which shares of the Funds are purchased and redeemed by
shareholders is equal to the NAV per share determined on the effective date of
the purchase or redemption.
WHEN
The NAV per share for each Fund is calculated at the close of the regular
trading session of the NYSE, which is usually 4:00 p.m. Eastern Time. You may
buy and sell Fund shares at the NAV per share without a sales charge.
HOW
The NAV per share is calculated by adding the value of all securities and other
assets in a Fund, deducting liabilities, and dividing by the number of shares
outstanding. Securities of the New York Bond Fund are valued each business day
at their current market value as determined by a pricing service approved by the
Board of Directors. Securities which cannot be valued by the pricing service,
and all other assets, are valued in good faith at fair value using methods
determined by the Manager under the general supervision of the Board of
Directors. In addition, securities purchased with maturities of 60 days or less
and all securities of the New York Money Market Fund are stated at amortized
cost.
For additional information, see VALUATION OF SECURITIES in the SAI.
22
<PAGE>
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
Net investment income of each Fund is accrued daily and distributed to
shareholders on the last business day of each month. Net capital gains, if any,
generally will be distributed at least annually. The Funds intend to make such
additional distributions as may be necessary to avoid the imposition of any
federal excise tax.
All shares purchased will begin accruing dividends on the day following the
effective date of the purchase and will receive dividends through the effective
date of redemption.
All income dividends and capital gain distributions are automatically
reinvested, unless the shareholder specifies otherwise. The share price will be
the net asset value of the Fund shares computed on the ex-dividend date. Any
capital gain distribution paid by the New York Bond Fund will reduce the NAV per
share by the amount of the distribution. An investor should consider carefully
the effects of purchasing shares of the New York Bond Fund shortly before any
capital gain distribution. Although in effect a return of capital, these
distributions are subject to taxes. If a shareholder becomes a resident of a
state other than New York, a check for proceeds of income dividends will be
mailed to such shareholder monthly, and a check for any capital gain
distribution will be mailed after the distribution is paid.
Any dividend or distribution payment returned to the Manager as not
deliverable will be invested in the shareholder's Fund account at the
then-current NAV per share. If any check for the payment of dividends or
distributions is not cashed within six months from the date on the check, it
becomes void. The amount of the check will then be invested in the shareholder's
Fund account at the then-current NAV per share.
FEDERAL TAXES
The exemption of interest income for federal income tax purposes does not
necessarily result in exemption under the income or other tax laws of any state
or local taxing authority. The following discussion relates only to generally
applicable federal income tax provisions in effect as of the date of this
Prospectus. Therefore, shareholders are urged to consult their own tax advisers
about the status of distributions from a Fund in their own states and
localities.
FUND - Each Fund intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the Code). By
complying with the applicable provisions of the Code, neither Fund will be
subject to federal income tax on its net investment income and net capital gains
(capital gains in excess of capital losses) distributed to shareholders.
SHAREHOLDER - Dividends of net tax-exempt interest income paid by a Fund are
excluded from a shareholder's gross income for federal income tax purposes.
Dividends from taxable net investment income and distributions of net short-term
capital gains are taxable to shareholders as ordinary income, whether received
in cash or reinvested in additional shares. However, it is expected that any
taxable net investment income will be minimal in relation to the tax-exempt
interest generated by a Fund.
Distributions of net long-term capital gains are taxable as long-term
capital gains whether received in cash or reinvested in additional shares, and
regardless of the length of time the investor has held the shares of a Fund.
23
<PAGE>
Redemptions, including exchanges, are subject to income tax, based on the
difference between the cost of shares when purchased and the price received upon
redemption or exchange.
Tax-exempt interest from private activity bonds (for example, industrial
development revenue bonds) issued after August 7, 1986, although otherwise
exempt from federal tax, is treated as a tax preference item for purposes of the
alternative minimum tax. For corporations, all tax-exempt interest will be
considered in calculating the alternative minimum tax as part of the adjusted
current earnings.
WITHHOLDING - Each Fund is required by federal law to withhold and remit to the
U.S. Treasury a portion of the income dividends and capital gain distributions
and proceeds of redemptions paid to any non-corporate shareholder who fails to
furnish the Fund with a correct tax identification number, who underreports
dividend or interest income, or who fails to certify that he is not subject to
withholding. To avoid this withholding requirement, you must certify on your
application, or on a separate Form W-9 supplied by the Transfer Agent, that your
tax identification number is correct and that you are not currently subject to
backup withholding.
REPORTING - Each Fund will report annually to its shareholders the federal tax
status of dividends and distributions paid or declared by each Fund during the
preceding calendar year, including the portion of the dividends constituting
interest on private activity bonds, and the percentage and source, on a
state-by-state basis, of interest income earned on tax-exempt securities held by
the Fund during the preceding year.
NEW YORK TAXATION Each Fund intends to satisfy such requirements of applicable
New York law so as to pay dividends, as described below, that are exempt from
New York State and New York City personal income taxes. Dividends derived from
interest on qualifying New York Municipal Obligations (including certain
territories and possessions of the United States such as Puerto Rico, the Virgin
Islands, and Guam) will be exempt from New York State and New York City personal
income taxes, but not corporate franchise taxes. Dividends and distributions
derived from income (including capital gains on all New York Municipal
Obligations) other than interest on qualifying New York Municipal Obligations
are not exempt from New York State and New York City taxes. Interest on
indebtedness incurred by a shareholder to purchase or carry shares of the Fund
is not deductible for New York State and New York City personal income tax
purposes. Each shareholder will receive an annual notification stating the
shareholder's portion of each Fund's tax-exempt income attributable to qualified
New York Municipal Obligations. The foregoing is only a general summary of
certain state and local tax considerations generally affecting shareholders and
is not intended as a substitute for careful tax planning. Potential investors
should consult their own tax advisers regarding their own tax situations.
24
<PAGE>
MANAGEMENT OF THE COMPANY
The business affairs of the Company are subject to the supervision of the Board
of Directors.
The Manager, USAA Investment Management Company (IMCO), was organized in
May 1970 and is an affiliate of United Services Automobile Association (USAA), a
large diversified financial services institution. As of the date of this
Prospectus, the Manager had approximately $35 billion in total assets under
management. The Manager's mailing address is 9800 Fredericksburg Rd., San
Antonio, TX 78288.
Officers and employees of the Manager are permitted to engage in personal
securities transactions subject to restrictions and procedures set forth in the
Joint Code of Ethics adopted by the Company and the Manager. Such restrictions
and procedures include substantially all of the recommendations of the Advisory
Group of the Investment Company Institute and comply with SEC rules and
regulations.
ADVISORY AGREEMENT
The Manager serves as the manager and investment adviser of the Company,
providing services under an Advisory Agreement. Under the Advisory Agreement,
the Manager is responsible for the management of the business affairs,
investment portfolios, and placement of brokerage orders, subject to the
authority of and supervision by the Board of Directors.
For its services under the Advisory Agreement, each Fund pays the Manager
an annual fee which is computed as a percentage of the aggregate ANA of both
Funds combined. The fee is accrued daily, paid monthly, and allocated between
the Funds based on the relative net assets of each. The fee is computed at .50%
of the first $50,000,000 ANA, .40% of that portion over $50,000,000 and not over
$100,000,000 ANA, and .30% of that portion over $100,000,000 ANA. For the fiscal
year ended March 31, 1997, the fees paid to the Manager, net of the
reimbursements, were .29% of ANA for the New York Bond Fund and .26% of ANA for
the New York Money Market Fund.
OPERATING EXPENSES
For the fiscal year ended March 31, 1997, the Manager limited each Fund's total
operating expenses to .50% of its ANA. The Manager reimbursed the New York Bond
Fund $85,840 and the New York Money Market Fund $86,217 for expenses in excess
of the limitation. The Manager has voluntarily agreed to continue to limit each
Fund's annual expenses until August 1, 1998, to .50% of its ANA and will
reimburse the Funds for all expenses in excess of the limitation.
PORTFOLIO MANAGERS
The following individuals are primarily responsible for managing the Funds.
NEW YORK BOND FUND
Kenneth E. Willmann, Vice President of Fixed Income Investments since December
1986, has managed the Fund since its inception in October 1990. He has 23 years
investment management experience and has worked for IMCO for 20 years. Mr.
Willmann earned the Chartered Financial Analyst (CFA) designation in 1978 and is
a member of the Association for Investment Management and Research (AIMR), San
Antonio Financial Analysts Society, Inc. (SAFAS), and the National Federation of
Municipal Analysts (NFMA). He holds an MBA and a BA from the University of
Texas.
25
<PAGE>
NEW YORK MONEY MARKET FUND
John C. Bonnell, Executive Director of Money Market Funds since May 1996, has
managed the Fund since May 1996. He has eight years investment management
experience working for IMCO, where he has held various positions in Fixed Income
Investments. Mr. Bonnell earned the CFA designation in 1994 and is a member of
the AIMR, the SAFAS, the NFMA and the Southern Municipal Finance Society. He
holds an MBA from St. Mary's University and a BBA from the University of Texas
at San Antonio.
DESCRIPTION OF SHARES
The Company is an open-end management investment company incorporated under the
laws of the State of Maryland on November 16, 1981. The Company is authorized to
issue shares in separate portfolios. Ten such portfolios have been established,
two of which are described in this Prospectus. Each of the two Funds is
classified as diversified. Under the Company's charter, the Board of Directors
is authorized to create new portfolios in addition to those already existing
without the approval of the shareholders of the Company.
Under the provisions of the Bylaws of the Company, no annual meeting of
shareholders is required. Ordinarily, no shareholder meeting will be held unless
required by the 1940 Act. The Directors may fill vacancies on the Board or
appoint new Directors provided that immediately after such action at least
two-thirds of the Directors have been elected by shareholders.
Shareholders are entitled to one vote per share (with proportionate voting
for fractional shares) irrespective of the relative net asset value of the
shares. For matters affecting an individual portfolio, a separate vote of the
shareholders of that portfolio is required.
26
<PAGE>
SERVICE PROVIDERS
UNDERWRITER/ USAA Investment Management Company
DISTRIBUTOR 9800 Fredericksburg Rd., San Antonio, Texas 78288.
TRANSFER USAA Shareholder Account Services
AGENT 9800 Fredericksburg Rd., San Antonio, Texas 78288.
CUSTODIAN State Street Bank and Trust Company
P.O. Box 1713, Boston, Massachusetts 02105.
LEGAL Goodwin, Procter & Hoar LLP
COUNSEL Exchange Place, Boston, Massachusetts 02109.
INDEPENDENT KPMG Peat Marwick LLP
AUDITORS 112 East Pecan, Suite 2400, San Antonio, Texas 78205.
TELEPHONE ASSISTANCE
(Call toll free - Central Time)
Monday-Friday 8:00 a.m. to 8:00 p.m.
Saturday 8:30 a.m. to 5:00 p.m.
For further information on mutual funds:
1-800-531-8181
In San Antonio 456-7211
For account servicing, exchanges or redemptions:
1-800-531-8448
In San Antonio 456-7202
RECORDED 24 HOUR SERVICE
MUTUAL FUND PRICE QUOTES
(From any phone)
1-800-531-8066
In San Antonio 498-8066
MUTUAL FUND TOUCHLINE(R)
(From Touchtone phones only)
For account balance, last transaction or fund prices:
1-800-531-8777
In San Antonio 498-8777
27
<PAGE>
[THIS PAGE LEFT BLANK INTENTIONALLY]
28
<PAGE>
Part A
Prospectus for the
Virginia Bond and
Virginia Money Market Funds
<PAGE>
USAA VIRGINIA FUNDS
AUGUST 1, 1997 PROSPECTUS
USAA VIRGINIA BOND FUND and USAA VIRGINIA MONEY MARKET FUND (collectively, the
Funds or the Virginia Funds) are two of ten no-load mutual funds offered by USAA
Tax Exempt Fund, Inc. (the Company). The Funds are managed by USAA Investment
Management Company (the Manager).
WHAT ARE THE INVESTMENT OBJECTIVES AND POLICIES?
The Funds have a common objective of providing Virginia investors with a
high level of current interest income that is exempt from federal and Virginia
state income taxes. The Virginia Money Market Fund has a further objective of
preserving capital and maintaining liquidity. Each Fund has separate investment
policies to achieve its objective.
The VIRGINIA BOND FUND invests primarily in long-term investment grade
Virginia tax-exempt securities. The Fund's average portfolio maturity is not
restricted, but is expected to be greater than 10 years.
Page 11.
The VIRGINIA MONEY MARKET FUND invests in high quality Virginia tax-exempt
securities with maturities of 397 days or less. The Manager will maintain a
dollar-weighted average portfolio maturity of no more than 90 days. The Fund
will endeavor to maintain a constant net asset value per share of $1.00. Page
11.
HOW DO YOU BUY?
Fund shares are sold on a continuous basis at the net asset value per share
without a sales charge. Make your initial investment directly with the Manager
by mail, in person, or in certain instances, by telephone. Page 15.
HOW DO YOU SELL?
You may redeem Fund shares by mail, telephone, fax, or telegraph on any day that
the net asset value is calculated. Page 17.
Shares of the Virginia Funds are authorized for sale only to residents of
the Commonwealth of Virginia. The delivery of this Prospectus shall not
constitute an offer in any state in which shares of the Virginia Funds may not
lawfully be made.
SHARES OF THE USAA VIRGINIA FUNDS ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF,
OR GUARANTEED BY, THE USAA FEDERAL SAVINGS BANK, ARE NOT INSURED BY THE FDIC OR
ANY OTHER GOVERNMENT AGENCY, AND ARE SUBJECT TO INVESTMENT RISKS, INCLUDING
POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED.
This Prospectus, which should be read and retained for future reference,
provides information regarding the Company and the Virginia Funds that you
should know before investing.
If you would like more information about the Funds, you may call
1-800-531-8181 to request a free copy of the most recent financial report and/or
the Funds' Statement of Additional Information (SAI), dated August 1, 1997. The
SAI has been filed with the Securities and Exchange Commission (SEC) and is
incorporated by reference into this Prospectus (meaning it is legally a part of
the Prospectus).
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
AN INVESTMENT IN THE VIRGINIA MONEY MARKET FUND IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT AND THERE CAN BE NO ASSURANCE THAT THE FUND
WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE. THIS FUND
MAY INVEST A SIGNIFICANT PERCENTAGE OF ITS ASSETS IN A SINGLE ISSUER, AND
THEREFORE AN INVESTMENT IN THE FUND MAY BE RISKIER THAN AN INVESTMENT IN OTHER
TYPES OF MONEY MARKET FUNDS.
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
SUMMARY DATA
Fees and Expenses.............................................. 3
Financial Highlights........................................... 4
Performance Information........................................ 8
USING MUTUAL FUNDS
USAA Family of No-Load Mutual Funds............................ 9
Using Mutual Funds in an Investment Program.................... 10
INVESTMENT PORTFOLIO INFORMATION
Investment Objectives and Policies............................. 11
Virginia Bond Fund......................................... 11
Virginia Money Market Fund................................. 11
Other Investment Information................................... 12
SHAREHOLDER INFORMATION
Purchase of Shares............................................. 15
Redemption of Shares........................................... 17
Conditions of Purchase and Redemption.......................... 19
Exchanges...................................................... 20
Other Services................................................. 20
Share Price Calculation........................................ 21
Dividends, Distributions and Taxes............................. 22
Management of the Company...................................... 24
Description of Shares.......................................... 25
Service Providers.............................................. 26
Telephone Assistance Numbers................................... 26
- --------------------------------------------------------------------------------
2
<PAGE>
FEES AND EXPENSES
The following summary, which is based on actual expenses and average net assets
(ANA) of each Fund for the year ended March 31, 1997, is provided to assist you
in understanding the expenses you will bear directly or indirectly as a Fund
investor.
SHAREHOLDER TRANSACTION EXPENSES (APPLICABLE TO EACH FUND)
- --------------------------------------------------------------------------------
Sales Load Imposed on Purchases.......................... None
Sales Load Imposed on Reinvested Dividends............... None
Deferred Sales Load...................................... None
Redemption Fee*.......................................... None
Exchange Fee............................................. None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE OF ANA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
VIRGINIA VIRGINIA
BOND MONEY MARKET
FUND FUND
Management Fees, net of reimbursements.......................... .34% .31%
12b-1 Fees...................................................... None None
Other Expenses, net of reimbursements
Transfer Agent Fees**...................................... .07% .10%
Custodian Fees............................................. .03% .05%
All Other Expenses......................................... .02% .04%
--- ---
Total Other Expenses............................................ .12% .19%
--- ---
Total Fund Operating Expenses, net of reimbursements............ .46% .50%
=== ===
</TABLE>
- --------------
* A shareholder who requests delivery of redemption proceeds by wire transfer
will be subject to a $10 fee. See REDEMPTION OF SHARES - BANK WIRE.
** The Funds pay USAA Shareholder Account Services an annual fixed fee per
account for its services. See TRANSFER AGENT in the SAI, page 15.
During the year, the Manager voluntarily limited each Fund's annual
expenses to .50% of its ANA and reimbursed the Funds for all expenses in excess
of the limitation. The Management Fees, Other Expenses, and Total Fund Operating
Expenses reflect all such expense reimbursements by the Manager. Absent such
reimbursements, the amount of the Virginia Money Market Fund's Management Fees,
Other Expenses, and Total Fund Operating Expenses, as a percentage of its ANA,
would have been .34%, .19%, and .53%. Total Fund Operating Expenses for the
Virginia Bond Fund did not exceed the limitation, therefore no reimbursements
were required. The Manager has voluntarily agreed to continue to limit each
Fund's annual expenses until August 1, 1998, to .50% of its ANA and will
reimburse the Funds for all expenses in excess of the limitation.
EXAMPLE OF EFFECT OF FUND EXPENSES
- --------------------------------------------------------------------------------
You would pay the following expenses on a $1,000 investment in one of the Funds
below, assuming (1) 5% annual return and (2) redemption at the end of the
periods shown:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
Virginia Bond Fund.................... $5 $15 $26 $58
Virginia Money Market Fund............ $5 $16 $28 $63
THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The following per share operating performance for a share outstanding throughout
each period in the seven-year period ended March 31, 1997, has been audited by
KPMG Peat Marwick LLP. This table should be read in conjunction with the Funds'
financial statements for the year ended March 31, 1997, and the auditors' report
thereon, that appear in the Funds' Annual Report. Further performance
information is contained in the Annual Report and is available upon request
without charge.
VIRGINIA BOND FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 10.93 $ 10.76 $ 10.71 $ 11.16 $ 10.57
Net investment income .63 .63 .62 .62 .64
Net realized and
unrealized gain (loss) (.01) .17 .05 (.30) .65
Distributions from net
investment income (.63) (.63) (.62) (.62) (.64)
Distributions of realized
capital gains - - - (.15) (.06)
--------- --------- -------- -------- --------
Net asset value at
end of period $ 10.92 $ 10.93 $ 10.76 $ 10.71 $ 11.16
======== ======== ======== ======== ========
Total return (%)** 5.82 7.57 6.61 2.69 12.61
Net assets at end of
period (000) $292,914 $267,111 $238,920 $235,901 $207,302
Ratio of expenses to
average net assets (%) .46 .48 .50 .49 .50(a)
Ratio of net investment
income to average net
assets (%) 5.76 5.74 5.95 5.44 5.90(a)
Portfolio turnover (%) 26.84 27.20 27.77 92.17 91.31
</TABLE>
- --------------
* Fund commenced operations October 15, 1990.
** Assumes reinvestment of all dividend income and capital gains distributions
during the period.
(a) Based on actual expenses for the period, after giving effect to
reimbursements of expenses by the Manager. Absent such reimbursements
the Fund's ratios would have been:
YEAR ENDED MARCH 31,
--------------------
1993 1992 1991*
---- ---- -----
Ratio of expenses to
average net assets (%) .54 .65 .99(b)
Ratio of net investment income
to average net assets (%) 5.86 6.25 6.34(b)
(b) Annualized. The ratio is not necessarily indicative of 12 months of
operations.
4
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
VIRGINIA BOND FUND:
YEAR ENDED MARCH 31,
-------------------
1992 1991*
---- -----
Net asset value at
beginning of period $ 10.28 $ 10.00
Net investment income .67 .32
Net realized and
unrealized gain (loss) .29 .28
Distributions from net
investment income (.67) (.32)
Distributions of realized
capital gains - -
-------- -------
Net asset value at
end of period $ 10.57 $ 10.28
======== =======
Total return (%)** 9.61 6.01
Net assets at end of
period (000) $131,475 $58,045
Ratio of expenses to
average net assets (%) .50(a) .50(a)(b)
Ratio of net investment
income to average net
assets (%) 6.40(a) 6.83(a)(b)
Portfolio turnover (%) 86.77 142.56
5
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
VIRGINIA MONEY MARKET FUND:
YEAR ENDED MARCH 31,
--------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .03 .03 .03 .02 .03
Distributions from net
investment income (.03) (.03) (.03) (.02) (.03)
--------- -------- ------- ------- -------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
========= ======== ======= ======= =======
Total return (%)** 3.14 3.42 2.91 2.14 2.65
Net assets at end of
period (000) $113,330 $110,308 $98,049 $92,570 $77,263
Ratio of expenses to
average net assets (%) .50(a) .50(a) .50(a) .50(a) .50(a)
Ratio of net investment
income to average net
assets (%) 3.10(a) 3.36(a) 2.88(a) 2.12(a) 2.62(a)
</TABLE>
- --------------
* Fund commenced operations October 15, 1990.
** Assumes reinvestment of all dividend income distributions during the period.
(a) Based on actual expenses for the period, after giving effect to
reimbursements of expenses by the Manager. Absent such reimbursements
the Fund's ratios would have been:
YEAR ENDED MARCH 31,
--------------------
1997 1996 1995 1994 1993 1992 1991*
---- ---- ---- ---- ---- ---- ----
Ratio of expenses to
average net assets (%) .53 .55 .56 .61 .63 .74 1.08(b)
Ratio of net investment
income to average net
assets (%) 3.07 3.31 2.82 2.01 2.49 3.72 4.45(b)
(b) Annualized. The ratio is not necessarily indicative of 12 months of
operations.
6
<PAGE>
FINANCIAL HIGHLIGHTS CONT.
VIRGINIA MONEY MARKET FUND:
YEAR ENDED MARCH 31,
-------------------
1992 1991*
---- -----
Net asset value at
beginning of period $ 1.00 $ 1.00
Net investment income .04 .02
Distributions from net
investment income (.04) (.02)
------- -------
Net asset value at
end of period $ 1.00 $ 1.00
======= =======
Total return (%)** 4.09 2.38
Net assets at end of
period (000) $73,220 $42,513
Ratio of expenses to
average net assets (%) .50(a) .50(a)(b)
Ratio of net investment
income to average net
assets (%) 3.96(a) 5.03(a)(b)
7
<PAGE>
PERFORMANCE INFORMATION
Performance information should be considered in light of each Fund's investment
objective and policies and market conditions during the time periods for which
it is reported. Historical performance should not be considered as
representative of the future performance of either Fund.
The Company may quote a Fund's total return or yield in advertisements and
reports to shareholders or prospective investors. A Fund's performance may also
be compared to that of other mutual funds with similar investment objectives and
relevant indexes that are referenced in APPENDIX B to the SAI. Standard total
return and yield results reported by the Funds do not take into account
recurring and nonrecurring charges for optional services which only certain
shareholders elect and which involve nominal fees, such as the $10 fee for a
delivery of redemption proceeds by wire transfer.
Further information concerning yield and total return is included in the
SAI.
TOTAL RETURN - VIRGINIA BOND FUND. The Fund's average annual total return is
computed by determining the average annual compounded rate of return for a
specified period which, when applied to a hypothetical $1,000 investment in the
Fund at the beginning of the period, would produce the redeemable value of that
investment at the end of the period, assuming reinvestment of all dividends and
distributions during the period.
YIELD - VIRGINIA BOND FUND. The Fund may advertise performance in terms of a 30-
day yield quotation. The yield quotation is computed by dividing the net
investment income per share earned during the period by the offering price per
share on the last day of the period. This income is then annualized. For
purposes of the yield calculation, interest income is computed based on the
yield to maturity of each debt obligation in a Fund's portfolio and all
recurring charges are recognized.
YIELD - VIRGINIA MONEY MARKET FUND. The Fund may advertise its yield and
effective yield. The yield of the Fund refers to the income generated by an
investment in the Fund over a seven-day period (which period will be stated in
the advertisement). This income is then annualized, that is, the amount of
income generated by the investment during the week is assumed to be generated
each week over a 52-week period and is shown as a percentage of the investment.
The effective yield is calculated similarly but, when annualized, the income
earned by an investment in the Fund is assumed to be reinvested. The effective
yield will be slightly higher than the yield because of the compounding effect
of this assumed reinvestment.
TAX EQUIVALENT YIELD - The Funds may also utilize tax equivalent yields with
adjustments for assumed income tax rates. See Appendix C - Taxable Equivalent
Yield Table in the SAI for illustrations of this
yield.
8
<PAGE>
USAA FAMILY OF NO-LOAD MUTUAL FUNDS
The USAA Family of No-Load Mutual Funds includes a variety of Funds, each with
different objectives and policies. In combination, these Funds are designed to
provide investors with the opportunity to formulate their own investment
program. You may exchange any shares you hold in any one USAA Fund for shares in
any other USAA Fund. For more complete information about the Funds in the USAA
Family of Funds, including charges and expenses, call the Manager for a
Prospectus. Read it carefully before you invest or send money.
USAA TAX EXEMPT FUND, INC.
Long-Term Fund
Intermediate-Term Fund
Short-Term Fund
Tax Exempt Money Market Fund
California Bond Fund*
California Money Market Fund*
New York Bond Fund*
New York Money Market Fund*
Virginia Bond Fund*
Virginia Money Market Fund*
USAA MUTUAL FUND, INC.
Aggressive Growth Fund
Science & Technology Fund
Growth Fund
First Start Growth Fund
S&P 500 Index Fund**
Growth & Income Fund
Income Stock Fund
Income Fund
Short-Term Bond Fund
Money Market Fund
USAA INVESTMENT TRUST
Income Strategy Fund
Growth and Tax Strategy Fund
Balanced Strategy Fund
Cornerstone Strategy Fund
Growth Strategy Fund
Emerging Markets Fund
Gold Fund
International Fund
World Growth Fund
GNMA Trust
Treasury Money Market Trust
USAA STATE TAX-FREE TRUST
Florida Tax-Free Income Fund*
Florida Tax-Free Money Market Fund*
Texas Tax-Free Income Fund*
Texas Tax-Free Money Market Fund*
* Available for sale only to residents of these specific states.
** S&P is a trademark of The McGraw-Hill Companies, Inc., and has been
licensed for use. The Product is not sponsored, sold or promoted by
Standard & Poor's and Standard & Poor's makes no representation regarding
the advisability of investing in the Product.
9
<PAGE>
USING MUTUAL FUNDS IN AN INVESTMENT PROGRAM
I. THE IDEA BEHIND MUTUAL FUNDS
Mutual funds provide small investors some of the advantages enjoyed by wealthy
investors. A relatively small investment can buy part of a widely diversified
portfolio. That portfolio is managed by investment professionals, relieving the
shareholder of the need to make individual stock or bond selections. The
investor also enjoys conveniences, such as daily pricing, liquidity, and in the
case of the USAA Family of Funds, no sales charge. The portfolio, because of its
size, has lower transaction costs on its trades than most individuals would
have. As a result each shareholder owns an investment that in earlier times
would have been available only to very wealthy people.
II. USING FUNDS IN AN INVESTMENT PROGRAM
In choosing a mutual fund as an investment vehicle, the shareholder is foregoing
some investment decisions, but must still make others. The decisions foregone
are those involved with choosing individual securities. The Fund Manager will
perform that function. In addition, the Manager will arrange for the safekeeping
of securities, auditing the annual financial statements, and daily valuation of
the Fund, as well as other functions.
The shareholder, however, retains at least part of the responsibility for
an equally important decision. This decision includes determining a portfolio of
mutual funds that balances the investor's investment goals with his or her
tolerance for risk. It is likely that this decision may involve the use of more
than one fund of the USAA Family of Funds.
For example, assume a shareholder wishes to pursue the higher yields usually
available in the long-term bond market, but is also concerned about the possible
price swings of the long-term bonds. He or she could divide investments between
the Virginia Bond Fund and the Virginia Money Market Fund. This would create a
portfolio with a higher yield than that of the money market and less volatility
than that of the long-term market. This is just one example of how an individual
could combine funds to create a portfolio tailored to his or her own risk and
reward goals.
III. USAA'S FAMILY OF FUNDS
The Manager offers investors another alternative in its asset strategy funds,
the Income Strategy, Growth and Tax Strategy, Balanced Strategy, Cornerstone
Strategy and Growth Strategy Funds. These unique mutual funds provide a
professionally managed diversified investment portfolio within a mutual fund.
These Funds are designed for the shareholder who prefers to delegate the asset
allocation process to an investment manager. The Funds are structured to achieve
diversification across a number of investment categories.
Whether you prefer to create your own mix of mutual funds or use an asset
strategy fund, the USAA Family of Funds provides a broad range of choices
covering just about any investor's investment objectives. Our sales
representatives stand ready to inform you of your choices and to help you craft
a portfolio which meets your needs.
10
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
INVESTMENT OBJECTIVES
The Funds have a common investment objective of providing Virginia investors
with a high level of current interest income that is exempt from federal and
Virginia state income taxes. The Virginia Money Market Fund has a further
objective of preserving capital and maintaining liquidity.
INVESTMENT POLICIES
The Manager will pursue this common objective by investing each Fund's assets in
debt obligations issued by the Commonwealth of Virginia, its political
subdivisions and instrumentalities, and by other governmental entities if, in
the opinion of counsel, the interest from such obligations is excluded from
gross income for federal income tax purposes and is exempt from Virginia state
income taxes. It is a fundamental policy of each Fund that during normal market
conditions at least 80% of the Fund's net assets will consist of Virginia
tax-exempt securities and at least 80% of the Fund's annual income will be
exempt from federal and Virginia state income taxes and excluded from the
calculation of federal alternative minimum taxes for individual taxpayers.
VIRGINIA BOND FUND. Under normal market conditions, the Manager will invest the
assets of the Fund so that at least 50% of the total market value of the
tax-exempt securities is rated within the three highest long-term rating
categories (at least A) by Moody's Investors Service, Inc. (Moody's), Standard &
Poor's Ratings Group (S&P), or Fitch Investors Service, Inc. (Fitch), in the
highest short-term rating category by Moody's, S&P, or Fitch, or, if a security
is not rated by those rating agencies, it must be of equivalent investment
quality as determined by the Manager. In no event will a security be purchased
for the Fund unless it is rated at least investment grade; i.e., rated by
Moody's, S&P, or Fitch at least in the fourth highest rating category for
long-term securities, in the second highest rating category for short-term
securities, or, if not rated by those rating agencies, determined by the Manager
to be of equivalent investment quality. Securities rated in the lowest level of
investment grade have speculative characteristics since adverse economic
conditions and changing circumstances are more likely to have an adverse impact
on such securities.
If the rating of a security is downgraded, the Manager will determine
whether it is in the best interest of the Fund's shareholders to continue to
hold such security in the Fund's portfolio. Unless otherwise directed by the
Board of Directors, if downgrades result in more than 5% of a Fund's net assets
being invested in securities that are less than investment grade quality, the
Manager will take immediate action to reduce the Fund's holdings in such
securities to 5% or less of the Fund's net assets. For a more complete
description of tax-exempt securities and their ratings, see APPENDIX A to the
SAI.
The Fund's average portfolio maturity is not restricted, but is expected to
be greater than ten years. In determining a security's maturity for purposes of
calculating the Fund's average maturity, estimates of the expected time for its
principal to be paid may be used. This can be substantially shorter than its
stated final maturity. For a discussion of the method of calculating the average
weighted maturity of the Fund's portfolio, see INVESTMENT POLICIES in the SAI.
The net asset value (NAV) per share of the Virginia Bond Fund will fluctuate
with portfolio maturity, the quality of securities held, and inversely to
interest rate levels.
VIRGINIA MONEY MARKET FUND. The Fund will purchase only high quality securities
that qualify as "eligible securities" under the SEC rules applicable to money
market mutual funds. These securities must also be determined by the Manager to
present
11
<PAGE>
minimal credit risk. In general, the category of eligible securities may include
a security that is:
(1) issued or guaranteed by the U.S. Government or any agency or
instrumentality thereof, including "prerefunded" and "escrowed to maturity"
tax-exempt securities;
(2) rated in one of the two highest categories for short-term securities by at
least two Nationally Recognized Statistical Rating Organizations (NRSROs),
or by one NRSRO if the security is rated by only one NRSRO;
(3) unrated but issued by an issuer or guaranteed by a guarantor that has other
comparable short-term debt obligations so rated; or
(4) unrated but determined to be of comparable quality by the Manager.
If a security is downgraded after purchase, the Manager will follow written
procedures adopted by the Company's Board of Directors and a determination will
be made as to whether it is in the best interest of the Fund's shareholders for
the Fund to continue to hold the security.
Current NRSROs include Moody's, S&P, Fitch, Duff & Phelps Inc., Thompson
BankWatch, Inc., and IBCA Inc. For a description of tax-exempt securities and
their ratings, see APPENDIX A to the SAI.
Consistent with regulatory requirements, the Manager will purchase
securities with remaining maturities of 397 days or less and will maintain a
dollar-weighted average portfolio maturity of no more than 90 days. The Fund
will endeavor to maintain a constant net asset value of $1.00 per share,
although there is no assurance that it will be able to do so.
OTHER INVESTMENT INFORMATION
The investment objectives of the Funds may not be changed without shareholder
approval. In view of the risks inherent in all investments in securities, there
is no assurance that these objectives will be achieved. The investment policies
and techniques used to pursue the Funds' objectives may be changed without
shareholder approval, except as otherwise noted. Further information regarding
the Funds' investment policies and restrictions is provided in the SAI.
TAX-EXEMPT SECURITIES
These securities include general obligation bonds, which are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest; revenue bonds, which are payable from the revenue
derived from a particular facility or class of facilities or, in some cases,
from annual appropriations made by the state legislature for the repayment of
interest and principal or other specific revenue source, but not from the
general taxing power; lease obligations backed by the municipality's covenant to
budget for the payments due under the lease obligation; and certain types of
industrial development bonds issued by or on behalf of public authorities to
obtain funds for privately- operated facilities, provided that the interest paid
on such securities qualifies as exempt from federal and Virginia state income
taxes.
The value of the securities in which a Fund will invest generally fluctuates
inversely with changes in prevailing interest rates. Changes in the
creditworthiness of issuers and changes in other market factors such as the
relative supply of and demand for tax-exempt bonds also create value
fluctuations.
Each Fund may on a temporary basis due to market or other conditions invest
up to 100% of its assets in short-term securities whether or not exempt from
federal and Virginia state income taxes. Such taxable securities may consist of
obligations of the
12
<PAGE>
U.S. Government, its agencies or instrumentalities, and repurchase agreements
secured by such instruments.
INVESTMENT TECHNIQUES
VARIABLE RATE SECURITIES - Each Fund may invest in tax-exempt securities that
bear interest at rates which are adjusted periodically to market rates. These
interest rate adjustments can both raise and lower the income generated by such
securities. These changes will have the same effect on the income earned by a
Fund depending on the proportion of such securities held.
The market value of fixed coupon securities fluctuates with changes in
prevailing interest rates, increasing in value when interest rates decline and
decreasing in value when interest rates rise. The value of variable rate
securities, however, is less affected by changes in prevailing interest rates
because of the periodic adjustment of their coupons to a market rate. The
shorter the period between adjustments, the smaller the impact of interest rate
fluctuations on the value of these securities. The market value of tax-exempt
variable rate securities usually tends toward par (100% of face value) at
interest rate adjustment time.
In the case of the Virginia Money Market Fund only, any variable rate
instrument with a demand feature will be deemed to have a maturity equal to
either the date on which the underlying principal amount may be recovered
through demand or the next rate adjustment date consistent with applicable
regulatory requirements.
PUT BONDS - Each Fund may invest in tax-exempt securities (including securities
with variable interest rates) which may be redeemed or sold back (put) to the
issuer of the security or a third party prior to stated maturity (put bonds).
Such securities will normally trade as if maturity is the earlier put date, even
though stated maturity is longer. For the Virginia Bond Fund, maturity for put
bonds is deemed to be the date on which the put becomes exercisable. Generally,
maturity for put bonds for the Virginia Money Market Fund is determined as
stated under Variable Rate Securities.
ZERO COUPON BONDS - Each Fund may invest in zero coupon bonds. A zero coupon
bond is a security that is sold at a deep discount from its face value, makes no
periodic interest payments, and is redeemed at face value when it matures. The
lump sum payment at maturity increases the price volatility of the zero coupon
bond to changes in interest rates when compared to a bond that distributes a
semiannual coupon payment. In calculating its dividend, each Fund records as
income the daily amortization of the purchase discount.
WHEN-ISSUED SECURITIES - Each Fund may invest in new issues of tax-exempt
securities offered on a when-issued basis; that is, delivery and payment take
place after the date of the commitment to purchase, normally within 45 days.
Both price and interest rate are fixed at the time of commitment. The Funds do
not earn interest on the securities until settlement, and the market value of
the securities may fluctuate between purchase and settlement. Such securities
can be sold before settlement date.
Cash or high quality liquid debt securities equal to the amount of the when-
issued commitments are segregated at the Fund's custodian bank. The segregated
securities are valued at market, and daily adjustments are made to keep the
value of the cash and segregated securities at least equal to the amount of such
commitments by the Fund. On the settlement date, the Fund will meet its
obligations from then available cash, sale of segregated securities, sale of
other securities, or sale of the when-issued securities themselves.
MUNICIPAL LEASE OBLIGATIONS - Each Fund may invest in municipal lease
obligations and certificates of participation in such obligations (collectively,
lease obligations). A
13
<PAGE>
lease obligation does not constitute a general obligation of the municipality
for which the municipality's taxing power is pledged, although the lease
obligation is ordinarily backed by the municipality's covenant to budget for the
payments due under the lease obligation.
Certain lease obligations contain "non-appropriation" clauses which
provide that the municipality has no obligation to make lease obligation
payments in future years unless money is appropriated for such purpose on a
yearly basis. Although "non-appropriation" lease obligations are secured by the
leased property, disposition of the property in the event of foreclosure might
prove difficult. In evaluating a potential investment in such a lease
obligation, the Manager will consider: (1) the credit quality of the obligor,
(2) whether the underlying property is essential to a governmental function, and
(3) whether the lease obligation contains covenants prohibiting the obligor from
substituting similar property if the obligor fails to make appropriations for
the lease obligation.
LIQUIDITY - The Virginia Bond Fund and Virginia Money Market Fund may invest up
to 15% and 10%, respectively, of their net assets in illiquid securities.
Lease obligations and certain put bonds that are subject to restrictions on
transfer may be determined to be liquid in accordance with the guidelines
established by the Board of Directors.
In determining the liquidity of a lease obligation, the Manager will
consider: (1) the frequency of trades and quotes for the lease obligation, (2)
the number of dealers willing to purchase or sell the lease obligation and the
number of other potential purchasers, (3) dealer undertakings to make a market
in the lease obligation, (4) the nature of the marketplace trades, including the
time needed to dispose of the lease obligation, the method of soliciting offers,
and the mechanics of transfer, (5) whether the lease obligation is of a size
that will be attractive to institutional investors, (6) whether the lease
obligation contains a non-appropriation clause and the likelihood that the
obligor will fail to make an appropriation therefor, and (7) such other factors
as the Manager may determine to be relevant to such determination.
In determining the liquidity of put bonds with restrictions on transfer, the
Manager will evaluate the credit quality of the party (the Put Provider) issuing
(or unconditionally guaranteeing performance on) the unconditional put or demand
feature of the put bond.
INVESTMENT RESTRICTIONS
The following restrictions may not be changed without shareholder approval:
(1) Neither Fund may borrow money, except for temporary or emergency purposes
in an amount not exceeding 33 1/3% of its total assets (including the
amount borrowed) less liabilities (other than borrowings).
(2) Neither Fund may invest 25% or more of its total assets in securities
issued in connection with the financing of projects with similar
characteristics, such as toll road revenue bonds, housing revenue bonds or
electric power project revenue bonds or in industrial revenue bonds which
are based, directly or indirectly, on the credit of private entities of any
one industry. However, each Fund reserves he right to invest more than 25%
of its total assets in tax-exempt industrial revenue bonds.
(3) Neither Fund will invest 25% or more of its total assets in the securities
of a single issuer, and neither Fund will, with respect to 75% of its total
assets, invest more than 5% of its total assets in securities of a single
issuer.
14
<PAGE>
RISK FACTORS
Each Fund is subject to credit and market risks, which will be intensified by
concentration in obligations issued by or on behalf of Virginia public
authorities. For this reason, the Funds are affected by political, economic,
legal, regulatory or other developments which constrain the taxing, spending and
revenue collection authority of Virginia issuers or otherwise affect the ability
of Virginia issuers to pay interest, repay principal or any premium. AN
INVESTMENT IN THE VIRGINIA MONEY MARKET FUND MAY BE RISKIER THAN AN INVESTMENT
IN OTHER TYPES OF MONEY MARKET FUNDS BECAUSE OF THIS CONCENTRATION.
In addition, because each Fund invests in securities backed by banks and
other financial institutions, changes in the credit quality of these
institutions could cause losses to a Fund and affect its share price.
Other considerations affecting the Funds' investments in Virginia
obligations are summarized in the SAI under SPECIAL RISK CONSIDERATIONS.
PURCHASE OF SHARES
OPENING AN ACCOUNT
You may open an account and make an investment by any of the following methods.
A complete, signed application is required together with a check for each new
account.
TAX ID NUMBER
We require that each shareholder named on the account provide the Company with a
social security number or tax identification number to avoid possible tax
withholding requirements.
EFFECTIVE DATE
When you make a purchase, your purchase price will be the NAV per share next
determined after the Fund receives your request in proper form. The NAV of each
Fund is determined at the close of the regular trading session of the New York
Stock Exchange (NYSE) each day the Exchange is open. If a Fund receives your
request prior to that time, your purchase price will be the NAV per share
determined for that day. If a Fund receives your request after the NAV per share
is calculated, the purchase will be effective on the next business day.
Because of the more lengthy clearing process and the need to convert foreign
currency, a check drawn on a foreign bank will not be deemed received for the
purchase of shares until such time as the check has cleared and the Manager has
received good funds, which may take up to four to six weeks. Furthermore, a bank
charge may be assessed in the clearing process, which will be deducted from the
amount of the purchase. To avoid a delay in the effectiveness of your purchase,
the Manager suggests that you convert your foreign check to U.S. dollars prior
to investment in the Funds.
15
<PAGE>
PURCHASE OF SHARES
MINIMUM INVESTMENTS
- -------------------
Initial Purchase: $3,000
Additional Purchases: $50 - (Except transfers from brokerage accounts
into the Virginia Money Market Fund, which are
exempt from minimum)
HOW TO PURCHASE:
- ---------------
MAIL o To open an account, send your application and check to:
USAA Investment Management Company
9800 Fredericksburg Rd., San Antonio, TX 78288
o To add to your account, send your check and the "Invest by
Mail" stub that accompanies your fund's transaction
confirmation to the Transfer Agent:
USAA Shareholder Account Services
9800 Fredericksburg Rd., San Antonio, TX 78288
o To exchange by mail, call 1-800-531-8448 for instructions.
IN PERSON o To open an account, bring your application and check to:
USAA Investment Management Company
USAA Federal Savings Bank
10750 Robert F. McDermott Freeway, San Antonio
AUTOMATICALLY o Additional purchases on a regular basis can be deducted
VIA from a bank account, paycheck, income-producing investment
ELECTRONIC or from a USAA money market account. Sign up for these
FUNDS services when opening an account or call 1-800-531-8448 to
TRANSFER add these services.
o Purchases through payroll deduction ($25 minimum each pay
period with (EFT) no initial investment) can be made by any
employee of USAA, its subsidiaries or affiliated companies.
BANK WIRE o To add to an account, instruct your bank (which may
charge a fee for the service) to wire the specified amount
to the Fund as follows:
State Street Bank and Trust Company, Boston, MA 02101
ABA#011000028
Attn: USAA [Fund Name]
USAA AC-69384998
Shareholder(s) Name(s)_________________
Shareholder(s) Account Number___________________
PHONE o If you have an existing USAA account and would like to open
1-800-531-8448 a new account or if you would like to exchange to another
USAA fund, call for instructions. The new account must have
the same registration as your existing account.
o To add to an account, intermittent (as-needed) purchases
can be deducted from your bank account through our Buy/Sell
Service. Call for instructions.
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REDEMPTION OF SHARES
You may redeem shares of a Fund by any of the following methods on any day the
NAV per share is calculated. Redemptions will be effective on the day
instructions are received in accordance with the requirements set forth below.
However, if instructions are received after the NAV per share calculation,
redemption will be effective on the next business day.
REDEMPTION PROCEEDS
Redemption proceeds are distributed within seven days after the effective date
of redemption. Payment for redemption of shares purchased by check or electronic
funds transfer will not be disbursed until the purchase check or electronic
funds transfer has cleared, which could take up to 15 days from the purchase
date. If you are considering redeeming shares soon after purchase, you should
purchase by bank wire or certified check to avoid delay.
In addition, the Company may elect to suspend the redemption of shares or
postpone the date of payment during any period that the NYSE is closed, or
trading in the markets the Company normally utilizes is restricted, or during
any period that redemption is otherwise permitted to be suspended by the SEC.
HOW TO REDEEM:
- -------------
WRITTEN, o Send your written instructions to:
FAX, OR USAA Shareholder Account Services
TELEGRAPH 9800 Fredericksburg Rd., San Antonio, TX 78288
o Send a signed fax to 1-800-292-8177, or send a telegraph to
USAA Shareholder Account Services.
Written redemption requests must include the following: (1) a letter of
instruction or stock assignment, and stock certificate (if issued), specifying
the Fund and the number of shares or dollar amount to be redeemed; (2)
signatures of all owners of the shares exactly as their names appear on the
account; (3) other supporting legal documents, if required, as in the case of
estates, trusts, guardianships, custodianships, partnerships, corporations, and
pension and profit-sharing plans; and (4) method of payment.
PHONE o Call toll free 1-800-531-8448, in San Antonio, 456-7202.
Telephone redemption is automatically established when you complete your
application. The Fund will employ reasonable procedures to confirm that
instructions communicated by telephone are genuine, and if it does not, it may
be liable for any losses due to unauthorized or fraudulent instructions.
Information is obtained prior to any discussion regarding an account including:
(1) USAA number or account number, (2) the name(s) on the account registration,
and (3) social security number or tax identification number for the account
registration. In addition, all telephone communications with a shareholder are
recorded, and confirmations of all account transactions are sent to the address
of record.
Redemption by telephone, fax, or telegraph is not available for shares
represented by stock certificates.
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<PAGE>
METHODS OF PAYMENT:
- ------------------
BANK WIRE o Allows redemptions to be sent directly to your bank account.
Establish this service when you apply for your account, or later upon
request. Please obtain precise wiring instructions from your financial
institution. USAA Shareholder Account Services (Transfer Agent) deducts a wire
fee from the account for the redemption by wire. The fee as of the date of this
Prospectus is $10 ($25 for wires to a foreign bank) and is subject to change at
any time. The fee is paid to State Street Bank and Trust Company (SSB) and the
Transfer Agent for their services in connection with the wire redemption. Your
financial institution may also charge a fee for receiving funds by wire.
AUTOMATICALLY o Systematic (regular) or intermittent (as-needed) redemptions
VIA EFT can be credited to your bank account.
Establish any of our electronic investing services when you apply for your
account, or later upon request.
CHECK o A check payable to the registered shareholder(s) will be
REDEMPTION mailed to the address of record.
This check redemption privilege is automatically established when your
application is completed and accepted. There is a 15-day waiting period before a
check redemption can be processed following a telephone address change. Should
you wish to redeem shares within the 15 days following a telephone address
change, you may do so by providing written instructions by mail or facsimile.
CHECKWRITING o Checks can be issued for your Virginia Money Market Fund
account.
To establish your checkwriting privilege (CWP), complete the signature card
which accompanies the application form or Shareholder Services Guide, or request
and complete the signature card separately. There is no charge for the use of
checks nor for subsequent reorders. This privilege is subject to SSB's rules and
regulations governing checking accounts. Checks must be written for an amount of
at least $250. Checks written for less than $250 will be returned. Checkwriting
may not be used to close an account because the value of the account changes
daily as dividends are accrued.
When a check is presented to the Transfer Agent for payment, a sufficient
number of full and fractional shares in the investor's account will be redeemed
to cover the amount of the check. Checks will be returned if there are
insufficient shares to cover the amount of the check. Presently, there is a $15
processing fee assessed against an account for any redemption check not honored
by a clearing or paying agent. A check paid during the month will be returned to
the shareholder by separate mail. Checkwriting fees are subject to change at any
time. The Company, the Transfer Agent and SSB each reserve the right to change
or suspend the checkwriting privilege upon 30 days' written notice to
participating shareholders. See the SAI for further information.
You may request that the Transfer Agent stop payment on a check. The
Transfer Agent will use its best efforts to execute stop payment instructions,
but does not guarantee that such efforts will be effective. A $10 charge will be
made for each stop payment requested by a shareholder.
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CONDITIONS OF PURCHASE AND REDEMPTION
NONPAYMENT
If any order to purchase shares is cancelled due to nonpayment or if the Company
does not receive good funds either by check or electronic funds transfer, the
Transfer Agent will treat the cancellation as a redemption of shares purchased,
and you will be responsible for any resulting loss incurred by the Fund or the
Manager. If you are a shareholder, the Transfer Agent can redeem shares from any
of your account(s) as reimbursement for all losses. In addition, you may be
prohibited or restricted from making future purchases in any of the USAA Family
of Funds. A $15 fee is charged for all returned items, including checks and
electronic funds transfers.
TRANSFER OF SHARES
You may transfer Fund shares to another person by sending written instructions
to the Transfer Agent. The account must be clearly identified, and you must
include the number of shares to be transferred, the signatures of all registered
owners, and all stock certificates, if any, which are the subject of transfer.
You also need to send written instructions signed by all registered owners and
supporting documents to change an account registration due to events such as
divorce, marriage, or death. If a new account needs to be established, you must
complete and return an application to the Transfer Agent.
ACCOUNT BALANCE
Beginning in September 1998, and occurring each September thereafter, the
Transfer Agent will assess a small balance account fee of $12 to each
shareholder account with a balance, at the time of assessment, of less than
$2,000. The fee will be used to reduce total transfer agency fees paid by each
Fund to the Transfer Agent. Accounts exempt from the fee include: (1) any
account regularly purchasing additional shares each month through an automatic
investment plan; (2) any account registered under the Uniform Gifts/Transfers to
Minors Act (UGMA or UTMA); (3) all (non IRA) money market fund accounts; (4) any
account whose registered owner has an aggregate balance of $50,000 or more
invested in USAA mutual funds; and (5) all IRA accounts (for the first year the
account is open).
COMPANY RIGHTS The Company reserves the right to:
(1) reject purchase or exchange orders when in the best interest of the
Company;
(2) limit or discontinue the offering of shares of any portfolio of the Company
without notice to the shareholders;
(3) impose a redemption charge of up to 1% of the net asset value of shares
redeemed if circumstances indicate a charge is necessary for the protection
of remaining investors (for example, if excessive market-timing share
activity unfairly burdens long-term investors); provided, however, this 1%
charge will not be imposed upon shareholders unless authorized by the Board
of Directors and the required notice has been given to shareholders;
(4) require a signature guarantee for purchases, redemptions, or changes in
account information in those instances where the appropriateness of a
signature authorization is in question. The section ADDITIONAL INFORMATION
REGARDING REDEMPTION OF SHARES in the SAI contains information on
acceptable guarantors;
(5) redeem an account with a balance of less than 50 full shares of either
Fund, subject to certain limitations described in ADDITIONAL INFORMATION
REGARDING REDEMPTION OF SHARES in the SAI.
19
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EXCHANGES
EXCHANGE PRIVILEGE
The Exchange Privilege is automatically established when you complete your
application. You may exchange shares among Funds in the USAA Family of Funds,
provided you do not hold these shares in stock certificate form and that the
shares to be acquired are offered in your state of residence. Only Virginia
residents may exchange into a Virginia Fund. Exchange redemptions and purchases
will be processed simultaneously at the share prices next determined after the
exchange order is received. For federal income tax purposes, an exchange between
Funds is a taxable event. Accordingly, when exchanging shares, you may realize a
capital gain or loss.
The Funds have undertaken certain procedures regarding telephone
transactions. See REDEMPTION OF SHARES - PHONE.
EXCHANGE LIMITATIONS, EXCESSIVE TRADING
To minimize Fund costs and to protect the Funds and their shareholders from
unfair expense burdens, the Funds restrict excessive exchanges. Exchanges out of
any Fund in the USAA Family of Funds are limited for each account to six per
calendar year except that there is no limitation on exchanges out of the Tax
Exempt Short-Term Fund, Short-Term Bond Fund, or any of the money market funds
in the USAA Family of Funds.
OTHER SERVICES
INVESTMENT PLANS
AUTOMATIC INVESTMENT PLANS - You may establish an automatic investment plan by
completing the appropriate forms, if any. At the time you sign up for any of the
following investment plans that utilize the electronic funds transfer service,
you will choose the day of the month (the effective date) on which you would
like to regularly purchase shares. When this day falls on a weekend or holiday,
the electronic transfer will take place on the last business day before the
effective date. Call the Manager to obtain instructions. More information about
these preauthorized plans is contained in the SAI.
o INVESTRONIC(R) - The regular purchase of additional shares through electronic
funds transfer from a checking or savings account. You may invest as little as
$50 per month.
o DIRECT PURCHASE SERVICE - The periodic purchase of shares through electronic
funds transfer from an employer (including government allotments), an
income-producing investment, or an account with a participating financial
institution.
o AUTOMATIC PURCHASE PLAN - The periodic transfer of funds from a USAA money
market fund to purchase shares in another non-money market USAA mutual fund.
o BUY/SELL SERVICE - The intermittent purchase or redemption of shares through
electronic funds transfer to or from a checking or savings account.
o SYSTEMATIC WITHDRAWAL PLAN - The periodic redemption of shares from one of
your accounts permitting you to receive a fixed amount of money monthly or
quarterly.
o DIRECTED DIVIDENDS - If you own shares in more than one of the Funds in the
USAA Family of Funds, you may direct that dividends and/or capital gain
distributions earned in one fund be used to purchase shares automatically in
another fund.
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<PAGE>
SHAREHOLDER STATEMENTS AND REPORTS
You will receive a confirmation after each transaction in your Virginia Bond
Fund account except:
(1) a reinvested dividend;
(2) a payment you make under the InvesTronic(R), Direct Purchase Service,
Automatic Purchase Plan, or Directed Dividends investment plans; or
(3) a redemption you make under the Systematic Withdrawal Plan.
If you own shares in the Virginia Money Market Fund, you will receive a
confirmation for purchases or redemptions by check and exchanges. If that money
market fund account had activity other than reinvested dividends, such as wire
purchases or redemptions or purchases under the InvesTronic(R), Direct Purchase
Service, Automatic Purchase Plan or Directed Dividends investment plans, you
will receive a monthly statement that will reflect quarter-to-date account
activity.
At the end of each quarter, you will receive a consolidated statement for
all of your mutual fund accounts, regardless of account activity. The fourth
quarter consolidated statement will reflect all account activity for the prior
tax year. There will be a $10 fee charged for copies of historical statements
for other than the prior tax year for any one account. You will receive a Fund's
financial statements with a summary of its investments and performance at least
semiannually.
In an effort to reduce expenses and respond to shareholders' requests to
reduce mail, the Company intends to consolidate mailings of Annual and
Semiannual Reports to households having multiple accounts with the same address
of record. One copy of each report will be furnished to that address. You may
request additional reports by notifying the Company.
TELEPHONE ASSISTANCE
Call our telephone assistance numbers for specific forms, a copy of the SAI, the
most recent Annual Report and/or Semiannual Report, or if you have any questions
concerning any of the services offered.
SHARE PRICE CALCULATION
The price at which shares of the Funds are purchased and redeemed by
shareholders is equal to the NAV per share determined on the effective date of
the purchase or redemption.
WHEN
The NAV per share for each Fund is calculated at the close of the regular
trading session of the NYSE, which is usually 4:00 p.m. Eastern Time. You may
buy and sell Fund shares at the NAV per share without a sales charge.
HOW
The NAV per share is calculated by adding the value of all securities and other
assets in a Fund, deducting liabilities, and dividing by the number of shares
outstanding. Securities of the Virginia Bond Fund are valued each business day
at their current market value as determined by a pricing service approved by the
Board of Directors. Securities which cannot be valued by the pricing service,
and all other assets, are valued in good faith at fair value using methods
determined by the Manager under the general supervision of the Board of
Directors. In addition, securities purchased with maturities of 60 days or less
and all securities of the Virginia Money Market Fund are stated at amortized
cost.
For additional information, see VALUATION OF SECURITIES in the SAI.
21
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DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
Net investment income of each Fund is accrued daily and distributed to
shareholders on the last business day of each month. Net capital gains, if any,
generally will be distributed at least annually. The Funds intend to make such
additional distributions as may be necessary to avoid the imposition of any
federal excise tax.
All shares purchased will begin accruing dividends on the day following the
effective date of the purchase and will receive dividends through the effective
date of redemption.
All income dividends and capital gain distributions are automatically
reinvested, unless the shareholder specifies otherwise. The share price will be
the net asset value of the Fund shares computed on the ex- dividend date. Any
capital gain distribution paid by the Virginia Bond Fund will reduce the NAV per
share by the amount of the distribution. An investor should consider carefully
the effects of purchasing shares of the Virginia Bond Fund shortly before any
capital gain distribution. Although in effect a return of capital, these
distributions are subject to taxes. If a shareholder becomes a resident of a
state other than Virginia, a check for proceeds of income dividends will be
mailed to such shareholder monthly, and a check for any capital gain
distribution will be mailed after the distribution is paid.
Any dividend or distribution payment returned to the Manager as not
deliverable will be invested in the shareholder's Fund account at the
then-current NAV per share. If any check for the payment of dividends or
distributions is not cashed within six months from the date on the check, it
becomes void. The amount of the check will then be invested in the shareholder's
Fund account at the then-current NAV per share.
FEDERAL TAXES
The exemption of interest income for federal income tax purposes does not
necessarily result in exemption under the income or other tax laws of any state
or local taxing authority. The following discussion relates only to generally
applicable federal income tax provisions in effect as of the date of this
Prospectus. Therefore, shareholders are urged to consult their own tax advisers
about the status of distributions from a Fund in their own states and
localities.
FUND - Each Fund intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the Code). By
complying with the applicable provisions of the Code, neither Fund will be
subject to federal income tax on its net investment income and net capital gains
(capital gains in excess of capital losses) distributed to shareholders.
SHAREHOLDER - Dividends of net tax-exempt interest income paid by a Fund are
excluded from a shareholder's gross income for federal income tax purposes.
Dividends from taxable net investment income and distributions of net short-term
capital gains are taxable to shareholders as ordinary income, whether received
in cash or reinvested in additional shares. However, it is expected that any
taxable net investment income will be minimal in relation to the tax-exempt
interest generated by a Fund.
Distributions of net long-term capital gains are taxable as long-term
capital gains whether received in cash or reinvested in additional shares, and
regardless of the length of time the investor has held the shares of a Fund.
22
<PAGE>
Redemptions, including exchanges, are subject to income tax, based on the
difference between the cost of shares when purchased and the price received upon
redemption or exchange.
Tax-exempt interest from private activity bonds (for example, industrial
development revenue bonds) issued after August 7, 1986, although otherwise
exempt from federal tax, is treated as a tax preference item for purposes of the
alternative minimum tax. For corporations, all tax-exempt interest will be
considered in calculating the alternative minimum tax as part of the adjusted
current earnings.
WITHHOLDING - Each Fund is required by federal law to withhold and remit to the
U.S. Treasury a portion of the income dividends and capital gain distributions
and proceeds of redemptions paid to any non-corporate shareholder who fails to
furnish the Fund with a correct tax identification number, who underreports
dividend or interest income, or who fails to certify that he is not subject to
withholding. To avoid this withholding requirement, you must certify on your
application, or on a separate Form W-9 supplied by the Transfer Agent, that your
tax identification number is correct and that you are not currently subject to
backup withholding.
REPORTING - Each Fund will report annually to its shareholders the federal tax
status of dividends and distributions paid or declared by each Fund during the
preceding calendar year, including the portion of the dividends constituting
interest on private activity bonds, and the percentage and source, on a
state-by-state basis, of interest income earned on tax-exempt securities held by
the Fund during the preceding year.
VIRGINIA TAXATION
Dividends paid by the Funds and derived from interest on obligations of the
Commonwealth of Virginia or of any political subdivision or instrumentality of
the Commonwealth, which pay interest excludable from federal gross income, or
derived from obligations of the United States, which pay interest or dividends
excludable from Virginia taxable income under the laws of the United States,
will be exempt from the Virginia income tax. Dividends (1) paid by the Funds,
(2) excluded from gross income for federal income tax purposes, and (3) derived
from interest on obligations of certain territories and possessions of the
United States (those issued by Puerto Rico, the Virgin Islands and Guam) will be
exempt from the Virginia income tax. To the extent a portion of the dividends is
derived from interest on obligations other than those described above, such
portion will be subject to the Virginia income tax even though it may be
excludable from gross income for federal income tax purposes.
As a general rule, distribution of short-term capital gains realized by the
Funds will be taxable to the shareholders as ordinary income. Distributions of
long-term capital gains generally will be taxable as such to the shareholders
regardless of how long they have held their shares.
The foregoing is only a summary of some of the important Virginia income
tax considerations generally affecting the Funds and their shareholders, and
does not address any Virginia taxes other than income taxes. This discussion is
not intended as a substitute for careful planning. Potential investors in the
Funds should consult their tax advisers with specific reference to their own tax
situations.
23
<PAGE>
MANAGEMENT OF THE COMPANY
The business affairs of the Company are subject to the supervision of the Board
of Directors.
The Manager, USAA Investment Management Company (IMCO), was organized in
May 1970 and is an affiliate of United Services Automobile Association (USAA), a
large diversified financial services institution. As of the date of this
Prospectus, the Manager had approximately $35 billion in total assets under
management. The Manager's mailing address is 9800 Fredericksburg Rd., San
Antonio, TX 78288.
Officers and employees of the Manager are permitted to engage in personal
securities transactions subject to restrictions and procedures set forth in the
Joint Code of Ethics adopted by the Company and the Manager. Such restrictions
and procedures include substantially all of the recommendations of the Advisory
Group of the Investment Company Institute and comply with SEC rules and
regulations.
ADVISORY AGREEMENT
The Manager serves as the manager and investment adviser of the Company,
providing services under an Advisory Agreement. Under the Advisory Agreement,
the Manager is responsible for the management of the business affairs,
investment portfolios, and placement of brokerage orders, subject to the
authority of and supervision by the Board of Directors.
For its services under the Advisory Agreement, each Fund pays the Manager
an annual fee which is computed as a percentage of the aggregate ANA of both
Funds combined. The fee is accrued daily, paid monthly, and allocated between
the Funds based on the relative net assets of each. The fee is computed at .50%
of the first $50,000,000 ANA, .40% of that portion over $50,000,000 and not over
$100,000,000 ANA, and .30% of that portion over $100,000,000 ANA. For the fiscal
year ended March 31, 1997, the fees paid to the Manager, net of reimbursements,
were .34% of ANA for the Virginia Bond Fund and .31% of ANA for the Virginia
Money Market Fund.
OPERATING EXPENSES
For the fiscal year ended March 31, 1997, the Manager limited each Fund's total
operating expenses to .50% of its ANA. The Manager reimbursed the Virginia Money
Market Fund $36,204 for expenses in excess of the limitation. Total operating
expenses for the Virginia Bond Fund were .46% of its ANA, and as such no
reimbursements were required. The Manager has voluntarily agreed to continue to
limit each Fund's annual expenses until August 1, 1998, to .50% of its ANA and
will reimburse the Funds for all expenses in excess of the limitation.
PORTFOLIO MANAGERS
The following individuals are primarily responsible for managing the Funds.
VIRGINIA BOND FUND
Robert R. Pariseau, Assistant Vice President of Fixed Income Investments since
June 1995, has managed the Fund since May 1995. He has 13 years investment
management experience working for IMCO, where he has held various positions in
Fixed Income and Equity Investments. Mr. Pariseau earned the Chartered Financial
Analyst (CFA) designation in 1987 and is a member of the Association for
Investment Management and Research (AIMR), San Antonio Financial Analysts
Society, Inc. (SAFAS), and the National Federation of Municipal Analysts (NFMA).
He holds an MBA from Lindenwood College and a BS from the U.S. Naval Academy.
24
<PAGE>
VIRGINIA MONEY MARKET FUND
John C. Bonnell, Executive Director of Money Market Funds since May 1996, has
managed the Fund since May 1996. He has eight years investment management
experience working for IMCO, where he has held various positions in Fixed Income
Investments. Mr. Bonnell earned the CFA designation in 1994 and is a member of
the AIMR, the SAFAS, the NFMA and the Southern Municipal Finance Society. He
holds an MBA from St. Mary's University and a BBA from the University of Texas
at San Antonio.
DESCRIPTION OF SHARES
The Company is an open-end management investment company incorporated under the
laws of the State of Maryland on November 16, 1981. The Company is authorized to
issue shares in separate portfolios. Ten such portfolios have been established,
two of which are described in this Prospectus. Each of the two Funds is
classified as diversified. Under the Company's charter, the Board of Directors
is authorized to create new portfolios in addition to those already existing
without the approval of the shareholders of the Company.
Under the provisions of the Bylaws of the Company, no annual meeting of
shareholders is required. Ordinarily, no shareholder meeting will be held unless
required by the 1940 Act. The Directors may fill vacancies on the Board or
appoint new Directors provided that immediately after such action at least
two-thirds of the Directors have been elected by shareholders.
Shareholders are entitled to one vote per share (with proportionate voting
for fractional shares) irrespective of the relative net asset value of the
shares. For matters affecting an individual portfolio, a separate vote of the
shareholders of that portfolio is required.
25
<PAGE>
SERVICE PROVIDERS
UNDERWRITER/ USAA Investment Management Company
DISTRIBUTOR 9800 Fredericksburg Rd., San Antonio, Texas 78288.
TRANSFER USAA Shareholder Account Services
AGENT 9800 Fredericksburg Rd., San Antonio, Texas 78288.
CUSTODIAN State Street Bank and Trust Company
P.O. Box 1713, Boston, Massachusetts 02105.
LEGAL Goodwin, Procter & Hoar LLP
COUNSEL Exchange Place, Boston, Massachusetts 02109.
INDEPENDENT KPMG Peat Marwick LLP
AUDITORS 112 East Pecan, Suite 2400, San Antonio, Texas 78205.
TELEPHONE ASSISTANCE
(Call toll free - Central Time)
Monday-Friday 8:00 a.m. to 8:00 p.m.
Saturday 8:30 a.m. to 5:00 p.m.
For further information on mutual funds:
1-800-531-8181
In San Antonio 456-7211
For account servicing, exchanges or redemptions:
1-800-531-8448
In San Antonio 456-7202
RECORDED 24 HOUR SERVICE
MUTUAL FUND PRICE QUOTES
(From any phone)
1-800-531-8066
In San Antonio 498-8066
MUTUAL FUND TOUCHLINE(R)
(From Touchtone phones only)
For account balance, last transaction or fund prices:
1-800-531-8777
In San Antonio 498-8777
26
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28
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PART B
Statements of Additional Information for the
Long-Term, Intermediate-Term, Short-Term
and Tax Exempt Money Market Funds,
California Bond and California Money Market Funds,
New York Bond and New York Money Market Funds, and
Virginia Bond and Virginia Money Market Funds
are included herein
<PAGE>
Part B
Statement of Additional Information for the
Long-Term, Intermediate-Term, Short-Term
and Tax Exempt Money Market Funds
<PAGE>
[USAA EAGLE LOGO]
USAA STATEMENT OF
TAX EXEMPT ADDITIONAL INFORMATION
FUND, INC. August 1, 1997
- --------------------------------------------------------------------------------
USAA TAX EXEMPT FUND, INC.
USAA TAX EXEMPT FUND, INC. (the Company) is a registered investment company
offering shares of ten no-load mutual funds, four of which are described in this
Statement of Additional Information (SAI): the Long-Term Fund, Intermediate-Term
Fund, Short-Term Fund, and Tax Exempt Money Market Fund (collectively, the
Funds). Each Fund is classified as diversified and has a common investment
objective of providing investors with interest income that is exempt from
federal income tax. The Tax Exempt Money Market Fund has a further objective of
preserving capital and maintaining liquidity.
You may obtain a free copy of a Prospectus for the Funds dated August 1, 1997,
by writing to USAA Tax Exempt Fund, Inc., 9800 Fredericksburg Rd., San Antonio,
TX 78288, or by calling toll free 1-800-531-8181. The Prospectus provides the
basic information you should know before investing in the Funds. This SAI is not
a Prospectus and contains information in addition to and more detailed than that
set forth in the Prospectus. It is intended to provide you with additional
information regarding the activities and operations of the Company and the
Funds, and should be read in conjunction with the Prospectus.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
2 Valuation of Securities
2 Additional Information Regarding Redemption of Shares
3 Investment Plans
4 Investment Policies
5 Investment Restrictions
6 Portfolio Transactions
7 Further Description of Shares
7 Tax Considerations
9 Directors and Officers of the Company
12 The Company's Manager
13 General Information
13 Calculation of Performance Data
15 Appendix A - Tax-Exempt Securities and Their Ratings
18 Appendix B - Comparison of Portfolio Performance
20 Appendix C - Taxable Equivalent Yield Table
21 Appendix D - Dollar-Cost Averaging
<PAGE>
VALUATION OF SECURITIES
Shares of each Fund are offered on a continuing best efforts basis through USAA
Investment Management Company (IMCO or the Manager). The offering price for
shares of each Fund is equal to the current net asset value (NAV) per share. The
NAV per share of each Fund is calculated by adding the value of all its
portfolio securities and other assets, deducting its liabilities, and dividing
by the number of shares outstanding.
A Fund's NAV per share is calculated each day, Monday through Friday,
except days on which the New York Stock Exchange (NYSE) is closed. The NYSE is
currently scheduled to be closed on New Year's Day, Martin Luther King Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving, and Christmas, and on the preceding Friday or subsequent Monday
when one of these holidays falls on a Saturday or Sunday, respectively.
The investments of the LONG-TERM, INTERMEDIATE-TERM, AND SHORT-TERM FUNDS
are valued each business day by a pricing service (the Service) approved by the
Company's Board of Directors. The Service uses the mean between quoted bid and
asked prices or the last sale price to price securities when, in the Service's
judgment, these prices are readily available and are representative of the
securities' market values. For many securities, such prices are not readily
available. The Service generally prices these securities based on methods which
include consideration of yields or prices of tax-exempt securities of comparable
quality, coupon, maturity and type, indications as to values from dealers in
securities, and general market conditions. Securities purchased with maturities
of 60 days or less are stated at amortized cost which approximates market value.
Repurchase agreements are valued at cost. Securities which cannot be valued by
the Service, and all other assets, are valued in good faith at fair value using
methods determined by the Manager under the general supervision of the Board of
Directors.
The value of the TAX EXEMPT MONEY MARKET FUND'S securities is stated at
amortized cost which approximates market value. This involves valuing a security
at its cost and thereafter assuming a constant amortization to maturity of any
discount or premium, regardless of the impact of fluctuating interest rates.
While this method provides certainty in valuation, it may result in periods
during which the value of an instrument, as determined by amortized cost, is
higher or lower than the price the Fund would receive upon the sale of the
instrument.
The valuation of the Tax Exempt Money Market Fund's portfolio instruments
based upon their amortized cost is subject to the Fund's adherence to certain
procedures and conditions. Consistent with regulatory requirements, the Manager
will only purchase securities with remaining maturities of 397 days or less and
will maintain a dollar-weighted average portfolio maturity of no more than 90
days. The Manager will invest only in securities that have been determined to
present minimal credit risk and that satisfy the quality and diversification
requirements of applicable rules and regulations of the Securities and Exchange
Commission (SEC).
The Board of Directors has established procedures designed to stabilize
the Tax Exempt Money Market Fund's price per share, as computed for the purpose
of sales and redemptions, at $1.00. There can be no assurance, however, that the
Fund will at all times be able to maintain a constant $1.00 NAV per share. Such
procedures include review of the Fund's holdings at such intervals as is deemed
appropriate to determine whether the Fund's NAV calculated by using available
market quotations deviates from $1.00 per share and, if so, whether such
deviation may result in material dilution or is otherwise unfair to existing
shareholders. In the event that it is determined that such a deviation exists,
the Board of Directors will take such corrective action as it regards as
necessary and appropriate. Such action may include selling portfolio instruments
prior to maturity to realize capital gains or losses or to shorten average
portfolio maturity, withholding dividends, or establishing a NAV per share by
using available market quotations.
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
The value of a shareholder's investment at the time of redemption may be more or
less than the cost at purchase, depending on the value of the securities held in
each Fund's portfolio. Requests for redemption which are subject to any special
conditions, or which specify an effective date other than as provided herein,
cannot be accepted. A gain or loss for tax purposes may be realized on the sale
of shares, depending upon the price when redeemed.
The Board of Directors may cause the redemption of an account with a
balance of less than 50 shares provided (1) the value of the account has been
reduced, for reasons other than market action, below the minimum initial
investment in such Fund at the time of the establishment of the account, (2) the
account has remained below the minimum level for six months, and (3) 60 days'
prior written notice of the proposed redemption has been sent to the
shareholder. Shares will be redeemed at the NAV on the date fixed for redemption
by the Board of Directors. Prompt payment will be made by mail to the last known
address of the shareholder.
2
<PAGE>
The Company reserves the right to suspend the right of redemption or
postpone the date of payment (1) for any periods during which the NYSE is
closed, (2) when trading in the markets the Company normally utilizes is
restricted, or an emergency exists as determined by the SEC so that disposal of
the Company's investments or determination of its NAV is not reasonably
practicable, or (3) for such other periods as the SEC by order may permit for
protection of the Company's shareholders.
For the mutual protection of the investor and the Funds, the Company may
require a signature guarantee. If required, EACH signature on the account
registration must be guaranteed. Signature guarantees are acceptable from FDIC
member banks, brokers, dealers, municipal securities dealers, municipal
securities brokers, government securities dealers, government securities
brokers, credit unions, national securities exchanges, registered securities
associations, clearing agencies and savings associations. A signature guarantee
for active duty military personnel stationed abroad may be provided by an
officer of the United States Embassy or Consulate, a staff officer of the Judge
Advocate General, or an individual's commanding officer.
REDEMPTION BY CHECK
Shareholders in the Short-Term Fund or Tax Exempt Money Market Fund may request
that checks be issued for their accounts. Checks must be written in the amount
of at least $250.
Checks issued to shareholders of either Fund will be sent only to the
person in whose name the account is registered and only to the address of
record. The checks must be manually signed by the registered owner(s) exactly as
the account is registered. For joint accounts the signature of either or both
joint owners will be required on the check, according to the election made on
the signature card. Dividends will continue to be earned by the shareholder
until the shares are redeemed by the presentation of a check.
When a check is presented to USAA Shareholder Account Services (Transfer
Agent) for payment, a sufficient number of full and fractional shares in the
investor's account will be redeemed to cover the amount of the check. If an
investor's account is not adequate to cover the amount of a check, the check
will be returned unpaid. A check drawn on an account in the Short-Term Fund may
be returned for insufficient funds if the NAV per share of that Fund declines
over the time between the date the check was written and the date it was
presented for payment. Because the value of an account in either the Short-Term
Fund or Tax Exempt Money Market Fund changes as dividends are accrued on a daily
basis, checks may not be used to close an account.
The Transfer Agent will return to the shareholder checks paid during the
month by separate mail. The checkwriting privilege will be subject to the
customary rules and regulations of State Street Bank and Trust Company (State
Street Bank or the Custodian) governing checking accounts. There is no charge to
the shareholder for the use of the checks or for subsequent reorders of checks.
The Company reserves the right to assess a processing fee against a
shareholder's account for any redemption check not honored by a clearing or
paying agent. Currently, this fee is $15 and is subject to change at any time.
Some examples of such dishonor are improper endorsement, checks written for an
amount less than the minimum check amount, and insufficient or uncollectible
funds.
The Company, the Transfer Agent, and State Street Bank each reserve the
right to change or suspend the checkwriting privilege upon 30 days' written
notice to participating shareholders.
INVESTMENT PLANS
The following investment plans are made available by the Company to shareholders
of all the Funds. At the time you sign up for any of the following investment
plans that utilize the electronic funds transfer service, you will choose the
day of the month (the effective date) on which you would like to regularly
purchase shares. When this day falls on a weekend or holiday, the electronic
transfer will take place on the last business day before the effective date. You
may terminate your participation in a plan at any time. Please call the Manager
for details and necessary forms or applications.
AUTOMATIC PURCHASE OF SHARES
INVESTRONIC(R) - The regular purchase of additional shares through electronic
funds transfers from a checking or savings account. You may invest as little as
$50 per month.
DIRECT PURCHASE SERVICE - The periodic purchase of shares through electronic
funds transfer from an employer (including government allotments), an
income-producing investment, or an account with a participating financial
institution.
AUTOMATIC PURCHASE PLAN - The periodic transfer of funds from a USAA money
market fund to purchase shares in another non-money market USAA mutual fund.
There is a minimum investment required for this program of $5,000 in the money
market fund, with a monthly transaction minimum of $50.
BUY/SELL SERVICE - The intermittent purchase or redemption of shares through
electronic funds transfer to or from a checking or savings account.
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Participation in these systematic purchase plans will permit a shareholder
to engage in dollar-cost averaging. For additional information concerning the
benefits of dollar-cost averaging, see APPENDIX D.
SYSTEMATIC WITHDRAWAL PLAN
If a shareholder in a single investment account (accounts in different Funds
cannot be aggregated for this purpose) owns shares having a NAV of $5,000 or
more, the shareholder may request that enough shares to produce a fixed amount
of money be liquidated from the account monthly or quarterly. The amount of each
withdrawal must be at least $50. Using the electronic funds transfer service,
shareholders may choose to have withdrawals electronically deposited at their
bank or other financial institution. They may also elect to have checks mailed
to a designated address.
Such a plan may be initiated by depositing shares worth at least $5,000
with the Transfer Agent and by completing a Systematic Withdrawal Plan
application, which may be requested from the Manager. The shareholder may
terminate participation in the plan at any time. There is no charge to the
shareholder for withdrawals under the Systematic Withdrawal Plan. The Company
will not bear any expenses in administering the plan beyond the regular transfer
agent and custodian costs of issuing and redeeming shares. The Manager will bear
any additional expenses of administering the plan.
Withdrawals will be made by redeeming full and fractional shares on the
date selected by the shareholder at the time the plan is established. Withdrawal
payments made under this plan may exceed dividends and distributions and, to
this extent, will involve the use of principal and could reduce the dollar value
of a shareholder's investment and eventually exhaust the account. Reinvesting
dividends and distributions helps replenish the account. Because share values
and net investment income can fluctuate, shareholders should not expect
withdrawals to be offset by rising income or share value gains.
Each redemption of shares may result in a gain or loss, which must be
reported on the shareholder's income tax return. Therefore, a shareholder should
keep an accurate record of any gain or loss on each withdrawal.
INVESTMENT POLICIES
The section captioned INVESTMENT OBJECTIVES AND POLICIES in the Prospectus
describes the fundamental investment objectives and the investment policies
applicable to each Fund and the following is provided as additional information.
CALCULATION OF PORTFOLIO WEIGHTED AVERAGE MATURITIES
Weighted average maturity is derived by multiplying the value of each investment
by the number of days remaining to its maturity, adding these calculations, and
then dividing the total by the value of a Fund's portfolio. An obligation's
maturity is typically determined on a stated final maturity basis, although
there are some exceptions to this rule.
With respect to obligations held by the Long-Term Fund, the
Intermediate-Term Fund, and the Short-Term Fund, if it is probable that the
issuer of an instrument will take advantage of a maturity-shortening device,
such as a call, refunding, or redemption provision, the date on which the
instrument will probably be called, refunded, or redeemed may be considered to
be its maturity date. Also, the maturities of securities subject to sinking fund
arrangements are determined on a weighted average life basis, which is the
average time for principal to be repaid. The weighted average life of these
securities is likely to be substantially shorter than their stated final
maturity. In addition, for purposes of these Funds' investment policies, an
instrument will be treated as having a maturity earlier than its stated maturity
date if the instrument has technical features such as puts or demand features
which, in the judgment of the Manager, will result in the instrument being
valued in the market as though it has the earlier maturity.
The Tax Exempt Money Market Fund will determine the maturity of an
obligation in its portfolio in accordance with Rule 2a-7 under the Investment
Company Act of 1940, as amended (1940 Act).
LENDING OF SECURITIES
Each Fund may lend its securities. A lending policy may be authorized by the
Company's Directors and implemented by the Manager, but securities may be loaned
only to qualified broker-dealers or institutional investors that agree to
maintain cash collateral with the Company equal at all times to at least 100% of
the value of the loaned securities. The Directors will establish procedures and
monitor the creditworthiness of any institution or broker-dealer during such
time as any loan is outstanding. The Company will continue to receive interest
on the loaned securities and will invest the cash collateral in readily
marketable short-term obligations of high quality, thereby earning additional
interest. Interest on loaned tax-exempt securities received by the borrower and
paid to the Company will not be exempt from federal income taxes in the hands of
the Company.
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No loan of securities will be made if, as a result, the aggregate of such
loans would exceed 33 1/3% of the value of a Fund's total assets. The Company
may terminate such loans at any time.
REPURCHASE AGREEMENTS
Each Fund may invest up to 5% of its total assets in repurchase agreements. A
repurchase agreement is a transaction in which a security is purchased with a
simultaneous commitment to sell the security back to the seller (a commercial
bank or recognized securities dealer) at an agreed upon price on an agreed upon
date, usually not more than seven days from the date of purchase. The resale
price reflects the purchase price plus an agreed upon market rate of interest
which is unrelated to the coupon rate or maturity of the purchased security. A
repurchase agreement involves the obligation of the seller to pay the agreed
upon price, which obligation is in effect secured by the value of the underlying
security. In these transactions, the securities purchased by a Fund will have a
total value equal to or in excess of the amount of the repurchase obligation and
will be held by the Funds' custodian until repurchased. If the seller defaults
and the value of the underlying security declines, a Fund may incur a loss and
may incur expenses in selling the collateral. If the seller seeks relief under
the bankruptcy laws, the disposition of the collateral may be delayed or
limited. Any investments in repurchase agreements will give rise to income which
will not qualify as tax-exempt income when distributed by a Fund.
INVESTMENT RESTRICTIONS
The following investment restrictions have been adopted by the Company for and
are applicable to each Fund. These restrictions may not be changed for any given
Fund without approval by the lesser of (1) 67% or more of the voting securities
present at a meeting of the Fund if more than 50% of the outstanding voting
securities of the Fund are present or represented by proxy or (2) more than 50%
of the Fund's outstanding voting securities. The investment restrictions of one
Fund may be changed without affecting those of any other Fund.
Under the restrictions, each Fund may not:
(1) With respect to 75% of its total assets, purchase the securities of any
issuer (except Government Securities, as such term is defined in the 1940
Act if, as a result, the Fund would have more than 5% of the value of its
total assets invested in the securities of such issuer;
(2) Purchase more than 10% of the outstanding voting securities of any issuer;
(3) Borrow money, except for temporary or emergency purposes in an amount not
exceeding 33 1/3% of its total assets (including the amount borrowed) less
liabilities (other than borrowings);
(4) Pledge, mortgage or hypothecate its assets to any extent greater than 10%
of the value of its total assets;
(5) Purchase or retain securities of any issuer if any officer or Director of
the Company or its Manager owns individually more than one-half of one
percent (1/2%) of the securities of that issuer, and collectively the
officers and Directors of the Company and Manager together own more than
5% of the securities of that issuer;
(6) Purchase any securities which would cause more than 25% of the value of
that Fund's total assets at the time of such purchase to be invested in
either (i) the securities of issuers conducting their principal activities
in the same state, or (ii) the securities the interest upon which is
derived from revenues or projects with similar characteristics, such as
toll road revenue bonds, housing revenue bonds, electric power project
revenue bonds, etc.; provided that the foregoing limitation does not apply
with respect to investments in U.S. Treasury Bills, other obligations
issued or guaranteed by the U.S. Government, its agencies and
instrumentalities, and, in the case of the Tax Exempt Money Market Fund,
certificates of deposit and banker's acceptances of domestic banks;
(7) Invest in issuers for the purpose of exercising control of management;
(8) Issue senior securities as defined in the 1940 Act, except that it may
purchase tax-exempt securities on a "when-issued" basis as permitted by
Section 18(f)(2);
(9) Underwrite securities of other issuers, except to the extent that it may
be deemed to act as a statutory underwriter in the distribution of any
restricted securities or not readily marketable securities;
(10) Purchase or sell real estate, but this shall not prevent investments in
tax-exempt securities secured by real estate or interests therein;
(11) Lend any securities or make any loan if, as a result, more than 33 1/3% of
its total assets would be lent to other parties, except that this
limitation does not apply to purchases of debt securities or to repurchase
agreements;
(12) Purchase on margin or sell short;
(13) Purchase or sell commodities or commodities contracts;
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(14) Invest its assets in securities of other investment companies except by
purchases in the open market involving only customary brokers' commissions
or as part of a merger, consolidation, reorganization or purchase of
assets approved by the shareholders; or
(15) Invest in put, call, straddle or spread options or interests in oil, gas
or other mineral exploration or development programs.
ADDITIONAL RESTRICTIONS
The following restrictions are not considered to be fundamental policies of the
Funds. The Company's Board of Directors may change these additional restrictions
without notice to or approval by the shareholders.
Each Fund may not:
(1) Invest more than 15% (10% with respect to the Tax Exempt Money Market
Fund) of the value of its net assets in illiquid securities, including
repurchase agreements maturing in more than seven days.
(2) Purchase any security while borrowings representing more than 5% of the
Fund's total assets are outstanding.
PORTFOLIO TRANSACTIONS
The Manager, pursuant to the Advisory Agreement dated July 20, 1990, and subject
to the general control of the Company's Board of Directors, places all orders
for the purchase and sale of Fund securities. Purchases of Fund securities are
made either directly from the issuer or from dealers who deal in tax-exempt
securities. The Manager may sell Fund securities prior to maturity if
circumstances warrant and if it believes such disposition is advisable. In
connection with portfolio transactions for the Company, the Manager seeks to
obtain the best available net price and most favorable execution for its orders.
The Manager has no agreement or commitment to place transactions with any
broker-dealer and no regular formula is used to allocate orders to any
broker-dealer. However, the Manager may place security orders with brokers or
dealers who furnish research or other services to the Manager as long as there
is no sacrifice in obtaining the best overall terms available. Payment for such
services would be generated only through purchase of new issue fixed income
securities.
Such research and other services may include, for example: advice
concerning the value of securities, the advisability of investing in,
purchasing, or selling securities, and the availability of securities or the
purchasers or sellers of securities; analyses and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy, and
performance of accounts; and various functions incidental to effecting
securities transactions, such as clearance and settlement. The Manager
continuously reviews the performance of the broker-dealers with whom it places
orders for transactions. The receipt of research from broker-dealers that
execute transactions on behalf of the Company may be useful to the Manager in
rendering investment management services to other clients (including affiliates
of the Manager), and conversely, such research provided by broker-dealers who
have executed transaction orders on behalf of other clients may be useful to the
Manager in carrying out its obligations to the Company. While such research is
available to and may be used by the Manager in providing investment advice to
all its clients (including affiliates of the Manager), not all of such research
may be used by the Manager for the benefit of the Company. Such research and
services will be in addition to and not in lieu of research and services
provided by the Manager, and the expenses of the Manager will not necessarily be
reduced by the receipt of such supplemental research. See THE COMPANY'S MANAGER.
On occasions when the Manager deems the purchase or sale of a security to
be in the best interest of the Company, as well as the Manager's other clients,
the Manager, to the extent permitted by applicable laws and regulations, may
aggregate such securities to be sold or purchased for the Company with those to
be sold or purchased for other customers in order to obtain best execution and
lower brokerage commissions, if any. In such event, allocation of the securities
so purchased or sold, as well as the expenses incurred in the transaction, will
be made by the Manager in the manner it considers to be most equitable and
consistent with its fiduciary obligations to all such customers, including the
Company. In some instances, this procedure may impact the price and size of the
position obtainable for the Company.
The tax-exempt security market is typically a "dealer" market in which
investment dealers buy and sell bonds for their own accounts, rather than for
customers, and although the price may reflect a dealer's mark-up or mark-down,
the Company pays no brokerage commissions as such. In addition, some securities
may be purchased directly from issuers.
PORTFOLIO TURNOVER RATES
The portfolio turnover rate is computed by dividing the dollar amount of
securities purchased or sold (whichever is smaller) by the average value of
securities owned during the year.
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The rate of portfolio turnover will not be a limiting factor when the
Manager deems changes in the Long-Term, Intermediate-Term, and Short-Term Funds'
portfolios appropriate in view of each Fund's investment objective. For example,
securities may be sold in anticipation of a rise in interest rates (market
decline) or purchased in anticipation of a decline in interest rates (market
rise) and later sold. In addition, a security may be sold and another security
of comparable quality may be purchased at approximately the same time in order
to take advantage of what the Fund believes to be a temporary disparity in the
normal yield relationship between the two securities. These yield disparities
may occur for reasons not directly related to the investment quality of
particular issues or the general movement of interest rates, such as changes in
the overall demand for or supply of various types of tax-exempt securities.
For the last two fiscal years the Funds' portfolio turnover rates were as
follows:
FUND 1996 1997
---- ---- ----
Long-Term 53.25% 40.78%
Intermediate-Term 27.51% 23.05%
Short-Term 35.99% 27.67%
Portfolio turnover rates have been calculated excluding short-term variable rate
securities, which are those with put date intervals of less than one year.
FURTHER DESCRIPTION OF SHARES
The Company is authorized to issue shares in separate portfolios. Ten such
portfolios have been established, four of which are described in this SAI. Under
the Articles of Incorporation, the Board of Directors is authorized to create
new portfolios in addition to those already existing without shareholder
approval. The Company began offering shares of the Long-Term, Intermediate-Term
and Short-Term Funds in March 1982 and began offering shares of the Tax Exempt
Money Market Fund in February 1984.
Each Fund's assets and all income, earnings, profits and proceeds thereof,
subject only to the rights of creditors, are specifically allocated to such
Fund. They constitute the underlying assets of each Fund, are required to be
segregated on the books of account, and are to be charged with the expenses of
such Fund. Any general expenses of the Company not readily identifiable as
belonging to a particular Fund are allocated on the basis of the Funds' relative
net assets during the fiscal year or in such other manner as the Board
determines to be fair and equitable. Each share of each Fund represents an equal
proportionate interest in that Fund with every other share and is entitled to
dividends and distributions out of the net income and capital gains belonging to
that Fund when declared by the Board.
On any matter submitted to the shareholders, the holder of each Fund share
is entitled to one vote per share (with proportionate voting for fractional
shares) regardless of the relative net asset values of the Funds' shares.
However, on matters affecting an individual Fund, a separate vote of the
shareholders of that Fund is required. Shareholders of a Fund are not entitled
to vote on any matter which does not affect that Fund but which requires a
separate vote of another Fund. Shares do not have cumulative voting rights,
which means that holders of more than 50% of the shares voting for the election
of Directors can elect 100% of the Company's Board of Directors, and the holders
of less than 50% of the shares voting for the election of Directors will not be
able to elect any person as a Director.
Shareholders of a particular Fund might have the power to elect all of the
Directors of the Company because that Fund has a majority of the total
outstanding shares of the Company. When issued, each Fund's shares are fully
paid and nonassessable, have no pre-emptive or subscription rights, and are
fully transferable. There are no conversion rights.
TAX CONSIDERATIONS
TAXATION OF THE FUNDS
Each Fund intends to qualify as a regulated investment company under Subchapter
M of the Internal Revenue Code of 1986, as amended (the Code). Accordingly, each
Fund will not be liable for federal income taxes on its taxable net investment
income and net capital gains (capital gains in excess of capital losses) that
are distributed to shareholders, provided that each Fund distributes at least
90% of its net investment income and net short-term capital gain for the taxable
year.
To qualify as a regulated investment company, a Fund must, among other
things, (1) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, gains from the
sale or other disposition of stock, securities or foreign currencies, or other
income derived with respect to its business of investing in such stock,
securities or currencies (the 90% test); (2) derive in each taxable year less
than 30% of its gross income from the sale or other disposition of stock or
securities held less than three months (the 30% test), and (3) satisfy certain
diversification requirements at the close of each quarter of the Fund's taxable
year. Furthermore, to pay tax-exempt interest income dividends, at least 50%
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of the value of each Fund's total assets at the close of each quarter of its
taxable year must consist of obligations the interest of which is exempt from
federal income tax. Each Fund intends to satisfy this requirement.
The Code imposes a nondeductible 4% excise tax on a regulated investment
company that fails to distribute during each calendar year an amount at least
equal to the sum of (1) 98% of its taxable net investment income for the
calendar year, (2) 98% of its capital gain net income for the twelve-month
period ending on October 31, and (3) any prior amounts not distributed. Each
Fund intends to make such distributions as are necessary to avoid imposition of
this excise tax.
For federal income tax purposes, debt securities purchased by the Funds
may be treated as having original issue discount. Original issue discount
represents interest income for federal income tax purposes and can generally be
defined as the excess of the stated redemption price at maturity of a debt
obligation over the issue price. Original issue discount is treated for federal
income tax purposes as earned by the Funds, whether or not any income is
actually received, and therefore is subject to the distribution requirements of
the Code. However, original issue discount with respect to tax-exempt
obligations generally will be excluded from the Funds' taxable income, although
such discount will be included in gross income for purposes of the 90% test and
the 30% test described previously. Original issue discount with respect to
tax-exempt securities is accrued and added to the adjusted tax basis of such
securities for purposes of determining gain or loss upon sale or at maturity.
Generally, the amount of original issue discount is determined on the basis of a
constant yield to maturity which takes into account the compounding of accrued
interest. An investment in a stripped bond or stripped coupon will result in
original issue discount.
Debt securities may be purchased by the Funds at a market discount. Market
discount occurs when a security is purchased at a price less than the original
issue price adjusted for accrued original issue discount, if any. The Funds
intend to defer recognition of accrued market discount until maturity or other
disposition of the bond. For securities purchased at a market discount, the gain
realized on disposition will be treated as taxable ordinary income to the extent
it does not exceed accrued market discount on the bond.
The Funds may also purchase debt securities at a premium, i.e., at a
purchase price in excess of face amount. With respect to tax-exempt securities,
the premium must be amortized to the maturity date but no deduction is allowed
for the premium amortization. The amortized bond premium will reduce the Funds'
adjusted tax basis in the securities. For taxable securities, the premium may be
amortized if the Funds so elect. The amortized premium on taxable securities is
first offset against interest received on the securities and then allowed as a
deduction, and, for securities issued after September 27, 1985, must be
amortized under an economic accrual method.
TAXATION OF THE SHAREHOLDERS
Taxable distributions are generally included in a shareholder's gross income for
the taxable year in which they are received. Dividends declared in October,
November, or December and made payable to shareholders of record in such a month
will be deemed to have been received on December 31, if a Fund pays the dividend
during the following January. It is expected that none of the Funds'
distributions will qualify for the corporate dividends-received deduction.
To the extent that a Fund's dividends distributed to shareholders are
derived from interest income exempt from federal income tax and are designated
as "exempt-interest dividends" by a Fund, they will be excludable from a
shareholder's gross income for federal income tax purposes. Shareholders who are
recipients of Social Security benefits should be aware that exempt-interest
dividends received from a Fund are includible in their "modified adjusted gross
income" for purposes of determining the amount of such Social Security benefits,
if any, that are required to be included in their gross income.
All distributions of investment income during the year will have the same
percentage designated as tax-exempt. This method is called the "average annual
method." Since the Funds invest primarily in tax-exempt securities, the
percentage will be substantially the same as the amount actually earned during
any particular distribution period.
A shareholder of the Long-Term, Intermediate-Term, or Short-Term Funds
should be aware that a redemption of shares (including any exchange into another
USAA Fund) is a taxable event and, accordingly, a capital gain or loss may be
recognized. If a shareholder receives an exempt-interest dividend with respect
to any share and such share has been held for six months or less, any loss on
the redemption or exchange will be disallowed to the extent of such
exempt-interest dividend. Similarly, if a shareholder of a Fund receives a
distribution taxable as long-term capital gain with respect to shares of a Fund
and redeems or exchanges shares before he has held them for more than six
months, any loss on the redemption or exchange (not otherwise disallowed as
attributable to an exempt-interest dividend) will be treated as long-term
capital loss.
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The Funds may invest in private activity bonds. Interest on certain
private activity bonds issued after August 7, 1986, is an item of tax preference
for purposes of the Federal Alternative Minimum Tax (AMT), although the interest
continues to be excludable from gross income for other purposes. AMT is a
supplemental tax designed to ensure that taxpayers pay at least a minimum amount
of tax on their income, even if they make substantial use of certain tax
deductions and exclusions (referred to as tax preference items). Interest from
private activity bonds is one of the tax preference items that is added to
income from other sources for the purposes of determining whether a taxpayer is
subject to the AMT and the amount of any tax to be paid. For corporate
investors, alternative minimum taxable income is increased by 75% of the amount
by which adjusted current earnings (ACE) exceeds alternative minimum taxable
income before the ACE adjustment. For corporate taxpayers, all tax-exempt
interest is considered in calculating the AMT as part of the ACE. Prospective
investors should consult their own tax advisers with respect to the possible
application of the AMT to their tax situation.
Opinions relating to the validity of tax-exempt securities and the
exemption of interest thereon from federal income tax are rendered by recognized
bond counsel to the issuers. Neither the Manager's nor the Funds' counsel makes
any review of the basis of such opinions.
STATE AND LOCAL TAXES
The exemption of interest income for federal income tax purposes does not
necessarily result in exemption under the income or other tax laws of any state
or local taxing authority. Shareholders of a Fund may be exempt from state and
local taxes on distributions of tax-exempt interest income derived from
obligations of the state and/or municipalities of the state in which they are
resident, but generally are subject to tax on income derived from obligations of
other jurisdictions. Shareholders should consult their tax advisers about the
status of distributions from a Fund in their own states and localities.
DIRECTORS AND OFFICERS OF THE COMPANY
The Board of Directors of the Company consists of seven Directors. Set forth
below are the Directors and officers of the Company, and their respective
offices and principal occupations during the last five years. Unless otherwise
indicated, the business address of each is 9800 Fredericksburg Rd., San Antonio,
TX 78288.
Robert G. Davis 1, 2
Director and Chairman of the Board of Directors
Age: 50
President, Chief Executive Officer, Director and Vice Chairman of the Board of
Directors of USAA Capital Corporation and several of its subsidiaries and
affiliates (1/97-present); Director, Chairman, President, and Chief Executive
Officer, USAA Financial Planning Network, Inc. (1/97-present); Director, Vice
Chairman, Executive Vice President, and Chief Operating Officer, USAA Financial
Planning Network, Inc. (9/96-1/97); Special Assistant to Chairman, United
Services Automobile Association (USAA) (6/96-12/96); President and Chief
Executive Officer, Banc One Credit Corporation (12/95-6/96); and President and
Chief Executive Officer, Banc One Columbus, (8/91-12/95). Mr. Davis also serves
as a Trustee and Chairman of the Board of Trustees of USAA Investment Trust and
USAA State Tax-Free Trust and as a Director and Chairman of the Boards of
Directors of USAA Investment Management Company (IMCO), USAA Mutual Fund, Inc.,
USAA Shareholder Account Services, USAA Federal Savings Bank and USAA Real
Estate Company.
Michael J.C. Roth 1, 2
Director, President and Vice Chairman of the Board of Directors
Age: 55
Chief Executive Officer, IMCO (10/93-present); President, Director and Vice
Chairman of the Board of Directors, IMCO (1/90-present). Mr. Roth serves as
President, Trustee and Vice Chairman of the Boards of Trustees of USAA
Investment Trust and USAA State Tax-Free Trust, as President, Director and Vice
Chairman of the Boards of Directors of USAA Mutual Fund, Inc., and USAA
Shareholder Account Services, as Director of USAA Life Insurance Company and as
Trustee and Vice Chairman of USAA Life Investment Trust.
John W. Saunders, Jr. 1, 2, 4
Director and Vice President
Age: 62
Senior Vice President, Fixed Income Investments, IMCO (10/85-present). Mr.
Saunders serves as Trustee and Vice President of USAA Investment Trust and USAA
State Tax-Free Trust, Director of IMCO, Director and Vice President of USAA
Mutual Fund, Inc., as Senior Vice President of USAA Shareholder Account
Services, and as Vice President of USAA Life Investment Trust.
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Barbara B. Dreeben 3, 4, 5
200 Patterson #1008
San Antonio, TX 78209
Director
Age: 52
President, Postal Addvantage (7/92-present); Consultant, Nancy Harkins Stationer
(8/91-12/95). Mrs. Dreeben serves as a Trustee of USAA Investment Trust and USAA
State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Howard L. Freeman, Jr. 2, 3, 4, 5
2710 Hopeton
San Antonio, TX 78230
Director
Age: 62
Retired. Assistant General Manager for Finance, San Antonio City Public Service
Board (1976-1996). Mr. Freeman serves as a Trustee of USAA Investment Trust and
USAA State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Robert L. Mason, Ph.D. 3, 4, 5
12823 Queens Forest
San Antonio, TX 78230
Director
Age: 51
Manager, Statistical Analysis Section, Southwest Research Institute
(8/75-present). Dr. Mason serves as a Trustee of USAA Investment Trust and USAA
State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Richard A. Zucker 3, 4, 5
407 Arch Bluff
San Antonio, TX 78216
Director
Age: 54
Vice President, Beldon Roofing and Remodeling (1985-present). Mr. Zucker serves
as a Trustee of USAA Investment Trust and USAA State Tax-Free Trust and as a
Director of USAA Mutual Fund, Inc.
Michael D. Wagner 1
Secretary
Age: 49
Vice President, Corporate Counsel, USAA (1982-present). Mr. Wagner has held
various positions in the legal department of USAA since 1970 and serves as Vice
President, Secretary and Counsel, IMCO and USAA Shareholder Account Services,
Secretary, USAA Investment Trust, USAA Mutual Fund, Inc. and USAA State Tax-Free
Trust; and as Vice President, Corporate Counsel for various other USAA
subsidiaries and affiliates.
Alex M. Ciccone 1
Assistant Secretary
Age: 47
Vice President, Compliance, IMCO (12/94-present); Vice President and Chief
Operating Officer, Commonwealth Shareholder Services (6/94-11/94); and Vice
President, Compliance, IMCO (12/91-5/94). Mr. Ciccone serves as Assistant
Secretary of USAA Investment Trust, USAA State Tax-Free Trust, and USAA Mutual
Fund, Inc.
Sherron A. Kirk 1
Treasurer
Age: 52
Vice President, Controller, IMCO (10/92-present); Vice President, Corporate
Financial Analysis, USAA (9/92- 10/92); Assistant Vice President, Financial
Plans and Support, USAA (8/91-9/92). Mrs. Kirk serves as Treasurer of USAA
Investment Trust, USAA State Tax-Free Trust, and USAA Mutual Fund, Inc., and as
Vice President, Controller of USAA Shareholder Account Services.
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Dean R. Pantzar 1
Assistant Treasurer
Age: 38
Executive Director, Mutual Fund Accounting, IMCO (10/95-present); Director,
Mutual Fund Accounting, IMCO (12/94-10/95); Senior Manager, KPMG Peat Marwick
LLP (7/88-12/94). Mr. Pantzar serves as Assistant Treasurer of USAA Mutual Fund,
Inc., USAA State Tax-Free Trust, and USAA Investment Trust.
- -----------------
1 Indicates those Directors and officers who are employees of the Manager or
affiliated companies and are considered "interested persons" under the 1940
Act.
2 Member of Executive Committee
3 Member of Audit Committee
4 Member of Pricing and Investment Committee
5 Member of Corporate Governance Committee
Between the meetings of the Board of Directors and while the Board is not
in session, the Executive Committee of the Board of Directors has all the powers
and may exercise all the duties of the Board of Directors in the management of
the business of the Company which may be delegated to it by the Board. The
Pricing and Investment Committee of the Board of Directors acts upon various
investment-related issues and other matters which have been delegated to it by
the Board. The Audit Committee of the Board of Directors reviews the financial
statements and the auditor's reports and undertakes certain studies and analyses
as directed by the Board. The Corporate Governance Committee of the Board of
Directors maintains oversight of the organization, performance, and
effectiveness of the Board and Independent Directors.
In addition to the previously listed Directors and/or officers of the
Company who also serve as Directors and/or officers of the Manager, the
following individuals are Directors and/or executive officers of the Manager:
Harry W. Miller, Senior Vice President, Investments (Equity); Carl W. Shirley,
Senior Vice President, Insurance Company Portfolios; and John J. Dallahan,
Senior Vice President, Investment Services. There are no family relationships
among the Directors, officers and managerial level employees of the Company or
its Manager.
The following table sets forth information describing the compensation of
the current Directors of the Company for their services as Directors for the
fiscal year ended March 31, 1997.
Name Aggregate Total Compensation
of Compensation from the USAA
Director from the Company Family of Funds (b)
- -------- ------------------- ---------------------
George E. Brown* $6,824 $25,600
Robert G. Davis None (a) None (a)
Barbara B. Dreeben 9,787 36,600
Howard L. Freeman, Jr. 9,787 36,600
Robert L. Mason* 2,963 11,000
Michael J.C. Roth None (a) None (a)
John W. Saunders, Jr. None (a) None (a)
Richard A. Zucker 9,787 36,600
- ----------------
* Effective January 1, 1997, Robert L. Mason replaced George E. Brown as a
Director on the Board of Directors. Mr. Brown retired on December 31, 1996.
(a) Robert G. Davis, Michael J.C. Roth, and John W. Saunders, Jr. are affiliated
with the Company's investment adviser, IMCO, and, accordingly, receive no
remuneration from the Company or any other Fund of the USAA Family of Funds.
(b) At March 31, 1997, the USAA Family of Funds consisted of four registered
investment companies offering 33 individual funds. Each Director presently
serves as a Trustee or Director of each investment company in the USAA
Family of Funds. In addition, Michael J.C. Roth presently serves as a
Trustee of USAA Life Investment Trust, a registered investment company
advised by IMCO, consisting of seven funds offered to investors in a fixed
and variable annuity contract with USAA Life Insurance Company. Mr. Roth
receives no compensation as Trustee of USAA Life Investment Trust.
All of the above Directors are also Trustees/Directors of the other funds
for which IMCO serves as investment adviser. No compensation is paid by any fund
to any Trustee/Director who is a director, officer, or employee of IMCO or its
affiliates. No pension or retirement benefits are accrued as part of fund
expenses. The Company reimburses certain expenses of the Directors who are not
affiliated with the investment adviser. As of June 30, 1997, the officers and
Directors of the Company and their families as a group owned beneficially or of
record less than 1% of the outstanding shares of the Company.
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As of June 30, 1997, USAA and its affiliates (including related employee
benefit plans) owned 4,509,608 shares (3.3%) of the Intermediate-Term Fund, and
no shares of the Long-Term, Short-Term and Tax Exempt Money Market Funds.
The Company knows of no one person who, as of June 30, 1997, held of
record or owned beneficially 5% or more of any Fund's shares.
THE COMPANY'S MANAGER
As described in the Prospectus, USAA Investment Management Company is the
Manager and investment adviser, providing services under the Advisory Agreement.
The Manager, organized in May 1970, has served as investment adviser and
underwriter for USAA Tax Exempt Fund, Inc. from its inception.
In addition to managing the Company's assets, the Manager advises and
manages the investments for USAA and its affiliated companies as well as those
of USAA Mutual Fund, Inc., USAA Investment Trust, USAA State Tax-Free Trust and
USAA Life Investment Trust. As of the date of this SAI, total assets under
management by the Manager were approximately $35 billion, of which approximately
$20 billion were in mutual fund portfolios.
ADVISORY AGREEMENT
Under the Advisory Agreement, the Manager provides an investment program,
carries out the investment policy and manages the portfolio assets for each
Fund. The Manager is authorized, subject to the control of the Board of
Directors of the Company, to determine the selection, amount and time to buy or
sell securities for each Fund. In addition to providing investment services, the
Manager pays for office space, facilities, business equipment and accounting
services (in addition to those provided by the Custodian) for the Company. The
Manager compensates all personnel, officers and Directors of the Company if such
persons are also employees of the Manager or its affiliates. For these services
under the Advisory Agreement, the Company has agreed to pay the Manager a fee
computed as described under MANAGEMENT OF THE COMPANY in the Prospectus.
Management fees are computed and accrued daily and payable monthly.
Except for the services and facilities provided by the Manager, the Funds
pay all other expenses incurred in their operations. Expenses for which the
Funds are responsible include taxes (if any), brokerage commissions on portfolio
transactions (if any), expenses of issuance and redemption of shares, charges of
transfer agents, custodians and dividend disbursing agents, costs of preparing
and distributing proxy material, costs of printing and engraving stock
certificates, auditing and legal expenses, certain expenses of registering and
qualifying shares for sale, fees of Directors who are not interested persons
(not affiliated) of the Manager, costs of typesetting, printing and mailing the
Prospectus, SAI and periodic reports to existing shareholders, and any other
charges or fees not specifically enumerated. The Manager pays the cost of
printing and mailing copies of the Prospectus, the SAI, and reports to
prospective shareholders.
The Advisory Agreement will remain in effect until June 30, 1998, for each
Fund and will continue in effect from year to year thereafter for each Fund as
long as it is approved at least annually by a vote of the outstanding voting
securities of such Fund (as defined by the 1940 Act) or by the Board of
Directors (on behalf of such Fund) including a majority of the Directors who are
not interested persons of the Manager or (otherwise than as Directors) of the
Company, at a meeting called for the purpose of voting on such approval. The
Advisory Agreement may be terminated at any time by either the Company or the
Manager on 60 days' written notice. It will automatically terminate in the event
of its assignment (as defined in the 1940 Act).
From time to time the Manager may, without prior notice to shareholders,
waive all or any portion of fees or agree to reimburse expenses incurred by a
Fund. Any such waiver or reimbursement may be terminated by the Manager at any
time without prior notice to shareholders.
For the last three fiscal years, the Company paid the Manager the
following fees:
FUND 1995 1996 1997
---- ---- ---- ----
Long-Term $4,931,411 $5,119,811 $5,167,507
Intermediate-Term $4,220,542 $4,532,471 $4,723,990
Short-Term $2,489,834 $2,188,350 $2,188,649
Tax Exempt Money Market $4,299,382 $4,067,473 $4,208,391
UNDERWRITER
The Company has an agreement with the Manager for exclusive underwriting and
distribution of the Funds' shares on a continuing best efforts basis. This
agreement provides that the Manager will receive no fee or other compensation
for such distribution services.
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TRANSFER AGENT
The Transfer Agent performs transfer agent services for the Company under a
Transfer Agency Agreement. Services include maintenance of shareholder account
records, handling of communications with shareholders, distribution of Fund
dividends and production of reports with respect to account activity for
shareholders and the Company. For its services under the Transfer Agency
Agreement, each Fund pays the Transfer Agent an annual fixed fee of $26.00 per
account. This fee is subject to change at any time.
The fee to the Transfer Agent includes processing of all transactions and
correspondence. Fees are billed on a monthly basis at the rate of one-twelfth of
the annual fee. In addition, the Funds pay all out-of-pocket expenses of the
Transfer Agent and other expenses which are incurred at the specific direction
of the Company.
GENERAL INFORMATION
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 1713, Boston, MA 02105, is the
Company's Custodian. The Custodian is responsible for, among other things,
safeguarding and controlling the Company's cash and securities, handling the
receipt and delivery of securities and collecting interest on the company's
investments.
COUNSEL
Goodwin, Procter & Hoar LLP, Exchange Place, Boston, MA 02109, will review
certain legal matters for the Company in connection with the shares offered by
the Prospectus.
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP, 112 East Pecan, Suite 2400, San Antonio, TX 78205, is the
Company's independent auditor. In this capacity, the firm is responsible for
auditing the annual financial statements of the Funds and reporting thereon.
FINANCIAL STATEMENTS
The financial statements of the Funds and the Independent Auditors' Report
thereon for the fiscal year ended March 31, 1997, are included in the Annual
Report to Shareholders of that date and are incorporated herein by reference.
The Manager will deliver a copy of the Annual Report free of charge with each
SAI requested.
CALCULATION OF PERFORMANCE DATA
Information regarding total return and yield of each Fund is provided under
PERFORMANCE INFORMATION in the Prospectus. See VALUATION OF SECURITIES herein
for a discussion of the manner in which each Fund's price per share is
calculated.
TOTAL RETURN
The Funds, other than the Tax Exempt Money Market Fund, may each advertise
performance in terms of average annual total return for 1-, 5-, and 10-year
periods. Average annual total return is computed by finding the average annual
compounded rates of return over the periods that would equate the initial amount
invested to the ending redeemable value, according to the following formula:
P(1 + T)N = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1-, 5-, or 10-year periods at
the end of the year or period
The calculation assumes all charges are deducted from the initial $1,000
payment and assumes all dividends and distributions by such Fund are reinvested
at the price stated in the Prospectus on the reinvestment dates during the
period, and includes all recurring fees that are charged to all shareholder
accounts.
AVERAGE ANNUAL TOTAL RETURNS
FOR PERIODS ENDED 3/31/97
1 5 10
Fund year years years
---- ---- ----- -----
Long-Term 6.51% 6.80% 7.04%
Intermediate-Term 5.80% 6.82% 6.92%
Short-Term 4.70% 4.85% 5.38%
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<PAGE>
YIELD
The Funds, other than the Tax Exempt Money Market Fund, each may advertise
performance in terms of a 30-day yield quotation. The 30-day yield quotation is
computed by dividing the net investment income per share earned during the
period by the maximum offering price per share on the last day of the period,
according to the following formula:
YIELD~=~2 left [ left ({a-b} over cd + 1 right)^6 - 1 right]
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursement)
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends
d = the maximum offering price per share on the last day of the
period
For purposes of the yield calculation, interest income is computed based
on the yield to maturity of each debt obligation in a Fund's portfolio and all
recurring charges are recognized.
The 30-day yields for the Funds for the period ended March 31, 1997 were
as follows:
Long-Term Fund . . . . . 5.62%
Intermediate-Term Fund . . . . 5.23%
Short-Term Fund . . . . 4.33%
YIELD - TAX EXEMPT MONEY MARKET FUND
When the Tax Exempt Money Market Fund quotes a current annualized yield, it is
based on a specified recent seven-calendar-day period. It is computed by (1)
determining the net change, exclusive of capital changes, in the value of a
hypothetical preexisting account having a balance of one share at the beginning
of the period, (2) dividing the net change in account value by the value of the
account at the beginning of the base period to obtain the base return, then (3)
multiplying the base period return by 52.14 (365/7). The resulting yield figure
is carried to the nearest hundredth of one percent.
The calculation includes (1) the value of additional shares purchased with
dividends on the original share, and dividends declared on both the original
share and any such additional shares, and (2) any fees charged to all
shareholder accounts, in proportion to the length of the base period and the
Fund's average account size.
The capital changes excluded from the calculation are realized capital
gains and losses from the sale of securities and unrealized appreciation and
depreciation. The Fund's effective (compounded) yield will be computed by
dividing the seven-day annualized yield as defined above by 365, adding 1 to the
quotient, raising the sum to the 365th power, and subtracting 1 from the result.
Current and effective yields fluctuate daily and will vary with factors
such as interest rates and the quality, length of maturities, and type of
investments in the portfolio.
Yield For 7-day Period Ended 3/31/97 . . . . 3.18%
Effective Yield For 7-day Period Ended 3/31/97 . . . . 3.23%
TAX EQUIVALENT YIELD
A tax-exempt mutual fund may provide more "take-home" income than a fully
taxable mutual fund after paying taxes. Calculating a "tax equivalent yield"
means converting a tax exempt yield to a pretax equivalent so that a meaningful
comparison can be made between a tax-exempt municipal fund and a fully taxable
fund. The Tax Exempt Money Market Fund may advertise performance in terms of a
tax equivalent yield based on the 7-day yield or effective yield and the other
Funds may advertise performance in terms of a 30-day tax equivalent yield.
To calculate a tax equivalent yield, an investor must know his federal
marginal income tax rate. The tax equivalent yield is then computed by dividing
the tax-exempt yield of a fund by the complement of the federal marginal tax
rate. The complement, for example, of a federal marginal tax rate of 36.0% is
64.0%, that is (1.00-0.36= 0.64).
Tax Equivalent Yield = Tax Exempt Yield / (1- Federal Marginal Tax Rate)
Based on a federal marginal tax rate of 36.0%, the tax equivalent yields
for the Long-Term, Intermediate-Term, Short-Term, and Tax Exempt Money Market
Funds for the period ended March 31, 1997 were 8.78%, 8.17%, 6.77%, and 4.97%,
respectively.
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APPENDIX A - TAX-EXEMPT SECURITIES AND THEIR RATINGS
TAX-EXEMPT SECURITIES
Tax-exempt securities generally include debt obligations issued by states and
their political subdivisions, and duly constituted authorities and corporations,
to obtain funds to construct, repair or improve various public facilities such
as airports, bridges, highways, hospitals, housing, schools, streets, and water
and sewer works. Tax-exempt securities may also be issued to refinance
outstanding obligations as well as to obtain funds for general operating
expenses and for loans to other public institutions and facilities.
The two principal classifications of tax-exempt securities are "general
obligations" and "revenue" or "special tax" bonds. General obligation bonds are
secured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue or special tax bonds are payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise or other tax, but not
from general tax revenues. The Funds may also invest in tax-exempt private
activity bonds, which in most cases are revenue bonds and generally do not have
the pledge of the credit of the issuer. The payment of the principal and
interest on such industrial revenue bonds is dependent solely on the ability of
the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed as
security for such payment. There are, of course, many variations in the terms
of, and the security underlying tax-exempt securities. Short-term obligations
issued by states, cities, municipalities or municipal agencies, include Tax
Anticipation Notes, Revenue Anticipation Notes, Bond Anticipation Notes,
Construction Loan Notes and Short-Term Discount Notes.
The yields of tax-exempt securities depend on, among other things, general
money market conditions, conditions of the tax-exempt bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. (Moody's), Standard &
Poor's Ratings Group (S&P), Fitch Investors Service, Inc. (Fitch), Duff & Phelps
Inc., Thompson BankWatch, Inc., and IBCA Inc. represent their opinions of the
quality of the securities rated by them. It should be emphasized that such
ratings are general and are not absolute standards of quality. Consequently,
securities with the same maturity, coupon and rating may have different yields,
while securities of the same maturity and coupon but with different ratings may
have the same yield. It will be the responsibility of the Manager to appraise
independently the fundamental quality of the tax-exempt securities included in a
Fund's portfolio.
RATINGS
EXCERPTS FROM MOODY'S BOND (TAX-EXEMPT SECURITIES) RATINGS:
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risk appear
somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in
the future.
Baa Bonds which are rated Baa are considered as medium-grade obligations,
i.e., (they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
NOTE: THOSE BONDS IN THE AA, A, AND BAA GROUPS WHICH MOODY'S BELIEVES POSSESS
THE STRONGEST INVESTMENT ATTRIBUTES ARE DESIGNATED BY THE SYMBOLS AA1, A1, AND
BAA1.
EXCERPTS OF MOODY'S RATINGS OF SHORT-TERM LOANS (STATE AND TAX-EXEMPT NOTES):
Moody's ratings for state and tax-exempt notes and other short-term obligations
are designated Moody's Investment Grade (MIG). Symbols used will be as follows:
MIG-1 This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or
demonstrated broadbased access to the market for refinancing.
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<PAGE>
MIG-2 This designation denotes high quality. Margins of protection are ample
although not so large as in the preceding group.
EXCERPTS OF MOODY'S RATING OF COMMERCIAL PAPER:
Prime-1 Issuers rated Prime-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics:
o Leading market positions in well-established industries.
o High rates of return on funds employed.
o Conservative capitalization structures with moderate reliance on
debt and ample asset protection.
o Broad margins in earnings coverage of fixed financial charges
and high internal cash generation.
o Well-established access to a range of financial markets and
assured sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited
above but to a lesser degree. Earnings trends and coverage ratios,
while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
EXCERPTS FROM S&P'S BOND RATINGS:
AAA Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small
degree.
A Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher
rated categories.
BBB Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher
rated categories.
PLUS (+) OR MINUS (-): THE RATINGS FROM AA TO BBB MAY BE MODIFIED BY THE
ADDITION OF A PLUS OR MINUS SIGN TO SHOW RELATIVE STANDING WITHIN THE MAJOR
RATING CATEGORIES.
EXCERPTS OF S&P'S RATINGS OF TAX-EXEMPT NOTES:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term
of the notes.
EXCERPTS OF S&P'S RATING OF COMMERCIAL PAPER:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus (+) sign
designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as
for issues designated A-1.
EXCERPTS OF FITCH'S RATINGS OF BONDS:
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated AAA. Because
bonds rated in the AAA and AA categories are not significantly
vulnerable to foreseeable future developments, short-term debt of
these issuers is generally rated F-1+.
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes
in economic conditions and circumstances than bonds with higher
ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal
is considered to be adequate. Adverse changes in economic
16
<PAGE>
conditions and circumstances, however, are more likely to have adverse
impact on these bonds, and therefore, impair timely payment. The
likelihood that the ratings of these bonds will fall below investment
grade is higher than for bonds with higher ratings.
PLUS (+) AND MINUS (-): PLUS AND MINUS SIGNS ARE USED WITH A RATING SYMBOL TO
INDICATE THE RELATIVE POSITION OF A CREDIT WITHIN THE RATING CATEGORY. PLUS AND
MINUS SIGNS, HOWEVER, ARE NOT USED IN THE AAA CATEGORY.
EXCERPTS OF FITCH'S RATINGS TO COMMERCIAL PAPER, CERTIFICATES OF DEPOSIT AND
TAX-EXEMPT NOTES:
F-1+ Exceptionally strong credit quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely
payment.
F-1 Very strong credit quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues
rated F-1+.
F-2 Good credit quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payments, but the margin of safety is
not as great as for issues assigned F-1+ and F-1 ratings.
EXCERPTS FROM DUFF & PHELPS LONG-TERM RATING SCALE:
AAA Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA High credit quality. Protection factors are strong. Risk is modest but
may vary slightly from time to time because of economic conditions.
A Protection factors are average but adequate. However, risk factors are
more variable and greater in periods of economic stress.
BBB Below average protection factors but still considered sufficient for
prudent investment. Considerable variability in risk during economic
cycles.
EXCERPTS FROM DUFF & PHELPS COMMERCIAL PAPER RATING SCALE:
D-1+ Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of
funds, is outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are
minor.
D-1- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are
very small.
D-2 Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge
total financing requirements, access to capital markets is good. Risk
factors are small.
THOMPSON BANKWATCH, INC.
TBW-1 The highest category; indicates a very high likelihood that principal
and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated TBW-1.
TBW-3 The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal
and external) than those with higher ratings, the capacity to service
principal and interest in a timely fashion is considered adequate.
IBCA INC.
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating of
A1+ is assigned.
A2 Obligations supported by a satisfactory capacity for timely repayment
although such capacity may be susceptible to adverse changes in
business, economic or financial conditions.
A3 Obligations supported by an adequate capacity for timely repayment.
Such capacity is more susceptible to adverse changes in business,
economic or financial conditions than for obligations in higher
categories.
B Obligations for which the capacity for timely repayment is susceptible
to adverse changes in business, economic or financial conditions.
C Obligations for which there is a high risk of default or which are
currently in default.
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APPENDIX B - COMPARISON OF PORTFOLIO PERFORMANCE
Occasionally, we may make comparisons in advertising and sales literature
between the Funds contained in this SAI and other Funds in the USAA Family of
Funds. These comparisons may include such topics as risk and reward, investment
objectives, investment strategies, and performance.
Fund performance also may be compared to the performance of broad groups
of mutual funds with similar investment goals or unmanaged indexes of comparable
securities. Evaluations of Fund performance made by independent sources may be
used in advertisements concerning the Fund, including reprints of, or selections
from, editorials or articles about the Fund. The Fund or its performance may
also be compared to products and services not constituting securities subject to
registration under the Securities Act of 1933 such as, but not limited to,
certificates of deposit and money market accounts. Sources for performance
information and articles about the Fund may include the following:
AAII JOURNAL, a monthly association magazine for members of the American
Association of Individual Investors.
ARIZONA REPUBLIC, a newspaper which may cover financial and investment news.
AUSTIN AMERICAN-STATESMAN, a newspaper which may cover financial news.
BARRON'S, a Dow Jones and Company, Inc. business and financial weekly that
periodically reviews mutual fund performance data.
THE BOND BUYER, a daily newspaper which covers bond market news.
BUSINESS WEEK, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds.
CHICAGO TRIBUNE, a newspaper which may cover financial news.
CONSUMER REPORTS, a monthly magazine which from time to time reports on
companies in the mutual fund industry.
DALLAS MORNING NEWS, a newspaper which may cover financial news.
DENVER POST, a newspaper which may quote financial news.
FINANCIAL PLANNING, a monthly magazine that periodically features companies in
the mutual fund industry.
FINANCIAL SERVICES WEEK, a weekly newspaper which covers financial news.
FINANCIAL WORLD, a monthly magazine which may periodically review mutual fund
companies.
FORBES, a national business publication that periodically reports the
performance of companies in the mutual fund industry.
FORTUNE, a national business publication that periodically rates the performance
of a variety of mutual funds.
FUND ACTION, a mutual fund news report.
HOUSTON CHRONICLE, a newspaper which may cover financial news.
HOUSTON POST, a newspaper which may cover financial news.
IBC/DONOGHUE'S MONEYLETTER, a biweekly newsletter which covers financial news
and from time to time rates specific mutual funds.
IBC'S MONEY MARKET INSIGHT, a monthly money market industry analysis prepared by
IBC USA, Inc.
INCOME AND SAFETY, a monthly newsletter that rates mutual funds.
INVESTECH, a bimonthly investment newsletter.
INVESTMENT ADVISOR, a monthly publication directed primarily to the advisor
community; includes ranking of mutual funds using a proprietary methodology.
INVESTMENT COMPANY INSTITUTE, a national association of the American investment
company industry.
INVESTOR'S BUSINESS DAILY, a newspaper which covers financial news.
KIPLINGER'S PERSONAL FINANCE MAGAZINE, a monthly investment advisory publication
that periodically features the performance of a variety of securities.
LIPPER ANALYTICAL SERVICES, INC.'S FIXED INCOME FUND PERFORMANCE ANALYSIS, a
monthly publication of industry-wide mutual fund performance averages by type of
fund.
LIPPER ANALYTICAL SERVICES, INC.'S MUTUAL FUND PERFORMANCE ANALYSIS, a weekly
and quarterly publication of industry-wide mutual fund performance averages by
type of fund.
LOS ANGELES TIMES, a newspaper which may cover financial news.
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LOUIS RUKEYSER'S WALL STREET, a publication for investors.
MEDICAL ECONOMICS, a monthly magazine providing information to the medical
profession.
MONEY, a monthly magazine that features the performance of both specific funds
and the mutual fund industry as a whole.
MONEY FUND REPORT, a weekly publication of the Donoghue Organization, Inc.,
reporting on the performance of the nation's money market funds, summarizing
money market fund activity, and including certain averages as performance
benchmarks, specifically: (1) Taxable Money Fund Averages: "100% U.S. Treasury"
and "First Tier" and (2) Tax-Free Money Fund Averages: "Stockbroker and General
Purpose" and "State Specific Stockbroker and General Purpose."
MORNINGSTAR 5 STAR INVESTOR, a monthly newsletter which covers financial news
and rates mutual funds produced by Morningstar, Inc. (a data service which
tracks open-end mutual funds).
MUNI BOND FUND REPORT, a monthly newsletter which covers news on the municipal
bond market and features performance data for municipal bond mutual funds.
MUNIWEEK, a weekly newspaper which covers news on the municipal bond market.
MUTUAL FUND FORECASTER, a monthly newsletter that ranks mutual funds.
MUTUAL FUND INVESTING, a newsletter covering mutual funds.
MUTUAL FUND PERFORMANCE REPORT, a monthly publication of industry-wide mutual
fund averages produced by Morningstar, Inc.
MUTUAL FUNDS MAGAZINE, a monthly publication reporting on mutual fund investing.
MUTUAL FUND SOURCE BOOK, an annual publication produced by Morningstar, Inc.
which describes and rates mutual funds.
MUTUAL FUND VALUES, a biweekly guidebook to mutual funds produced by
Morningstar, Inc.
NEWSWEEK, a national business weekly.
NEW YORK TIMES, a newspaper which may cover financial news.
NO LOAD FUND INVESTOR, a newsletter covering companies in the mutual fund
industry.
PERSONAL INVESTOR, a monthly magazine which from time to time features mutual
fund companies and the mutual fund industry.
SAN ANTONIO BUSINESS JOURNAL, a weekly newspaper that periodically covers mutual
fund companies as well as financial news.
SAN ANTONIO EXPRESS-NEWS, a newspaper which may cover financial news.
SAN FRANCISCO CHRONICLE, a newspaper which may cover financial news.
SMART MONEY, a monthly magazine featuring news and articles on investing and
mutual funds.
USA TODAY, a newspaper which may cover financial news.
U.S. NEWS AND WORLD REPORT, a national business weekly that periodically reports
mutual fund performance data.
WALL STREET JOURNAL, a Dow Jones and Company, Inc. newspaper which covers
financial news.
WASHINGTON POST, a newspaper which may cover financial news.
WEISENBERGER MUTUAL FUNDS INVESTMENT REPORT, a monthly newsletter that reports
on both specific mutual fund companies and the mutual fund industry as a whole.
WORTH, a magazine which covers financial and investment subjects including
mutual funds.
YOUR MONEY, a monthly magazine directed towards the novice investor.
In addition to the sources above, performance of our Funds may also be
tracked by Lipper Analytical Services, Inc. Each Fund will be compared to
Lipper's appropriate fund category according to objective and portfolio
holdings. The Long-Term Fund will be compared to funds in Lipper's general
tax-exempt bond fund category, Intermediate-Term Fund to funds in Lipper's
intermediate (5-10 yr.) tax-exempt bond fund category, Short-Term Fund to
Lipper's short (1-5 yr.) tax-exempt bond fund category, and Tax Exempt Money
Market Fund to Lipper's general short-term tax-exempt bond fund category.
Footnotes in advertisements and other sales literature will include the time
period applicable for any rankings used.
19
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For comparative purposes, unmanaged indices of comparable securities or
economic data may be cited. Examples include the following:
- Shearson Lehman Hutton Bond Indices, indices of fixed-rate debt issues rated
investment grade or higher which can be found in the BOND MARKET REPORT.
- Bond Buyer Indices, indices of debt of varying maturities including revenue
bonds, general obligation bonds, and U.S. Treasury bonds which can be found in
MUNIWEEK and THE BOND BUYER.
Other sources for total return and other performance data which may be
used by the Fund or by those publications listed previously are Morningstar,
Inc., Schabaker Investment Management, and Investment Company Data, Inc. These
are services that collect and compile data on mutual fund companies.
APPENDIX C - TAXABLE EQUIVALENT YIELD TABLE
Assuming a Federal
Marginal Tax Rate of: 28% 31% 36% 39.6%
To Match a
Tax Free Yield of: A Fully Taxable Investment Would Have to Pay You:
2.00% 2.78% 2.90% 3.13% 3.31%
3.00% 4.17% 4.35% 4.69% 4.97%
4.00% 5.56% 5.80% 6.25% 6.62%
5.00% 6.94% 7.25% 7.81% 8.28%
6.00% 8.33% 8.70% 9.38% 9.93%
7.00% 9.72% 10.15% 10.94% 11.59%
THIS TABLE IS A HYPOTHETICAL ILLUSTRATION AND SHOULD NOT BE CONSIDERED AN
INDICATION OF FUND PERFORMANCE OF ANY OF THE USAA FAMILY OF FUNDS.
THESE RATES WERE SELECTED AS EXEMPLARY RATES THAT WOULD BE RELEVANT TO MOST
TAXPAYERS.
20
<PAGE>
APPENDIX D - DOLLAR-COST AVERAGING
Dollar-cost averaging is a systematic investing method which can be used by
investors as a disciplined technique for investing. A fixed amount of money is
invested in a security (such as a stock or mutual fund) on a regular basis over
a period of time, regardless of whether securities markets are moving up or
down.
This practice reduces average share costs to the investor who acquires
more shares in periods of lower securities prices and fewer shares in periods of
higher prices.
While dollar-cost averaging does not assure a profit or protect against
loss in declining markets, this investment strategy is an effective way to help
calm the effect of fluctuations in the financial markets. Systematic investing
involves continuous investment in securities regardless of fluctuating price
levels of such securities. Investors should consider their financial ability to
continue purchases through periods of low and high price levels.
As the following chart illustrates, dollar-cost averaging tends to keep
the overall cost of shares lower. This example is for illustration only, and
different trends would result in different average costs.
HOW DOLLAR-COST AVERAGING WORKS
$100 Invested Regularly for 5 Periods
Market Trend
-----------------------------------------------------------------
Down Up Mixed
-----------------------------------------------------------------
Share Shares Share Shares Share Shares
Investment Price Purchased Price Purchased Price Purchased
------------------- --------------------- ------------------
$100 10 10 6 16.67 10 10
100 9 11.1 7 14.29 9 11.1
100 8 12.5 7 14.29 8 12.5
100 8 12.5 9 11.1 9 11.1
100 6 16.67 10 10 10 10
---- -- ---- -- ---- --- ---
$500 ***41 62.77 ***39 66.35 ***46 54.7
*Avg. Cost: $7.97 *Avg. Cost: $7.54 *Avg. Cost: $9.14
----- ----- -----
**Avg. Price: $8.20 **Avg. Price:$7.80 **Avg Price: $9.20
----- ----- -----
* Average Cost is the total amount invested divided by number of shares
purchased.
** Average Price is the sum of the prices paid divided by number of purchases.
*** Cumulative total of share prices used to compute average prices.
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23
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06052-0897
<PAGE>
Part B
Statement of Additional Information for the
California Bond and
California Money Market Funds
<PAGE>
[USAA EAGLE LOGO]
USAA STATEMENT OF
TAX EXEMPT ADDITIONAL INFORMATION
FUND, INC. August 1, 1997
- --------------------------------------------------------------------------------
USAA TAX EXEMPT FUND, INC.
CALIFORNIA FUNDS
USAA TAX EXEMPT FUND, INC. (the Company) is a registered investment company
offering shares of ten no-load mutual funds, two of which are described in this
Statement of Additional Information (SAI): the California Bond Fund and
California Money Market Fund (collectively, the Funds or the California Funds).
Each Fund is classified as diversified and has a common investment objective of
providing California investors with a high level of current interest income that
is exempt from federal and California state income taxes. The California Money
Market Fund has a further objective of preserving capital and maintaining
liquidity.
You may obtain a free copy of a Prospectus for the California Funds dated August
1, 1997, by writing to USAA Tax Exempt Fund, Inc., 9800 Fredericksburg Rd., San
Antonio, TX 78288, or by calling toll free 1-800-531- 8181. The Prospectus
provides the basic information you should know before investing in the Funds.
This SAI is not a Prospectus and contains information in addition to and more
detailed than that set forth in the Prospectus. It is intended to provide you
with additional information regarding the activities and operations of the
Company and the Funds, and should be read in conjunction with the Prospectus.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
2 Valuation of Securities
2 Additional Information Regarding Redemption of Shares
3 Investment Plans
4 Investment Policies
5 Investment Restrictions
6 Special Risk Considerations
10 Portfolio Transactions
11 Further Description of Shares
11 Certain Federal Income Tax Considerations
13 California Taxation
14 Directors and Officers of the Company
16 The Company's Manager
17 General Information
18 Calculation of Performance Data
19 Appendix A - Tax-Exempt Securities and Their Ratings
22 Appendix B - Comparison of Portfolio Performance
25 Appendix C - Taxable Equivalent Yield Table
26 Appendix D - Dollar-Cost Averaging
<PAGE>
VALUATION OF SECURITIES
Shares of each Fund are offered on a continuing best efforts basis through USAA
Investment Management Company (IMCO or the Manager). The offering price for
shares of each Fund is equal to the current net asset value (NAV) per share. The
NAV per share of each Fund is calculated by adding the value of all its
portfolio securities and other assets, deducting its liabilities, and dividing
by the number of shares outstanding.
A Fund's NAV per share is calculated each day, Monday through Friday,
except days on which the New York Stock Exchange (NYSE) is closed. The NYSE is
currently scheduled to be closed on New Year's Day, Martin Luther King Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving, and Christmas, and on the preceding Friday or subsequent Monday
when one of these holidays falls on a Saturday or Sunday, respectively.
The investments of the CALIFORNIA BOND FUND are valued each business day
by a pricing service (the Service) approved by the Company's Board of Directors.
The Service uses the mean between quoted bid and asked prices or the last sale
price to price securities when, in the Service's judgment, these prices are
readily available and are representative of the securities' market values. For
many securities, such prices are not readily available. The Service generally
prices these securities based on methods which include consideration of yields
or prices of tax-exempt securities of comparable quality, coupon, maturity and
type, indications as to values from dealers in securities, and general market
conditions. Securities purchased with maturities of 60 days or less are stated
at amortized cost which approximates market value. Repurchase agreements are
valued at cost. Securities which cannot be valued by the Service, and all other
assets, are valued in good faith at fair value using methods determined by the
Manager under the general supervision of the Board of Directors.
The value of the CALIFORNIA MONEY MARKET FUND'S securities is stated at
amortized cost which approximates market value. This involves valuing a security
at its cost and thereafter assuming a constant amortization to maturity of any
discount or premium, regardless of the impact of fluctuating interest rates.
While this method provides certainty in valuation, it may result in periods
during which the value of an instrument, as determined by amortized cost, is
higher or lower than the price the Fund would receive upon the sale of the
instrument.
The valuation of the California Money Market Fund's portfolio instruments
based upon their amortized cost is subject to the Fund's adherence to certain
procedures and conditions. Consistent with regulatory requirements, the Manager
will only purchase securities with remaining maturities of 397 days or less and
will maintain a dollar-weighted average portfolio maturity of no more than 90
days. The Manager will invest only in securities that have been determined to
present minimal credit risk and that satisfy the quality and diversification
requirements of applicable rules and regulations of the Securities and Exchange
Commission (SEC).
The Board of Directors has established procedures designed to stabilize
the California Money Market Fund's price per share, as computed for the purpose
of sales and redemptions, at $1.00. There can be no assurance, however, that the
Fund will at all times be able to maintain a constant $1.00 NAV per share. Such
procedures include review of the Fund's holdings at such intervals as is deemed
appropriate to determine whether the Fund's NAV calculated by using available
market quotations deviates from $1.00 per share and, if so, whether such
deviation may result in material dilution or is otherwise unfair to existing
shareholders. In the event that it is determined that such a deviation exists,
the Board of Directors will take such corrective action as it regards as
necessary and appropriate. Such action may include selling portfolio instruments
prior to maturity to realize capital gains or losses or to shorten average
portfolio maturity, withholding dividends, or establishing a NAV per share by
using available market quotations.
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
The value of a shareholder's investment at the time of redemption may be more or
less than the cost at purchase, depending on the value of the securities held in
each Fund's portfolio. Requests for redemption which are subject to any special
conditions, or which specify an effective date other than as provided herein,
cannot be accepted. A gain or loss for tax purposes may be realized on the sale
of shares, depending upon the price when redeemed.
The Board of Directors may cause the redemption of an account with a
balance of less than 50 shares provided (1) the value of the account has been
reduced, for reasons other than market action, below the minimum initial
investment in such Fund at the time of the establishment of the account, (2) the
account has remained below the minimum level for six months, and (3) 60 days'
prior written notice of the proposed redemption has been sent to the
shareholder. Shares will be redeemed at the NAV on the date fixed for
2
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redemption by the Board of Directors. Prompt payment will be made by mail to the
last known address of the shareholder.
The Company reserves the right to suspend the right of redemption or
postpone the date of payment (1) for any periods during which the NYSE is
closed, (2) when trading in the markets the Company normally utilizes is
restricted, or an emergency exists as determined by the SEC so that disposal of
the Company's investments or determination of its NAV is not reasonably
practicable, or (3) for such other periods as the SEC by order may permit for
protection of the Company's shareholders.
For the mutual protection of the investor and the Funds, the Company may
require a signature guarantee. If required, EACH signature on the account
registration must be guaranteed. Signature guarantees are acceptable from FDIC
member banks, brokers, dealers, municipal securities dealers, municipal
securities brokers, government securities dealers, government securities
brokers, credit unions, national securities exchanges, registered securities
associations, clearing agencies and savings associations. A signature guarantee
for active duty military personnel stationed abroad may be provided by an
officer of the United States Embassy or Consulate, a staff officer of the Judge
Advocate General, or an individual's commanding officer.
REDEMPTION BY CHECK
Shareholders in the California Money Market Fund may request that checks be
issued for their account. Checks must be written in the amount of at least $250.
Checks issued to shareholders of the Fund will be sent only to the person
in whose name the account is registered and only to the address of record. The
checks must be manually signed by the registered owner(s) exactly as the account
is registered. For joint accounts the signature of either or both joint owners
will be required on the check, according to the election made on the signature
card. Dividends will continue to be earned by the shareholder until the shares
are redeemed by the presentation of a check.
When a check is presented to USAA Shareholder Account Services (Transfer
Agent) for payment, a sufficient number of full and fractional shares in the
investor's account will be redeemed to cover the amount of the check. If an
investor's account is not adequate to cover the amount of a check, the check
will be returned unpaid. Because the value of each account changes as dividends
are accrued on a daily basis, checks may not be used to close an account.
The Transfer Agent will return to the shareholder checks paid during the
month by separate mail. The checkwriting privilege will be subject to the
customary rules and regulations of State Street Bank and Trust Company (State
Street Bank or the Custodian) governing checking accounts. There is no charge to
the shareholder for the use of the checks or for subsequent reorders of checks.
The Company reserves the right to assess a processing fee against a
shareholder's account for any redemption check not honored by a clearing or
paying agent. Currently, this fee is $15 and is subject to change at any time.
Some examples of such dishonor are improper endorsement, checks written for an
amount less than the minimum check amount, and insufficient or uncollectible
funds.
The Company, the Transfer Agent, and State Street Bank each reserve the
right to change or suspend the checkwriting privilege upon 30 days' written
notice to participating shareholders.
INVESTMENT PLANS
The following investment plans are made available by the Company to shareholders
of the Funds. At the time you sign up for any of the following investment plans
that utilize the electronic funds transfer service, you will choose the day of
the month (the effective date) on which you would like to regularly purchase
shares. When this day falls on a weekend or holiday, the electronic transfer
will take place on the last business day before the effective date. You may
terminate your participation in a plan at any time. Please call the Manager for
details and necessary forms or applications.
AUTOMATIC PURCHASE OF SHARES
INVESTRONIC(R) - The regular purchase of additional shares through electronic
funds transfer from a checking or savings account. You may invest as little as
$50 per month.
DIRECT PURCHASE SERVICE - The periodic purchase of shares through electronic
funds transfer from an employer (including government allotments), an
income-producing investment, or an account with a participating financial
institution.
AUTOMATIC PURCHASE PLAN - The periodic transfer of funds from a USAA money
market fund to purchase shares in another non-money market USAA mutual fund.
There is a minimum investment required for this program of $5,000 in the money
market fund, with a monthly transaction minimum of $50.
3
<PAGE>
BUY/SELL SERVICE - The intermittent purchase or redemption of shares through
electronic funds transfer to or from a checking or savings account.
Participation in these systematic purchase plans will permit a shareholder
to engage in dollar-cost averaging. For additional information concerning the
benefits of dollar-cost averaging, see APPENDIX D.
SYSTEMATIC WITHDRAWAL PLAN
If a shareholder in a single investment account (accounts in different Funds
cannot be aggregated for this purpose) owns shares having a NAV of $5,000 or
more, the shareholder may request that enough shares to produce a fixed amount
of money be liquidated from the account monthly or quarterly. The amount of each
withdrawal must be at least $50. Using the electronic funds transfer service,
shareholders may choose to have withdrawals electronically deposited at their
bank or other financial institution. They may also elect to have checks mailed
to a designated address.
Such a plan may be initiated by depositing shares worth at least $5,000
with the Transfer Agent and by completing a Systematic Withdrawal Plan
application, which may be requested from the Manager. The shareholder may
terminate participation in the plan at any time. There is no charge to the
shareholder for withdrawals under the Systematic Withdrawal Plan. The Company
will not bear any expenses in administering the plan beyond the regular transfer
agent and custodian costs of issuing and redeeming shares. The Manager will bear
any additional expenses of administering the plan.
Withdrawals will be made by redeeming full and fractional shares on the
date selected by the shareholder at the time the plan is established. Withdrawal
payments made under this plan may exceed dividends and distributions and, to
this extent, will involve the use of principal and could reduce the dollar value
of a shareholder's investment and eventually exhaust the account. Reinvesting
dividends and distributions helps replenish the account. Because share values
and net investment income can fluctuate, shareholders should not expect
withdrawals to be offset by rising income or share value gains.
Each redemption of shares may result in a gain or loss, which must be
reported on the shareholder's income tax return. Therefore, a shareholder should
keep an accurate record of any gain or loss on each withdrawal.
INVESTMENT POLICIES
The section captioned INVESTMENT OBJECTIVES AND POLICIES in the Prospectus
describes the fundamental investment objectives and the investment policies
applicable to each Fund and the following is provided as additional information.
CALCULATION OF PORTFOLIO WEIGHTED AVERAGE MATURITIES
Weighted average maturity is derived by multiplying the value of each investment
by the number of days remaining to its maturity, adding these calculations, and
then dividing the total by the value of the Fund's portfolio. An obligation's
maturity is typically determined on a stated final maturity basis, although
there are some exceptions to this rule.
With respect to obligations held by the California Bond Fund, if it is
probable that the issuer of an instrument will take advantage of a
maturity-shortening device, such as a call, refunding, or redemption provision,
the date on which the instrument will probably be called, refunded, or redeemed
may be considered to be its maturity date. Also, the maturities of securities
subject to sinking fund arrangements are determined on a weighted average life
basis, which is the average time for principal to be repaid. The weighted
average life of these securities is likely to be substantially shorter than
their stated final maturity. In addition, for purposes of the Fund's investment
policies, an instrument will be treated as having a maturity earlier than its
stated maturity date if the instrument has technical features such as puts or
demand features which, in the judgment of the Manager, will result in the
instrument being valued in the market as though it has the earlier maturity.
The California Money Market Fund will determine the maturity of an
obligation in its portfolio in accordance with Rule 2a-7 under the Investment
Company Act of 1940, as amended (1940 Act).
LENDING OF SECURITIES
Each Fund may lend its securities. A lending policy may be authorized by the
Company's Directors and implemented by the Manager, but securities may be loaned
only to qualified broker-dealers or institutional investors that agree to
maintain cash collateral with the Company equal at all times to at least 100% of
the value of the loaned securities. The Directors will establish procedures and
monitor the creditworthiness of any institution or broker-dealer during such
time as any loan is outstanding. The Company will continue to receive interest
on the loaned securities and will invest the cash collateral in readily
marketable short-term obligations of high quality, thereby earning additional
interest. Interest on loaned tax-exempt securities
4
<PAGE>
received by the borrower and paid to the Company will not be exempt from federal
income taxes in the hands of the Company.
No loan of securities will be made if, as a result, the aggregate of such
loans would exceed 331/3% of the value of a Fund's total assets. The Company may
terminate such loans at any time.
REPURCHASE AGREEMENTS
Each Fund may invest up to 5% of its total assets in repurchase agreements. A
repurchase agreement is a transaction in which a security is purchased with a
simultaneous commitment to sell the security back to the seller (a commercial
bank or recognized securities dealer) at an agreed upon price on an agreed upon
date, usually not more than seven days from the date of purchase. The resale
price reflects the purchase price plus an agreed upon market rate of interest
which is unrelated to the coupon rate or maturity of the purchased security. A
repurchase agreement involves the obligation of the seller to pay the agreed
upon price, which obligation is in effect secured by the value of the underlying
security. In these transactions, the securities purchased by a Fund will have a
total value equal to or in excess of the amount of the repurchase obligation and
will be held by the Funds' custodian until repurchased. If the seller defaults
and the value of the underlying security declines, a Fund may incur a loss and
may incur expenses in selling the collateral. If the seller seeks relief under
the bankruptcy laws, the disposition of the collateral may be delayed or
limited. Any investments in repurchase agreements will give rise to income which
will not qualify as tax-exempt income when distributed by a Fund.
OTHER POLICIES
Although the California Bond Fund is permitted to invest in options, financial
futures contracts and options on financial futures contracts, the Fund has no
current intention of doing so and will not invest in such securities without
first notifying shareholders and supplying further information in the
Prospectus.
INVESTMENT RESTRICTIONS
The following investment restrictions have been adopted by the Company for and
are applicable to each Fund. These restrictions may not be changed for any given
Fund without approval by the lesser of (1) 67% or more of the voting securities
present at a meeting of the Fund if more than 50% of the outstanding voting
securities of the Fund are present or represented by proxy or (2) more than 50%
of the Fund's outstanding voting securities. The investment restrictions of one
Fund may be changed without affecting those of the other Fund.
Under the restrictions, neither Fund will:
(1) With respect to 75% of its total assets, purchase securities of any issuer
(except the U.S. Government, its agencies and instrumentalities and any
tax-exempt security guaranteed by the U.S. Government) if as a result more
than 5% of the total assets of that Fund would be invested in securities of
such issuer; for purposes of this limitation, identification of the
"issuer" will be based on a determination of the source of assets and
revenues committed to meeting interest and principal payments of each
security; for purposes of this limitation the State of California or other
jurisdictions and each of its separate political subdivisions, agencies,
authorities and instrumentalities shall be treated as a separate issuer;
(2) Purchase more than 10% of the outstanding voting securities of any issuer;
(3) Borrow money, except for temporary or emergency purposes in an amount not
exceeding 33 1/3% of its total assets (including the amount borrowed) less
liabilities (other than borrowings);
(4) Pledge, mortgage or hypothecate its assets to any extent greater than 10%
of the value of its total assets;
(5) Purchase or retain securities of any issuer if any officer or Director of
the Company or its Manager owns individually more than one-half of one
percent (1/2%) of the securities of that issuer, and collectively the
officers and Directors of the Company and Manager together own more than 5%
of the securities of that issuer;
(6) Purchase any securities which would cause more than 25% of the value of
that Fund's total assets at the time of such purchase to be invested in
securities the interest upon which is derived from revenues or projects
with similar characteristics, such as toll road revenue bonds, housing
revenue bonds, electric power project revenue bonds, or in industrial
revenue bonds which are based, directly or indirectly, on the credit of
private entities of any one industry; provided that the foregoing
limitation does not apply with respect to investments in U.S. Treasury
Bills, other obligations issued or guaranteed by the U.S. Government, its
agencies and instrumentalities, and, in the case of the California Money
Market Fund, certificates of deposit and banker's acceptances of domestic
banks;
(7) Invest in issuers for the purpose of exercising control or management;
5
<PAGE>
(8) Issue senior securities as defined in the 1940 Act, except that it may
purchase tax-exempt securities on a "when-issued" basis or in financial
futures contracts as permitted by Section 18(f)(2);
(9) Underwrite securities of other issuers, except to the extent that it may be
deemed to act as a statutory underwriter in the distribution of any
restricted securities or not readily marketable securities;
(10) Purchase or sell real estate, but this shall not prevent investments in
tax-exempt securities secured by real estate or interests therein;
(11) Lend any securities or make any loan if, as a result, more than 33 1/3% of
its total assets would be lent to other parties, except that this
limitation does not apply to purchases of debt securities or to repurchase
agreements;
(12) Purchase on margin or sell short; for purposes of this restriction the
deposit or payment of initial or variation margin in connection with
financial futures contracts or related options will not be deemed to be a
purchase of securities on margin by a Fund;
(13) Purchase or sell commodities or commodities contracts, except that the Fund
may invest in financial futures contracts and options thereon;
(14) Invest its assets in securities of other investment companies except by
purchases in the open market involving only customary brokers' commissions
or as part of a merger, consolidation, reorganization or purchase of assets
approved by the shareholders; or
(15) Invest in put, call, straddle or spread options or interests in oil, gas or
other mineral exploration or development programs, except that a Fund may
write covered call options and purchase put options.
ADDITIONAL RESTRICTIONS
The following restrictions are not considered to be fundamental policies of the
Funds. The Company's Board of Directors may change these additional restrictions
without notice to or approval by the shareholders.
Neither Fund will:
(1) Invest more than 15% (10% with respect to the California Money Market Fund)
of the value of its net assets in illiquid securities, including repurchase
agreements maturing in more than seven days.
(2) Purchase any security while borrowings representing more than 5% of the
Fund's total assets are outstanding.
SPECIAL RISK CONSIDERATIONS
Certain California constitutional amendments, legislative measures, executive
orders, administrative regulations and voter initiatives could result in the
adverse effects described below. The following information constitutes only a
brief summary, does not purport to be a complete description, and is based on
information drawn from official statements and prospectuses relating to
securities offerings of the State of California (the "State") and various local
agencies in California and from other relevant sources. While the Funds have not
independently verified such information, they have no reason to believe that
such information is not correct in all material respects.
Certain of the tax-exempt securities in which the Funds may invest may be
obligations of issuers which rely in whole or in part on California State
revenues for payment of these obligations. Property tax revenues and a portion
of the State's General Fund surplus are distributed to counties, cities and
their various taxing entities, and the State assumes certain obligations
theretofore paid out of local funds. Whether and to what extent a portion of the
State's General Fund will be distributed in the future to counties, cities and
their various entities, is unclear.
Certain of the tax-exempt securities may be obligations of issuers who
rely in whole or in part on ad valorem real property taxes as a source of
revenue. On June 6, 1978, California voters approved an amendment to the
California Constitution known as Proposition 13, which added Article XIIIA to
the California Constitution. The effect of Article XIIIA is to limit ad valorem
taxes on real property, and to restrict the ability of taxing entities to
increase real property tax revenues. On November 7, 1978, California voters
approved Proposition 8, and on June 3, 1986, California voters approved
Proposition 46, both of which amended Article XIIIA.
Section 1 of Article XIIIA limits the maximum ad valorem property tax on
real property to 1% of full cash value (as defined in Section 2), to be
collected by the counties and apportioned according to law; provided that the 1%
limitation does not apply to ad valorem taxes or special assessments to pay the
interest and redemption charges or (1) any indebtedness approved by the voters
prior to July 1, 1978, or (2) any bonded indebtedness for the acquisition or
improvement of real property approved on or after July 1, 1978, by two-thirds of
the votes cast by the voters voting on the proposition. Section 2 of Article
XIIIA defines "full cash value" to mean "the County Assessor's valuation of real
property as shown on the 1975-76 tax bill under full cash value or,
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thereafter, the appraised value of real property when purchased, newly
constructed, or a change in ownership has occurred after the 1975 assessment."
The "full cash value" may be adjusted annually to reflect inflation at a rate
not to exceed 2% per year, or a reduction in the Consumer Price Index or
comparable local data, or reduced in the event of declining property value
caused by damage, destruction or other factors. The California State Board of
Equalization has adopted regulations, binding on county assessors, interpreting
the meaning of "change in ownership" and "new construction" for purposes of
determining full cash value of property under Article XIIIA.
Legislation enacted by the California Legislature to implement Article
XIIIA (statutes of 1978, Chapter 292, as amended) provides, that notwithstanding
any other law, local agencies may not levy any ad valorem property tax except to
pay debt service on indebtedness approved by the voters prior to July 1, 1978,
and that each county will levy the maximum tax permitted by Article XIIIA of
$4.00 per $100 assessed valuation (based on the former practice of using 25%,
instead of 100%, of full cash value as the assessed value for tax purposes). The
legislation further provided that, for the 1978-79 fiscal year only, the tax
levied by each county was to be apportioned among all taxing agencies within the
county in proportion to their average share of taxes levied in certain pervious
years. The apportionment of property taxes for fiscal years after 1978-79 has
been revised pursuant to Statutes of 1979, Chapter 282, which provides relief
funds from state attorneys beginning in fiscal year 1979-80 and is designed to
provide a permanent system for sharing state taxes and budget funds with local
agencies. Under Chapter 282, cities and counties receive more of the remaining
property tax revenues collected under Proposition 13 instead of direct State
aid. School districts receive a correspondingly reduced amount of property
taxes, but receive compensation directly from the State and are given additional
relief. Chapter 282 does not affect the derivation of the base levy ($4 per $100
of assessed valuation) and the bonded debt tax rate. However, there can be no
assurance that any particular level of State aid to local governments will be
maintained in future years.
On November 6, 1979, another initiative known as "Proposition 4" or the
"Gann Initiative" was approved by the California voters, which added Article
XIIIB to the California Constitution. Under Article XIIIB, state and local
governmental entities have an annual "appropriations limit" and are not able to
spend certain moneys called "appropriations subject to limitation" in an amount
higher than the "appropriations limit." Article XIIIB does not affect the
appropriation of moneys which are excluded from the definition of
"appropriations subject to limitation," including debt service on indebtedness
existing or authorized as of January 1, 1979, or bonded indebtedness
subsequently approved by the voters. In general terms, the "appropriations
limit" is to be based on certain 1978-79 expenditures, and is to be adjusted
annually to reflect changes in consumer prices, population and certain services
provided by these entities. Article XIIIB also provides that if these entities'
revenues in any year exceed the amount permitted to be spent, the excess would
have to be returned by revising tax rates or fee schedules over the subsequent
two years.
In June 1982, the voters of California passed two initiative measures to
repeal the California gift and inheritance tax laws and to enact, in lieu
thereof, a California death tax. California voters also passed an initiative
measure to increase, for taxable years commencing on or after January 1, 1982,
the amount by which personal income tax brackets will be adjusted annually in an
effort to index such tax brackets to account for the effects of inflation.
Decreases in State and local revenues in future fiscal years as a consequence of
these initiatives may result in reductions in allocations of state revenues to
California issuers or in the ability of California issuers to pay their
obligations.
At the November 8, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (1) the California Legislature establish a prudent state reserve
fund in an amount as shall be reasonable and necessary and (2) revenues in
excess of amounts permitted to be spent and which would otherwise be returned
pursuant to Article XIIIB by revision of tax rates or fees schedules, be
transferred and allocated (up to a maximum of 40%) to the State School Fund and
be expended solely for purposes of instructional improvement and accountability.
No such transfer or allocation of funds will be required if certain designated
state officials determine that annual student expenditures and class size meet
certain criteria as set forth in Proposition 98. Any funds allocated to the
State School Fund shall cause the appropriation limits established in Article
XIIIB to be annually increased for any such allocation made in the prior year.
Proposition 98 also amends Article XVI to require that the State of
California provide a minimum level of funding for public schools and community
colleges. Commencing with the 1988-89 fiscal year, moneys to be applied by the
State for the support of school districts and community college districts shall
not be less than the greater of: (1) the amount which, as a percentage of the
State General Fund revenues which may be appropriated pursuant to Article XIIIB,
equals the percentage of such State General Fund revenues appropriated for
school districts and community college districts, respectively, in fiscal year
1986-87, or (2) the amount required to ensure that the total allocations to
school districts and community college districts from the State general fund
proceeds of taxes appropriated pursuant to Article XIIIB and allocated local
proceeds of taxes shall not be less than the total amount from the sources in
the prior year, adjusted for increases in
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enrollment and adjusted for changes in the cost of living pursuant to the
provisions of Article XIIIB. The initiative permits the enactment of
legislation, by a two-thirds vote, to suspend the minimum funding requirements
for one year.
In June 1989, the California Legislature enacted Senate Constitutional
amendment number one ("SCA 1"), a proposed modification of the California
Constitution to alter the spending limit in the educational funding provisions
of Proposition 98. SCA 1 was approved by the voters on the June 1990 ballot and
took effect on July 1, 1990. SCA 1 permits annual adjustments to the spending
limit to be more closely linked to the rate of economic growth in the State.
Instead of being tied to the consumer price index, the change in "cost of
living" is measured by the change in California per capita personal income. In
addition, if certain kinds of emergencies are declared by the Governor, an
appropriation enacted by a two-thirds vote of the Legislature will be excluded
from the State's appropriations limit.
SCA 1 also provides two new exceptions to the calculation of
appropriations which are subject to the spending limit. First, there will be
excluded all appropriations for "qualified capital outlay projects" as defined
by the Legislature. Second, there will be excluded any increase in gasoline
taxes above their current 9% per gallon level. In addition, SCA 1 recalculates
the appropriation limits for each unit in government, beginning in the 1990-91
fiscal year, based upon a two-year cycle. The Proposition 98 provision regarding
excess taxes will also be modified. After a two-year period if there are any
excess state tax revenues, 50% (instead of 100%) of the excess will be
transferred to schools with the balance returned to taxpayers. SCA 1 also
modifies in certain respects the complex adjustment in the Proposition 98
formula which guarantees schools a certain amount of the General Fund revenues.
In September 1980, the legislature enacted a measure (Chapter 1342,
Statutes of 1980) declaring that tax increment revenues are not "proceeds of
taxes" within the meaning of Article XIIIB and that the allocation and
expenditure of such moneys are not appropriations subject to the limitations
under Article XIIIB, if used for repayment of indebtedness incurred for
redevelopment activity. While the California Supreme Court expressly declined to
rule on the validity of Chapter 1342 and the applicability of Article XIIIB to
redevelopment agencies in HUNTINGTON PARK REDEVELOPMENT AGENCY V. MARTIN, two
subsequent decisions of the California Court of Appeal have upheld the validity
of Chapter 1342 and have concluded that redevelopment agencies are not subject
to the appropriations limit of Article XIIIB. Proposition 87 was approved by the
California voters on November 8, 1988. Proposition 87 amends Article XVI,
Section 16, of the California Constitution by authorizing the California
Legislature to prohibit redevelopment agencies from receiving any of the
property tax revenue raised by increased property tax rates levied to repay
bonded indebtedness of local governments which is approved by voters on or after
January 1, 1989. It is not possible to predict whether the California
Legislature will enact such a prohibition, nor is it possible to predict the
impact of Proposition 87 on redevelopment agencies and their ability to make
payments on outstanding debt obligations.
On November 4, 1986, California voters approved an initiative statute
known as Proposition 62. This initiative (1) requires that any tax for general
governmental purposes imposed by local governments be approved by resolution or
ordinance adopted by a two-thirds vote of the governmental entity's legislative
body and by a majority vote of the electorate of the governmental entity, (2)
requires that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within the jurisdiction, (3) restricts the use of
revenues from a special tax to the purposes or for the service for which the
special tax was imposed, (4) prohibits the imposition of ad valorem taxes on
real property by local governmental entities except as permitted by Article
XIIIA, (5) prohibits the imposition of transaction taxes and sales taxes on the
sale of real property by local governments, (6) requires that any tax imposed by
a local government on or after August 1, 1985 be ratified by a majority vote of
the electorate within two years of the adoption of the initiative or be
terminated by November 15, 1988, (7) requires that, in the event a local
government fails to comply with the provisions of this measure, a reduction in
the amount of property tax revenue allocated to such local government occurs in
an amount equal to the revenues received by such entity attributable to the tax
levied in violation of the initiative, and (8) permits these provisions to be
amended exclusively by the voters of the State of California. In September 1995,
the California Supreme Court upheld the constitutionality of Proposition 62,
creating uncertainty as to the legality of certain local taxes enacted by
non-charter cities in California without voter approval. It is not possible to
predict the impact of the decision.
In November 1996, California voters approved Proposition 218. The
initiative applied the provisions of Proposition 62 to all entities, including
charter cities. It requires that all taxes for general purposes obtain a simple
majority popular vote and that taxes for special purposes obtain a two-thirds
majority vote. Prior to the effectiveness of Proposition 218, charter cities
could levy certain taxes such as transient occupancy taxes and utility user's
taxes without a popular vote. Proposition 218 will also limit the authority of
local governments to impose property-related assessments, fees and charges,
requiring that such assessments be limited to the special benefit conferred and
prohibiting their use for general governmental services.
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Proposition 218 also allows voters to use their initiative power to reduce or
repeal previously-authorized taxes, assessments, fees and charges.
California is the most populous state in the nation with a total
population at the 1990 Census of 29,976,000. Growth has been incessant since
World War II, with population gains in each decade since 1950 of between 18% and
49%. During the last decade, population rose 20%. The State now comprises 12.3%
of the nation's population and 12.9% of its total personal income. Its economy
is broad and diversified with major concentrations in high technology research
and manufacturing, aerospace and defense-related manufacturing, trade, real
estate, and financial services. After experiencing strong growth throughout much
of the 1980s, the State was adversely affected by both the national recession
and the cutbacks in aerospace and defense spending. Although California is still
experiencing some of the effects of the recession and its unemployment is above
the national average, the gap is narrowing and is projected to close to within
1% of the national average in 1997. California's economic recovery from the
recession is continuing at a strong pace. Recent economic reports indicate that,
while the rate of economic growth in California is expected to moderate over the
next three years, the increases in employment and income will likely exceed
those of the nation as a whole by a significant margin.
California's economic difficulties exacerbated a structural budget
imbalance which had been evident since fiscal year 1985-86. Many of the State's
budget problems were attributed to a great population increase which increased
demand for educational and social services at a pace far greater than growth in
revenues. To combat its budget problems, the State has cut non-mandatory
spending and aggressively sought assistance from the federal government.
In July 1996, the Governor signed into law a $62.8 billion budget which,
among other things, significantly increases education spending from the previous
fiscal year, reduces taxes for corporations and banks and provides for a
balanced budget at the close of the fiscal year. At the same time, the budget
continues several funding reductions made in past years, mostly to health and
welfare programs. The Governor's proposed budget for fiscal year 1997-98, as
revised in May, 1997, indicates total spending of $68.2 billion and anticipates
a $580 million reserve for economic uncertainties. The Governor's proposed
budget was revised in May, 1997, to include an unanticipated flow of $2.2
billion in new revenues. As in past years, the State's budget assumes savings
which depend on future federal actions, both to fund programs relating to
MediCal and incarceration costs associated with undocumented immigrants and to
relieve the State from federally mandated spending, which may not occur.
Accordingly, the anticipated reserves may be reduced unless the economy
outperforms expectations or spending falls below planned levels.
Although an improving economy and healthier tax revenues are anticipated,
the political environment and voter initiatives may constrain the State's
financial flexibility. For example, according to the Legislative Analyst's
Office, the passage of Proposition 184 in the November 1994 election, which
imposes mandatory, lengthy prison sentences on individuals convicted of three
felonies, is expected to increase prison operating costs by $3 billion annually
and increase prison construction costs by $20 billion.
With the apparent recovery in California's economy, revenue growth over
the next few years could recommence at levels that would enable California to
restore fiscal stability. The political environment, however, combined with
pressures on the State's financial flexibility, may frustrate its ability to
reach this goal. Strong interests in long-established state programs ranging
from low-cost public higher education access to welfare and health benefits join
with the more recently emerging pressures for expanded prison construction and
heightened awareness and concern over the State's business climate.
Because of the State of California's continuing budget problems, the
State's General Obligation bonds were downgraded in July 1994 to A1 from Aa by
Moody's, to A from A+ by Standard & Poor's, and to A from AA by Fitch. All three
rating agencies expressed uncertainty in the State's ability to balance the
budget by 1996. However, in 1996, citing California's improving economy and
budget situation, both Fitch and Standard & Poor's raised their ratings from A
to A+.
On December 6, 1994, Orange County became the largest municipality in the
United States to file for protection under the federal bankruptcy laws. The
filing stemmed from approximately $1.7 billion in losses suffered by the
County's investment pool due to investments in high risk "derivative"
securities. In September 1995, the state legislature approved legislation
permitting Orange County to use for bankruptcy recovery $820 million over 20
years in sales taxes previously earmarked for highways, transit and development.
In June 1996 the County completed a $880 million bond offering secured by real
property owned by the County. On June 12, 1996, the County emerged from
bankruptcy protection. On January 7, 1997, Orange County returned to the
municipal bond market with a $136 million bond issue maturing in 13 years at an
insured yield of 7.23%.
Los Angeles County, the nation's largest county, is also experiencing
financial difficulty. In August 1995, the credit rating of the county's
long-term bonds was downgraded for the third time since 1992 as a result of,
among other things, severe operating deficits for the county's health care
system. Also, the county has not yet
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recovered from the ongoing loss of revenue caused by state property tax shift
initiatives in 1993 through 1995. In April 1997, the Los Angeles County Board of
Supervisors gave preliminary approval to an approximately $12 billion 1997-98
proposed budget containing measures to eliminate a $157 million deficit. The
county's budgetary difficulties have continued with their effect on the 1997-98
budget still uncertain.
Certain tax-exempt securities in which the Funds may invest may be
obligations payable solely from the revenues of specific institutions, or may be
secured by specific properties, which are subject to provisions of California
law that could adversely affect the holders of such obligations. For example,
the revenues of California health care institutions may be subject to state
laws, and California laws limit the remedies of a creditor secured by a mortgage
or deed of trust on real property.
PORTFOLIO TRANSACTIONS
The Manager, pursuant to the Advisory Agreement dated July 20, 1990, and subject
to the general control of the Company's Board of Directors, places all orders
for the purchase and sale of Fund securities. Purchases of Fund securities are
made either directly from the issuer or from dealers who deal in tax-exempt
securities. The Manager may sell Fund securities prior to maturity if
circumstances warrant and if it believes such disposition is advisable. In
connection with portfolio transactions for the Company, the Manager seeks to
obtain the best available net price and most favorable execution for its orders.
The Manager has no agreement or commitment to place transactions with any
broker-dealer and no regular formula is used to allocate orders to any
broker-dealer. However, the Manager may place security orders with brokers or
dealers who furnish research or other services to the Manager as long as there
is no sacrifice in obtaining the best overall terms available. Payment for such
services would be generated only through purchase of new issue fixed income
securities.
Such research and other services may include, for example: advice
concerning the value of securities, the advisability of investing in,
purchasing, or selling securities, and the availability of securities or the
purchasers or sellers of securities; analyses and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy, and
performance of accounts; and various functions incidental to effecting
securities transactions, such as clearance and settlement. The Manager
continuously reviews the performance of the broker-dealers with whom it places
orders for transactions. The receipt of research from broker-dealers that
execute transactions on behalf of the Company may be useful to the Manager in
rendering investment management services to other clients (including affiliates
of the Manager), and conversely, such research provided by broker-dealers who
have executed transaction orders on behalf of other clients may be useful to the
Manager in carrying out its obligations to the Company. While such research is
available to and may be used by the Manager in providing investment advice to
all its clients (including affiliates of the Manager), not all of such research
may be used by the Manager for the benefit of the Company. Such research and
services will be in addition to and not in lieu of research and services
provided by the Manager, and the expenses of the Manager will not necessarily be
reduced by the receipt of such supplemental research. See THE COMPANY'S MANAGER.
On occasions when the Manager deems the purchase or sale of a security to
be in the best interest of the Company, as well as the Manager's other clients,
the Manager, to the extent permitted by applicable laws and regulations, may
aggregate such securities to be sold or purchased for the Company with those to
be sold or purchased for other customers in order to obtain best execution and
lower brokerage commissions, if any. In such event, allocation of the securities
so purchased or sold, as well as the expenses incurred in the transaction, will
be made by the Manager in the manner it considers to be most equitable and
consistent with its fiduciary obligations to all such customers, including the
Company. In some instances, this procedure may impact the price and size of the
position obtainable for the Company.
The tax-exempt security market is typically a "dealer" market in which
investment dealers buy and sell bonds for their own accounts, rather than for
customers, and although the price may reflect a dealer's mark-up or mark-down,
the Company pays no brokerage commissions as such. In addition, some securities
may be purchased directly from issuers.
PORTFOLIO TURNOVER RATES
The portfolio turnover rate is computed by dividing the dollar amount of
securities purchased or sold (whichever is smaller) by the average value of
securities owned during the year.
The rate of portfolio turnover will not be a limiting factor when the
Manager deems changes in the California Bond Fund's portfolio appropriate in
view of its investment objective. For example, securities may be sold in
anticipation of a rise in interest rates (market decline) or purchased in
anticipation of a decline in interest rates (market rise) and later sold. In
addition, a security may be sold and another security of comparable quality may
be purchased at approximately the same time in order to take advantage of what
the Fund believes to be a temporary disparity in the normal yield relationship
between the two securities. These yield disparities may occur for reasons not
directly related to the investment quality of particular issues or the
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general movement of interest rates, such as changes in the overall demand for or
supply of various types of tax-exempt securities.
For the last two fiscal years the California Bond Fund's portfolio
turnover rates were as follows:
1996 . . . . . 23.09% 1997 . . . . 23.72%
Portfolio turnover rates have been calculated excluding short-term variable rate
securities, which are those with put date intervals of less than one year.
FURTHER DESCRIPTION OF SHARES
The Company is authorized to issue shares in separate portfolios. Ten such
portfolios have been established, two of which are described in this SAI. Under
the Articles of Incorporation, the Board of Directors is authorized to create
new portfolios in addition to those already existing without shareholder
approval. The Company began offering shares of the California Bond and the
California Money Market Funds in August 1989.
Each Fund's assets and all income, earnings, profits and proceeds thereof,
subject only to the rights of creditors, are specifically allocated to such
Fund. They constitute the underlying assets of each Fund, are required to be
segregated on the books of account, and are to be charged with the expenses of
such Fund. Any general expenses of the Company not readily identifiable as
belonging to a particular Fund are allocated on the basis of the Funds' relative
net assets during the fiscal year or in such other manner as the Board
determines to be fair and equitable. Each share of each Fund represents an equal
proportionate interest in that Fund with every other share and is entitled to
dividends and distributions out of the net income and capital gains belonging to
that Fund when declared by the Board.
On any matter submitted to the shareholders, the holder of each Fund share
is entitled to one vote per share (with proportionate voting for fractional
shares) regardless of the relative net asset values of the Funds' shares.
However, on matters affecting an individual Fund, a separate vote of the
shareholders of that Fund is required. Shareholders of a Fund are not entitled
to vote on any matter which does not affect that Fund but which requires a
separate vote of another Fund. Shares do not have cumulative voting rights,
which means that holders of more than 50% of the shares voting for the election
of Directors can elect 100% of the Company's Board of Directors, and the holders
of less than 50% of the shares voting for the election of Directors will not be
able to elect any person as a Director.
Shareholders of a particular Fund might have the power to elect all of the
Directors of the Company because that Fund has a majority of the total
outstanding shares of the Company. When issued, each Fund's shares are fully
paid and nonassessable, have no pre-emptive or subscription rights, and are
fully transferable. There are no conversion rights.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
TAXATION OF THE FUNDS
Each Fund intends to qualify as a regulated investment company under Subchapter
M of the Internal Revenue Code of 1986, as amended (the Code). Accordingly, each
Fund will not be liable for federal income taxes on its taxable net investment
income and net capital gains (capital gains in excess of capital losses) that
are distributed to shareholders, provided that each Fund distributes at least
90% of its net investment income and net short-term capital gain for the taxable
year.
To qualify as a regulated investment company, a Fund must, among other
things, (1) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, gains from the
sale or other disposition of stock, securities or foreign currencies, or other
income derived with respect to its business of investing in such stock,
securities or currencies (the 90% test); (2) derive in each taxable year less
than 30% of its gross income from the sale or other disposition of stock or
securities held less than three months (the 30% test), and (3) satisfy certain
diversification requirements at the close of each quarter of the Fund's taxable
year. Furthermore, to pay tax-exempt interest income dividends, at least 50% of
the value of each Fund's total assets at the close of each quarter of its
taxable year must consist of obligations the interest of which is exempt from
federal income tax. Each Fund intends to satisfy this requirement.
The Code imposes a nondeductible 4% excise tax on a regulated investment
company that fails to distribute during each calendar year an amount at least
equal to the sum of (1) 98% of its taxable net investment income for the
calendar year, (2) 98% of its capital gain net income for the twelve-month
period ending on October 31, and (3) any prior amounts not distributed. Each
Fund intends to make such distributions as are necessary to avoid imposition of
this excise tax.
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For federal income tax purposes, debt securities purchased by the Funds
may be treated as having original issue discount. Original issue discount
represents interest income for federal income tax purposes and can generally be
defined as the excess of the stated redemption price at maturity of a debt
obligation over the issue price. Original issue discount is treated for federal
income tax purposes as earned by the Funds, whether or not any income is
actually received, and therefore is subject to the distribution requirements of
the Code. However, original issue discount with respect to tax-exempt
obligations generally will be excluded from the Funds' taxable income, although
such discount will be included in gross income for purposes of the 90% test and
the 30% test described previously. Original issue discount with respect to
tax-exempt securities is accrued and added to the adjusted tax basis of such
securities for purposes of determining gain or loss upon sale or at maturity.
Generally, the amount of original issue discount is determined on the basis of a
constant yield to maturity which takes into account the compounding of accrued
interest. An investment in a stripped bond or stripped coupon will result in
original issue discount.
Debt securities may be purchased by the Funds at a market discount. Market
discount occurs when a security is purchased at a price less than the original
issue price adjusted for accrued original issue discount, if any. The Funds
intend to defer recognition of accrued market discount until maturity or other
disposition of the bond. For securities purchased at a market discount, the gain
realized on disposition will be treated as taxable ordinary income to the extent
it does not exceed accrued market discount on the bond.
The Funds may also purchase debt securities at a premium, i.e., at a
purchase price in excess of face amount. With respect to tax-exempt securities,
the premium must be amortized to the maturity date but no deduction is allowed
for the premium amortization. The amortized bond premium will reduce the Funds'
adjusted tax basis in the securities. For taxable securities, the premium may be
amortized if the Funds so elect. The amortized premium on taxable securities is
first offset against interest received on the securities and then allowed as a
deduction, and, for securities issued after September 27, 1985, must be
amortized under an economic accrual method.
TAXATION OF THE SHAREHOLDERS
Taxable distributions are generally included in a shareholder's gross income for
the taxable year in which they are received. Dividends declared in October,
November, or December and made payable to shareholders of record in such a month
will be deemed to have been received on December 31, if a Fund pays the dividend
during the following January. It is expected that none of the Funds'
distributions will qualify for the corporate dividends-received deduction.
To the extent that a Fund's dividends distributed to shareholders are
derived from interest income exempt from federal income tax and are designated
as "exempt-interest dividends" by a Fund, they will be excludable from a
shareholder's gross income for federal income tax purposes. Shareholders who are
recipients of Social Security benefits should be aware that exempt-interest
dividends received from a Fund are includible in their "modified adjusted gross
income" for purposes of determining the amount of such Social Security benefits,
if any, that are required to be included in their gross income.
All distributions of investment income during the year will have the same
percentage designated as tax-exempt. This method is called the "average annual
method." Since the Funds invest primarily in tax-exempt securities, the
percentage will be substantially the same as the amount actually earned during
any particular distribution period.
A shareholder of the California Bond Fund should be aware that a
redemption of shares (including any exchange into another USAA Fund) is a
taxable event and, accordingly, a capital gain or loss may be recognized. If a
shareholder receives an exempt-interest dividend with respect to any share and
such share has been held for six months or less, any loss on the redemption or
exchange will be disallowed to the extent of such exempt-interest dividend.
Similarly, if a shareholder of the Fund receives a distribution taxable as
long-term capital gain with respect to shares of the Fund and redeems or
exchanges shares before he has held them for more than six months, any loss on
the redemption or exchange (not otherwise disallowed as attributable to an
exempt-interest dividend) will be treated as long-term capital loss.
The Funds may invest in private activity bonds. Interest on certain
private activity bonds issued after August 7, 1986, is an item of tax preference
for purposes of the Federal Alternative Minimum Tax (AMT), although the interest
continues to be excludable from gross income for other purposes. AMT is a
supplemental tax designed to ensure that taxpayers pay at least a minimum amount
of tax on their income, even if they make substantial use of certain tax
deductions and exclusions (referred to as tax preference items). Interest from
private activity bonds is one of the tax preference items that is added to
income from other sources for the purposes of determining whether a taxpayer is
subject to the AMT and the amount of any tax to be paid. For corporate
investors, alternative minimum taxable income is increased by 75% of the amount
by which adjusted current earnings (ACE) exceeds alternative minimum taxable
income before the ACE adjustment. For corporate taxpayers, all tax-exempt
interest is considered in calculating the AMT as part of the ACE.
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Prospective investors should consult their own tax advisers with respect to the
possible application of the AMT to their tax situation.
Opinions relating to the validity of tax-exempt securities and the
exemption of interest thereon from federal income tax are rendered by recognized
bond counsel to the issuers. Neither the Manager's nor the Funds' counsel makes
any review of the basis of such opinions.
CALIFORNIA TAXATION
The State of California has adopted legislation incorporating the federal
provisions relating to regulated investment companies. Thus, to the extent the
Funds distribute their income, they will be exempt from the California franchise
and corporate income taxes as regulated investment companies under Section 24870
of the California Revenue and Taxation Code.
In the year in which a Fund qualifies as a regulated investment company
under the Code and is exempt from federal income tax, (1) the Fund will also be
exempt from the California corporate income and franchise taxes to the extent it
distributes its income and (2), provided 50% or more of the value of the total
assets of the Fund at the close of each quarter of its taxable year consists of
obligations, the interest on which (when held by an individual) is exempt from
personal income taxation under California law, the Fund will be qualified under
California law to distribute dividends ("California exempt-interest dividends")
which will be exempt from the California personal income tax. The Funds intend
to qualify under the above requirement so that they can distribute California
exempt-interest dividends. If the Funds fail to so qualify, no part of their
dividends will be exempt from the California personal income tax.
The portion of dividends constituting California exempt-interest dividends
is that portion derived from interest on obligations issued by California and
its municipalities and localities, (as well as certain territories and
possessions of the United States such as Puerto Rico, the Virgin Islands, and
Guam), the interest on which (when held by an individual) is excludable from
California personal income under California law. Distributions from the Funds
that are attributable to sources other than those described in the preceding
sentence generally will be taxable to such shareholders as ordinary income. In
addition, distributions other than exempt-interest dividends to such
shareholders are includable in income that may be subject to the California
alternative minimum tax. The total amount of California exempt-interest
dividends paid by each Fund to all of its shareholders with respect to any
taxable year cannot exceed the amount of interest received by each Fund during
such year on California municipal obligations less any expenses and
expenditures. California exempt-interest dividends are excludable from income
for California personal income tax purposes only. Any dividends paid to
shareholders subject to the California franchise tax will be taxed as ordinary
dividends to such shareholders notwithstanding that all or a portion of such
dividends are exempt from the California personal income tax.
To the extent any portion of the dividends distributed to the shareholders
by the Funds are derived from taxable interest for California purposes or net
short-term capital gains, such portion will be taxable to the shareholders as
ordinary income. The character of long-term capital gains realized and
distributed by the California Bond Fund will flow through to its shareholders
regardless of how long the shareholders have held their shares. If a shareholder
of the Funds received any California exempt-interest dividends on shares
thereafter sold within six months of acquisition, then any realized loss, to the
extent of the amount of exempt- interest dividends received prior to such sale,
will be disallowed. Interest on indebtedness incurred by shareholders to
purchase or carry shares of the Funds' will not be deductible for California
personal income tax purposes. Any loss realized upon the redemption of shares
within 30 days before or after the acquisition of other shares of the same
series may be disallowed under the "wash sale" rules.
The foregoing is only a summary of some of the important California
personal income tax considerations generally affecting the Funds and their
shareholders. No attempt is made to present a detailed explanation of the
California personal income tax treatment of the Funds or their shareholders, and
this discussion is not intended as a substitute for careful planning.
Accordingly, potential investors in the Funds should consult their tax advisers
with respect to the application of California taxes to the receipt of the Funds'
dividends and as to their own California tax situation.
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DIRECTORS AND OFFICERS OF THE COMPANY
The Board of Directors of the Company consists of seven Directors. Set forth
below are the Directors and officers of the Company, and their respective
offices and principal occupations during the last five years. Unless otherwise
indicated, the business address of each is 9800 Fredericksburg Rd., San Antonio,
TX 78288.
Robert G. Davis 1, 2
Director and Chairman of the Board of Directors
Age: 50
President, Chief Executive Officer, Director and Vice Chairman of the Board of
Directors of USAA Capital Corporation and several of its subsidiaries and
affiliates (1/97-present); Director, Chairman, President, and Chief Executive
Officer, USAA Financial Planning Network, Inc. (1/97-present); Director, Vice
Chairman, Executive Vice President, and Chief Operating Officer, USAA Financial
Planning Network, Inc. (9/96-1/97); Special Assistant to Chairman, United
Services Automobile Association (USAA) (6/96-12/96); President and Chief
Executive Officer, Banc One Credit Corporation (12/95-6/96); and President and
Chief Executive Officer, Banc One Columbus, (8/91-12/95). Mr. Davis also serves
as a Trustee and Chairman of the Board of Trustees of USAA Investment Trust and
USAA State Tax-Free Trust and as a Director and Chairman of the Boards of
Directors of USAA Investment Management Company (IMCO), USAA Mutual Fund, Inc.,
USAA Shareholder Account Services, USAA Federal Savings Bank and USAA Real
Estate Company.
Michael J.C. Roth 1, 2
Director, President and Vice Chairman of the Board of Directors
Age: 55
Chief Executive Officer, IMCO (10/93-present); President, Director and Vice
Chairman of the Board of Directors, IMCO (1/90-present). Mr. Roth serves as
President, Trustee and Vice Chairman of the Boards of Trustees of USAA
Investment Trust and USAA State Tax-Free Trust, as President, Director and Vice
Chairman of the Boards of Directors of USAA Mutual Fund, Inc. and USAA
Shareholder Account Services, as Director of USAA Life Insurance Company and as
Trustee and Vice Chairman of USAA Life Investment Trust.
John W. Saunders, Jr. 1, 2, 4
Director and Vice President
Age: 62
Senior Vice President, Fixed Income Investments, IMCO (10/85-present). Mr.
Saunders serves as Trustee and Vice President of USAA Investment Trust and USAA
State Tax-Free Trust, as a Director of IMCO, Director and Vice President of USAA
Mutual Fund, Inc., as Senior Vice President of USAA Shareholder Account
Services, and as Vice President of USAA Life Investment Trust.
Barbara B. Dreeben 3, 4, 5
200 Patterson #1008
San Antonio, TX 78209
Director
Age: 52
President, Postal Addvantage (7/92-present); Consultant, Nancy Harkins Stationer
(8/91-12/95). Mrs. Dreeben serves as a Trustee of USAA Investment Trust and USAA
State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Howard L. Freeman, Jr. 2, 3, 4, 5
2710 Hopeton
San Antonio, TX 78230
Director
Age: 62
Retired. Assistant General Manager for Finance, San Antonio City Public Service
Board (1976-1996). Mr. Freeman serves as a Trustee of USAA Investment Trust and
USAA State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
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Robert L. Mason, Ph.D. 3, 4, 5
12823 Queens Forest
San Antonio, TX 78230
Director
Age: 51
Manager, Statistical Analysis Section, Southwest Research Institute
(8/75-present). Dr. Mason serves as a Trustee of USAA Investment Trust and USAA
State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Richard A. Zucker 3, 4, 5
407 Arch Bluff
San Antonio, TX 78216
Director
Age: 54
Vice President, Beldon Roofing and Remodeling (1985-present). Mr. Zucker serves
as a Trustee of USAA Investment Trust and USAA State Tax-Free Trust and as a
Director of USAA Mutual Fund, Inc.
Michael D. Wagner 1
Secretary
Age: 49
Vice President, Corporate Counsel, USAA (1982-present). Mr. Wagner has held
various positions in the legal department of USAA since 1970 and serves as Vice
President, Secretary and Counsel, IMCO and USAA Shareholder Account Services,
Secretary, USAA Investment Trust, USAA Mutual Fund, Inc., and USAA State
Tax-Free Trust; and as Vice President, Corporate Counsel for various other USAA
subsidiaries and affiliates.
Alex M. Ciccone 1
Assistant Secretary
Age: 47
Vice President, Compliance, IMCO (12/94-present); Vice President and Chief
Operating Officer, Commonwealth Shareholder Services (6/94-11/94); and Vice
President, Compliance, IMCO (12/91-5/94). Mr. Ciccone serves as Assistant
Secretary of USAA Investment Trust, USAA State Tax-Free Trust, and USAA Mutual
Fund, Inc.
Sherron A. Kirk 1
Treasurer
Age: 52
Vice President, Controller, IMCO (10/92-present); Vice President, Corporate
Financial Analysis, USAA (9/92- 10/92); Assistant Vice President, Financial
Plans and Support, USAA (8/91-9/92). Mrs. Kirk serves as Treasurer of USAA
Investment Trust, USAA State Tax-Free Trust, and USAA Mutual Fund, Inc., and as
Vice President, Controller of USAA Shareholder Account Services.
Dean R. Pantzar 1
Assistant Treasurer
Age: 38
Executive Director, Mutual Fund Accounting, IMCO (10/95-present); Director,
Mutual Fund Accounting, IMCO (12/94-10/95); Senior Manager, KPMG Peat Marwick
LLP (7/88-12/94). Mr. Pantzar serves as Assistant Treasurer of USAA Mutual Fund,
Inc., USAA State Tax-Free Trust, and USAA Investment Trust.
- -----------------
1 Indicates those Directors and officers who are employees of the Manager or
affiliated companies and are considered "interested persons" under the 1940
Act.
2 Member of Executive Committee
3 Member of Audit Committee
4 Member of Pricing and Investment Committee
5 Member of Corporate Governance Committee
Between the meetings of the Board of Directors and while the Board is not in
session, the Executive Committee of the Board of Directors has all the powers
and may exercise all the duties of the Board of Directors in the management of
the business of the Company which may be delegated to it by the Board. The
Pricing and Investment Committee of the Board of Directors acts upon various
investment-related issues and other matters which have been delegated to it by
the Board. The Audit Committee of the Board of Directors reviews the financial
statements and the auditor's reports and undertakes certain studies and analyses
as
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directed by the Board. The Corporate Governance Committee of the Board of
Directors maintains oversight of the organization, performance, and
effectiveness of the Board and Independent Directors.
In addition to the previously listed Directors and/or officers of the Company
who also serve as Directors and/or officers of the Manager, the following
individuals are Directors and/or executive officers of the Manager: Harry W.
Miller, Senior Vice President, Investments (Equity); Carl W. Shirley, Senior
Vice President, Insurance Company Portfolios; and John J. Dallahan, Senior Vice
President, Investment Services. There are no family relationships among the
Directors, officers and managerial level employees of the Company or its
Manager.
The following table sets forth information describing the compensation of the
current Directors of the Company for their services as Directors for the fiscal
year ended March 31, 1997.
Name Aggregate Total Compensation
of Compensation from the USAA
Director from the Company Family of Funds (b)
- ------- ------------------ ---------------------
George E. Brown * $6,824 $25,600
Robert G. Davis None (a) None (a)
Barbara B. Dreeben 9,787 36,600
Howard L. Freeman, Jr. 9,787 36,600
Robert L. Mason* 2,963 11,000
Michael J.C. Roth None (a) None (a)
John W. Saunders, Jr. None (a) None (a)
Richard A. Zucker 9,787 36,600
- ----------------
* Effective January 1, 1997, Robert L. Mason replaced George E. Brown as a
Director on the Board of Directors. Mr. Brown retired on December 31, 1996.
(a) Robert G. Davis, Michael J.C. Roth, and John W. Saunders, Jr. are affiliated
with the Company's investment adviser, IMCO, and, accordingly, receive no
remuneration from the Company or any other Fund of the USAA Family of Funds.
(b) At March 31, 1997, the USAA Family of Funds consisted of four registered
investment companies offering 33 individual funds. Each Director presently
serves as a Trustee or Director of each investment company in the USAA
Family of Funds. In addition, Michael J.C. Roth presently serves as a
Trustee of USAA Life Investment Trust, a registered investment company
advised by IMCO, consisting of seven funds offered to investors in a fixed
and variable annuity contract with USAA Life Insurance Company. Mr. Roth
receives no compensation as Trustee of USAA Life Investment Trust.
All of the above Directors are also Trustees/Directors of the other funds
for which IMCO serves as investment adviser. No compensation is paid by any fund
to any Trustee/Director who is a director, officer, or employee of IMCO or its
affiliates. No pension or retirement benefits are accrued as part of fund
expenses. The Company reimburses certain expenses of the Directors who are not
affiliated with the investment adviser. As of June 30, 1997, the officers and
Directors of the Company and their families as a group owned beneficially or of
record less than 1% of the outstanding shares of the Company.
The following table identifies all persons, who as of June 30, 1997, held
of record or owned beneficially 5% or more of either Fund's shares.
Name and address
Title of Class of beneficial owner Percent of class
------------------- ------------------------ ---------------
California Money Idanta Partners Ltd. 8.2%
Market Fund 4660 La Jolla Village Dr.
San Diego, CA 92122-4606
THE COMPANY'S MANAGER
As described in the Prospectus, USAA Investment Management Company is the
Manager and investment adviser, providing services under the Advisory Agreement.
The Manager, organized in May 1970, has served as investment adviser and
underwriter for USAA Tax Exempt Fund, Inc. from its inception.
In addition to managing the Company's assets, the Manager advises and
manages the investments for USAA and its affiliated companies as well as those
of USAA Mutual Fund, Inc., USAA Investment Trust, USAA State Tax-Free Trust and
USAA Life Investment Trust. As of the date of this SAI, total assets under
management by the Manager were approximately $35 billion, of which approximately
$20 billion were in mutual fund portfolios.
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ADVISORY AGREEMENT
Under the Advisory Agreement, the Manager provides an investment program,
carries out the investment policy and manages the portfolio assets for each
Fund. The Manager is authorized, subject to the control of the Board of
Directors of the Company, to determine the selection, amount and time to buy or
sell securities for each Fund. In addition to providing investment services, the
Manager pays for office space, facilities, business equipment and accounting
services (in addition to those provided by the Custodian) for the Company. The
Manager compensates all personnel, officers and Directors of the Company if such
persons are also employees of the Manager or its affiliates. For these services
under the Advisory Agreement, the Company has agreed to pay the Manager a fee
computed as described under MANAGEMENT OF THE COMPANY in the Prospectus.
Management fees are computed and accrued daily and payable monthly.
Except for the services and facilities provided by the Manager, the Funds
pay all other expenses incurred in their operations. Expenses for which the
Funds are responsible include taxes (if any), brokerage commissions on portfolio
transactions (if any), expenses of issuance and redemption of shares, charges of
transfer agents, custodians and dividend disbursing agents, costs of preparing
and distributing proxy material, costs of printing and engraving stock
certificates, auditing and legal expenses, certain expenses of registering and
qualifying shares for sale, fees of Directors who are not interested persons
(not affiliated) of the Manager, costs of typesetting, printing and mailing the
Prospectus, SAI and periodic reports to existing shareholders, and any other
charges or fees not specifically enumerated. The Manager pays the cost of
printing and mailing copies of the Prospectus, the SAI, and reports to
prospective shareholders.
The Advisory Agreement will remain in effect until June 30, 1998, for each
Fund and will continue in effect from year to year thereafter for each Fund as
long as it is approved at least annually by a vote of the outstanding voting
securities of such Fund (as defined by the 1940 Act) or by the Board of
Directors (on behalf of such Fund) including a majority of the Directors who are
not interested persons of the Manager or (otherwise than as Directors) of the
Company, at a meeting called for the purpose of voting on such approval. The
Advisory Agreement may be terminated at any time by either the Company or the
Manager on 60 days' written notice. It will automatically terminate in the event
of its assignment (as defined in the 1940 Act).
From time to time the Manager may, without prior notice to shareholders,
waive all or any portion of fees or agree to reimburse expenses incurred by a
Fund. Any such waiver or reimbursement may be terminated by the Manager at any
time without prior notice to shareholders.
For the last three fiscal years, the Company paid the Manager the
following fees:
1995 1996 1997
---- ---- ----
California Bond Fund $ 1,192,329 $ 1,281,538 $1,366,876
California Money Market Fund $ 823,095 $ 890,228 $1,004,583
UNDERWRITER
The Company has an agreement with the Manager for exclusive underwriting and
distribution of the Funds' shares on a continuing best efforts basis. This
agreement provides that the Manager will receive no fee or other compensation
for such distribution services.
TRANSFER AGENT
The Transfer Agent performs transfer agent services for the Company under a
Transfer Agency Agreement. Services include maintenance of shareholder account
records, handling of communications with shareholders, distribution of Fund
dividends and production of reports with respect to account activity for
shareholders and the Company. For its services under the Transfer Agency
Agreement, each Fund pays the Transfer Agent an annual fixed fee of $26.00 per
account. This fee is subject to change at any time.
The fee to the Transfer Agent includes processing of all transactions and
correspondence. Fees are billed on a monthly basis at the rate of one-twelfth of
the annual fee. In addition, the Funds pay all out-of-pocket expenses of the
Transfer Agent and other expenses which are incurred at the specific direction
of the Company.
GENERAL INFORMATION
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 1713, Boston, MA 02105, is the
Company's Custodian. The Custodian is responsible for, among other things,
safeguarding and controlling the Company's cash and securities, handling the
receipt and delivery of securities and collecting interest on the Company's
investments.
COUNSEL
Goodwin, Procter & Hoar LLP, Exchange Place, Boston, MA 02109, will review
certain legal matters for the Company in connection with the shares offered by
the Prospectus.
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INDEPENDENT AUDITORS
KPMG Peat Marwick LLP, 112 East Pecan, Suite 2400, San Antonio, TX 78205, is the
Company's independent auditor. In this capacity, the firm is responsible for
auditing the annual financial statements of the Funds and reporting thereon.
FINANCIAL STATEMENTS
The financial statements of the Funds and the Independent Auditors' Report
thereon for the fiscal year ended March 31, 1997, are included in the Annual
Report to Shareholders of that date and are incorporated herein by reference.
The Manager will deliver a copy of the Annual Report free of charge with each
SAI requested.
CALCULATION OF PERFORMANCE DATA
Information regarding total return and yield of each Fund is provided under
PERFORMANCE INFORMATION in the Prospectus. See VALUATION OF SECURITIES herein
for a discussion of the manner in which each Fund's price per share is
calculated.
TOTAL RETURN
The California Bond Fund may advertise performance in terms of average annual
total return for 1-, 5-, and 10-year periods, or for such lesser period as the
Fund has been in existence. Average annual total return is computed by finding
the average annual compounded rates of return over the periods that would equate
the initial amount invested to the ending redeemable value, according to the
following formula:
P(1 + T)N = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1-, 5-, or 10-year periods at
the end of the year or period
The calculation assumes all charges are deducted from the initial
$1,000 payment and assumes all dividends and distributions by such Fund are
reinvested at the price stated in the Prospectus on the reinvestment dates
during the period, and includes all recurring fees that are charged to all
shareholder accounts.
The date of commencement of operations for the California Bond Fund was
August 1, 1989. The Fund's average annual total returns for the periods ended
March 31, 1997 were:
1 year. . . 6.60% 5 years . . . 7.06% Since inception . . . 7.32%
YIELD
The California Bond Fund may advertise performance in terms of a 30-day yield
quotation. The 30-day yield quotation is computed by dividing the net investment
income per share earned during the period by the maximum offering price per
share on the last day of the period, according to the following formula:
YIELD = 2 left [ left ({a-b} over cd + 1 right)^6 - 1 right]
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursement)
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends
d = the maximum offering price per share on the last day of the
period
For purposes of the yield calculation, interest income is computed based
on the yield to maturity of each debt obligation in the Fund's portfolio and all
recurring charges are recognized.
The Fund's 30-day yield for the period ended March 31, 1997 was 5.49%.
YIELD - CALIFORNIA MONEY MARKET FUND
When the California Money Market Fund quotes a current annualized yield, it is
based on a specified recent seven-calendar-day period. It is computed by (1)
determining the net change, exclusive of capital changes, in the value of a
hypothetical preexisting account having a balance of one share at the beginning
of the period, (2) dividing the net change in account value by the value of the
account at the beginning of the base period to
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<PAGE>
obtain the base return, then (3) multiplying the base period return by 52.14
(365/7). The resulting yield figure is carried to the nearest hundredth of one
percent.
The calculation includes (1) the value of additional shares purchased with
dividends on the original share, and dividends declared on both the original
share and any such additional shares, and (2) any fees charged to all
shareholder accounts, in proportion to the length of the base period and the
Fund's average account size.
The capital changes excluded from the calculation are realized capital
gains and losses from the sale of securities and unrealized appreciation and
depreciation. The Fund's effective (compounded) yield will be computed by
dividing the seven-day annualized yield as defined above by 365, adding 1 to the
quotient, raising the sum to the 365th power, and subtracting 1 from the result.
Current and effective yields fluctuate daily and will vary with factors
such as interest rates and the quality, length of maturities, and type of
investments in the portfolio.
Yield for 7-day Period Ended 3/31/97 . . . 3.11%
Effective Yield for 7-day Period Ended 3/31/97 . . . 3.16%
TAX EQUIVALENT YIELD
A tax-exempt mutual fund may provide more "take-home" income than a fully
taxable mutual fund after paying taxes. Calculating a "tax equivalent yield"
means converting a tax-exempt yield to a pretax equivalent so that a meaningful
comparison can be made between a tax-exempt municipal fund and a fully taxable
fund. The California Money Market Fund may advertise performance in terms of a
tax equivalent yield based on the 7-day yield or effective yield and the
California Bond Fund may advertise performance in terms of a 30-day tax
equivalent yield.
To calculate a tax equivalent yield, the California investor must know his
Effective Marginal Tax Rate or EMTR. Assuming an investor can fully itemize
deductions on his or her federal tax return, the EMTR is the sum of the federal
marginal tax rate and the state marginal tax rate adjusted to reflect the
deductibility of state taxes from federal taxable income. The formula for
computing the EMTR to compare with fully taxable securities subject to both
federal and state taxes is:
EMTR = Federal Marginal Tax Rate + [State Marginal
Tax Rate x (1-Federal Marginal Tax Rate)]
The tax equivalent yield is then computed by dividing the tax-exempt yield
of a fund by the complement of the EMTR. The complement, for example, of an EMTR
of 41.9% is 58.1%, that is (1.00-0.419=0.581).
Tax Equivalent Yield = Tax Exempt Yield / (1-Effective Marginal Tax Rate)
Using a federal marginal tax rate of 36% and state marginal tax rate of
9.30%, resulting in an EMTR of 41.95%, the tax equivalent yields for the
California Bond and California Money Market Funds for the period ended March 31,
1997 were 9.46% and 5.36%, respectively.
APPENDIX A - TAX-EXEMPT SECURITIES AND THEIR RATINGS
TAX-EXEMPT SECURITIES
Tax-exempt securities generally include debt obligations issued by states and
their political subdivisions, and duly constituted authorities and corporations,
to obtain funds to construct, repair or improve various public facilities such
as airports, bridges, highways, hospitals, housing, schools, streets, and water
and sewer works. Tax-exempt securities may also be issued to refinance
outstanding obligations as well as to obtain funds for general operating
expenses and for loans to other public institutions and facilities.
The two principal classifications of tax-exempt securities are "general
obligations" and "revenue" or "special tax" bonds. General obligation bonds are
secured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue or special tax bonds are payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise or other tax, but not
from general tax revenues. The Funds may also invest in tax-exempt private
activity bonds, which in most cases are revenue bonds and generally do not have
the pledge of the credit of the issuer. The payment of the principal and
interest on such industrial revenue bonds is dependent solely on the ability of
the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed as
security for such payment. There are, of course, many variations in the terms
of, and the security underlying tax-exempt securities. Short-term obligations
issued by states, cities, municipalities or municipal agencies, include Tax
Anticipation Notes, Revenue Anticipation Notes, Bond Anticipation Notes,
Construction Loan Notes and Short-Term Discount Notes.
The yields of tax-exempt securities depend on, among other things, general
money market conditions, conditions of the tax-exempt bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. (Moody's), Standard &
Poor's Ratings Group (S&P), Fitch Investors Service, Inc. (Fitch), Duff & Phelps
Inc., Thompson BankWatch, Inc., and IBCA Inc. represent their opinions of the
quality of the securities rated by them. It should be emphasized that such
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ratings are general and are not absolute standards of quality. Consequently,
securities with the same maturity, coupon and rating may have different yields,
while securities of the same maturity and coupon but with different ratings may
have the same yield. It will be the responsibility of the Manager to appraise
independently the fundamental quality of the tax-exempt securities included in a
Fund's portfolio.
RATINGS
EXCERPTS FROM MOODY'S BOND (TAX-EXEMPT SECURITIES) RATINGS:
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risk appear
somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in
the future.
Baa Bonds which are rated Baa are considered as medium-grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
NOTE: THOSE BONDS IN THE AA, A, AND BAA GROUPS WHICH MOODY'S BELIEVES POSSESS
THE STRONGEST INVESTMENT ATTRIBUTES ARE DESIGNATED BY THE SYMBOLS AA1, A1, AND
BAA1.
EXCERPTS OF MOODY'S RATINGS OF SHORT-TERM LOANS (STATE AND TAX-EXEMPT NOTES):
Moody's ratings for state and tax-exempt notes and other short-term obligations
are designated Moody's Investment Grade (MIG). Symbols used will be as follows:
MIG-1 This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or
demonstrated broadbased access to the market for refinancing.
MIG-2 This designation denotes high quality. Margins of protection are ample
although not so large as in the preceding group.
EXCERPTS OF MOODY'S RATING OF COMMERCIAL PAPER:
Prime-1 Issuers rated Prime-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics:
o Leading market positions in well-established industries.
o High rates of return on funds employed.
o Conservative capitalization structures with moderate reliance on
debt and ample asset protection.
o Broad margins in earning coverage of fixed financial charges and
high internal cash generation.
o Well-established access to a range of financial markets and assured
sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited
above but to a lesser degree. Earnings trends and coverage ratios,
while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
EXCERPTS FROM S&P'S BOND RATINGS:
AAA Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small
degree.
20
<PAGE>
A Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher
rated categories.
BBB Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher
rated categories.
PLUS (+) OR MINUS (-): THE RATINGS FROM AA TO BBB MAY BE MODIFIED BY THE
ADDITION OF A PLUS OR MINUS SIGN TO SHOW RELATIVE STANDING WITHIN THE MAJOR
RATING CATEGORIES.
EXCERPTS OF S&P'S RATINGS OF TAX-EXEMPT NOTES:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term
of the notes.
EXCERPTS OF S&P'S RATING OF COMMERCIAL PAPER:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus (+) sign
designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as
for issues designated A-1.
EXCERPTS OF FITCH'S RATINGS OF BONDS:
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated AAA. Because
bonds rated in the AAA and AA categories are not significantly
vulnerable to foreseeable future developments, short-term debt of
these issuers is generally rated F-1+.
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes
in economic conditions and circumstances than bonds with higher
ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on
these bonds, and therefore, impair timely payment. The likelihood that
the ratings of these bonds will fall below investment grade is higher
than for bonds with higher ratings.
PLUS (+) AND MINUS (-): PLUS AND MINUS SIGNS ARE USED WITH A RATING SYMBOL TO
INDICATE THE RELATIVE POSITION OF A CREDIT WITHIN THE RATING CATEGORY. PLUS AND
MINUS SIGNS, HOWEVER, ARE NOT USED IN THE AAA CATEGORY.
EXCERPTS OF FITCH'S RATINGS TO COMMERCIAL PAPER, CERTIFICATES OF DEPOSIT AND
TAX-EXEMPT NOTES:
F-1+ Exceptionally strong credit quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely
payment.
F-1 Very strong credit quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues
rated F-1+.
F-2 Good credit quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is
not as great as for issues assigned F-1+ and F-1 ratings.
EXCERPTS FROM DUFF & PHELPS LONG-TERM RATING SCALE:
AAA Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA High credit quality. Protection factors are strong. Risk is modest but
may vary slightly from time to time because of economic conditions.
A Protection factors are average but adequate. However, risk factors are
more variable and greater in periods of economic stress.
21
<PAGE>
BBB Below average protection factors but still considered sufficient for
prudent investment. Considerable variability in risk during economic
cycles.
EXCERPTS FROM DUFF & PHELPS COMMERCIAL PAPER RATING SCALE:
D-1+ Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of
funds, is outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are
minor.
D-1- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are
very small.
D-2 Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge
total financing requirements, access to capital markets is good. Risk
factors are small.
THOMPSON BANKWATCH, INC.
TBW-1 The highest category; indicates a very high likelihood that principal
and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated TBW-1.
TBW-3 The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal
and external) than those with higher ratings, the capacity to service
principal and interest in a timely fashion is considered adequate.
IBCA INC.
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating of
A1+ is assigned.
A2 Obligations supported by a satisfactory capacity for timely repayment
although such capacity may be susceptible to adverse changes in
business, economic or financial conditions.
A3 Obligations supported by an adequate capacity for timely repayment.
Such capacity is more susceptible to adverse changes in business,
economic or financial conditions than for obligations in higher
categories.
B Obligations for which the capacity for timely repayment is susceptible
to adverse changes in business, economic or financial conditions.
C Obligations for which there is a high risk of default or which are
currently in default.
APPENDIX B - COMPARISON OF PORTFOLIO PERFORMANCE
Occasionally, we may make comparisons in advertising and sales literature
between the Funds contained in this SAI and other Funds in the USAA Family of
Funds. These comparisons may include such topics as risk and reward, investment
objectives, investment strategies, and performance.
Fund performance also may be compared to the performance of broad groups
of mutual funds with similar investment goals or unmanaged indexes of comparable
securities. Evaluations of Fund performance made by independent sources may be
used in advertisements concerning the Fund, including reprints of, or selections
from, editorials or articles about the Fund. The Fund or its performance may
also be compared to products and services not constituting securities subject to
registration under the Securities Act of 1933 such as, but not limited to,
certificates of deposit and money market accounts. Sources for performance
information and articles about the Fund may include the following:
AAII JOURNAL, a monthly association magazine for members of the American
Association of Individual Investors.
ARIZONA REPUBLIC, a newspaper which may cover financial and investment news.
AUSTIN AMERICAN-STATESMAN, a newspaper which may cover financial news.
BARRON'S, a Dow Jones and Company, Inc. business and financial weekly that
periodically reviews mutual fund performance data.
THE BOND BUYER, a daily newspaper which covers bond market news.
BUSINESS WEEK, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds.
22
<PAGE>
CHICAGO TRIBUNE, a newspaper which may cover financial news.
CONSUMER REPORTS, a monthly magazine which from time to time reports on
companies in the mutual fund industry.
DALLAS MORNING NEWS, a newspaper which may cover financial news.
DENVER POST, a newspaper which may quote financial news.
FINANCIAL PLANNING, a monthly magazine that periodically features companies in
the mutual fund industry.
FINANCIAL SERVICES WEEK, a weekly newspaper which covers financial news.
FINANCIAL WORLD, a monthly magazine which may periodically review mutual fund
companies.
FORBES, a national business publication that periodically reports the
performance of companies in the mutual fund industry.
FORTUNE, a national business publication that periodically rates the performance
of a variety of mutual funds.
FUND ACTION, a mutual fund news report.
HOUSTON CHRONICLE, a newspaper which may cover financial news.
HOUSTON POST, a newspaper which may cover financial news.
IBC/DONOGHUE'S MONEYLETTER, a biweekly newsletter which covers financial news
and from time to time rates specific mutual funds.
IBC'S MONEY MARKET INSIGHT, a monthly money market industry analysis prepared by
IBC USA, Inc.
INCOME AND SAFETY, a monthly newsletter that rates mutual funds.
INVESTECH, a bimonthly investment newsletter.
INVESTMENT ADVISOR, a monthly publication directed primarily to the advisor
community; includes ranking of mutual funds using a proprietary methodology.
INVESTMENT COMPANY INSTITUTE, a national association of the American investment
company industry.
INVESTOR'S BUSINESS DAILY, a newspaper which covers financial news.
KIPLINGER'S PERSONAL FINANCE MAGAZINE, a monthly investment advisory publication
that periodically features the performance of a variety of securities.
LIPPER ANALYTICAL SERVICES, INC.'S FIXED INCOME FUND PERFORMANCE ANALYSIS, a
monthly publication of industry-wide mutual fund performance averages by type of
fund.
LIPPER ANALYTICAL SERVICES, INC.'S MUTUAL FUND PERFORMANCE ANALYSIS, a weekly
and quarterly publication of industry-wide mutual fund performance averages by
type of fund.
LOS ANGELES TIMES, a newspaper which may cover financial news.
LOUIS RUKEYSER'S WALL STREET, a publication for investors.
MEDICAL ECONOMICS, a monthly magazine providing information to the medical
profession.
MONEY, a monthly magazine that features the performance of both specific funds
and the mutual fund industry as a whole.
MONEY FUND REPORT, a weekly publication of the Donoghue Organization, Inc.,
reporting on the performance of the nation's money market funds, summarizing
money market fund activity, and including certain averages as performance
benchmarks, specifically: (1) Taxable Money Fund Averages: "100% U.S. Treasury"
and "First Tier" and (2) Tax-Free Money Fund Averages: "Stockbroker and General
Purpose" and "State Specific Stockbroker and General Purpose."
MORNINGSTAR 5 STAR INVESTOR, a monthly newsletter which covers financial news
and rates mutual funds produced by Morningstar, Inc. (a data service which
tracks open-end mutual funds).
MUNI BOND FUND REPORT, a monthly newsletter which covers news on the municipal
bond market and features performance data for municipal bond mutual funds.
MUNIWEEK, a weekly newspaper which covers news on the municipal bond market.
MUTUAL FUND FORECASTER, a monthly newsletter that ranks mutual funds.
MUTUAL FUND INVESTING, a newsletter covering mutual funds.
MUTUAL FUND PERFORMANCE REPORT, a monthly publication of industry-wide mutual
fund averages produced by Morningstar, Inc.
MUTUAL FUNDS MAGAZINE, a monthly publication reporting on mutual fund investing.
23
<PAGE>
MUTUAL FUND SOURCE BOOK, an annual publication produced by Morningstar, Inc.
which describes and rates mutual funds.
MUTUAL FUND VALUES, a biweekly guidebook to mutual funds produced by
Morningstar, Inc.
NEWSWEEK, a national business weekly.
NEW YORK TIMES, a newspaper which may cover financial news.
NO LOAD FUND INVESTOR, a newsletter covering companies in the mutual fund
industry.
PERSONAL INVESTOR, a monthly magazine which from time to time features mutual
fund companies and the mutual fund industry.
SAN ANTONIO BUSINESS JOURNAL, a weekly newspaper that periodically covers mutual
fund companies as well as financial news.
SAN ANTONIO EXPRESS-NEWS, a newspaper which may cover financial news.
SAN FRANCISCO CHRONICLE, a newspaper which may cover financial news.
SMART MONEY, a monthly magazine featuring news and articles on investing and
mutual funds.
USA TODAY, a newspaper which may cover financial news.
U.S. NEWS AND WORLD REPORT, a national business weekly that periodically reports
mutual fund performance data.
WALL STREET JOURNAL, a Dow Jones and Company, Inc. newspaper which covers
financial news.
WASHINGTON POST, a newspaper which may cover financial news.
WEISENBERGER MUTUAL FUNDS INVESTMENT REPORT, a monthly newsletter that reports
on both specific mutual fund companies and the mutual fund industry as a whole.
WORTH, a magazine which covers financial and investment subjects including
mutual funds.
YOUR MONEY, a monthly magazine directed towards the novice investor.
In addition to the sources above, performance of our Funds may also be
tracked by Lipper Analytical Services, Inc. Each Fund will be compared to
Lipper's appropriate fund category according to objective and portfolio
holdings. The California Bond Fund will be compared to funds in Lipper's
California tax-exempt bond funds category, and the California Money Market Fund
to funds in Lipper's California short-term tax-exempt bond funds category.
Footnotes in advertisements and other sales literature will include the time
period applicable for any rankings used.
For comparative purposes, unmanaged indices of comparable securities or
economic data may be cited. Examples include the following:
- Shearson Lehman Hutton Bond Indices, indices of fixed-rate debt issues rated
investment grade or higher which can be found in the BOND MARKET REPORT.
- Bond Buyer Indices, indices of debt of varying maturities including revenue
bonds, general obligation bonds, and U.S. Treasury bonds which can be found in
MUNIWEEK and THE BOND BUYER.
Other sources for total return and other performance data which may be
used by the Fund or by those publications listed previously are Morningstar,
Inc., Schabaker Investment Management, and Investment Company Data, Inc. These
are services that collect and compile data on mutual fund companies.
24
<PAGE>
APPENDIX C - TAXABLE EQUIVALENT YIELD TABLE
COMBINED FEDERAL AND CALIFORNIA STATE INCOME TAX RATES
Assuming a Federal
Marginal Tax Rate of: 28% 31% 36% 39.6%
and a State Rate of: 8.0% 9.3% 9.3% 9.3%
The Effective Marginal
Tax Rate would be: 33.760% (a) 37.417% (b) 41.952% (c) 45.217% (d)
To Match a Double
Tax Free Yield of: A Fully Taxable Investment Would Have to Pay You:
2.00% 3.02% 3.20% 3.45% 3.65%
3.00% 4.53% 4.79% 5.17% 5.48%
4.00% 6.04% 6.39% 6.89% 7.30%
5.00% 7.55% 7.99% 8.61% 9.13%
6.00% 9.06% 9.59% 10.34% 10.95%
7.00% 10.57% 11.19% 12.06% 12.78%
(a)FEDERALRATE OF 28% + (CALIFORNIA STATE RATE OF 8.0% x (1 - 28%))
(b)FEDERALRATE OF 31% + (CALIFORNIA STATE RATE OF 9.3% x (1 - 31%))
(c)FEDERALRATE OF 36% + (CALIFORNIA STATE RATE OF 9.3% x (1 - 36%))
(d)FEDERAL RATE OF 39.6% + (CALIFORNIA STATE RATE OF 9.3% x (1 - 39.6%))
THIS TABLE IS A HYPOTHETICAL ILLUSTRATION AND SHOULD NOT BE CONSIDERED AN
INDICATION OF FUND PERFORMANCE OF ANY OF THE USAA FAMILY OF FUNDS.
THESE RATES WERE SELECTED AS EXEMPLARY RATES THAT WOULD BE RELEVANT TO MOST
TAXPAYERS.
25
<PAGE>
APPENDIX D - DOLLAR-COST AVERAGING
Dollar-cost averaging is a systematic investing method which can be used by
investors as a disciplined technique for investing. A fixed amount of money is
invested in a security (such as a stock or mutual fund) on a regular basis over
a period of time, regardless of whether securities markets are moving up or
down.
This practice reduces average share costs to the investor who acquires
more shares in periods of lower securities prices and fewer shares in periods of
higher prices.
While dollar-cost averaging does not assure a profit or protect against
loss in declining markets, this investment strategy is an effective way to help
calm the effect of fluctuations in the financial markets. Systematic investing
involves continuous investment in securities regardless of fluctuating price
levels of such securities. Investors should consider their financial ability to
continue purchases through periods of low and high price levels.
As the following chart illustrates, dollar-cost averaging tends to keep
the overall cost of shares lower. This example is for illustration only, and
different trends would result in different average costs.
HOW DOLLAR-COST AVERAGING WORKS
$100 Invested Regularly for 5 Periods
Market Trend
-----------------------------------------------------------------
Down Up Mixed
-----------------------------------------------------------------
Share Shares Share Shares Share Shares
Investment Price Purchased Price Purchased Price Purchased
------------------- --------------------- ------------------
$100 10 10 6 16.67 10 10
100 9 11.1 7 14.29 9 11.1
100 8 12.5 7 14.29 8 12.5
100 8 12.5 9 11.1 9 11.1
100 6 16.67 10 10 10 10
---- -- ---- -- ---- --- ---
$500 ***41 62.77 ***39 66.35 ***46 54.7
*Avg. Cost: $7.97 *Avg. Cost: $7.54 *Avg. Cost: $9.14
----- ----- -----
**Avg. Price: $8.20 **Avg. Price:$7.80 **Avg Price: $9.20
----- ----- -----
* Average Cost is the total amount invested divided by number of shares
purchased.
** Average Price is the sum of the prices paid divided by number of purchases.
*** Cumulative total of share prices used to compute average prices.
26
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27
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14356-0897
<PAGE>
Part B
Statement of Additional Information for the
New York Bond and
New York Money Market Funds
<PAGE>
[USAA EAGLE LOGO]
USAA STATEMENT OF
TAX EXEMPT ADDITIONAL INFORMATION
FUND, INC. August 1, 1997
- --------------------------------------------------------------------------------
USAA TAX EXEMPT FUND, INC.
NEW YORK FUNDS
USAA TAX EXEMPT FUND, INC. (the Company) is a registered investment company
offering shares of ten no-load mutual funds, two of which are described in this
Statement of Additional Information (SAI): the New York Bond Fund and New York
Money Market Fund (collectively, the Funds or the New York Funds). Each Fund is
classified as diversified and has a common investment objective of providing New
York investors with a high level of current interest income that is exempt from
federal income taxes and New York State and New York City personal income taxes.
The New York Money Market Fund has a further objective of preserving capital and
maintaining liquidity.
You may obtain a free copy of a Prospectus for the New York Funds dated August
1, 1997, by writing to USAA Tax Exempt Fund, Inc., 9800 Fredericksburg Rd., San
Antonio, TX 78288, or by calling toll free 1-800-531-8181. The Prospectus
provides the basic information you should know before investing in the Funds.
This SAI is not a Prospectus and contains information in addition to and more
detailed than that set forth in the Prospectus. It is intended to provide you
with additional information regarding the activities and operations of the
Company and the Funds, and should be read in conjunction with the Prospectus.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
2 Valuation of Securities
2 Additional Information Regarding Redemption of Shares
3 Investment Plans
4 Investment Policies
5 Investment Restrictions
6 Special Risk Considerations
14 Portfolio Transactions
15 Further Description of Shares
15 Certain Federal Income Tax Considerations
17 Directors and Officers of the Company
20 The Company's Manager
21 General Information
21 Calculation of Performance Data
23 Appendix A - Tax-Exempt Securities and Their Ratings
26 Appendix B - Comparison of Portfolio Performance
28 Appendix C - Taxable Equivalent Yield Tables
30 Appendix D - Dollar-Cost Averaging
<PAGE>
VALUATION OF SECURITIES
Shares of each Fund are offered on a continuing best efforts basis through USAA
Investment Management Company (IMCO or the Manager). The offering price for
shares of each Fund is equal to the current net asset value (NAV) per share. The
NAV per share of each Fund is calculated by adding the value of all its
portfolio securities and other assets, deducting its liabilities, and dividing
by the number of shares outstanding.
A Fund's NAV per share is calculated each day, Monday through Friday,
except days on which the New York Stock Exchange (NYSE) is closed. The NYSE is
currently scheduled to be closed on New Year's Day, Martin Luther King Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving, and Christmas, and on the preceding Friday or subsequent Monday
when one of these holidays falls on a Saturday or Sunday, respectively.
The investments of the NEW YORK BOND FUND are valued each business day by
a pricing service (the Service) approved by the Company's Board of Directors.
The Service uses the mean between quoted bid and asked prices or the last sale
price to price securities when, in the Service's judgment, these prices are
readily available and are representative of the securities' market values. For
many securities, such prices are not readily available. The Service generally
prices these securities based on methods which include consideration of yields
or prices of tax-exempt securities of comparable quality, coupon, maturity and
type, indications as to values from dealers in securities, and general market
conditions. Securities purchased with maturities of 60 days or less are stated
at amortized cost which approximates market value. Repurchase agreements are
valued at cost. Securities which cannot be valued by the Service, and all other
assets, are valued in good faith at fair value using methods determined by the
Manager under the general supervision of the Board of Directors.
The value of the NEW YORK MONEY MARKET FUND'S securities is stated at
amortized cost which approximates market value. This involves valuing a security
at its cost and thereafter assuming a constant amortization to maturity of any
discount or premium, regardless of the impact of fluctuating interest rates.
While this method provides certainty in valuation, it may result in periods
during which the value of an instrument, as determined by amortized cost, is
higher or lower than the price the Fund would receive upon the sale of the
instrument.
The valuation of the New York Money Market Fund's portfolio instruments
based upon their amortized cost is subject to the Fund's adherence to certain
procedures and conditions. Consistent with regulatory requirements, the Manager
will only purchase securities with remaining maturities of 397 days or less and
will maintain a dollar-weighted average portfolio maturity of no more than 90
days. The Manager will invest only in securities that have been determined to
present minimal credit risk and that satisfy the quality and diversification
requirements of applicable rules and regulations of the Securities and Exchange
Commission (SEC).
The Board of Directors has established procedures designed to stabilize
the New York Money Market Fund's price per share, as computed for the purpose of
sales and redemptions, at $1.00. There can be no assurance, however, that the
Fund will at all times be able to maintain a constant $1.00 NAV per share. Such
procedures include review of the Fund's holdings at such intervals as is deemed
appropriate to determine whether the Fund's NAV calculated by using available
market quotations deviates from $1.00 per share and, if so, whether such
deviation may result in material dilution or is otherwise unfair to existing
shareholders. In the event that it is determined that such a deviation exists,
the Board of Directors will take such corrective action as it regards as
necessary and appropriate. Such action may include selling portfolio instruments
prior to maturity to realize capital gains or losses or to shorten average
portfolio maturity, withholding dividends, or establishing a NAV per share by
using available market quotations.
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
The value of a shareholder's investment at the time of redemption may be more or
less than the cost at purchase, depending on the value of the securities held in
each Fund's portfolio. Requests for redemption which are subject to any special
conditions, or which specify an effective date other than as provided herein,
cannot be accepted. A gain or loss for tax purposes may be realized on the sale
of shares, depending upon the price when redeemed.
The Board of Directors may cause the redemption of an account with a
balance of less than 50 shares provided (1) the value of the account has been
reduced, for reasons other than market action, below the minimum initial
investment in such Fund at the time of the establishment of the account, (2) the
total value of such shares has been reduced, for reasons other than market
action, below $50 in the case of an account in the New York Money Market Fund or
$500 in the case of an account in the New York Bond Fund, (3) the account has
remained below the minimum level for six months, and (4) 60 days' prior written
notice of the proposed redemption has been sent to the shareholder. Shares will
be redeemed at the NAV on the date fixed
2
<PAGE>
for redemption by the Board of Directors. Prompt payment will be made by mail to
the last known address of the shareholder.
The Company reserves the right to suspend the right of redemption or
postpone the date of payment (1) for any periods during which the NYSE is
closed, (2) when trading in the markets the Company normally utilizes is
restricted, or an emergency exists as determined by the SEC so that disposal of
the Company's investments or determination of its NAV is not reasonably
practicable, or (3) for such other periods as the SEC by order may permit for
protection of the Company's shareholders.
For the mutual protection of the investor and the Funds, the Company may
require a signature guarantee. If required, EACH signature on the account
registration must be guaranteed. Signature guarantees are acceptable from FDIC
member banks, brokers, dealers, municipal securities dealers, municipal
securities brokers, government securities dealers, government securities
brokers, credit unions, national securities exchanges, registered securities
associations, clearing agencies and savings associations. A signature guarantee
for active duty military personnel stationed abroad may be provided by an
officer of the United States Embassy or Consulate, a staff officer of the Judge
Advocate General, or an individual's commanding officer.
REDEMPTION BY CHECK
Shareholders in the New York Money Market Fund may request that checks be issued
for their account. Checks must be written in the amount of at least $250.
Checks issued to shareholders of the Fund will be sent only to the person
in whose name the account is registered and only to the address of record. The
checks must be manually signed by the registered owner(s) exactly as the account
is registered. For joint accounts the signature of either or both joint owners
will be required on the check, according to the election made on the signature
card. Dividends will continue to be earned by the shareholder until the shares
are redeemed by the presentation of a check.
When a check is presented to USAA Shareholder Account Services (Transfer
Agent) for payment, a sufficient number of full and fractional shares in the
investor's account will be redeemed to cover the amount of the check. If an
investor's account is not adequate to cover the amount of a check, the check
will be returned unpaid. Because the value of each account changes as dividends
are accrued on a daily basis, checks may not be used to close an account.
The Transfer Agent will return to the shareholder checks paid during the
month by separate mail. The checkwriting privilege will be subject to the
customary rules and regulations of State Street Bank and Trust Company (State
Street Bank or the Custodian) governing checking accounts. There is no charge to
the shareholder for the use of the checks or for subsequent reorders of checks.
The Company reserves the right to assess a processing fee against a
shareholder's account for any redemption check not honored by a clearing or
paying agent. Currently, this fee is $15 and is subject to change at any time.
Some examples of such dishonor are improper endorsement, checks written for an
amount less than the minimum check amount, and insufficient or uncollectible
funds.
The Company, the Transfer Agent, and State Street Bank each reserve the
right to change or suspend the checkwriting privilege upon 30 days' written
notice to participating shareholders.
INVESTMENT PLANS
The following investment plans are made available by the Company to shareholders
of the Funds. At the time you sign up for any of the following investment plans
that utilize the electronic funds transfer service, you will choose the day of
the month (the effective date) on which you would like to regularly purchase
shares. When this day falls on a weekend or holiday, the electronic transfer
will take place on the last business day before the effective date. You may
terminate your participation in a plan at any time. Please call the Manager for
details and necessary forms or applications.
AUTOMATIC PURCHASE OF SHARES
INVESTRONIC(R) - The regular purchase of additional shares through electronic
funds transfer from a checking or savings account. You may invest as little as
$50 per month.
DIRECT PURCHASE SERVICE - The periodic purchase of shares through electronic
funds transfer from an employer (including government allotments), an
income-producing investment, or an account with a participating financial
institution.
AUTOMATIC PURCHASE PLAN - The periodic transfer of funds from a USAA money
market fund to purchase shares in another non-money market USAA mutual fund.
There is a minimum investment required for this program of $5,000 in the money
market fund, with a monthly transaction minimum of $50.
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BUY/SELL SERVICE - The intermittent purchase or redemption of shares through
electronic funds transfer to or from a checking or savings account.
Participation in these systematic purchase plans will permit a shareholder
to engage in dollar-cost averaging. For additional information concerning the
benefits of dollar-cost averaging, see APPENDIX D.
SYSTEMATIC WITHDRAWAL PLAN
If a shareholder in a single investment account (accounts in different Funds
cannot be aggregated for this purpose) owns shares having a NAV of $5,000 or
more, the shareholder may request that enough shares to produce a fixed amount
of money be liquidated from the account monthly or quarterly. The amount of each
withdrawal must be at least $50. Using the electronic funds transfer service,
shareholders may choose to have withdrawals electronically deposited at their
bank or other financial institution. They may also elect to have checks mailed
to a designated address.
Such a plan may be initiated by depositing shares worth at least $5,000
with the Transfer Agent and by completing the Systematic Withdrawal Plan
application, which may be requested from the Manager. The shareholder may
terminate participation in the plan at any time. There is no charge to the
shareholder for withdrawals under the Systematic Withdrawal Plan. The Company
will not bear any expenses in administering the plan beyond the regular transfer
agent and custodian costs of issuing and redeeming shares. The Manager will bear
any additional expenses of administering the plan.
Withdrawals will be made by redeeming full and fractional shares on the
date selected by the shareholder at the time the plan is established. Withdrawal
payments made under this plan may exceed dividends and distributions and, to
this extent, will involve the use of principal and could reduce the dollar value
of a shareholder's investment and eventually exhaust the account. Reinvesting
dividends and distributions helps replenish the account. Because share values
and net investment income can fluctuate, shareholders should not expect
withdrawals to be offset by rising income or share value gains.
Each redemption of shares may result in a gain or loss, which must be
reported on the shareholder's income tax return. Therefore, a shareholder should
keep an accurate record of any gain or loss on each withdrawal.
INVESTMENT POLICIES
The section captioned INVESTMENT OBJECTIVES AND POLICIES in the Prospectus
describes the fundamental investment objectives and the investment policies
applicable to each Fund and the following is provided as additional information.
CALCULATION OF PORTFOLIO WEIGHTED AVERAGE MATURITIES
Weighted average maturity is derived by multiplying the value of each investment
by the number of days remaining to its maturity, adding these calculations, and
then dividing the total by the value of the Fund's portfolio. An obligation's
maturity is typically determined on a stated final maturity basis, although
there are some exceptions to this rule.
With respect to obligations held by the New York Bond Fund, if it is
probable that the issuer of an instrument will take advantage of a
maturity-shortening device, such as a call, refunding, or redemption provision,
the date on which the instrument will probably be called, refunded, or redeemed
may be considered to be its maturity date. Also, the maturities of securities
subject to sinking fund arrangements are determined on a weighted average life
basis, which is the average time for principal to be repaid. The weighted
average life of these securities is likely to be substantially shorter than
their stated final maturity. In addition, for purposes of the Fund's investment
policies, an instrument will be treated as having a maturity earlier than its
stated maturity date if the instrument has technical features such as puts or
demand features which, in the judgment of the Manager, will result in the
instrument being valued in the market as though it has the earlier maturity.
The New York Money Market Fund will determine the maturity of an
obligation in its portfolio in accordance with Rule 2a-7 under the Investment
Company Act of 1940, as amended (1940 Act).
LENDING OF SECURITIES
Each Fund may lend its securities. A lending policy may be authorized by the
Company's Directors and implemented by the Manager, but securities may be loaned
only to qualified broker-dealers or institutional investors that agree to
maintain cash collateral with the Company equal at all times to at least 100% of
the value of the loaned securities. The Directors will establish procedures and
monitor the creditworthiness of any institution or broker-dealer during such
time as any loan is outstanding. The Company will continue to receive interest
on the loaned securities and will invest the cash collateral in readily
marketable short-term obligations of high quality, thereby earning additional
interest. Interest on loaned tax-exempt securities
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received by the borrower and paid to the Company will not be exempt from federal
income taxes in the hands of the Company.
No loan of securities will be made if, as a result, the aggregate of such
loans would exceed 331/3% of the value of a Fund's total assets. The Company may
terminate such loans at any time.
REPURCHASE AGREEMENTS
Each Fund may invest up to 5% of its total assets in repurchase agreements. A
repurchase agreement is a transaction in which a security is purchased with a
simultaneous commitment to sell the security back to the seller (a commercial
bank or recognized securities dealer) at an agreed upon price on an agreed upon
date, usually not more than seven days from the date of purchase. The resale
price reflects the purchase price plus an agreed upon market rate of interest
which is unrelated to the coupon rate or maturity of the purchased security. A
repurchase agreement involves the obligation of the seller to pay the agreed
upon price, which obligation is in effect secured by the value of the underlying
security. In these transactions, the securities purchased by a Fund will have a
total value equal to or in excess of the amount of the repurchase obligation and
will be held by the Funds' custodian until repurchased. If the seller defaults
and the value of the underlying security declines, a Fund may incur a loss and
may incur expenses in selling the collateral. If the seller seeks relief under
the bankruptcy laws, the disposition of the collateral may be delayed or
limited. Any investments in repurchase agreements will give rise to income which
will not qualify as tax-exempt income when distributed by a Fund.
OTHER POLICIES
Although the New York Bond Fund is permitted to invest in options, financial
futures contracts and options on financial futures contracts, the Fund has no
current intention of doing so and will not invest in such securities without
first notifying shareholders and supplying further information in the
Prospectus.
INVESTMENT RESTRICTIONS
The following investment restrictions have been adopted by the Company for and
are applicable to each Fund. These restrictions may not be changed for any given
Fund without approval by the lesser of (1) 67% or more of the voting securities
present at a meeting of the Fund if more than 50% of the outstanding voting
securities of the Fund are present or represented by proxy or (2) more than 50%
of the Fund's outstanding voting securities. The investment restrictions of one
Fund may be changed without affecting those of the other Fund.
Under the restrictions, neither Fund will:
(1) With respect to 75% of its total assets, purchase securities of any issuer
(other than a security issued or guaranteed as to principal or interest by
the United States, or by a person controlled or supervised by and acting
as an instrumentality of the Government of the United States; or any
certificate of deposit for any of the foregoing) if as a result more than
5% of the total assets of that Fund would be invested in securities of
such issuer; for purposes of this limitation, identification of the
"issuer" will be based on a determination of the source of assets and
revenues committed to meeting interest and principal payments of each
security; for purposes of this limitation the State of New York or other
jurisdictions and each of its separate political subdivisions, agencies,
authorities and instrumentalities shall be treated as a separate issuer;
(2) Purchase more than 10% of the outstanding voting securities of any issuer;
(3) Borrow money, except for temporary or emergency purposes in an amount not
exceeding 33 1/3% of its total assets (including the amount borrowed) less
liabilities (other than borrowings);
(4) Pledge, mortgage or hypothecate its assets to any extent greater than 10%
of the value of its total assets;
(5) Purchase or retain securities of any issuer if any officer or Director of
the Company or its Manager owns individually more than one-half of one
percent (1/2%) of the securities of that issuer, and collectively the
officers and Directors of the Company and Manager together own more than
5% of the securities of that issuer;
(6) Purchase any securities which would cause 25% or more of the value of that
Fund's total assets at the time of such purchase to be invested in
securities the interest upon which is derived from revenues or projects
with similar characteristics, such as toll road revenue bonds, housing
revenue bonds, electric power project revenue bonds, or in industrial
revenue bonds which are based, directly or indirectly, on the credit of
private entities of any one industry; provided that the foregoing
limitation does not apply with respect to investments in U.S. Treasury
Bills, other obligations issued or guaranteed by the U.S. Government, its
agencies and instrumentalities, and, in the case of the New York Money
Market Fund, certificates of deposit and banker's acceptances of domestic
banks;
(7) Invest in issuers for the purpose of exercising control or management;
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(8) Issue senior securities as defined in the 1940 Act, except that it may
purchase tax-exempt securities on a "when-issued" basis and may purchase
and sell financial futures contracts and options as permitted by Section
18(f)(2);
(9) Underwrite securities of other issuers, except to the extent that it may
be deemed to act as a statutory underwriter in the distribution of any
restricted securities or not readily marketable securities;
(10) Purchase or sell real estate, but this shall not prevent investments in
tax-exempt securities secured by real estate or interests therein;
(11) Lend any securities or make any loan if, as a result, more than 33 1/3% of
its total assets would be lent to other parties, except that this
limitation does not apply to purchases of debt securities or to repurchase
agreements;
(12) Purchase on margin or sell short; for purposes of this restriction the
deposit or payment of initial or variation margin in connection with
financial futures contracts or related options will not be deemed to be a
purchase of securities on margin by a Fund;
(13) Purchase or sell commodities or commodities contracts, except that the
Fund may invest in financial futures and contracts and options thereon;
(14) Invest its assets in securities of other investment companies except by
purchases in the open market involving only customary brokers' commissions
or as part of a merger, consolidation, reorganization or purchase of
assets approved by the shareholders; or
(15) Invest in put, call, straddle or spread options or interests in oil, gas,
or other mineral exploration or development programs, except that a Fund
may write covered call options and purchase put options.
ADDITIONAL RESTRICTIONS
The following restrictions are not considered to be fundamental policies of the
Funds. The Company's Board of Directors may change these additional restrictions
without notice to or approval by the shareholders.
Neither Fund will:
(1) Invest more than 15% (10% with respect to the New York Money Market Fund)
of the value of its net assets in illiquid securities, including
repurchase agreements maturing in more than seven days.
(2) Purchase any security while borrowings representing more than 5% of the
Fund's total assets are outstanding.
SPECIAL RISK CONSIDERATIONS
SPECIAL CONSIDERATIONS RELATING TO NEW YORK MUNICIPAL OBLIGATIONS
Some of the significant financial considerations relating to the Fund's
investments in New York Municipal Obligations are summarized below. This summary
information is not intended to be a complete description and is principally
derived from official statements relating to issues of New York Municipal
Obligations that were available prior to the date of this SAI. The accuracy and
completeness of the information contained in those official statements have not
been independently verified.
STATE ECONOMY. New York is the third most populous state in the nation and has a
relatively high level of personal wealth. The State's economy is diverse with a
comparatively large share of the nation's finance, insurance, transportation,
communications and services employment, and a very small share of the nation's
farming and mining activity. The State has a declining proportion of its
workforce engaged in manufacturing, and an increasing proportion engaged in
service industries. New York City (the City), which is the most populous city in
the State and nation and is the center of the nation's largest metropolitan
area, accounts for a large portion of the State's population and personal
income.
The State has historically been one of the wealthiest states in the
nation. For decades, however, the State has grown more slowly than the nation as
a whole, gradually eroding its relative economic position.
There can be no assurance that the State economy will not experience
worse-than-predicted results in the 1997-98 fiscal year, with corresponding
material and adverse effects on the State's projections of receipts and
disbursements.
State per capita personal income has historically been significantly
higher than the national average, although the ratio has varied substantially.
Between 1975 and 1990, total employment grew by 21.3% while the labor force grew
only by 15.7%, unemployment fell from 9.5% to 5.2% of the labor force. In 1991
and 1992, however, total employment in the State fell by 5.5%. As a result, the
unemployment rate rose to 8.5% reflecting a recession that has had a
particularly strong impact on the entire Northeast. Calendar years 1993 and 1994
saw only a partial recovery, with the unemployment rate decreasing to 7.8% and
6.9%, respectively. The unemployment rate for 1995 was 6.3% and was projected by
the Division of Budget to be 6.2% for 1996.
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STATE BUDGET. The State Constitution requires the governor (the Governor) to
submit to the State legislature (the Legislature) a balanced executive budget
which contains a complete plan of expenditures for the ensuing fiscal year and
all moneys and revenues estimated to be available therefor, accompanied by bills
containing all proposed appropriations or reappropriations and any new or
modified revenue measures to be enacted in connection with the executive budget.
The entire plan constitutes the proposed State financial plan for that fiscal
year. The Governor is required to submit to the Legislature quarterly budget
updates which include a revised cash-basis state financial plan, and an
explanation of any changes from the previous state financial plan.
The State's budget for the 1996-97 fiscal year was enacted by the
Legislature on July 13, 1996, more than three months after the start of the
fiscal year. Prior to adoption of the budget, the Legislature enacted
appropriations for disbursements considered to be necessary for State operations
and other purposes, including necessary appropriations for all State-supported
debt service. The State Financial Plan for the 1996-97 fiscal year was
formulated on July 25, 1996, and was based upon the State's budget as enacted by
the Legislature and signed into law by the Governor as well as actual results
for the first quarter of the current fiscal year (the 1996-97 State Financial
Plan).
The Governor presented his 1997-98 Executive Budget to the Legislature on
January 14, 1997. It is expected that the Governor will prepare amendments to
his Executive Budget as permitted under law. There can be no assurance that the
Legislature will enact the Executive Budget as proposed by the Governor into
law, or that the State's adopted budget projections will not differ materially
and adversely from the projections set forth therein.
The 1997-98 Executive Budget projected balance on a cash basis in the
General Fund. It reflected a continuing strategy of substantially reduced State
spending, including program restructurings, reductions in social welfare
spending, and efficiency and productivity initiatives. Total General Fund
receipts and transfers from other funds were projected to be $32.88 billion, a
decrease of $88 million from total receipts projected in the 1996-97 fiscal
year. Total General Fund disbursements and transfers to other funds were
projected to be $32.84 billion, a decrease of $56 million from spending totals
projected for the 1996-97 fiscal year. As compared to the 1996-97 State
Financial Plan, the 1997-98 Executive Budget proposed a year-to-year decline in
General Fund spending of 0.2%. State funds spending (i.e., General Fund plus
other dedicated funds, with the exception of federal aid) was projected to grow
by 1.2%. Spending from all governmental funds (excluding transfers) was proposed
to increase by 2.2% from the prior fiscal year.
In the 1997-98 Executive Budget, the Governor indicated that, before
taking action to balance the 1997-98 financial plan, the budget forecast
projected an imbalance of almost $2.3 billion. Before reflecting any actions
proposed by the Governor to restrain spending, General Fund disbursements for
1997-98 were projected to grow by approximately 4%. This increase would have
resulted from growth in Medicaid, higher fixed costs such as pensions and debt
service, collective bargaining agreements, inflation, and the loss of
non-recurring resources that offset spending in 1996-97. General Fund receipts
were projected to fall by roughly 3%. This reduction would have been
attributable to modest growth in the State's economy and underlying tax base,
the loss of non-recurring revenues available in 1996-97 and implementation of
previously enacted tax reduction programs. The 1997-98 Executive Budget proposed
to close this gap primarily through a series of spending reductions and Medicaid
cost containment measures, the use of a portion of the 1996-97 projected budget
surplus, and other actions, with a projected 1997-98 closing fund balance in the
General Fund of $397 million.
The 1997-98 Executive Budget projected General Fund receipts of $33.02
billion and $33.91 billion for 1998-99 and 1999-2000, respectively. The receipts
projections were prepared on the basis of an economic forecast of a steadily
growing national economy, in an environment of low inflation and slow employment
growth. The forecast for the State's economic performance likewise was for slow
but steady economic growth. The receipt projections reflected tax reductions
proposed in the 1997-98 Executive Budget that will reduce receipts by an
estimated $798 million in 1998-99 and at $1.43 billion in 1999-2000. The bulk of
previously enacted tax reductions are annualized in 1997-98 and their impact in
the out years was largely proportional to projected growth in the underlying tax
liability.
Disbursements from the General Fund are projected at $34.60 billion in
1998-99 and $35.93 billion in 1999-2000, before assuming additional spending
efficiencies and/or additional federal revenue maximization. Assuming
implementation of proposed cost containment and other actions proposed in the
1997-98 Executive Budget, annual disbursements for fiscal years 1998-99 and
1999-2000 grow by $1.77 billion and $1.33 billion respectively.
The Executive Budget contained projections of a potential imbalance in the
1998-99 fiscal year of $988 million and in the 1999-2000 fiscal year of $1.2
billion, assuming implementation of the 1997-98 Executive Budget recommendations
and implementation of $600 million and $800 million of unspecified efficiency
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initiatives and other actions in the 1998-99 and 1999-2000 fiscal years,
respectively. The Executive Budget stated that the assumed unspecified
efficiency initiatives and other actions for such fiscal years are comparable
with reductions over the past several years, and that the Governor plans to make
additional proposals to limit State spending in order to address any potential
remaining gap.
It is expected that the 1997-98 financial plan will reflect a continuing
strategy of substantially reduced State spending, including agency
consolidations, reductions in the State workforce, and efficiency and
productivity initiatives.
The Division of the Budget believed that the economic assumptions and
projections of receipts and disbursements accompanying the 1997-98 Executive
Budget were reasonable. However, the economic and financial condition of the
State may be affected by various financial, social, economic and political
factors. Those factors can be very complex, can vary from fiscal year to fiscal
year, and are frequently the result of actions taken not only by the State but
also by entities, such as the federal government, that are outside the State's
control. Because of the uncertainty and unpredictability of changes in these
factors, their impact cannot be fully included in the assumptions underlying the
State's projections. There can be no assurance that the State economy will not
experience results that are worse than predicted, with corresponding material
and adverse effects on the State's financial projections.
To make progress toward addressing recurring budgetary imbalances, the
1997-98 Executive Budget proposed significant actions to align recurring
receipts and disbursements in future fiscal years. However, there can be no
assurance that the Legislature will enact the Governor's proposals or that the
State's actions will be sufficient to preserve budgetary balance or to align
recurring receipts and disbursements in either 1997-98 or in future fiscal
years. In the State's 1997-98 fiscal year and in certain recent fiscal years,
the State has failed to enact a budget prior to the beginning of the State's
fiscal year.
In addition, there has been discussion of additional tax reductions,
beyond those reflected in the State's current projections for 1997-98 and the
out years that, if enacted, could make it more difficult to achieve budget
balance over this period. In particular, modifying the State's sales tax
treatment of clothing has been discussed. The State now receives approximately
$700 million annually under the current tax statutes from taxation on clothing,
and localities receive a roughly equivalent amount.
Uncertainties with regard to both the economy and potential decisions at
the Federal level add further pressure on future budget balance in New York
State. Risks to the financial plan include either a financial market or broader
economic "correction" during the period, a risk heightened by the relatively
lengthy expansions currently underway. In addition, a normal "forecast error" of
one percentage point in the expected growth rate could raise or lower receipts
by $600 million during the last year of projection period. Potential changes to
federal tax law could alter the federal definitions of income on which many
State taxes rely. Similarly, the financial plan assumed no significant federal
disallowances or other actions which could affect State finances.
On August 22, 1996, the President signed into law the Personal
Responsibility and Work Opportunity Reconciliation Act of 1996. This federal
legislation fundamentally changed the programmatic and fiscal responsibilities
for administration of welfare programs at the federal, state and local levels.
The new law abolishes the federal Aid to Families with Dependent Children
program (AFDC), and creates a new Temporary Assistance to Needy Families program
(TANF) funded with a fixed federal block grant to states. The new law also
imposes (with certain exceptions) a five-year durational limit on TANF
recipients, requires that virtually all recipients be engaged in work or
community service activities within two years of receiving benefits, and limits
assistance provided to certain immigrants and other classes of individuals.
States are required to meet work activity participation targets for their TANF
caseload; these requirement are phased in over time. States that fail to meet
these federally mandated job participation rates, or that fail to conform with
certain other federal standards, face potential sanctions in the form of a
reduced federal block grant.
On October 16, 1996, the Governor submitted the State's TANF
implementation plan to the federal government as required under the new federal
welfare law. On December 13, 1996, the State's plan was approved by the federal
government. Legislation will be required to implement the State's TANF plan, and
the Governor has introduced legislation necessary to conform with federal law.
States are required to comply with the new federal welfare reform law no
later than July 1, 1997. There can be no assurances that the State Legislature
will enact welfare reform proposals as submitted by the Governor and as required
under federal law.
An additional risk to the financial plan arises from the potential impact
of certain litigation now pending against the State, which could produce adverse
effects on the State's projections of receipts and disbursements. Specifically,
in the case of TUG BUSTER BOUCHARD ET AL. V. WETZLER, the Division of the Budget
believed that the court's decision, as interpreted by the State, would reduce
tax revenues by approximately $5 million in 1997-98 and $2 million thereafter.
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RECENT FINANCIAL RESULTS. The General Fund is the principal operating fund of
the State and is used to account for all financial transactions, except those
required to be accounted for in another fund. It is the State's largest fund and
receives almost all State taxes and other resources not dedicated to particular
purposes.
The General Fund was projected to be balanced on a cash basis for the
1996-97 fiscal year. Total receipts and transfers from other funds were
projected to be $33.17 billion, an increase of $365 million from the prior
fiscal year. Total General Fund disbursements and transfers to other funds were
projected to be $33.12 billion for the 1996-97 fiscal year, an increase of $444
million from the total in the prior fiscal year.
The State's financial position on a GAAP (generally accepted accounting
principles) basis as of March 31, 1996, showed an accumulated deficit in its
combined governmental funds of $1.24 billion, reflecting liabilities of $14.59
billion and assets of $13.35 billion.
DEBT LIMITS AND OUTSTANDING DEBT. There are a number of methods by which the
State of New York may incur debt. Under the State Constitution, the State may
not, with limited exceptions for emergencies, undertake long-term general
obligation borrowing (I.E., borrowing for more than one year) unless the
borrowing is authorized in a specific amount for a single work or purpose by the
Legislature and approved by the voters. There is no limitation on the amount of
long-term general obligation debt that may be so authorized and subsequently
incurred by the State.
The State may undertake short-term borrowings without voter approval (i)
in anticipation of the receipt of taxes and revenues, by issuing tax and revenue
anticipation notes, and (ii) in anticipation of the receipt of proceeds from the
sale of duly authorized but unissued general obligation bonds, by issuing bond
anticipation notes. The State may also, pursuant to specific constitutional
authorization, directly guarantee certain obligations of the State of New York's
authorities and public benefit corporations (Authorities). Payments of debt
service on New York State general obligation and New York State-guaranteed bonds
and notes are legally enforceable obligations of the State of New York.
The State employs additional long-term financing mechanisms,
lease-purchase and contractual-obligation financings, which involve obligations
of public authorities or municipalities that are State-supported, but are not
general obligations of the State. Under these financing arrangements, certain
public authorities and municipalities have issued obligations to finance the
construction and rehabilitation of facilities or the acquisition and
rehabilitation of equipment, and expect to meet their debt service requirements
through the receipt of rental or other contractual payments made by the State.
Although these financing arrangements involve a contractual agreement by the
State to make payments to a public authority, municipality or other entity, the
State's obligation to make such payments is generally expressly made subject to
appropriation by the Legislature and the actual availability of money to the
State for making the payments. The State has also entered into a
contractual-obligation financing arrangement with the Local Government
Assistance Corporation (LGAC) to restructure the way the State makes certain
local aid payments.
In 1990, as part of a State fiscal reform program, legislation was enacted
creating LGAC, a public benefit corporation empowered to issue long-term
obligations to fund certain payments to local governments traditionally funded
through New York State's annual seasonal borrowing. The legislation empowered
LGAC to issue its bonds and notes in an amount not in excess of $4.7 billion
(exclusive of certain refunding bonds) plus certain other amounts. Over a period
of years, the issuance of these long-term obligations, which were to be
amortized over no more than 30 years, was expected to eliminate the need for
continued short-term seasonal borrowing. The legislation also dedicated revenues
equal to one-quarter of the four cent State sales and use tax to pay debt
service on these bonds. The legislation also imposed a cap on the annual
seasonal borrowing of the State at $4.7 billion, less net proceeds of bonds
issued by LGAC and bonds issued to provide for capitalized interest, except in
cases where the Governor and the legislative leaders have certified the need for
additional borrowing and provided a schedule for reducing it to the cap. If
borrowing above the cap was thus permitted in any fiscal year, it is required by
law to be reduced to the cap by the fourth fiscal year after the limit was first
exceeded. As of June 1995, LGAC had issued bonds to provide net proceeds of $4.7
billion, completing the program.
On January 13, 1992, Standard & Poor's Ratings Group (Standard & Poor's)
reduced its ratings on the State's general obligation bonds from A to A- and, in
addition, reduced its ratings on the State's moral obligation, lease purchase,
guaranteed and contractual obligation debt. On January 6, 1992, Moody's
Investors Service, Inc. (Moody's) reduced its ratings on outstanding
limited-liability State lease purchase and contractual obligations from A to
Baa1. On February 28, 1994, Moody's reconfirmed its A rating on the State's
general obligation long-term indebtedness.
The State had anticipated that its capital programs would be financed, in
part, by State and public authorities borrowings in 1996-97. The State had
expected to issue $411 million in general obligation bonds (including $153.6
million for purposes of redeeming outstanding bond anticipation notes) and $154
million in general obligation commercial paper. The Legislature had also
authorized the issuance of up to $101 million
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in certificates of participation during the State's 1996-97 fiscal year for
equipment purchases. The projection of the State regarding its borrowings may
change if circumstances require.
In November 1996, voters approved a $1.75 billion State general obligation
bond referendum to finance various environmental improvement and remediation
projects. As a result, the amount of general obligation bonds issued during the
1996-97 fiscal year may increase above the $411 million currently included in
the 1996-97 borrowing plan to finance a portion of this new program.
Principal and interest payments on general obligation bonds and interest
payments on bond anticipation notes were $735 million for the 1995-96 fiscal
year, and were estimated to be $719 million for the 1996-97 fiscal year.
Principal and interest payments on fixed rate and variable rate bonds issued by
LGAC were $340 million for the 1995-96 fiscal year, and were estimated to be
$323 million for 1996-97.
New York State has never defaulted on any of its general obligation
indebtedness or its obligations under lease-purchase or contractual-obligation
financing arrangements and has never been called upon to make any direct
payments pursuant to its guarantees.
LITIGATION. Certain litigation pending against New York State or its officers or
employees could have a substantial or long-term adverse effect on New York State
finances. Among the more significant of these cases are those that involve (1)
the validity of agreements and treaties by which various Indian tribes
transferred title to New York State of certain land in central and upstate New
York; (2) certain aspects of New York State's Medicaid policies, including its
rates, regulations and procedures; (3) action against New York State and New
York City officials alleging inadequate shelter allowances to maintain proper
housing; (4) challenges to the practice of reimbursing certain Office of Mental
Health patient care expenses from the client's Social Security benefits; (5)
alleged responsibility of New York State officials to assist in remedying racial
segregation in the City of Yonkers; (6) challenges by commercial insurers,
employee welfare benefit plans, and health maintenance organizations to the
imposition of surcharges on inpatient hospital bills; (7) challenges to certain
aspects of petroleum business taxes; (8) action alleging damages resulting from
the failure by the State's Department of Environmental Conservation to timely
provide certain data; (9) a challenge to the constitutionality of a State
lottery game; (10) an action seeking reimbursement from the State for certain
costs arising out of the provision of pre-school services and programs for
children with handicapped conditions; and (11) challenges to regulations
promulgated by the Superintendent of Insurance establishing excess malpractice
premium rates for the 1986-87 through 1995-96 and 1996-97 fiscal years,
respectively.
Several actions challenging the constitutionality of legislation enacted
during the 1990 legislative session which changed actuarial funding methods for
determining state and local contributions to state employee retirement systems
have been decided against the State. As a result, the Comptroller developed a
plan to restore the State's retirement systems to prior funding levels. Such
funding is expected to exceed prior levels by $116 million in fiscal 1996-97,
$193 million in fiscal 1997-98, peaking at $241 million in fiscal 1998-99.
Beginning in fiscal 2001-02, State contributions required under the
Comptroller's plan are projected to be less than that required under the prior
funding method. As a result of the United States Supreme Court decision in the
case of STATE OF DELAWARE V. STATE OF NEW YORK, on January 21, 1994, the State
entered into a settlement agreement with various parties. Pursuant to all
agreements executed in connection with the action, the State was required to
make aggregate payments of $351.4 million. Annual payments to the various
parties will continue through the State's 2002-03 fiscal year in amounts which
will not exceed $48.4 million in any fiscal year subsequent to the State's
1994-95 fiscal year. Litigation challenging the constitutionality of the
treatment of certain moneys held in a reserve fund was settled in June 1996 and
certain amounts in a Supplemental Reserve Fund previously credited by the State
against prior State and local pension contributions will be paid in 1998.
The legal proceedings noted above involve State finances, State programs
and miscellaneous tort, real property and contract claims in which the State is
a defendant and the monetary damages sought are substantial. These proceedings
could affect adversely the financial condition of the State. Adverse
developments in these proceedings or the initiation of new proceedings could
affect the ability of the State to maintain a balanced financial plan. An
adverse decision in any of these proceedings could exceed the amount of the
reserve established in the State's financial plan for the payment of judgments
and, therefore, could affect the ability of the State to maintain a balanced
financial plan. In its audited financial statements for the fiscal year ended
March 31, 1996, the State reported its estimated liability for awarded and
anticipated unfavorable judgments to be $474 million.
Although other litigation is pending against New York State, except as
described herein, no current litigation involves New York State's authority, as
a matter of law, to contract indebtedness, issue its obligations, or pay such
indebtedness when it matures, or affects New York State's power or ability, as a
matter of law, to impose or collect significant amounts of taxes and revenues.
AUTHORITIES. The fiscal stability of New York State is related, in part, to the
fiscal stability of its Authorities, which generally have responsibility for
financing, constructing and operating revenue-producing public benefit
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facilities. Authorities are not subject to the constitutional restrictions on
the incurrence of debt which apply to the State itself, and may issue bonds and
notes within the amounts of, and as otherwise restricted by, their legislative
authorization. The State's access to the public credit markets could be
impaired, and the market price of its outstanding debt may be materially and
adversely affected, if any of the Authorities were to default on their
respective obligations, particularly with respect to debt that are
State-supported or State-related. As of September 30, 1995, date of the latest
data available, there were 17 Authorities that had outstanding debt of $100
million or more. The aggregate outstanding debt, including refunding bonds, of
these 17 Authorities was $73.45 billion.
Authorities are generally supported by revenues generated by the projects
financed or operated, such as fares, user fees on bridges, highway tolls and
rentals for dormitory rooms and housing. In recent years, however, New York
State has provided financial assistance through appropriations, in some cases of
a recurring nature, to certain of the Authorities for operating and other
expenses and, in fulfillment of its commitments on moral obligation indebtedness
or otherwise, for debt service. This operating assistance is expected to
continue to be required in future years. In addition, certain statutory
arrangements provide for State local assistance payments otherwise payable to
localities to be made under certain circumstances to certain Authorities. The
State has no obligation to provide additional assistance to localities whose
local assistance payments have been paid to Authorities under these
arrangements. However, in the event that such local assistance payments are so
diverted, the affected localities could seek additional State funds.
NEW YORK CITY AND OTHER LOCALITIES. The fiscal health of the State of New York
may also be impacted by the fiscal health of its localities, particularly the
City of New York, which has required and continues to require significant
financial assistance from New York State. The City depends on State aid both to
enable the City to balance its budget and to meet its cash requirements. There
can be no assurance that there will not be reductions in State aid to the City
from amounts currently projected or that State budgets will be adopted by the
April 1 statutory deadline or that any such reductions or delays will not have
adverse effects on the City's cash flow or expenditures. In addition, the
Federal budget negotiation process could result in a reduction in or delay in
the receipt of Federal grants which could have additional adverse effects on the
City's cash flow or revenues.
For each of the 1981 through 1996 fiscal years, the City achieved balanced
operating results as reported in accordance with then applicable GAAP. The City
was required to close substantial budget gaps in recent years in order to
maintain balanced operating results. There can be no assurance that the City
will continue to maintain a balanced operating budget as required by State law
without additional tax or other revenue increases or additional reductions in
City services or entitlement programs, which could adversely affect the City's
economic base.
In 1975, New York City suffered a fiscal crisis that impaired the
borrowing ability of both the City and New York State. In that year, the City
lost access to the public credit markets. The City was not able to sell
short-term notes to the public again until 1979.
In 1975, Standard & Poor's suspended its A rating of City bonds. This
suspension remained in effect until March 1981, at which time the City received
an investment grade rating of BBB from Standard & Poor's. On July 2, 1985,
Standard & Poor's revised its rating of City bonds upward to BBB+ and on
November 19, 1987, to A-. Moody's ratings of City bonds were revised in November
1981 from B (in effect since 1977) to Ba1, in November 1983 to Baa, in December
1985 to Baa1, in May 1988 to A and again in February 1991 to Baa1. On July 10,
1995, Standard & Poor's downgraded its rating on the City's $23 billion of
outstanding general obligation bonds to "BBB+" from "A-", citing to the City's
chronic structural budget problems and weak economic outlook. Standard & Poor's
stated that New York City's reliance on one-time revenue measures to close
annual budget gaps, a dependence on unrealized labor savings, overly optimistic
estimates of revenues and state and federal aid and the City's continued high
debt levels also contributed to its decision to lower the rating.
New York City is heavily dependent on New York State and federal
assistance to cover insufficiencies in its revenues. There can be no assurance
that in the future federal and State assistance will enable the City to make up
its budget deficits. To help alleviate the City's financial difficulties, the
Legislature created the Municipal Assistance Corporation (MAC) in 1975. Since
its creation, MAC has provided, among other things, financing assistance to the
City by refunding maturing City short-term debt and transferring to the City
funds received from sales of MAC bonds and notes. MAC is authorized to issue
bonds and notes payable from certain stock transfer tax revenues, from the
City's portion of the State sales tax derived in the City and, subject to
certain prior claims, from State per capita aid otherwise payable by the State
to the City. Failure by the State to continue the imposition of such taxes, the
reduction of the rate of such taxes to rates less than those in effect on July
2, 1975, failure by the State to pay such aid revenues and the reduction of such
aid revenues below a specified level are included among the events of default in
the resolutions authorizing MAC's long-term debt. The occurrence of an event of
default may result in the acceleration of the maturity of all or a portion of
MAC's
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debt. MAC bonds and notes constitute general obligations of MAC and do not
constitute an enforceable obligation or debt of either the State or the City. As
of March 31, 1997, MAC had outstanding an aggregate of approximately $4.592
billion of its bonds. MAC is authorized to issue bonds and notes to refunds its
outstanding bonds and notes and to fund certain reserves, without limitation as
to principal amount, and to finance certain capital commitments to the Transit
Authority and the New York City School Construction Authority through 1997
fiscal years in the event the City fails to provide such financing.
As of March 31, 1997, the City had received an aggregate of approximately
$4.85 billion from MAC for certain authorized uses by the City exclusive of
capital purposes. In addition, the City had received an aggregate of
approximately $2.352 billion from MAC for capital purposes in exchange for
serial bonds in a like principal amount, of which $191 million was held by MAC
as of March 31, 1997, after $569.1 million was redeemed on January 7, 1997. MAC
has also exchanged $1.839 billion principal amount of MAC bonds for City debt,
of which approximately $57.1 million was redeemed on January 7, 1997. MAC made
the $609.3 million of net redemption proceeds available to the City for capital
financing.
Since 1975, the City's financial condition has been subject to oversight
and review by the New York State Financial Control Board (the Control Board) and
since 1978 the City's financial statements have been audited by independent
accounting firms. To be eligible for guarantees and assistance, the City is
required during a "control period" to submit annually for Control Board
approval, and when a control period is not in effect for Control Board review, a
financial plan for the next four fiscal years covering the City and certain
agencies showing balanced budgets determined in accordance with GAAP. New York
State also established the Office of the State Deputy Comptroller for New York
City (OSDC) to assist the Control Board in exercising its powers and
responsibilities. On June 30, 1986, the City satisfied the statutory
requirements for termination of the control period. This means that the Control
Board's powers of approval are suspended, but the Board continues to have
oversight responsibilities.
On May 8, 1997, the City released the Financial Plan for the 1998 through
2001 fiscal years (the 1998-2001 Financial Plan), which relates to the City,
the Board of Education (BOE) and the City University of New York (CUNY) and was
based on the Executive Budget and Budget Message for the City's 1998 fiscal year
(the City Executive Budget). The City Executive Budget and the 1998-2001
Financial Plan projected revenues and expenditures for the 1998 fiscal year
balanced in accordance with GAAP. The City Executive Budget and the 1998-2001
Financial Plan included increased tax revenue projections and additional
expenditures for textbooks, computers, improved education programs and welfare
reform, law enforcement, immigrant naturalization and other initiatives. In
addition, the City Executive Budget and the 1998-2001 Financial Plan set forth
gap-closing actions to eliminate a previously projected gap of $720 million for
the 1998 fiscal year, after taking into account the prepayment in the 1997
fiscal year of $856 million of debt service due in the 1998 and 1999 fiscal
years. The gap-closing actions for the 1998 fiscal year included (i) additional
agency actions totaling $660 million; (ii) the prepayment in the 1998 fiscal
year of $200 million of debt service due in the 1999 fiscal year; (iii) the
proposed sale of various assets; (iv) additional State aid of $294 million,
including a proposal that the State accelerate a $142 million revenue sharing
payment to the City from March 1999; and (v) entitlement savings of $128 million
which would result from certain of the reductions in Medicaid spending proposed
in the Governor's 1997-98 Executive Budget and the State making available to
the City $77 million of additional Federal block grant aid, as proposed in the
Governor's 1997-98 Executive Budget. The City Executive Budget is subject to
approval by the City Council, and there can be no assurance that the City
Executive Budget will be adopted in its proposed form. The 1998-2001 Financial
Plan also set forth projections for the 1999 through 2001 fiscal years and
projected gaps of $2.0 billion, $2.9 billion and $2.7 billion for the 1999
through 2001 fiscal years, respectively.
The 1998-2001 Financial Plan included a proposed tax reduction program
totaling $284 million, $651 million, $895 million and $1.2 billion in the 1998
through 2001 fiscal year, respectively. The tax reduction program included a
proposed elimination of the 4% City sales tax on clothing items under $500 as of
December 1, 1997, as well as a proposed reduction in the City property tax and
personal income tax which the 1998-2001 Financial Plan assumed will be offset by
proposed increased State aid totaling $47 million, $254 million, $472 million
and $722 million in the 1998 through 2001 fiscal years, respectively.
The 1998-2001 Financial Plan assumed (i) approval by the Governor and the
State Legislature of the extension of the 14% personal income tax surcharge,
which is scheduled to expire on December 31, 1997 and is projected to provide
revenue (if extended) of $169 million, $501 million and $531 million in the 1998
through 2000 fiscal years, respectively, and of the extension of the 12.5%
personal income tax surcharge, which is scheduled to expire on December 31, 1998
and is projected to provide revenue (if extended) of $190 million and $527
million in the 1999 and 2000 fiscal years, respectively; (ii) collection of the
project rent payments for the City's airports, totalling $270 million and $180
million in the 1998 and 1999 fiscal years, respectively, which may depend on the
successful completion of negotiations with the Port Authority or the enforcement
of the City's rights under the existing leases through pending legal actions;
(iii) the ability of the New York City Health and Hospital Corporation to
identify actions to offset substantial City and State revenue reductions
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and the receipt by BOE of additional State aid; and (iv) State approval of the
cost containment initiatives and State aid proposed by the City for the 1998
fiscal year, and $115 million in State aid which is assumed in the 1998-2001
Financial Plan but not provided for in the Governor's 1997-98 Executive Budget.
The 1998-2001 Financial Plan reflected the increased costs which the City is
prepared to incur as a result of welfare legislation recently enacted by
Congress, but not certain of the costs resulting from legislation proposed by
the Governor, which would, if enacted, implement such Federal welfare
legislation. Moreover, certain of the proposed entitlement cost containment and
other initiatives included in the 1998-2001 Financial Plan have been previously
considered and rejected by the Legislature. The nature and extent of the impact
on the City of the State budget, when adopted, is uncertain, and no assurance
can be given that the State actions included in the State adopted budget may not
have a significant adverse impact on the City's budget and its financial plan.
The projections set forth in the 1998-2001 Financial Plan were based on
various assumptions and contingencies which are uncertain and which may not
materialize. Changes in major assumptions could significantly affect the City's
ability to balance its budget as required by State law and to meet its annual
cash flow and financing requirements. Such assumptions and contingencies include
the condition of the regional and local economies, the impact on real estate tax
revenues of the real estate market, wage increases for City employees consistent
with those assumed in the 1998-2001 Financial Plan, employment growth, the
ability to implement proposed reductions in City personnel and other cost
reduction initiatives, the ability of the HHC and the BOE to take actions to
offset reduced revenues, the ability to complete revenue generating
transactions, provision of State and Federal aid and mandate relief and the
impact on City revenues and expenditures of Federal and State welfare reform and
any future legislation affecting Medicare or other entitlements.
Implementation of the 1998-2001 Financial Plan is also dependent upon the
City's ability to market its securities successfully. The City's financing
program for fiscal years 1998 through 2001 contemplates the issuance of $5.7
billion of general obligation bonds and $5.7 billion of bonds to be issued by
the proposed New York City Transitional Finance Authority (the Finance
Authority) to finance City capital projects. The Finance Authority, was created
as part of the City's effort to assist in keeping the City's indebtedness within
the forecast level of the constitutional restrictions on the amount of debt the
City is authorized to incur. Indebtedness subject to the constitutional debt
limit includes liability on capital contracts that are expected to be funded
with general obligation bonds, as well as general obligation bonds. In addition,
the City issues revenue and tax anticipation notes to finance its seasonal
working capital requirements. The success of projected public sales of City
bonds and notes, New York City Municipal Water Finance Authority (Water
Authority) bonds and Finance Authority bonds will be subject to prevailing
market conditions, and no assurance can be given that such sales will be
completed. If the City were unable to sell its general obligation bonds and
notes or the Water Authority or the Finance Authority were unable to sell its
bonds, the City would be prevented from meeting its planned capital and
operating expenditures. Future developments concerning the City and public
discussion of such developments, as well as prevailing market conditions, may
affect the market for outstanding City general obligation bonds and notes.
The City Comptroller and other agencies and public officials have issued
reports and made public statements which, among other things, state that
projected revenues and expenditures may be different from those forecast in the
City's financial plans. It is reasonable to expect that such reports and
statements will continue to be issued and to engender public comment. It is
expected that the City Comptroller and other agencies will issue reports in the
near future commenting on the City Executive Budget and/or the 1998-2001
Financial Plan.
The City since 1981 has fully satisfied its seasonal financing needs in
the public credit markets, repaying all short-term obligations within their
fiscal year of issuance. The City has issued $2.4 billion of short-term
obligations in fiscal year 1997 to finance the City's current estimate of its
seasonal cash flow needs for the 1997 fiscal year. Seasonal financing
requirements for the 1996 fiscal year increased to $2.4 billion from $2.2
billion and $1.75 billion in the 1995 and 1994 fiscal years, respectively.
Seasonal financing requirements were $1.4 billion and $2.25 billion in the 1993
and 1992 fiscal years, respectively. The delay in the adoption of the State's
budget in certain past fiscal years has required the City to issue short-term
notes in amounts exceeding those expected early in such fiscal year.
Certain localities, in addition to the City, could have financial problems
leading to requests for additional New York State assistance. The potential
impact on the State of such requests by localities was not included in the
State's projections of its receipts and disbursements.
Fiscal difficulties experienced by the City of Yonkers (Yonkers) resulted
in the creation of the Financial Control Board for the City of Yonkers (the
Yonkers Board) by New York State in 1984. The Yonkers Board is charged with
oversight of the fiscal affairs of Yonkers. Future actions taken by the Governor
or the Legislature to assist Yonkers could result in allocation of New York
State resources in amounts that cannot yet be determined.
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Beginning in 1990, the City of Troy experienced a series of budgetary
deficits that resulted in the establishment of a Supervisory Board for the City
of Troy in 1994. The Supervisory Board's powers were increased in 1995, when
Troy MAC was created to help Troy avoid default on certain obligations. The
legislation creating Troy MAC prohibits the City of Troy from seeking federal
bankruptcy protection while Troy MAC bonds are outstanding.
Seventeen municipalities received extraordinary assistance during the 1996
legislative session through $50 million in special appropriations targeted for
distressed cities.
Municipalities and school districts have engaged in substantial short-term
and long-term borrowings. In 1994, the total indebtedness of all localities in
New York State other than New York City was approximately $17.7 billion. A small
portion (approximately $82.9 million) of that indebtedness represented borrowing
to finance budgetary deficits and was issued pursuant to enabling New York State
legislation. State law requires the comptroller to review and make
recommendations concerning the budgets of those local government units other
than New York City authorized by State law to issue debt to finance deficits
during the period that such deficit financing is outstanding. Seventeen
localities had outstanding indebtedness for deficit financing at the close of
their fiscal year ending in 1994.
From time to time, federal expenditure reductions could reduce, or in some
cases eliminate, federal funding of some local programs and accordingly might
impose substantial increased expenditure requirements on affected localities. If
New York State, New York City or any of the Authorities were to suffer serious
financial difficulties jeopardizing their respective access to the public credit
markets, the marketability of notes and bonds issued by localities within New
York State could be adversely affected. Localities also face anticipated and
potential problems resulting from certain pending litigation, judicial decisions
and long-range economic trends. Long-range potential problems of declining urban
population, increasing expenditures and other economic trends could adversely
affect localities and require increasing New York State assistance in the
future.
PORTFOLIO TRANSACTIONS
The Manager, pursuant to the Advisory Agreement dated July 20, 1990,
supplemented by letter agreement dated July 26, 1990, and subject to the general
control of the Company's Board of Directors, places all orders for the purchase
and sale of Fund securities. Purchases of Fund securities are made either
directly from the issuer or from dealers who deal in tax-exempt securities. The
Manager may sell Fund securities prior to maturity if circumstances warrant and
if it believes such disposition is advisable. In connection with portfolio
transactions for the Company, the Manager seeks to obtain the best available net
price and most favorable execution for its orders. The Manager has no agreement
or commitment to place transactions with any broker-dealer and no regular
formula is used to allocate orders to any broker-dealer. However, the Manager
may place security orders with brokers or dealers who furnish research or other
services to the Manager as long as there is no sacrifice in obtaining the best
overall terms available. Payment for such services would be generated only
through purchase of new issue fixed income securities.
Such research and other services may include, for example: advice
concerning the value of securities, the advisability of investing in,
purchasing, or selling securities, and the availability of securities or the
purchasers or sellers of securities; analyses and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy, and
performance of accounts; and various functions incidental to effecting
securities transactions, such as clearance and settlement. The Manager
continuously reviews the performance of the broker-dealers with whom it places
orders for transactions. The receipt of research from broker-dealers that
execute transactions on behalf of the Company may be useful to the Manager in
rendering investment management services to other clients (including affiliates
of the Manager), and conversely, such research provided by broker-dealers who
have executed transaction orders on behalf of other clients may be useful to the
Manager in carrying out its obligations to the Company. While such research is
available to and may be used by the Manager in providing investment advice to
all its clients (including affiliates of the Manager), not all of such research
may be used by the Manager for the benefit of the Company. Such research and
services will be in addition to and not in lieu of research and services
provided by the Manager, and the expenses of the Manager will not necessarily be
reduced by the receipt of such supplemental research. See THE COMPANY'S MANAGER.
On occasions when the Manager deems the purchase or sale of a security to
be in the best interest of the Company, as well as the Manager's other clients,
the Manager, to the extent permitted by applicable laws and regulations, may
aggregate such securities to be sold or purchased for the Company with those to
be sold or purchased for other customers in order to obtain best execution and
lower brokerage commissions, if any. In such event, allocation of the securities
so purchased or sold, as well as the expenses incurred in the transaction, will
be made by the Manager in the manner it considers to be most equitable and
consistent with its fiduciary obligations to all such customers, including the
Company. In some instances, this procedure may impact the price and size of the
position obtainable for the Company.
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The tax-exempt security market is typically a "dealer" market in which
investment dealers buy and sell bonds for their own accounts, rather than for
customers, and although the price may reflect a dealer's mark-up or mark-down,
the Company pays no brokerage commissions as such. In addition, some securities
may be purchased directly from issuers.
PORTFOLIO TURNOVER RATES
The portfolio turnover rate is computed by dividing the dollar amount of
securities purchased or sold (whichever is smaller) by the average value of
securities owned during the year.
The rate of portfolio turnover will not be a limiting factor when the
Manager deems changes in the New York Bond Fund's portfolio appropriate in view
of its investment objective. For example, securities may be sold in anticipation
of a rise in interest rates (market decline) or purchased in anticipation of a
decline in interest rates (market rise) and later sold. In addition, a security
may be sold and another security of comparable quality may be purchased at
approximately the same time in order to take advantage of what the Fund believes
to be a temporary disparity in the normal yield relationship between the two
securities. These yield disparities may occur for reasons not directly related
to the investment quality of particular issues or the general movement of
interest rates, such as changes in the overall demand for or supply of various
types of tax-exempt securities.
For the last two fiscal years the New York Bond Fund's portfolio turnover
rates were as follows:
1996. . . . . 74.80% 1997. . . . . 41.42%
Portfolio turnover rates have been calculated excluding short-term variable rate
securities, which are those with put date intervals of less than one year.
FURTHER DESCRIPTION OF SHARES
The Company is authorized to issue shares in separate portfolios. Ten such
portfolios have been established, two of which are described in this SAI. Under
the Articles of Incorporation, the Board of Directors is authorized to create
new portfolios in addition to those already existing without shareholder
approval. The Company began offering shares of the New York Bond and New York
Money Market Funds in October 1990.
Each Fund's assets and all income, earnings, profits and proceeds thereof,
subject only to the rights of creditors, are specifically allocated to such
Fund. They constitute the underlying assets of each Fund, are required to be
segregated on the books of account, and are to be charged with the expenses of
such Fund. Any general expenses of the Company not readily identifiable as
belonging to a particular Fund are allocated on the basis of the Funds' relative
net assets during the fiscal year or in such other manner as the Board
determines to be fair and equitable. Each share or each Fund represents an equal
proportionate interest in that Fund with every other share and is entitled to
dividends and distributions out of the net income and capital gains belonging to
that Fund when declared by the Board.
On any matter submitted to the shareholders, the holder of each Fund share
is entitled to one vote per share (with proportionate voting for fractional
shares) regardless of the relative net asset values of the Funds' shares.
However, on matters affecting an individual Fund, a separate vote of the
shareholders of that Fund is required. Shareholders of a Fund are not entitled
to vote on any matter which does not affect that Fund but which requires a
separate vote of another Fund. Shares do not have cumulative voting rights,
which means that holders of more than 50% of the shares voting for the election
of Directors can elect 100% of the Company's Board of Directors, and the holders
of less than 50% of the shares voting for the election of Directors will not be
able to elect any person as a Director.
Shareholders of a particular Fund might have the power to elect all of the
Directors of the Company because that Fund has a majority of the total
outstanding shares of the Company. When issued, each Fund's shares are fully
paid and nonassessable, have no pre-emptive or subscription rights, and are
fully transferable. There are no conversion rights.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
TAXATION OF THE FUNDS
Each Fund intends to qualify as a regulated investment company under Subchapter
M of the Internal Revenue Code of 1986, as amended (the Code). Accordingly, each
Fund will not be liable for federal income taxes on its taxable net investment
income and net capital gains (capital gains in excess of capital losses) that
are distributed to shareholders, provided that each Fund distributes at least
90% of its net investment income and net short-term capital gain for the taxable
year.
To qualify as a regulated investment company, a Fund must, among other
things, (1) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, gains from the
sale or other disposition of stock, securities or foreign currencies, or other
income derived
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with respect to its business of investing in such stock, securities or
currencies (the 90% test); (2) derive in each taxable year less than 30% of its
gross income from the sale or other disposition of stock or securities held less
than three months (the 30% test), and (3) satisfy certain diversification
requirements at the close of each quarter of the Fund's taxable year.
Furthermore, to pay tax-exempt interest income dividends, at least 50% of the
value of each Fund's total assets at the close of each quarter of its taxable
year must consist of obligations the interest of which is exempt from federal
income tax. Each Fund intends to satisfy this requirement.
The Code imposes a nondeductible 4% excise tax on a regulated investment
company that fails to distribute during each calendar year an amount at least
equal to the sum of (1) 98% of its taxable net investment income for the
calendar year, (2) 98% of its capital gain net income for the twelve-month
period ending on October 31, and (3) any prior amounts not distributed. Each
Fund intends to make such distributions as are necessary to avoid imposition of
this excise tax.
For federal income tax purposes, debt securities purchased by the Funds
may be treated as having original issue discount. Original issue discount
represents interest income for federal income tax purposes and can generally be
defined as the excess of the stated redemption price at maturity of a debt
obligation over the issue price. Original issue discount is treated for federal
income tax purposes as earned by the Funds, whether or not any income is
actually received, and therefore is subject to the distribution requirements of
the Code. However, original issue discount with respect to tax-exempt
obligations generally will be excluded from the Funds' taxable income, although
such discount will be included in gross income for purposes of the 90% test and
the 30% test described previously. Original issue discount with respect to
tax-exempt securities is accrued and added to the adjusted tax basis of such
securities for purposes of determining gain or loss upon sale or at maturity.
Generally, the amount of original issue discount is determined on the basis of a
constant yield to maturity which takes into account the compounding of accrued
interest. An investment in a stripped bond or stripped coupon will result in
original issue discount.
Debt securities may be purchased by the Funds at a market discount. Market
discount occurs when a security is purchased at a price less than the original
issue price adjusted for accrued original issue discount, if any. The Funds
intend to defer recognition of accrued market discount until maturity or other
disposition of the bond. For securities purchased at a market discount, the gain
realized on disposition will be treated as taxable ordinary income to the extent
it does not exceed accrued market discount on the bond.
The Funds may also purchase debt securities at a premium, i.e., at a
purchase price in excess of face amount. With respect to tax-exempt securities,
the premium must be amortized to the maturity date but no deduction is allowed
for the premium amortization. The amortized bond premium will reduce the Funds'
adjusted tax basis in the securities. For taxable securities, the premium may be
amortized if the Funds so elect. The amortized premium on taxable securities is
first offset against interest received on the securities and then allowed as a
deduction, and, for securities issued after September 27, 1985, must be
amortized under an economic accrual method.
TAXATION OF THE SHAREHOLDERS
Taxable distributions are generally included in a shareholder's gross income for
the taxable year in which they are received. Dividends declared in October,
November, or December and made payable to shareholders of record in such a month
will be deemed to have been received on December 31, if a Fund pays the dividend
during the following January. It is expected that none of the Funds'
distributions will qualify for the corporate dividends-received deduction.
To the extent that a Fund's dividends distributed to shareholders are
derived from interest income exempt from federal income tax and are designated
as "exempt-interest dividends" by a Fund, they will be excludable from a
shareholder's gross income for federal income tax purposes. Shareholders who are
recipients of Social Security benefits should be aware that exempt-interest
dividends received from a Fund are includible in their "modified adjusted gross
income" for purposes of determining the amount of such Social Security benefits,
if any, that are required to be included in their gross income.
All distributions of investment income during the year will have the same
percentage designated as tax-exempt. This method is called the "average annual
method." Since the Funds invest primarily in tax-exempt securities, the
percentage will be substantially the same as the amount actually earned during
any particular distribution period.
A shareholder of the New York Bond Fund should be aware that a redemption
of shares (including any exchange into another USAA Fund) is a taxable event
and, accordingly, a capital gain or loss may be recognized. If a shareholder
receives an exempt-interest dividend with respect to any share and such share
has been held for six months or less, any loss on the redemption or exchange
will be disallowed to the extent of such exempt-interest dividend. Similarly, if
a shareholder of the Fund receives a distribution taxable as long-term capital
gain with respect to shares of the Fund and redeems or exchanges shares before
he has held
16
<PAGE>
them for more than six months, any loss on the redemption or exchange (not
otherwise disallowed as attributable to an exempt-interest dividend) will be
treated as long-term capital loss.
The Funds may invest in private activity bonds. Interest on certain
private activity bonds issued after August 7, 1986, is an item of tax preference
for purposes of the Federal Alternative Minimum Tax (AMT), although the interest
continues to be excludable from gross income for other purposes. AMT is a
supplemental tax designed to ensure that taxpayers pay at least a minimum amount
of tax on their income, even if they make substantial use of certain tax
deductions and exclusions (referred to as tax preference items). Interest from
private activity bonds is one of the tax preference items that is added to
income from other sources for the purposes of determining whether a taxpayer is
subject to the AMT and the amount of any tax to be paid. For corporate
investors, alternative minimum taxable income is increased by 75% of the amount
by which adjusted current earnings (ACE) exceeds alternative minimum taxable
income before the ACE adjustment. For corporate taxpayers, all tax-exempt
interest is considered in calculating the AMT as part of the ACE. Prospective
investors should consult their own tax advisers with respect to the possible
application of the AMT to their tax situation.
Opinions relating to the validity of tax-exempt securities and the
exemption of interest thereon from federal income tax are rendered by recognized
bond counsel to the issuers. Neither the Manager's nor the Funds' counsel makes
any review of the basis of such opinions.
DIRECTORS AND OFFICERS OF THE COMPANY
The Board of Directors of the Company consists of seven Directors. Set forth
below are the Directors and officers of the Company, and their respective
offices and principal occupations during the last five years. Unless otherwise
indicated, the business address of each is 9800 Fredericksburg Rd., San Antonio,
TX 78288.
Robert G. Davis 1, 2
Director and Chairman of the Board of Directors
Age: 50
President, Chief Executive Officer, Director and Vice Chairman of the Board of
Directors of USAA Capital Corporation and several of its subsidiaries and
affiliates (1/97-present); Director, Chairman, President, and Chief Executive
Officer, USAA Financial Planning Network, Inc. (1/97-present); Director, Vice
Chairman, Executive Vice President, and Chief Operating Officer, USAA Financial
Planning Network, Inc. (9/96-1/97); Special Assistant to Chairman, United
Services Automobile Association (USAA) (6/96-12/96); President and Chief
Executive Officer, Banc One Credit Corporation (12/95-6/96); and President and
Chief Executive Officer, Banc One Columbus, (8/91-12/95). Mr. Davis also serves
as a Trustee and Chairman of the Board of Trustees of USAA Investment Trust and
USAA State Tax-Free Trust and as a Director and Chairman of the Boards of
Directors of USAA Investment Management Company (IMCO), USAA Mutual Fund, Inc.,
USAA Shareholder Account Services, USAA Federal Savings Bank and USAA Real
Estate Company.
Michael J.C. Roth 1, 2
Director, President and Vice Chairman of the Board of Directors
Age: 55
Chief Executive Officer, IMCO (10/93-present); President, Director and Vice
Chairman of the Board of Directors, IMCO (1/90-present). Mr. Roth serves as
President, Trustee and Vice Chairman of the Boards of Trustees of USAA
Investment Trust and USAA State Tax-Free Trust, as President, Director and Vice
Chairman of the Boards of Directors of USAA Mutual Fund, Inc. and USAA
Shareholder Account Services, as Director of USAA Life Insurance Company and as
Trustee and Vice Chairman of USAA Life Investment Trust.
John W. Saunders, Jr. 1, 2, 4
Director and Vice President
Age: 62
Senior Vice President, Fixed Income Investments, IMCO (10/85-present). Mr.
Saunders serves as a Trustee and Vice President of USAA Investment Trust and
USAA State Tax-Free Trust, as a Director of IMCO, Director and Vice President of
USAA Mutual Fund, Inc., as Senior Vice President of USAA Shareholder Account
Services, and as Vice President of USAA Life Investment Trust.
17
<PAGE>
Barbara B. Dreeben 3, 4, 5
200 Patterson #1008
San Antonio, TX 78209
Director
Age: 52
President, Postal Addvantage (7/92-present); Consultant, Nancy Harkins Stationer
(8/91-12/95). Mrs. Dreeben serves as a Trustee of USAA Investment Trust and USAA
State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Howard L. Freeman, Jr. 2, 3, 4, 5
2710 Hopeton
San Antonio, TX 78230
Director
Age: 62
Retired. Assistant General Manager for Finance, San Antonio City Public Service
Board (1976-1996). Mr. Freeman serves as a Trustee of USAA Investment Trust and
USAA State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Robert L. Mason, Ph.D. 3, 4, 5
12823 Queens Forest
San Antonio, TX 78230
Director
Age: 51
Manager, Statistical Analysis Section, Southwest Research Institute
(8/75-present). Dr. Mason serves as a Trustee of USAA Investment Trust and USAA
State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Richard A. Zucker 3, 4, 5
407 Arch Bluff
San Antonio, TX 78216
Director
Age: 54
Vice President, Beldon Roofing and Remodeling (1985-present). Mr. Zucker serves
as a Trustee of USAA Investment Trust and USAA State Tax-Free Trust and as a
Director of USAA Mutual Fund, Inc.
Michael D. Wagner 1
Secretary
Age: 49
Vice President, Corporate Counsel, USAA (1982-present). Mr. Wagner has held
various positions in the legal department of USAA since 1970 and serves as Vice
President, Secretary and Counsel, IMCO and USAA Shareholder Account Services;
Secretary, USAA Investment Trust, USAA Mutual Fund, Inc., and USAA State
Tax-Free Trust; and as Vice President, Corporate Counsel, for various other USAA
subsidiaries and affiliates.
Alex M. Ciccone 1
Assistant Secretary
Age: 47
Vice President, Compliance, IMCO (12/94-present); Vice President and Chief
Operating Officer, Commonwealth Shareholder Services (6/94-11/94); and Vice
President, Compliance, IMCO (12/91-5/94). Mr. Ciccone serves as Assistant
Secretary of USAA Investment Trust, USAA State Tax-Free Trust and USAA Mutual
Fund, Inc.
Sherron A. Kirk 1
Treasurer
Age: 52
Vice President, Controller, IMCO (10/92-present); Vice President, Corporate
Financial Analysis, USAA (9/92- 10/92); Assistant Vice President, Financial
Plans and Support, USAA (8/91-9/92). Mrs. Kirk serves as Treasurer of USAA
Investment Trust, USAA State Tax-Free Trust, and USAA Mutual Fund, Inc., and as
Vice President, Controller of USAA Shareholder Account Services.
18
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Dean R. Pantzar 1
Assistant Treasurer
Age: 38
Executive Director, Mutual Fund Accounting, IMCO (10/95-present); Director,
Mutual Fund Accounting, IMCO (12/94-10/95); Senior Manager, KPMG Peat Marwick
LLP (7/88-12/94). Mr. Pantzar serves as Assistant Treasurer of USAA Mutual Fund,
Inc., USAA State Tax-Free Trust, and USAA Investment Trust.
- ---------
1 Indicates those Directors and officers who are employees of the Manager or
affiliated companies and are considered "interested persons" under the
1940 Act.
2 Member of Executive Committee
3 Member of Audit Committee
4 Member of Pricing and Investment Committee
5 Member of Corporate Governance Committee
Between the meetings of the Board of Directors and while the Board is not
in session, the Executive Committee of the Board of Directors has all the powers
and may exercise all the duties of the Board of Directors in the management of
the business of the Company which may be delegated to it by the Board. The
Pricing and Investment Committee of the Board of Directors acts upon various
investment-related issues and other matters which have been delegated to it by
the Board. The Audit Committee of the Board of Directors reviews the financial
statements and the auditor's reports and undertakes certain studies and analyses
as directed by the Board. The Corporate Governance Committee of the Board of
Directors maintains oversight of the organization, performance, and
effectiveness of the Board and Independent Directors.
In addition to the previously listed Directors and/or officers of the
Company who also serve as Directors and/or officers of the Manager, the
following individuals are Directors and/or executive officers of the Manager:
Harry W. Miller, Senior Vice President, Investments (Equity); Carl W. Shirley,
Senior Vice President, Insurance Company Portfolios; and John J. Dallahan,
Senior Vice President, Investment Services. There are no family relationships
among the Directors, officers and managerial level employees of the Company or
its Manager.
The following table sets forth information describing the compensation of
the current Directors of the Company for their services as Directors for the
fiscal year ended March 31, 1997.
Name Aggregate Total Compensation
of Compensation from the USAA
Director from the Company Family of Funds (b)
- ------- ----------------- --------------------
George E. Brown* $ 6,824 $ 25,600
Robert G. Davis None (a) None (a)
Barbara B. Dreeben 9,787 36,600
Howard L. Freeman, Jr. 9,787 36,600
Robert L. Mason* 2,963 11,000
Michael J.C. Roth None (a) None (a)
John W. Saunders, Jr. None (a) None (a)
Richard A. Zucker 9,787 36,600
- ----------------
* Effective January 1, 1997, Robert L. Mason replaced George E. Brown as a
Director on the Board of Directors. Mr. Brown retired on December 31, 1996.
(a) Robert G. Davis, Michael J.C. Roth, and John W. Saunders, Jr. are affiliated
with the Company's investment adviser, IMCO, and, accordingly, receive no
remuneration from the Company or any other Fund of the USAA Family of Funds.
(b) At March 31, 1997, the USAA Family of Funds consisted of four registered
investment companies offering 33 individual funds. Each Director presently
serves as a Trustee or Director of each investment company in the USAA
Family of Funds. In addition, Michael J.C. Roth presently serves as a
Trustee of USAA Life Investment Trust, a registered investment company
advised by IMCO, consisting of seven funds offered to investors in a fixed
and variable annuity contract with USAA Life Insurance Company. Mr. Roth
receives no compensation as Trustee of USAA Life Investment Trust.
All of the above Directors are also Trustees/Directors of the other funds
for which IMCO serves as investment adviser. No compensation is paid by any fund
to any Trustee/Director who is a director, officer, or employee of IMCO or its
affiliates. No pension or retirement benefits are accrued as part of fund
expenses. The Company also reimburses certain expenses of the Directors who are
not affiliated with the investment adviser. As of June 30, 1997, the officers
and Directors of the Company and their families as a group owned beneficially or
of record less than 1% of the outstanding shares of the Company.
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The Company knows of no one person who, as of June 30, 1997, held of
record or owned beneficially 5% or more of either Fund's shares.
THE COMPANY'S MANAGER
As described in the Prospectus, USAA Investment Management Company is the
Manager and investment adviser, providing services under the Advisory Agreement.
The Manager, organized in May 1970, has served as investment adviser and
underwriter for USAA Tax Exempt Fund, Inc. from its inception.
In addition to managing the Company's assets, the Manager advises and
manages the investments for USAA and its affiliated companies as well as those
of USAA Mutual Fund, Inc., USAA Investment Trust, USAA State Tax-Free Trust and
USAA Life Investment Trust. As of the date of this SAI, total assets under
management by the Manager were approximately $35 billion, of which approximately
$20 billion were in mutual fund portfolios.
ADVISORY AGREEMENT
Under the Advisory Agreement, the Manager provides an investment program,
carries out the investment policy and manages the portfolio assets for each
Fund. The Manager is authorized, subject to the control of the Board of
Directors of the Company, to determine the selection, amount and time to buy or
sell securities for each Fund. In addition to providing investment services, the
Manager pays for office space, facilities, business equipment and accounting
services (in addition to those provided by the Custodian) for the Company. The
Manager compensates all personnel, officers and Directors of the Company if such
persons are also employees of the Manager or its affiliates. For these services
under the Advisory Agreement, the Company has agreed to pay the Manager a fee
computed as described under MANAGEMENT OF THE COMPANY in the Prospectus.
Management fees are computed and accrued daily and payable monthly.
Except for the services and facilities provided by the Manager, the Funds
pay all other expenses incurred in their operations. Expenses for which the
Funds are responsible include taxes (if any), brokerage commissions on portfolio
transactions (if any), expenses of issuance and redemption of shares, charges of
transfer agents, custodians and dividend disbursing agents, cost of preparing
and distributing proxy material, costs of printing and engraving stock
certificates, auditing and legal expenses, certain expenses of registering and
qualifying shares for sale, fees of Directors who are not interested persons
(not affiliated) of the Manager, costs of typesetting, printing and mailing the
Prospectus, SAI and periodic reports to existing shareholders, and any other
charges or fees not specifically enumerated. The Manager pays the cost of
printing and mailing copies of the Prospectus, the SAI, and reports to
prospective shareholders.
The Advisory Agreement will remain in effect until June 30, 1998, for each
Fund and will continue in effect from year to year thereafter for each Fund as
long as it is approved at least annually by a vote of the outstanding voting
securities of such Fund (as defined by the 1940 Act) or by the Board of
Directors (on behalf of such Fund) including a majority of the Directors who are
not interested persons of the Manager or (otherwise than as Directors) of the
Company, at a meeting called for the purpose of voting on such approval. The
Advisory Agreement may be terminated at any time by either the Company or the
Manager on 60 days' written notice. It will automatically terminate in the event
of its assignment (as defined in the 1940 Act).
From time to time the Manager may, without prior notice to shareholders,
waive all or any portion of fees or agree to reimburse expenses incurred by a
Fund. Any such waiver or reimbursement may be terminated by the Manager at any
time without prior notice to shareholders. The Manager has voluntarily agreed to
limit each Fund's annual expenses to .50% of its ANA until August 1, 1998, and
will reimburse the Funds for all expenses in excess of the limitations.
For the last three fiscal years, management fees were as follows:
1995 1996 1997
---- ---- ----
New York Bond Fund $239,018 $242,866 $248,023
New York Money Market Fund $124,264 $154,397 $208,986
Because the Funds' expenses exceeded the Manager's voluntary expense
limitation, the Manager did not receive management fees to which it would have
been entitled as follows:
1995 1996 1997
---- ---- ----
New York Bond Fund $110,439 $102,918 $ 85,840
New York Money Market Fund $ 94,923 $ 97,382 $ 86,217
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UNDERWRITER
The Company has an agreement with the Manager for exclusive underwriting and
distribution of the Funds' shares on a continuing best efforts basis. This
agreement provides that the Manager will receive no fee or other compensation
for such distribution services.
TRANSFER AGENT
The Transfer Agent performs transfer agent services for the Company under a
Transfer Agency Agreement. Services include maintenance of shareholder account
records, handling of communications with shareholders, distribution of Fund
dividends and production of reports with respect to account activity for
shareholders and the Company. For its services under the Transfer Agency
Agreement, each Fund pays the Transfer Agent an annual fixed fee of $26.00 per
account. This fee is subject to change at any time.
The fee to the Transfer Agent includes processing of all transactions
and correspondence. Fees are billed on a monthly basis at the rate of
one-twelfth of the annual fee. In addition, the Funds pay all out-of-pocket
expenses of the Transfer Agent and other expenses which are incurred at the
specific direction of the Company.
GENERAL INFORMATION
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 1713, Boston, MA 02105, is the
Company's Custodian. The Custodian is responsible for, among other things,
safeguarding and controlling the Company's cash and securities, handling the
receipt and delivery of securities and collecting interest on the Company's
investments.
COUNSEL
Goodwin, Procter & Hoar LLP, Exchange Place, Boston, MA 02109, will review
certain legal matters for the Company in connection with the shares offered by
the Prospectus.
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP, 112 East Pecan Suite 2400, San Antonio, TX 78205, is the
Company's independent auditor. In this capacity, the firm is responsible for
auditing the annual financial statements of the Funds and reporting thereon.
FINANCIAL STATEMENTS
The financial statements of the Funds and the Independent Auditors' Report
thereon for the fiscal year ended March 31, 1997, are included in the Annual
Report to Shareholders of that date and are incorporated herein by reference.
The Manager will deliver a copy of the Annual Report free of charge with each
SAI requested.
CALCULATION OF PERFORMANCE DATA
Information regarding total return and yield of each Fund is provided under
PERFORMANCE INFORMATION in the Prospectus. See VALUATION OF SECURITIES herein
for a discussion of the manner in which each Fund's price per share is
calculated.
TOTAL RETURN
The New York Bond Fund may advertise performance in terms of average annual
total return for 1-, 5-, and 10-year periods, or for such lesser period as the
Fund has been in existence. Average annual total return is computed by finding
the average annual compounded rates of return over the periods that would equate
the initial amount invested to the ending redeemable value, according to the
following formula:
P(1+T)N = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1-, 5-, or 10- year periods
at the end of the year or period
The calculation assumes all charges are deducted from the initial $1,000
payment and assumes all dividends and distributions by such Fund are reinvested
at the price stated in the Prospectus on the reinvestment dates during the
period, and includes all recurring fees that are charged to all shareholder
accounts.
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<PAGE>
The date of commencement of operations for the New York Bond Fund was
October 15, 1990. The Fund's average annual total returns for the periods ended
March 31, 1997 were:
1 year . . . . 5.89% 5 years . . . . 6.60% Since inception . . . . 8.03%
YIELD
The New York Bond Fund may advertise performance in terms of a 30-day yield
quotation. The 30-day yield quotation is computed by dividing the net investment
income per share earned during the period by the maximum offering price per
share on the last day of the period, according to the following formula:
YIELD = 2 left [ left ({a-b} over cd + 1 right)^6 - 1 right]
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursement)
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends
d = the maximum offering price per share on the last day of
the period
For purposes of the yield calculation, interest income is computed based
on the yield to maturity of each debt obligation in the Fund's portfolio and all
recurring charges are recognized.
The Fund's 30-day yield for the period ended March 31, 1997 was 5.42%.
YIELD - NEW YORK MONEY MARKET FUND
When the New York Money Market Fund quotes a current annualized yield, it is
based on a specified recent seven-calendar-day period. It is computed by (1)
determining the net change, exclusive of capital changes, in the value of a
hypothetical preexisting account having a balance of one share at the beginning
of the period, (2) dividing the net change in account value by the value of the
account at the beginning of the base period to obtain the base return, then (3)
multiplying the base period return by 52.14 (365/7). The resulting yield figure
is carried to the nearest hundredth of one percent.
The calculation includes (1) the value of additional shares purchased with
dividends on the original share, and dividends declared on both the original
share and any such additional shares, and (2) any fees charged to all
shareholder accounts, in proportion to the length of the base period and the
Fund's average account size.
The capital changes excluded from the calculation are realized capital
gains and losses from the sale of securities and unrealized appreciation and
depreciation. The Fund's effective (compounded) yield will be computed by
dividing the seven-day annualized yield as defined above by 365, adding 1 to the
quotient, raising the sum to the 365th power, and subtracting 1 from the result.
Current and effective yields fluctuate daily and will vary with factors
such as interest rates and the quality, length of maturities, and type of
investments in the portfolio.
Yield For 7-day Period Ended 3/31/97 . . . . . 2.95%
Effective Yield For 7-day Period Ended 3/31/97 . . . . . 2.99%
TAX EQUIVALENT YIELD
A tax-exempt mutual fund may provide more "take-home" income than a fully
taxable mutual fund after paying taxes. Calculating a "tax equivalent yield"
means converting a tax-exempt yield to a pretax equivalent so that a meaningful
comparison can be made between a tax-exempt municipal fund and a fully taxable
fund. The New York Money Market Fund may advertise performance in terms of a tax
equivalent yield based on the 7-day yield or effective yield and the New York
Bond Fund may advertise performance in terms of a 30-day tax equivalent yield.
To calculate a tax equivalent yield, the New York investor must know his
Effective Marginal Tax Rate or EMTR. Assuming an investor can fully itemize
deductions on his or her federal tax return, the EMTR is the sum of the Federal
marginal tax rate and the state (and city if applicable) marginal tax rate
adjusted to reflect the deductibility of state (and city if applicable) taxes
from Federal taxable income. The formula for computing the EMTR to compare with
fully taxable securities subject to federal, state and city taxes is:
EMTR = Federal Marginal Tax Rate + [(State Marginal Tax Rate + City
Marginal Tax Rate) x (1-Federal Marginal Tax Rate)]
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<PAGE>
The tax equivalent yield is then computed by dividing the tax-exempt
yield of a fund by the complement of the EMTR. The complement, for example, of
an EMTR of 43.67% is 56.33%, that is (1.00- 0.4367= 0.5633).
Tax Equivalent Yield = Tax Exempt Yield / (1-Effective Marginal Tax Rate)
Using a Federal marginal tax rate of 36% and state and city marginal
tax rate of 11.99%, resulting in an EMTR of 43.67%, the tax equivalent yields
for the New York Bond and New York Money Market Funds for the period ended March
31, 1997 were 9.62% and 5.24%, respectively.
APPENDIX A - TAX-EXEMPT SECURITIES AND THEIR RATINGS
TAX-EXEMPT SECURITIES
Tax-exempt securities generally include debt obligations issued by states and
their political subdivisions, and duly constituted authorities and corporations,
to obtain funds to construct, repair or improve various public facilities such
as airports, bridges, highways, hospitals, housing, schools, streets, and water
and sewer works. Tax-exempt securities may also be issued to refinance
outstanding obligations as well as to obtain funds for general operating
expenses and for loans to other public institutions and facilities.
The two principal classifications of tax-exempt securities are "general
obligations" and "revenue" or "special tax" bonds. General obligation bonds are
secured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue or special tax bonds are payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise or other tax, but not
from general tax revenues. The Funds may also invest in tax-exempt private
activity bonds, which in most cases are revenue bonds and generally do not have
the pledge of the credit of the issuer. The payment of the principal and
interest on such industrial revenue bonds is dependent solely on the ability of
the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed as
security for such payment. There are, of course, many variations in the terms
of, and the security underlying tax-exempt securities. Short-term obligations
issued by states, cities, municipalities or municipal agencies, include Tax
Anticipation Notes, Revenue Anticipation Notes, Bond Anticipation Notes,
Construction Loan Notes and Short-Term Discount Notes.
The yields of tax-exempt securities depend on, among other things,
general money market conditions, conditions of the tax-exempt bond market, the
size of a particular offering, the maturity of the obligation, and the rating of
the issue. The ratings of Moody's Investors Service, Inc. (Moody's), Standard &
Poor's Ratings Group (S&P), Fitch Investors Service, Inc. (Fitch), Duff & Phelps
Inc., Thompson BankWatch, Inc., and IBCA Inc. represent their opinions of the
quality of the securities rated by them. It should be emphasized that such
ratings are general and are not absolute standards of quality. Consequently,
securities with the same maturity, coupon and rating may have different yields,
while securities of the same maturity and coupon but with different ratings may
have the same yield. It will be the responsibility of the Manager to appraise
independently the fundamental quality of the tax-exempt securities included in a
Fund's portfolio.
RATINGS
EXCERPTS FROM MOODY'S BOND (TAX-EXEMPT SECURITIES) RATINGS:
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there
may be other elements present which make the long-term risk appear
somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in
the future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
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NOTE: THOSE BONDS IN THE AA, A, AND BAA GROUPS WHICH MOODY'S BELIEVES POSSESS
THE STRONGEST INVESTMENT ATTRIBUTES ARE DESIGNATED BY THE SYMBOLS AA1, A1, AND
BAA1.
EXCERPTS OF MOODY'S RATINGS OF SHORT-TERM LOANS (STATE AND TAX-EXEMPT NOTES):
Moody's ratings for state and tax-exempt notes and other short-term obligations
are designated Moody's Investment Grade (MIG). Symbols used will be as follows:
MIG-1 This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or
demonstrated broadbased access to the market for refinancing.
MIG-2 This designation denotes high quality. Margins of protection are ample
although not so large as in the preceding group.
EXCERPTS OF MOODY'S RATING OF COMMERCIAL PAPER:
Prime-1 Issuers rated Prime-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics:
o Leading market positions in well-established industries.
o High rates of return on funds employed.
o Conservative capitalization structure with moderate reliance on
debt and ample asset protection.
o Broad margins in earning coverage of fixed financial charges
and high internal cash generation.
o Well-established access to a range of financial markets and
assured sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited
above but to a lesser degree. Earnings trends and coverage ratios,
while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
EXCERPTS FROM S&P'S BOND RATINGS:
AAA Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small
degree.
A Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher
rated categories.
BBB Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher
rated categories.
PLUS (+) OR MINUS (-): THE RATINGS FROM AA TO BBB MAY BE MODIFIED BY THE
ADDITION OF A PLUS OR MINUS SIGN TO SHOW RELATIVE STANDING WITHIN THE MAJOR
RATING CATEGORIES.
EXCERPTS OF S&P'S RATINGS OF TAX-EXEMPT NOTES:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term
of the notes.
EXCERPTS OF S&P'S RATING OF COMMERCIAL PAPER:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus (+) sign
designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as
for issues designated A-1.
EXCERPTS OF FITCH'S RATINGS OF BONDS:
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
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<PAGE>
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated AAA. Because
bonds rated in the AAA and AA categories are not significantly
vulnerable to foreseeable future developments, short-term debt of
these issuers is generally rated F-1+.
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes
in economic conditions and circumstances than bonds with higher
ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on
these bonds, and therefore, impair timely payment. The likelihood that
the ratings of these bonds will fall below investment grade is higher
than for bonds with higher ratings.
PLUS (+) AND MINUS (-): PLUS AND MINUS SIGNS ARE USED WITH A RATING SYMBOL TO
INDICATE THE RELATIVE POSITION OF A CREDIT WITHIN THE RATING CATEGORY. PLUS AND
MINUS SIGNS, HOWEVER, ARE NOT USED IN THE AAA CATEGORY.
EXCERPTS OF FITCH'S RATINGS TO COMMERCIAL PAPER, CERTIFICATES OF DEPOSIT AND
TAX-EXEMPT NOTES:
F-1+ Exceptionally strong credit quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely
payment.
F-1 Very strong credit quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues
rated F-1+.
F-2 Good credit quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is
not as great as for issues assigned F-1+ and F-1 ratings.
EXCERPTS FROM DUFF & PHELPS LONG-TERM RATING SCALE:
AAA Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA High credit quality. Protection factors are strong. Risk is modest but
may vary slightly from time to time because of economic conditions.
A Protection factors are average but adequate. However, risk factors are
more variable and greater in periods of economic stress.
BBB Below average protection factors but still considered sufficient for
prudent investment. Considerable variability in risk during economic
cycles.
EXCERPTS FROM DUFF & PHELPS COMMERCIAL PAPER RATING SCALE:
D-1+ Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of
funds, is outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are
minor.
D-1- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are
very small.
D-2 Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge
total financing requirements, access to capital markets is good. Risk
factors are small.
THOMPSON BANKWATCH, INC.
TBW-1 The highest category; indicates a very high likelihood that principal
and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated TBW-1.
TBW-3 The lowest investment grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal
and external) than those with higher ratings, the capacity to service
principal and interest in a timely fashion is considered adequate.
25
<PAGE>
IBCA INC.
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating of
A1+ is assigned.
A2 Obligations supported by a satisfactory capacity for timely repayment
although such capacity may be susceptible to adverse changes in
business, economic, or financial conditions.
A3 Obligations supported by an adequate capacity for timely repayment.
Such capacity is more susceptible to adverse changes in business,
economic or financial conditions than for obligations in higher
categories.
B Obligations for which the capacity for timely repayment is susceptible
to adverse changes in business, economic or financial conditions.
C Obligations for which there is a high risk of default or which are
currently in default.
APPENDIX B - COMPARISON OF PORTFOLIO PERFORMANCE
Occasionally, we may make comparisons in advertising and sales literature
between the Funds contained in this SAI and other Funds in the USAA Family of
Funds. These comparisons may include such topics as risk and reward, investment
objectives, investment strategies, and performance.
Fund performance also may be compared to the performance of broad groups
of mutual funds with similar investment goals or unmanaged indexes of comparable
securities. Evaluations of Fund performance made by independent sources may be
used in advertisements concerning the Fund, including reprints of, or selections
from, editorials or articles about the Fund. The Fund or its performance may
also be compared to products and services not constituting securities subject to
registration under the Securities Act of 1933 such as, but not limited to,
certificates of deposit and money market accounts. Sources for performance
information and articles about the Fund may include the following:
AAII JOURNAL, a monthly association magazine for members of the American
Association of Individual Investors.
ARIZONA REPUBLIC, a newspaper which may cover financial and investment news.
AUSTIN AMERICAN-STATESMAN, a newspaper which may cover financial news.
BARRON'S, a Dow Jones and Company, Inc. business and financial weekly that
periodically reviews mutual fund performance data.
THE BOND BUYER, a daily newspaper which covers bond market news.
BUSINESS WEEK, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds.
CHICAGO TRIBUNE, a newspaper which may cover financial news.
CONSUMER REPORTS, a monthly magazine which from time to time reports on
companies in the mutual fund industry.
DALLAS MORNING NEWS, a newspaper which may cover financial news.
DENVER POST, a newspaper which may quote financial news.
FINANCIAL PLANNING, a monthly magazine that periodically features companies in
the mutual fund industry.
FINANCIAL SERVICES WEEK, a weekly newspaper which covers financial news.
FINANCIAL WORLD, a monthly magazine which may periodically review mutual fund
companies.
FORBES, a national business publication that periodically reports the
performance of companies in the mutual fund industry.
FORTUNE, a national business publication that periodically rates the performance
of a variety of mutual funds.
FUND ACTION, a mutual fund news report.
HOUSTON CHRONICLE, a newspaper which may cover financial news.
HOUSTON POST, a newspaper which may cover financial news.
IBC/DONOGHUE'S MONEYLETTER, a biweekly newsletter which covers financial news
and from time to time rates specific mutual funds.
IBC'S MONEY MARKET INSIGHT, a monthly money market industry analysis prepared by
IBC USA, Inc.
INCOME AND SAFETY, a monthly newsletter that rates mutual funds.
INVESTECH, a bimonthly investment newsletter.
26
<PAGE>
INVESTMENT ADVISOR, a monthly publication directed primarily to the advisor
community; includes ranking of mutual funds using a proprietary methodology.
INVESTMENT COMPANY INSTITUTE, a national association of the American Investment
Company industry.
INVESTOR'S BUSINESS DAILY, a newspaper which covers financial news.
KIPLINGER'S PERSONAL FINANCE MAGAZINE, a monthly investment advisory publication
that periodically features the performance of a variety of securities.
LIPPER ANALYTICAL SERVICES, INC.'S FIXED INCOME FUND PERFORMANCE ANALYSIS, a
monthly publication of industry-wide mutual fund performance averages by type of
fund.
LIPPER ANALYTICAL SERVICES, INC.'S MUTUAL FUND PERFORMANCE ANALYSIS, a weekly
and quarterly publication of industry-wide mutual fund performance averages by
type of fund.
LOS ANGELES TIMES, a newspaper which may cover financial news.
LOUIS RUKEYSER'S WALL STREET, a publication for investors.
MEDICAL ECONOMICS, a monthly magazine providing information to the medical
profession.
MONEY, a monthly magazine that features the performance of both specific funds
and the mutual fund industry as a whole.
MONEY FUND REPORT, a weekly publication of the Donoghue Organization, Inc.,
reporting on the performance of the nation's money market funds, summarizing
money market fund activity, and including certain averages as performance
benchmarks, specifically: (1) Taxable Money Fund Averages: "100% U.S. Treasury"
and "First Tier" and (2) Tax-Free Money Fund Averages: "Stockbroker and General
Purpose" and "State Specific Stockbroker and General Purpose".
MORNINGSTAR 5 STAR INVESTOR, a monthly newsletter which covers financial news
and rates mutual funds produced by Morningstar, Inc. (a data service which
tracks open-end mutual funds).
MUNI BOND FUND REPORT, a monthly newsletter which covers news on the municipal
bond market and features performance data for municipal bond mutual funds.
MUNIWEEK, a weekly newspaper which covers news on the municipal bond market.
MUTUAL FUND FORECASTER, a monthly newsletter that ranks mutual funds.
MUTUAL FUND INVESTING, a newsletter covering mutual funds.
MUTUAL FUND PERFORMANCE REPORT, a monthly publication of industry-wide mutual
fund averages produced by Morningstar, Inc.
MUTUAL FUNDS MAGAZINE, a monthly publication reporting on mutual fund investing.
MUTUAL FUND SOURCE BOOK, an annual publication produced by Morningstar, Inc.
which describes and rates mutual funds.
MUTUAL FUND VALUES, a biweekly guidebook to mutual funds produced by
Morningstar, Inc.
NEWSWEEK, a national business weekly.
NEW YORK TIMES, a newspaper which may cover financial news.
NO LOAD FUND INVESTOR, a newsletter covering companies in the mutual fund
industry.
PERSONAL INVESTOR, a monthly magazine which from time to time features mutual
fund companies and the mutual fund industry.
SAN ANTONIO BUSINESS JOURNAL, a weekly newspaper that periodically covers mutual
fund companies as well as financial news.
SAN ANTONIO EXPRESS-NEWS, a newspaper which may cover financial news.
SAN FRANCISCO CHRONICLE, a newspaper which may cover financial news.
SMART MONEY, a monthly magazine featuring news and articles on investing and
mutual funds.
USA TODAY, a newspaper which may cover financial news.
U.S. NEWS AND WORLD REPORT, a national business weekly that periodically reports
mutual fund performance data.
WALL STREET JOURNAL, a Dow Jones and Company, Inc. newspaper which covers
financial news.
WASHINGTON POST, a newspaper which may cover financial news.
WEISENBERGER MUTUAL FUNDS INVESTMENT REPORT, a monthly newsletter that reports
on both specific mutual fund companies and the mutual fund industry as a whole.
27
<PAGE>
WORTH, a magazine which covers financial and investment subjects including
mutual funds.
YOUR MONEY, a monthly magazine directed towards the novice investor.
In addition to the sources above, performance of our Funds may also be
tracked by Lipper Analytical Services, Inc. Each Fund will be compared to
Lipper's appropriate fund category according to objective and portfolio
holdings. The New York Bond Fund will be compared to funds in Lipper's New York
tax-exempt bond funds category, and the New York Money Market Fund to funds in
Lipper's New York short-term tax-exempt bond funds category. Footnotes in
advertisements and other sales literature will include the time period
applicable for any rankings used.
For comparative purposes, unmanaged indices of comparable securities or
economic data may be cited. Examples include the following:
- Shearson Lehman Hutton Bond Indices, indices of fixed-rate debt issues rated
investment grade or higher which can be found in the BOND MARKET REPORT.
- Bond Buyer Indices, indices of debt of varying maturities including revenue
bonds, general obligation bonds, and U.S. Treasury bonds which can be found in
MUNIWEEK and THE BOND BUYER.
Other sources for total return and other performance data which may be
used by the Fund or by those publications listed previously are Morningstar,
Inc., Schabaker Investment Management, and Investment Company Data, Inc. These
are services that collect and compile data on mutual fund companies.
APPENDIX C - TAXABLE EQUIVALENT YIELD TABLES
I. COMBINED FEDERAL AND NEW YORK STATE INCOME TAX RATES
Assuming a Federal
Marginal Tax Rate of: 28% 31% 36% 39.6%
and a State Rate of: 7.59% 7.59% 7.59% 7.59%
The Effective Marginal
Tax Rate would be: 33.4648% (a) 36.2371% (b) 40.8576% (c) 44.1844% (d)
To Match a Double
Tax Free Yield of: A Fully Taxable Investment Would Have to Pay You:
2.00% 3.01% 3.14% 3.38% 3.58%
3.00% 4.51% 4.70% 5.07% 5.37%
4.00% 6.01% 6.27% 6.76% 7.17%
5.00% 7.51% 7.84% 8.45% 8.96%
6.00% 9.02% 9.41% 10.15% 10.75%
7.00% 10.52% 10.98% 11.84% 12.54%
(a)FEDERAL RATE OF 28% + (NEW YORK STATE RATE OF 7.59% x (1 - 28%))
(b)FEDERAL RATE OF 31% + (NEW YORK STATE RATE OF 7.59% x (1 - 31%))
(c)FEDERAL RATE OF 36% + (NEW YORK STATE RATE OF 7.59% x (1 - 36%))
(d)FEDERAL RATE OF 39.6% + (NEW YORK STATE RATE OF 7.59% x (1 - 39.6%))
28
<PAGE>
II. COMBINED FEDERAL, NEW YORK STATE, AND NEW YORK CITY INCOME TAX RATES
Assuming a Federal
Marginal Tax Rate of: 28% 31% 36% 39.6%
and a State and City
Rate of: 11.99% 11.99% 11.99% 11.99%
The Effective Marginal
Tax Rate would be: 36.6328% (e) 39.2731% (f) 43.6736% (g) 46.8420% (h)
To Match a Triple
Tax Free Yield of: A Fully Taxable Investment Would Have to Pay You:
2.00% 3.16% 3.29% 3.55% 3.76%
3.00% 4.73% 4.94% 5.33% 5.64%
4.00% 6.31% 6.59% 7.10% 7.52%
5.00% 7.89% 8.23% 8.88% 9.41%
6.00% 9.47% 9.88% 10.65% 11.29%
7.00% 11.05% 11.53% 12.43% 13.17%
(e) FEDERAL RATE OF 28% + ((NEW YORK STATE RATE OF 7.59% +
CITY RATE OF 4.4%) x (1 - 28%))
(f) FEDERAL RATE OF 31% + ((NEW YORK STATE RATE OF 7.59% + CITY RATE OF 4.4%) x
(1 - 31%))
(g) FEDERAL RATE OF 36% + ((NEW YORK STATE RATE OF 7.59% + CITY RATE OF 4.4%) x
(1 - 36%))
(h) FEDERAL RATE OF 39.6% + ((NEW YORK STATE RATE OF 7.59% + CITY RATE OF 4.4%)
x (1 - 39.6%))
THESE TABLES ARE HYPOTHETICAL ILLUSTRATIONS AND SHOULD NOT BE CONSIDERED AN
INDICATION OF FUND PERFORMANCE OF ANY OF THE USAA FAMILY OF FUNDS.
THESE RATES WERE SELECTED AS EXEMPLARY RATES THAT WOULD BE RELEVANT TO MOST
TAXPAYERS.
29
<PAGE>
APPENDIX D - DOLLAR-COST AVERAGING
Dollar-cost averaging is a systematic investing method which can be used by
investors as a disciplined technique for investing. A fixed amount of money is
invested in a security (such as a stock or mutual fund) on a regular basis over
a period of time, regardless of whether securities markets are moving up or
down.
This practice reduces average share costs to the investor who acquires
more shares in periods of lower securities prices and fewer shares in periods of
higher prices.
While dollar-cost averaging does not assure a profit or protect against
loss in declining markets, this investment strategy is an effective way to help
calm the effect of fluctuations in the financial markets. Systematic investing
involves continuous investment in securities regardless of fluctuating price
levels of such securities. Investors should consider their financial ability to
continue purchases through periods of low and high price levels.
As the following chart illustrates, dollar-cost averaging tends to keep
the overall cost of shares lower. This example is for illustration only, and
different trends would result in different average costs.
HOW DOLLAR-COST AVERAGING WORKS
$100 Invested Regularly for 5 Periods
Market Trend
-----------------------------------------------------------------
Down Up Mixed
-----------------------------------------------------------------
Share Shares Share Shares Share Shares
Investment Price Purchased Price Purchased Price Purchased
------------------- --------------------- ------------------
$100 10 10 6 16.67 10 10
100 9 11.1 7 14.29 9 11.1
100 8 12.5 7 14.29 8 12.5
100 8 12.5 9 11.1 9 11.1
100 6 16.67 10 10 10 10
---- -- ---- -- ---- --- ---
$500 ***41 62.77 ***39 66.35 ***46 54.7
*Avg. Cost: $7.97 *Avg. Cost: $7.54 *Avg. Cost: $9.14
----- ----- -----
**Avg. Price: $8.20 **Avg. Price:$7.80 **Avg Price: $9.20
----- ----- -----
* Average Cost is the total amount invested divided by number of shares
purchased.
** Average Price is the sum of the prices paid divided by number of purchases.
*** Cumulative total of share prices used to compute average prices.
30
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31
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17005-0897
<PAGE>
Part B
Statement of Additional Information for the
Virginia Bond and
Virginia Money Market Funds
<PAGE>
[USAA EAGLE LOGO]
USAA STATEMENT OF
TAX EXEMPT ADDITIONAL INFORMATION
FUND, INC. August 1, 1997
- --------------------------------------------------------------------------------
USAA TAX EXEMPT FUND, INC.
VIRGINIA FUNDS
USAA TAX EXEMPT FUND, INC. (the Company) is a registered investment company
offering shares of ten no-load mutual funds, two of which are described in this
Statement of Additional Information (SAI): the Virginia Bond Fund and Virginia
Money Market Fund (collectively, the Funds or the Virginia Funds). Each Fund is
classified as diversified and has a common investment objective of providing
Virginia investors with a high level of current interest income that is exempt
from federal and Virginia state income taxes. The Virginia Money Market Fund has
a further objective of preserving capital and maintaining liquidity.
You may obtain a free copy of a Prospectus for the Virginia Funds dated August
1, 1997, by writing to USAA Tax Exempt Fund, Inc., 9800 Fredericksburg Rd., San
Antonio, TX 78288, or by calling toll free 1-800-531- 8181. The Prospectus
provides the basic information you should know before investing in the Funds.
This SAI is not a Prospectus and contains information in addition to and more
detailed than that set forth in the Prospectus. It is intended to provide you
with additional information regarding the activities and operations of the
Company and the Funds, and should be read in conjunction with the Prospectus.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
2 Valuation of Securities
2 Additional Information Regarding Redemption of Shares
3 Investment Plans
4 Investment Policies
5 Investment Restrictions
6 Special Risk Considerations
8 Portfolio Transactions
9 Further Description of Shares
10 Certain Federal Income Tax Considerations
11 Virginia Taxation
12 Directors and Officers of the Company
14 The Company's Manager
15 General Information
16 Calculation of Performance Data
17 Appendix A - Tax-Exempt Securities and Their Ratings
20 Appendix B - Comparison of Portfolio Performance
23 Appendix C - Taxable Equivalent Yield Table
24 Appendix D - Dollar-Cost Averaging
<PAGE>
VALUATION OF SECURITIES
Shares of each Fund are offered on a continuing best efforts basis through USAA
Investment Management Company (IMCO or the Manager). The offering price for
shares of each Fund is equal to the current net asset value (NAV) per share. The
NAV value per share of each Fund is calculated by adding the value of all its
portfolio securities and other assets, deducting its liabilities, and dividing
by the number of shares outstanding.
A Fund's NAV per share is calculated each day, Monday through Friday,
except days on which the New York Stock Exchange (NYSE) is closed. The NYSE is
currently scheduled to be closed on New Year's Day, Martin Luther King Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving, and Christmas, and on the preceding Friday or subsequent Monday
when one of these holidays falls on a Saturday or Sunday, respectively.
The investments of the VIRGINIA BOND FUND are valued each business day by
a pricing service (the Service) approved by the Company's Board of Directors.
The Service uses the mean between quoted bid and asked prices or the last sale
price to price securities when, in the Service's judgment, these prices are
readily available and are representative of the securities' market values. For
many securities, such prices are not readily available. The Service generally
prices these securities based on methods which include consideration of yields
or prices of tax-exempt securities of comparable quality, coupon, maturity and
type, indications as to values from dealers in securities, and general market
conditions. Securities purchased with maturities of 60 days or less are stated
at amortized cost which approximates market value. Repurchase agreements are
valued at cost. Securities which cannot be valued by the Service, and all other
assets, are valued in good faith at fair value using methods determined by the
Manager under the general supervision of the Board of Directors.
The value of the VIRGINIA MONEY MARKET FUND'S securities is stated at
amortized cost which approximates market value. This involves valuing a security
at its cost and thereafter assuming a constant amortization to maturity of any
discount or premium, regardless of the impact of fluctuating interest rates.
While this method provides certainty in valuation, it may result in periods
during which the value of an instrument, as determined by amortized cost, is
higher or lower than the price the Fund would receive upon the sale of the
instrument.
The valuation of the Virginia Money Market Fund's portfolio instruments
based upon their amortized cost is subject to the Fund's adherence to certain
procedures and conditions. Consistent with regulatory requirements, the Manager
will only purchase securities with remaining maturities of 397 days or less and
will maintain a dollar-weighted average portfolio maturity of no more than 90
days. The Manager will invest only in securities that have been determined to
present minimal credit risk and that satisfy the quality and diversification
requirements of applicable rules and regulations of the Securities and Exchange
Commission (SEC).
The Board of Directors has established procedures designed to stabilize
the Virginia Money Market Fund's price per share, as computed for the purpose of
sales and redemptions, at $1.00. There can be no assurance, however, that the
Fund will at all times be able to maintain a constant $1.00 NAV per share. Such
procedures include review of the Fund's holdings at such intervals as is deemed
appropriate to determine whether the Fund's NAV calculated by using available
market quotations deviates from $1.00 per share and, if so, whether such
deviation may result in material dilution or is otherwise unfair to existing
shareholders. In the event that it is determined that such a deviation exists,
the Board of Directors will take such corrective action as it regards necessary
and appropriate. Such action may include selling portfolio instruments prior to
maturity to realize capital gains or losses or to shorten average portfolio
maturity, withholding dividends, or establishing a NAV per share by using
available market quotations.
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
The value of a shareholder's investment at the time of redemption may be more or
less than the cost at purchase, depending on the value of the securities held in
each Fund's portfolio. Requests for redemption which are subject to any special
conditions, or which specify an effective date other than as provided herein,
cannot be accepted. A gain or loss for tax purposes may be realized on the sale
of shares, depending upon the price when redeemed.
The Board of Directors may cause the redemption of an account with a
balance of less than 50 shares provided (1) the value of the account has been
reduced, for reasons other than market action, below the minimum initial
investment in such Fund at the time of the establishment of the account, (2) the
total value of such shares has been reduced, for reasons other than market
action, below $50 in the case of an account in the Virginia Money Market Fund or
$500 in the case of an account in the Virginia Bond Fund, (3) the account has
remained below the minimum level for six months, and (4) 60 days' prior written
notice of the proposed redemption has been sent to the shareholder. Shares will
be redeemed at the NAV on the date fixed for
2
<PAGE>
redemption by the Board of Directors. Prompt payment will be made by mail to the
last known address of the shareholder.
The Company reserves the right to suspend the right of redemption or
postpone the date of payment (1) for any periods during which the NYSE is
closed, (2) when trading in the markets the Company normally utilizes is
restricted, or an emergency exists as determined by the SEC so that disposal of
the Company's investments or determination of its NAV is not reasonably
practicable, or (3) for such other periods as the SEC by order may permit for
protection of the Company's shareholders.
For the mutual protection of the investor and the Funds, the Company may
require a signature guarantee. If required, EACH signature on the account
registration must be guaranteed. Signature guarantees are acceptable from FDIC
member banks, brokers, dealers, municipal securities dealers, municipal
securities brokers, government securities dealers, government securities
brokers, credit unions, national securities exchanges, registered securities
associations, clearing agencies and savings associations. A signature guarantee
for active duty military personnel stationed abroad may be provided by an
officer of the United States Embassy or Consulate, a staff officer of the Judge
Advocate General, or an individual's commanding officer.
REDEMPTION BY CHECK
Shareholders in the Virginia Money Market Fund may request that checks be issued
for their account. Checks must be written in the amount of at least $250.
Checks issued to shareholders of the Fund will be sent only to the person
in whose name the account is registered and only to the address of record. The
checks must be manually signed by the registered owner(s) exactly as the account
is registered. For joint accounts the signature of either or both joint owners
will be required on the check, according to the election made on the signature
card. Dividends will continue to be earned by the shareholder until the shares
are redeemed by the presentation of a check.
When a check is presented to USAA Shareholder Account Services (Transfer
Agent) for payment, a sufficient number of full and fractional shares in the
investor's account will be redeemed to cover the amount of the check. If an
investor's account is not adequate to cover the amount of a check, the check
will be returned unpaid. Because the value of each account changes as dividends
are accrued on a daily basis, checks may not be used to close an account.
The Transfer Agent will return to the shareholder checks paid during the
month by separate mail. The checkwriting privilege will be subject to the
customary rules and regulations of State Street Bank and Trust Company (State
Street Bank or the Custodian) governing checking accounts. There is no charge to
the shareholder for the use of the checks or for subsequent reorders of checks.
The Company reserves the right to assess a processing fee against a
shareholder's account for any redemption check not honored by a clearing or
paying agent. Currently, this fee is $15 and is subject to change at any time.
Some examples of such dishonor are improper endorsement, checks written for an
amount less than the minimum check amount, and insufficient or uncollectible
funds.
The Company, the Transfer Agent and State Street Bank each reserve the
right to change or suspend the checkwriting privilege upon 30 days' written
notice to participating shareholders.
INVESTMENT PLANS
The following investment plans are made available by the Company to shareholders
of the Funds. At the time you sign up for any of the following investment plans
that utilize the electronic funds transfer service, you will choose the day of
the month (the effective date) on which you would like to regularly purchase
shares. When this day falls on a weekend or holiday, the electronic transfer
will take place on the last business day before the effective date. You may
terminate your participation in a plan at any time. Please call the Manager for
details and necessary forms or applications.
AUTOMATIC PURCHASE OF SHARES
INVESTRONIC(R) - The regular purchase of additional shares through electronic
funds transfer from a checking or savings account. You may invest as little as
$50 per month.
DIRECT PURCHASE SERVICE - The periodic purchase of shares through electronic
funds transfer from an employer (including government allotments), an
income-producing investment, or an account with a participating financial
institution.
AUTOMATIC PURCHASE PLAN - The periodic transfer of funds from a USAA money
market fund to purchase shares in another non-money market USAA mutual fund.
There is a minimum investment required for this program of $5,000 in the money
market fund, with a monthly transaction minimum of $50.
3
<PAGE>
BUY/SELL SERVICE - The intermittent purchase or redemption of shares through
electronic funds transfer to or from a checking or savings account.
Participation in these systematic purchase plans will permit a shareholder
to engage in dollar-cost averaging. For additional information concerning the
benefits of dollar-cost averaging, see APPENDIX D.
SYSTEMATIC WITHDRAWAL PLAN
If a shareholder in a single investment account (accounts in different Funds
cannot be aggregated for this purpose) owns shares having a NAV of $5,000 or
more, the shareholder may request that enough shares to produce a fixed amount
of money be liquidated from the account monthly or quarterly. The amount of each
withdrawal must be at least $50. Using the electronic funds transfer service,
shareholders may choose to have withdrawals electronically deposited at their
bank or other financial institution. They may also elect to have checks mailed
to a designated address.
Such a plan may be initiated by depositing shares worth at least $5,000
with the Transfer Agent and by completing the Systematic Withdrawal Plan
application, which may be requested from the Manager. The shareholder may
terminate participation in the plan at any time. There is no charge to the
shareholder for withdrawals under the Systematic Withdrawal Plan. The Company
will not bear any expenses in administering the plan beyond the regular transfer
agent and custodian costs of issuing and redeeming shares. The Manager will bear
any additional expenses of administering the plan.
Withdrawals will be made by redeeming full and fractional shares on the
date selected by the shareholder at the time the plan is established. Withdrawal
payments made under this plan may exceed dividends and distributions and, to
this extent, will involve the use of principal and could reduce the dollar value
of a shareholder's investment and eventually exhaust the account. Reinvesting
dividends and distributions helps replenish the account. Because share values
and net investment income can fluctuate, shareholders should not expect
withdrawals to be offset by rising income or share value gains.
Each redemption of shares may result in a gain or loss, which must be
reported on the shareholder's income tax return. Therefore, a shareholder should
keep an accurate record of any gain or loss on each withdrawal.
INVESTMENT POLICIES
The section captioned INVESTMENT OBJECTIVES AND POLICIES in the Prospectus
describes the fundamental investment objectives and the investment policies
applicable to each Fund and the following is provided as additional information.
CALCULATION OF PORTFOLIO WEIGHTED AVERAGE MATURITIES
Weighted average maturity is derived by multiplying the value of each investment
by the number of days remaining to its maturity, adding these calculations, and
then dividing the total by the value of the Fund's portfolio. An obligation's
maturity is typically determined on a stated final maturity basis, although
there are some exceptions to this rule.
With respect to obligations held by the Virginia Bond Fund, if it is
probable that the issuer of an instrument will take advantage of a
maturity-shortening device, such as a call, refunding, or redemption provision,
the date on which the instrument will probably be called, refunded, or redeemed
may be considered to be its maturity date. Also, the maturities of securities
subject to sinking fund arrangements are determined on a weighted average life
basis, which is the average time for principal to be repaid. The weighted
average life of these securities is likely to be substantially shorter than
their stated final maturity. In addition, for purposes of the Fund's investment
policies, an instrument will be treated as having a maturity earlier than its
stated maturity date if the instrument has technical features such as puts or
demand features which, in the judgment of the Manager, will result in the
instrument being valued in the market as though it has the earlier maturity.
The Virginia Money Market Fund will determine the maturity of an
obligation in its portfolio in accordance with Rule 2a-7 under the Investment
Company Act of 1940, as amended (1940 Act).
LENDING OF SECURITIES
Each Fund may lend its securities. A lending policy may be authorized by the
Company's Directors and implemented by the Manager, but securities may be loaned
only to qualified broker-dealers or institutional investors that agree to
maintain cash collateral with the Company equal at all time to at least 100% of
the value of the loaned securities. The Directors will establish procedures and
monitor the creditworthiness of any institution or broker-dealer during such
time as any loan is outstanding. The Company will continue to receive interest
on the loaned securities and will invest the cash collateral in readily
marketable short-term obligations of high quality, thereby earning additional
interest. Interest on loaned tax-exempt securities
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received by the borrower and paid to the Company will not be exempt from federal
income taxes in the hands of the Company.
No loan of securities will be made if, as a result, the aggregate of such
loans would exceed 33 1/3% of the value of a Fund's total assets. The Company
may terminate such loans at any time.
REPURCHASE AGREEMENTS
Each Fund may invest up to 5% of its total assets in repurchase agreements. A
repurchase agreement is a transaction in which a security is purchased with a
simultaneous commitment to sell the security back to the seller (a commercial
bank or recognized securities dealer) at an agreed upon price on an agreed upon
date, usually not more than seven days from the date of purchase. The resale
price reflects the purchase price plus an agreed upon market rate of interest
which is unrelated to the coupon rate or maturity of the purchased security. A
repurchase agreement involves the obligation of the seller to pay the agreed
upon price, which obligation is in effect secured by the value of the underlying
security. In these transactions, the securities purchased by a Fund will have a
total value equal to or in excess of the amount of the repurchase obligation and
will be held by the Funds' custodian until repurchased. If the seller defaults
and the value of the underlying security declines, a Fund may incur a loss and
may incur expenses in selling the collateral. If the seller seeks relief under
the bankruptcy laws, the disposition of the collateral may be delayed or
limited. Any investments in repurchase agreements will give rise to income which
will not qualify as tax-exempt income when distributed by a Fund.
OTHER POLICIES
Although the Virginia Bond Fund is permitted to invest in options, financial
futures contracts and options on financial futures contracts, the Fund has no
current intention of doing so and will not invest in such securities without
first notifying shareholders and supplying further information in the
Prospectus.
INVESTMENT RESTRICTIONS
The following investment restrictions have been adopted by the Company for and
are applicable to each Fund. These restrictions may not be changed for any given
Fund without approval by the lesser of (1) 67% or more of the voting securities
present at a meeting of the Fund if more than 50% of the outstanding voting
securities of the Fund are present or represented by proxy or (2) more than 50%
of the Fund's outstanding voting securities. The investment restrictions of one
Fund may be changed without affecting those of the other Fund.
Under the restrictions, neither Fund will:
(1) With respect to 75% of its total assets, purchase securities of any issuer
(other than a security issued or guaranteed as to principal or interest by
the United States, or by a person controlled or supervised by and acting
as an instrumentality of the Government of the United States; or any
certificate of deposit for any of the foregoing) if as a result more than
5% of the total assets of that Fund would be invested in securities of
such issuer; for purposes of this limitation, identification of the
"issuer" will be based on a determination of the source of assets and
revenues committed to meeting interest and principal payments of each
security; for purposes of this limitation the Commonwealth of Virginia or
other jurisdictions and each of its separate political subdivisions,
agencies, authorities and instrumentalities shall be treated as a separate
issuer;
(2) Purchase more than 10% of the outstanding voting securities of any issuer;
(3) Borrow money, except for temporary or emergency purposes in an amount not
exceeding 33 1/3% of its total assets (including the amount borrowed) less
liabilities (other than borrowings);
(4) Pledge, mortgage or hypothecate its assets to any extent greater than 10%
of the value of its total assets;
(5) Purchase or retain securities of any issuer if any officer or Director of
the Company or its Manager owns individually more than one-half of one
percent (1/2%) of the securities of that issuer, and collectively the
officers and Directors of the Company and Manager together own more than
5% of the securities of that issuer;
(6) Purchase any securities which would cause 25% or more of the value of that
Fund's total assets at the time of such purchase to be invested in
securities the interest upon which is derived from revenues or projects
with similar characteristics, such as toll road revenue bonds, housing
revenue bonds, electric power project revenue bonds, or in industrial
revenue bonds which are based, directly or indirectly, on the credit of
private entities of any one industry; provided that the foregoing
limitation does not apply with respect to investments in U.S. Treasury
Bills, other obligations issued or guaranteed by the U.S. Government, its
agencies and instrumentalities, and, in the case of the Virginia Money
Market Fund, certificates of deposit and banker's acceptances of domestic
banks;
(7) Invest in issuers for the purpose of exercising control or management;
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(8) Issue senior securities as defined in the 1940 Act, except that it may
purchase tax-exempt securities on a "when-issued" basis and may purchase
and sell financial futures contracts and options as permitted by Section
18(f)(2);
(9) Underwrite securities of other issuers, except to the extent that it may
be deemed to act as a statutory underwriter in the distribution of any
restricted securities or not readily marketable securities;
(10) Purchase or sell real estate, but this shall not prevent investments in
tax-exempt securities secured by real estate or interests therein;
(11) Lend any securities or make any loan if, as a result, more than 33 1/3% of
its total assets would be lent to other parties, except that this
limitation does not apply to purchases of debt securities or to repurchase
agreements;
(12) Purchase on margin or sell short; for purposes of this restriction the
deposit or payment of initial or variation margin in connection with
financial futures contracts or related options will not be deemed to be a
purchase of securities on margin by a Fund;
(13) Purchase or sell commodities or commodities contracts, except that the
Fund may invest in financial futures contracts and options thereon;
(14) Invest its assets in securities of other investment companies except by
purchases in the open market involving only customary brokers' commissions
or as part of a merger, consolidation, reorganization or purchase of
assets approved by the shareholders; or
(15) Invest in put, call, straddle or spread options or interests in oil, gas,
or other mineral exploration or development programs, except that a Fund
may write covered call options and purchase put options.
ADDITIONAL RESTRICTIONS
The following restrictions are not considered to be fundamental policies of the
Funds. The Company's Board of Directors may change these additional restrictions
without notice to or approval by the shareholders.
Neither Fund will:
(1) Invest more than 15% (10% with respect to the Virginia Money Market Fund)
of the value of its net assets in illiquid securities, including
repurchase agreements maturing in more than seven days.
(2) Purchase any security while borrowings representing more than 5% of the
Fund's total assets are outstanding.
SPECIAL RISK CONSIDERATIONS
A substantial portion of the Funds' investments will consist of debt obligations
issued to obtain funds for bonds issued by or on behalf of Virginia state and
local governments and other public authorities (Virginia Issues). For this
reason, the Funds are affected by political, economic, regulatory or other
developments which constrain the taxing, revenue collecting and spending
authority of Virginia issuers or otherwise affect the ability of Virginia
issuers to pay interest, repay principal, or any premium. The following
information constitutes only a brief summary of some of such developments and
does not purport to be a complete description.
Investors should be aware of certain factors that might affect the
financial condition of issuers of Virginia municipal securities.
Virginia Issues may include primarily debt obligations of the subdivisions
of the Commonwealth of Virginia issued to obtain funds for various public
purposes, including the construction of a wide range of public facilities such
as airports, bridges, highways, schools, streets and water and sewer works.
Other purposes for which bonds may be issued include the obtaining of funds to
lend to public or private institutions for the construction of facilities such
as educational, hospital, housing, and solid waste disposal facilities. The
latter are generally payable from private sources which, in varying degrees, may
depend on local economic conditions, but are not necessarily affected by the
ability of the Commonwealth of Virginia and its political subdivisions to pay
their debts. Therefore, the general risk factors as to the credit of the State
or its political subdivision discussed herein may not be relevant to the
Virginia Issues.
(a) THE COMMONWEALTH AS AN ISSUER. To the extent bonds of the Commonwealth
of Virginia are included in the Virginia Issues, information on the financial
condition of the Commonwealth is noted. The Constitution of Virginia limits the
ability of the Commonwealth to create debt. The Constitution requires a balanced
budget. The Commonwealth has maintained a high level of fiscal stability for
many years due in large part to conservative financial operations and diverse
sources of revenue. The economy of the Commonwealth of Virginia is based
primarily on manufacturing, the government sector (including defense),
agriculture, mining and tourism. The Federal Base Closing Commission has ordered
that a number of military facilities in Virginia be closed or reduced. In 1995
Motorola and IBM each announced the location
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of major manufacturing facilities in Virginia. The Commonwealth ended the fiscal
year on June 30, 1995, with general fund revenues exceeding budget projections
by $51.6 million.
In DAVIS V. MICHIGAN (decided March 28, 1989), the United States Supreme
Court ruled unconstitutional Michigan's statute exempting from state income tax
the retirement benefits paid by the state or local governments and not exempting
retirement benefits paid by the federal government. At the time of this ruling,
under legislation subsequently amended in 1989 to provide uniform taxation of
retirement benefits of all retirees, Virginia exempted state and local but not
federal government retirement benefits. A number of suits for refunds based on
DAVIS V. MICHIGAN were filed by federal retirees in state courts in 1989.
During pendency of an appeal to the Virginia Supreme Court in the
principal refund suit, HARPER V. DEPARTMENT OF TAXATION, the General Assembly
enacted legislation intended to settle the retirees' litigation by providing for
payments of $60 million on March 1, 1995, and (subject to appropriation) $70
million on each March 1 thereafter through March 31, 1999, to retirees who
accepted the settlement, released the Commonwealth from all claims based on
taxation of federal retirement benefits during 1985-88 and dismissed all related
lawsuits to which they were parties. Approximately 91% of the retirees accepted
the settlement. At June 30, 1985, the Commonwealth's long-term liability under
this legislation, as adjusted for opt-outs from the settlement, was $183.6
million.
On September 15, 1995, the Virginia Supreme Court decided the HARPER
appeal in favor of the retirees and ordered refunds with interest. The
Commonwealth did not seek an appeal or rehearing of this decision and has issued
refund checks to the retirees who opted out of the legislative settlement. The
cost of the refund was approximately $78.4 million, including interest.
The Governor proposed a plan to the General Assembly to eliminate or
reduce parole for persons convicted of violent crime. In that connection he
proposed the issuance of bonds to finance part of the cost of additional prisons
that would result from the program. The General Assembly approved part of the
plan, with bonds to be issued by the Virginia Public Building Authority or other
entities and leased to the Commonwealth.
The Commonwealth currently has a Standard & Poor's rating of AAA and a
Moody's rating of Aaa on its general obligation bonds. There can be no assurance
that the economic conditions on which these ratings are based will continue or
that particular bond issues may not be adversely affected by changes in economic
or political conditions. Further, the credit of the Commonwealth is not material
to the ability of political subdivisions and private entities to make payments
on the obligations described below.
(b) BONDS OF OTHER ENTITIES. General obligations of cities, towns and
counties in Virginia are payable from the general revenues of the entity,
including ad valorem tax revenues on property within the jurisdiction. The
obligation to levy taxes could be enforced by mandamus, but such a remedy may be
impracticable and difficult to enforce. Under section 15.1-227.61 of the Code of
Virginia of 1950, as amended, a holder of any general obligation bond in default
may file an affidavit setting forth such default with the Governor. If, after
investigating, the Governor determines that such default exists, he is directed
to order the State Comptroller to withhold State funds appropriated and payable
to the entity and apply the amount so withheld to unpaid principal and interest.
The Commonwealth, however, has no obligation to provide any additional funds
necessary to pay such principal and interest.
Revenue bonds issued by Virginia political subdivisions include (1)
revenue bonds payable exclusively from revenue producing governmental
enterprises and (2) industrial revenue bonds, college and hospital revenue bonds
and other "private activity bonds" which are essentially non-governmental debt
issues and which are payable exclusively by private entities such as non-profit
organizations and business concerns of all sizes. State and local governments
have no obligation to provide for payment of such private activity bonds and in
many cases would be legally prohibited from doing so. The value of such private
activity bonds may be affected by a wide variety of factors relevant to
particular localities or industries, including economic developments outside of
Virginia.
Virginia municipal securities that are lease obligations are customarily
subject to "non-appropriation" clauses which allow the municipality, or other
public entity, to terminate its lease obligations if moneys to make the lease
payments are not appropriated for that purpose. Legal principles may restrict
the enforcement of provisions in lease financing limiting the municipal issuer's
ability to utilize property similar to that leased in the event that debt
service is not appropriated.
Recent amendments to Chapter 9 of the United States Bankruptcy Code, which
applies to bankruptcies by political subdivisions, limit the filing under that
chapter to political subdivisions that have been specifically authorized to do
so under applicable state law. The Company is not aware of any statute in
Virginia that gives any such authorization to political subdivisions in
Virginia. Bonds payable exclusively by private entities may be subject to the
provisions of the United States Bankruptcy Code other than Chapter 9.
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(c) OTHER FACTORS. Virginia municipal issuers have generally not been
required to provide ongoing information about their finances and operations to
holders of their debt obligations, although a number of cities, counties and
other issuers prepare annual reports. Virginia political subdivisions that sell
bonds after July 3, 1995, will be subject to Rule 15c2-12 of the SEC that
requires continuing disclosure, including annual audited financial statements,
with respect to those obligations, unless exempted by the Rule.
Although revenue obligations of the Commonwealth or its political
subdivisions may be payable from a specific project or source, including lease
rentals, there can be no assurance that future economic difficulties and the
resulting impact on Commonwealth and local government finances will not
adversely affect the market value of the portfolio of the Fund or the ability of
the respective obligors to make timely payments of principal and interest on
such obligations.
With respect to Virginia Issues that are backed by a letter of credit
issued by a foreign or domestic bank, the ultimate source of payment is the
bank. Investment in foreign banks may involve risks not present in domestic
investments. These include the fact that the foreign bank may be subject to
different, and in some cases less comprehensive, regulatory, accounting,
financial reporting and disclosure standards than are domestic banks.
When Virginia Issues are insured by a municipal bond insurer, there are
certain risks which the bond insurance policy typically does not cover. For
example, some insurance policies do not insure against loss resulting from: (1)
a pre-payment premium; (2) an optional or mandatory redemption (other than
sinking fund redemptions); (3) an accelerated payment; (4) a payment of the
purchase price of Virginia Issues upon tender thereof; and (5) a preference.
Certain municipal bond insurers may not insure against nonpayment of principal
of or interest on Virginia Issues resulting from the insolvency, negligence or
any other act or omission of a paying agent for Virginia Issues. Also, the
capitalization of the various municipal bond insurers is not uniform. If an
insurer of Virginia Issues must make payments pursuant to its bond insurance
policy, such payments could be limited by, among other things, such companies'
capitalization and insurance regulatory authorities.
The rights of the holders of the Virginia Issues and the enforceability of
the Virginia Issues and the financing documents may be subject to (1)
bankruptcy, insolvency, reorganization, moratorium and other similar laws
relating to or affecting creditors' rights, in effect now or after the date of
the issuance of Virginia Issues, to the extent constitutionally applicable, (2)
principles of equity, and (3) the exercise of judicial discretion.
There are risks in any investment program, and there is no assurance that
either Fund will achieve its investment objective. Virginia Issues are subject
to relative degrees of risk, including credit risk, market volatility, tax law
change and fluctuation of the return of the investment of the Virginia Issues
proceeds. Credit risk relates to the issuer's, pledgor's, contributor's,
grantor's, credit enhancer's and/or guarantor's ability to make timely payments
of principal and interest and any premium. Furthermore, in revenue bond
financings, the bonds may be payable exclusively from moneys derived from the
fees, rents and other charges collected from the bond-financed project. Payment
of principal, interest and any premium on the bonds by the issuer of Virginia
Issues which are revenue bonds may be adversely affected if the collection of
fees, rents and charges from the project is diminished. Market volatility
relates to the changes in market price that occur as a result of variations in
the level of prevailing interest rates and yield relationships between sectors
in the tax-exempt securities market and other market factors. Also, each Fund
will be affected by general changes in interest rates nationally which will
result in increases or decreases in the value of the securities held by such
Fund.
The ability of each Fund to achieve its investment objectives is dependent
on the continuing ability of the issuers of Virginia Issues in which the Fund
invests to meet their obligations for the payment of principal, interest and
premium when due.
PORTFOLIO TRANSACTIONS
The Manager, pursuant to the Advisory Agreement dated July 20, 1990,
supplemented by letter agreement dated July 26, 1990, and subject to the general
control of the Company's Board of Directors, places all orders for the purchase
and sale of Fund securities. Purchases of Fund securities are made either
directly from the issuer or from dealers who deal in tax-exempt securities. The
Manager may sell Fund securities prior to maturity if circumstances warrant and
if it believes such disposition is advisable. In connection with portfolio
transactions for the Company, the Manager seeks to obtain the best available net
price and most favorable execution for its orders. The Manager has no agreement
or commitment to place transaction with any broker-dealer and no regular formula
is used to allocate orders to any broker-dealer. However, the Manager may place
security orders with brokers or dealers who furnish research or other services
to the Manager as long as there is no sacrifice in obtaining the best overall
terms available. Payment for such services would be generated only through
purchase of new issue fixed income securities.
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Such research and other services may include, for example: advice
concerning the value of securities, the advisability of investing in,
purchasing, or selling securities, and the availability of securities or the
purchasers or sellers of securities; analyses and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy, and
performance of accounts; and various functions incidental to effecting
securities transactions, such as clearance and settlement. The Manager
continuously reviews the performance of the broker-dealers with whom it places
orders for transactions. The receipt of research from broker-dealers that
execute transactions on behalf of the Company may be useful to the Manager in
rendering investment management services to other clients (including affiliates
of the Manager), and conversely, such research provided by broker-dealers who
have executed transaction orders on behalf of other clients may be useful to the
Manager in carrying out its obligations to the Company. While such research is
available to and may be used by the Manager in providing investment advice to
all its clients (including affiliates of the Manager), not all of such research
may be used by the Manager for the benefit of the Company. Such research and
services will be in addition to and not in lieu of research and services
provided by the Manager, and the expenses of the Manager will not necessarily be
reduced by the receipt of such supplemental research. See THE COMPANY'S MANAGER.
On occasions when the Manager deems the purchase or sale of a security to
be in the best interest of the Company, as well as the Manager's other clients,
the Manager, to the extent permitted by applicable laws and regulations, may
aggregate such securities to be sold or purchased for the Company with those to
be sold or purchased for other customers in order to obtain best execution and
lower brokerage commissions, if any. In such event, allocation of the securities
so purchased or sold, as well as the expenses incurred in the transaction, will
be made by the Manager in the manner it considers to be most equitable and
consistent with its fiduciary obligations to all such customers, including the
Company. In some instances, this procedure may impact the price and size of the
position obtainable for the Company.
The tax-exempt security market is typically a "dealer" market in which
investment dealers buy and sell bonds for their own accounts, rather than for
customers, and although the price may reflect a dealer's mark-up or mark-down,
the Company pays no brokerage commissions as such. In addition, some securities
may be purchased directly from issuers.
PORTFOLIO TURNOVER RATES
The portfolio turnover rate is computed by dividing the dollar amount of
securities purchased or sold (whichever is smaller) by the average value of
securities owned during the year.
The rate of portfolio turnover will not be a limiting factor when the
Manager deems changes in the Virginia Bond Fund's portfolio appropriate in view
of its investment objective. For example, securities may be sold in anticipation
of a rise in interest rates (market decline) or purchased in anticipation of a
decline in interest rates (market rise) and later sold. In addition, a security
may be sold and another security of comparable quality may be purchased at
approximately the same time in order to take advantage of what the Fund believes
to be a temporary disparity in the normal yield relationship between the two
securities. These yield disparities may occur for reasons not directly related
to the investment quality of particular issues or the general movement of
interest rates, such as changes in the overall demand for or supply of various
types of tax-exempt securities.
For the last two fiscal years the Virginia Bond Fund's portfolio turnover
rates were as follows:
1996. . . . . 27.20% 1997. . . . . 26.84%
Portfolio turnover rates have been calculated excluding short-term variable rate
securities, which are those with put date intervals of less than one year.
FURTHER DESCRIPTION OF SHARES
The Company is authorized to issue shares in separate portfolios. Ten such
portfolios have been established, two of which are described in this SAI. Under
the Articles of Incorporation, the Board of Directors is authorized to create
new portfolios in addition to those already existing without shareholder
approval. The Company began offering shares of the Virginia Bond and Virginia
Money Market Funds in October 1990.
Each Fund's assets and all income, earnings, profits and proceeds thereof,
subject only to the rights of creditors, are specifically allocated to such
Fund. They constitute the underlying assets of each Fund, are required to be
segregated on the books of account, and are to be charged with the expenses of
such Fund. Any general expenses of the Company not readily identifiable as
belonging to a particular Fund are allocated on the basis of the Funds' relative
net assets during the fiscal year or in such other manner as the Board
determines to be fair and equitable. Each share of each Fund represents an equal
proportionate interest in that Fund with every other share and is entitled to
dividends and distributions out of the net income and capital gains belonging to
that Fund when declared by the Board.
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On any matter submitted to the shareholders, the holder of each Fund share
is entitled to one vote per share (with proportionate voting for fractional
shares) regardless of the relative net asset values of the Funds' shares.
However, on matters affecting an individual Fund a separate vote of the
shareholders of that Fund is required. Shareholders of a Fund are not entitled
to vote on any matter which does not affect that Fund but which requires a
separate vote of another Fund. Shares do not have cumulative voting rights,
which means that holders of more than 50% of the shares voting for the election
of Directors can elect 100% of the Company's Board of Directors, and the holders
of less than 50% of the shares voting for the election of Directors will not be
able to elect any person as a Director.
Shareholders of a particular Fund might have the power to elect all of the
Directors of the Company because that Fund has a majority of the total
outstanding shares of the Company. When issued, each Fund's shares are fully
paid and nonassessable, have no pre-emptive or subscription rights, and are
fully transferable. There are no conversion rights.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
TAXATION OF THE FUNDS
Each Fund intends to qualify as a regulated investment company under Subchapter
M of the Internal Revenue Code of 1986, as amended (the Code). Accordingly, each
Fund will not be liable for federal income taxes on its taxable net investment
income and net capital gains (capital gains in excess of capital losses) that
are distributed to shareholders, provided that each Fund distributes at least
90% of its net investment income and net short-term capital gain for the taxable
year.
To qualify as a regulated investment company, a Fund must, among other
things, (1) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, gains from the
sale or other disposition of stock, securities or foreign currencies, or other
income derived with respect to its business of investing in such stock,
securities or currencies (the 90% test); (2) derive in each taxable year less
than 30% of its gross income from the sale or other disposition of stock or
securities held less than three months (the 30% test), and (3) satisfy certain
diversification requirements at the close of each quarter of the Fund's taxable
year. Furthermore, to pay tax-exempt interest income dividends, at least 50% of
the value of each Fund's total assets at the close of each quarter of its
taxable year must consist of obligations the interest of which is exempt from
federal income tax. Each Fund intends to satisfy this requirement.
The Code imposes a nondeductible 4% excise tax on a regulated investment
company that fails to distribute during each calendar year an amount at least
equal to the sum of (1) 98% of its taxable net investment income for the
calendar year, (2) 98% of its capital gain net income for the twelve-month
period ending on October 31, and (3) any prior amounts not distributed. Each
Fund intends to make such distributions as are necessary to avoid imposition of
this excise tax.
For federal income tax purposes, debt securities purchased by the Funds
may be treated as having original issue discount. Original issue discount
represents interest income for federal income tax purposes and can generally be
defined as the excess of the stated redemption price at maturity of a debt
obligation over the issue price. Original issue discount is treated for federal
income tax purposes as earned by the Funds, whether or not any income is
actually received, and therefore is subject to the distribution requirements of
the Code. However, original issue discount with respect to tax-exempt
obligations generally will be excluded from the Funds' taxable income, although
such discount will be included in gross income for purposes of the 90% test and
the 30% test described previously. Original issue discount with respect to
tax-exempt securities is accrued and added to the adjusted tax basis of such
securities for purposes of determining gain or loss upon sale or at maturity.
Generally, the amount of original issue discount is determined on the basis of a
constant yield to maturity which takes into account the compounding of accrued
interest. An investment in a stripped bond or stripped coupon will result in
original issue discount.
Debt securities may be purchased by the Funds at a market discount. Market
discount occurs when a security is purchased at a price less than the original
issue price adjusted for accrued original issue discount, if any. The Funds
intend to defer recognition of accrued market discount until maturity or other
disposition of the bond. For securities purchased at a market discount, the gain
realized on disposition will be treated as taxable ordinary income to the extent
it does not exceed accrued market discount on the bond.
The Funds may also purchase debt securities at a premium, i.e., at a
purchase price in excess of face amount. With respect to tax-exempt securities,
the premium must be amortized to the maturity date but no deduction is allowed
for the premium amortization. The amortized bond premium will reduce the Funds'
adjusted tax basis in the securities. For taxable securities, the premium may be
amortized if the Funds so elect. The amortized premium on taxable securities is
first offset against interest received on the securities and then allowed as a
deduction, and, for securities issued after September 27, 1985, must be
amortized under an economic accrual method.
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TAXATION OF THE SHAREHOLDERS
Taxable distributions are generally included in a shareholder's gross income for
the taxable year in which they are received. Dividends declared in October,
November, or December and made payable to shareholders of record in such a month
will be deemed to have been received on December 31, if a Fund pays the dividend
during the following January. It is expected that none of the Funds'
distributions will qualify for the corporate dividends-received deduction.
To the extent that a Fund's dividends distributed to shareholders are
derived from interest income exempt from federal income tax and are designated
as "exempt-interest dividends" by a Fund, they will be excludable from a
shareholder's gross income for federal income tax purposes. Shareholders who are
recipients of Social Security benefits should be aware that exempt-interest
dividends received from a Fund are includible in their "modified adjusted gross
income" for purposes of determining the amount of such Social Security benefits,
if any, that are required to be included in their gross income.
A shareholder of the Virginia Bond Fund should be aware that a redemption
of shares (including any exchange into another USAA Fund) is a taxable event
and, accordingly, a capital gain or loss may be recognized. If a shareholder
receives an exempt-interest dividend with respect to any share and such share
has been held for six months or less, any loss on the redemption or exchange
will be disallowed to the extent of such exempt-interest dividend. Similarly, if
a shareholder of the Fund receives a distribution taxable as long-term capital
gain with respect to shares of the Fund and redeems or exchanges shares before
he has held them for more than six months, any loss on the redemption or
exchange (not otherwise disallowed as attributable to an exempt-interest
dividend) will be treated as long-term capital loss.
The Funds may invest in private activity bonds. Interest on certain
private activity bonds issued after August 7, 1986, is an item of tax preference
for purposes of the Federal Alternative Minimum Tax (AMT), although the interest
continues to be excludable from gross income for other purposes. AMT is a
supplemental tax designed to ensure that taxpayers pay at least a minimum amount
of tax on their income, even if they make substantial use of certain tax
deductions and exclusions (referred to as tax preference items). Interest from
private activity bonds is one of the tax preference items that is added to
income from other sources for the purposes of determining whether a taxpayer is
subject to the AMT and the amount of any tax to be paid. For corporate
investors, alternative minimum taxable income is increased by 75% of the amount
by which adjusted current earnings (ACE) exceeds alternative minimum taxable
income before the ACE adjustment. For corporate taxpayers, all tax-exempt
interest is considered in calculating the AMT as part of the ACE. Prospective
investors should consult their own tax advisers with respect to the possible
application of the AMT to their tax situation.
Opinions relating to the validity of tax-exempt securities and the
exemption of interest thereon from federal income tax are rendered by recognized
bond counsel to the issuers. Neither the Manager's nor the Funds' counsel makes
any review of the basis of such opinions.
VIRGINIA TAXATION
As a regulated investment company, each Fund may distribute dividends (Virginia
exempt-interest dividends) that are exempt from the Virginia income tax to its
shareholders if (1) at the close of each quarter of its taxable year, at least
50% of the value of its total assets consists of obligations, the interest on
which is excluded from gross income for federal income tax purposes and (2) the
Fund satisfies certain Virginia reporting requirements. The Funds intend to
qualify and report under the above requirement so that they can distribute
Virginia exempt-interest dividends. If a Fund fails to so qualify or report, no
part of its dividends will be exempt from the Virginia income tax.
The portion of dividends constituting Virginia exempt-interest dividends
is that portion derived from obligations of Virginia or its political
subdivisions or instrumentalities which pay interest excludable from federal
gross income or derived from obligations of the United States which pay interest
excludable from Virginia taxable income under the laws of the United States.
Dividends (1) paid by the Funds, (2) excluded from gross income for federal
income tax purposes, and (3) derived from interest on obligations of certain
territories and possessions of the United States (those issued by Puerto Rico,
the Virgin Islands and Guam) will be exempt from the Virginia income tax.
To the extent any portion of the dividends distributed to the shareholders
by the Funds is derived from taxable interest for Virginia purposes or, as a
general rule, net short-term gains, such portion will be taxable to the
shareholders as ordinary income. The character of long-term capital gains
realized and distributed by the Funds will flow through to their shareholders
regardless of how long the shareholders have held their shares. Generally,
interest on indebtedness incurred by shareholders to purchase or carry shares of
the Funds will not be deductible for Virginia income tax purposes.
The foregoing is only a summary of some of the important Virginia income
tax considerations generally affecting the Funds and their shareholders, and
does not address any Virginia taxes other than income taxes.
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No attempt is made to present a detailed explanation of the Virginia income tax
treatment of the Funds or their shareholders, and this discussion is not
intended as a substitute for careful planning. Accordingly, potential investors
in the Funds should consult their tax advisers with respect to the application
of Virginia taxes to the receipt of the Funds' dividends and as to their own
Virginia tax situation.
DIRECTORS AND OFFICERS OF THE COMPANY
The Board of Directors of the Company consists of seven Directors. Set forth
below are the Directors and officers of the Company, and their respective
offices and principal occupations during the last five years. Unless otherwise
indicated, the business address of each is 9800 Fredericksburg Rd., San Antonio,
TX 78288.
Robert G. Davis 1, 2
Director and Chairman of the Board of Directors
Age: 50
President, Chief Executive Officer, Director and Vice Chairman of the Board of
Directors of USAA Capital Corporation and several of its subsidiaries and
affiliates (1/97-present); Director, Chairman, President, and Chief Executive
Officer, USAA Financial Planning Network, Inc. (1/97-present); Director, Vice
Chairman, Executive Vice President, and Chief Operating Officer, USAA Financial
Planning Network, Inc. (9/96-1/97); Special Assistant to Chairman, United
Services Automobile Association (USAA) (6/96-12/96); President and Chief
Executive Officer, Banc One Credit Corporation (12/95-6/96); and President and
Chief Executive Officer, Banc One Columbus, (8/91-12/95). Mr. Davis also serves
as a Trustee and Chairman of the Board of Trustees of USAA Investment Trust and
USAA State Tax-Free Trust and as a Director and Chairman of the Boards of
Directors of USAA Investment Management Company (IMCO), USAA Mutual Fund, Inc.,
USAA Shareholder Account Services, USAA Federal Savings Bank and USAA Real
Estate Company.
Michael J.C. Roth 1, 2
Director, President and Vice Chairman of the Board of Directors
Age: 55
Chief Executive Officer, IMCO (10/93-present); President, Director and Vice
Chairman of the Board of Directors, IMCO (1/90-present). Mr. Roth serves as
President, Trustee and Vice Chairman of the Boards of Trustees of USAA
Investment Trust and USAA State Tax-Free Trust, as President, Director and Vice
Chairman of the Boards of Directors of USAA Mutual Fund, Inc. and USAA
Shareholder Account Services, as Director of USAA Life Insurance Company and as
Trustee and Vice Chairman of USAA Life Investment Trust.
John W. Saunders, Jr. 1, 2, 4
Director and Vice President
Age: 62
Senior Vice President, Fixed Income Investments. Mr. Saunders serves as a
Trustee and Vice President of USAA Investment Trust and USAA State Tax-Free
Trust, as a Director of IMCO, Director and Vice President of USAA Mutual Fund,
Inc., as Senior Vice President of USAA Shareholder Account Services, and as Vice
President of USAA Life Investment Trust.
Barbara B. Dreeben 3, 4, 5
200 Patterson #1008
San Antonio, TX 78209
Director
Age: 52
President, Postal Addvantage (7/92-present); Consultant, Nancy Harkins Stationer
(8/91-12/95). Mrs. Dreeben serves as a Trustee of USAA Investment Trust and USAA
State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Howard L. Freeman, Jr. 2, 3, 4, 5
2710 Hopeton
San Antonio, TX 78230
Director
Age: 62
Retired. Assistant General Manager for Finance, San Antonio City Public Service
Board (1976-1996). Mr. Freeman serves as a Trustee of USAA Investment Trust and
USAA State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
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Robert L. Mason, Ph.D. 3, 4, 5
12823 Queens Forest
San Antonio, TX 78230
Director
Age: 51
Manager, Statistical Analysis Section, Southwest Research Institute
(8/75-present). Dr. Mason serves as a Trustee of USAA Investment Trust and USAA
State Tax-Free Trust and as a Director of USAA Mutual Fund, Inc.
Richard A. Zucker 3, 4, 5
407 Arch Bluff
San Antonio, TX 78216
Director
Age: 54
Vice President, Beldon Roofing and Remodeling (1985-present). Mr. Zucker serves
as a Trustee of USAA Investment Trust and USAA State Tax-Free Trust and as a
Director of USAA Mutual Fund, Inc.
Michael D. Wagner 1
Secretary
Age: 49
Vice President, Corporate Counsel, USAA (1982-present). Mr. Wagner has held
various positions in the legal department of USAA since 1970 and serves as Vice
President, Secretary and Counsel, IMCO and USAA Shareholder Account Services;
Secretary, USAA Investment Trust, USAA Mutual Fund, Inc., and USAA State
Tax-Free Trust; and as Vice President, Corporate Counsel, for various other USAA
subsidiaries and affiliates.
Alex M. Ciccone 1
Assistant Secretary
Age: 47
Vice President, Compliance, IMCO (12/94-present); Vice President and Chief
Operating Officer, Commonwealth Shareholder Services (6/94-11/94); and Vice
President, Compliance, IMCO (12/91-5/94). Mr. Ciccone serves as Assistant
Secretary of USAA Investment Trust, USAA State Tax-Free Trust and USAA Mutual
Fund, Inc.
Sherron A. Kirk 1
Treasurer
Age: 52
Vice President, Controller, IMCO (10/92-present); Vice President, Corporate
Financial Analysis, USAA (9/92- 10/92); Assistant Vice President, Financial
Plans and Support, USAA (8/91-9/92). Mrs. Kirk serves as Treasurer of USAA
Investment Trust, USAA State Tax-Free Trust, and USAA Mutual Fund, Inc., and as
Vice President, Controller of USAA Shareholder Account Services.
Dean R. Pantzar 1
Assistant Treasurer
Age: 38
Executive Director, Mutual Fund Accounting, IMCO (10/95-present); Director,
Mutual Fund Accounting, IMCO (12/94-10/95); Senior Manager, KPMG Peat Marwick
LLP (7/88-12/94). Mr. Pantzar serves as Assistant Treasurer of USAA Mutual Fund,
Inc., USAA State Tax-Free Trust, and USAA Investment Trust.
- ----------
1 Indicates those Directors and officers who are employees of the Manager or
affiliated companies and are considered "interested persons" under the
1940 Act.
2 Member of Executive Committee
3 Member of Audit Committee
4 Member of Pricing and Investment Committee
5 Member of Corporate Governance Committee
Between the meetings of the Board of Directors and while the Board is not
in session, the Executive Committee of the Board of Directors has all the powers
and may exercise all the duties of the Board of Directors in the management of
the business of the Company which may be delegated to it by the Board. The
Pricing and Investment Committee of the Board of Directors acts upon various
investment-related issues and other matters which have been delegated to it by
the Board. The Audit Committee of the Board of Directors reviews the financial
statements and the auditor's reports and undertakes certain studies and analyses
as
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directed by the Board. The Corporate Governance Committee of the Board of
Directors maintains oversight of the organization, performance, and
effectiveness of the Board and Independent Directors.
In addition to the previously listed Directors and/or officers of the
Company who also serve as Directors and/or officers of the Manager, the
following individuals are Directors and/or executive officers of the Manager:
Harry W. Miller, Senior Vice President, Investments (Equity); Carl W. Shirley,
Senior Vice President, Insurance Company Portfolios; and John J. Dallahan,
Senior Vice President, Investment Services. There are no family relationships
among the Directors, officers and managerial level employees of the Company or
its Manager.
The following table sets forth information describing the compensation of
the current Directors of the Company for their services as Directors for the
fiscal year ended March 31, 1997.
Name Aggregate Total Compensation
of Compensation from the USAA
Director from the Company Family of Funds (b)
- -------- ------------------- ----------------------
George E. Brown* $6,824 $25,600
Robert G. Davis None (a) None (a)
Barbara B. Dreeben 9,787 36,600
Howard L. Freeman, Jr. 9,787 36,600
Robert L. Mason* 2,963 11,000
Michael J.C. Roth None (a) None (a)
John W. Saunders, Jr. None (a) None (a)
Richard A. Zucker 9,787 36,600
- ----------------
* Effective January 1, 1997, Robert L. Mason replaced George E. Brown as a
Director on the Board of Directors. Mr. Brown retired on December 31, 1996.
(a) Robert G. Davis, Michael J.C. Roth, and John W. Saunders, Jr. are affiliated
with the Company's investment adviser, IMCO, and, accordingly, receive no
remuneration from the Company or any other Fund of the USAA Family of Funds.
(b) At March 31, 1997, the USAA Family of Funds consisted of four registered
investment companies offering 33 individual funds. Each Director presently
serves as a Trustee or Director of each investment company in the USAA
Family of Funds. In addition, Michael J.C. Roth presently serves as a
Trustee of USAA Life Investment Trust, a registered investment company
advised by IMCO, consisting of seven funds offered to investors in a fixed
and variable annuity contract with USAA Life Insurance Company. Mr. Roth
receives no compensation as Trustee of USAA Life Investment Trust.
All of the above Directors are also Trustees/Directors of the other funds
for which IMCO serves as investment adviser. No compensation is paid by any fund
to any Trustee/Director who is a director, officer, or employee of IMCO or its
affiliates. No pension or retirement benefits are accrued as part of fund
expenses. The Company reimburses certain expenses of the Directors who are not
affiliated with the investment adviser. As of June 30, 1997, the officers and
Directors of the Company and their families as a group owned beneficially or of
record less than 1% of the outstanding shares of the Company.
The Company knows of no one person who, as of June 30, 1997, held of
record or owned beneficially 5% or more of either Fund's shares.
THE COMPANY'S MANAGER
As described in the Prospectus, USAA Investment Management Company is the
Manager and investment adviser, providing services under the Advisory Agreement.
The Manager, organized in May 1970, has served as investment adviser and
underwriter for USAA Tax Exempt Fund, Inc. from its inception.
In addition to managing the Company's assets, the Manager advises and
manages the investments for USAA and its affiliated companies as well as those
of USAA Mutual Fund, Inc., USAA Investment Trust, USAA State Tax-Free Trust and
USAA Life Investment Trust. As of the date of this SAI, total assets under
management by the Manager were approximately $35 billion, of which approximately
$20 billion were in mutual fund portfolios.
ADVISORY AGREEMENT
Under the Advisory Agreement, the Manager provides an investment program,
carries out the investment policy and manages the portfolio assets for each
Fund. The Manager is authorized, subject to the control of the Board of
Directors of the Company, to determine the selection, amount and time to buy or
sell securities for each Fund. In addition to providing investment services, the
Manager pays for office space, facilities, business equipment and accounting
services (in addition to those provided by the Custodian) for the Company. The
Manager compensates all personnel, officers and Directors of the Company if such
persons are also employees of the Manager or its affiliates. For these services
under the Advisory Agreement, the
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Company has agreed to pay the Manager a fee computed as described under
MANAGEMENT OF THE COMPANY in the Prospectus. Management fees are computed and
accrued daily and payable monthly.
Except for the services and facilities provided by the Manager, the Funds
pay all other expenses incurred in their operations. Expenses for which the
Funds are responsible include taxes (if any), brokerage commissions on portfolio
transactions (if any), expenses of issuance and redemption of shares, charges of
transfer agents, custodians and dividend disbursing agents, cost of preparing
and distributing proxy material, costs of printing and engraving stock
certificates, auditing and legal expenses, certain expenses of registering and
qualifying shares for sale, fees of Directors who are not interested persons
(not affiliated) of the Manager, costs of typesetting, printing and mailing the
Prospectus, SAI and periodic reports to existing shareholders, and any other
charges or fees not specifically enumerated. The Manager pays the cost of
printing and mailing copies of the Prospectus, the SAI, and reports to
prospective shareholders.
The Advisory Agreement will remain in effect until June 30, 1998, for each
Fund and will continue in effect from year to year thereafter for each Fund as
long as it is approved at least annually by a vote of the outstanding voting
securities of such Fund (as defined by the 1940 Act) or by the Board of
Directors (on behalf of such Fund) including a majority of the Directors who are
not interested persons of the Manager or (otherwise than as Directors) of the
Company, at a meeting called for the purpose of voting on such approval. The
Advisory Agreement may be terminated at any time by either the Company or the
Manager on 60 days' written notice. It will automatically terminate in the event
of its assignment (as defined in the 1940 Act).
From time to time the Manager may, without prior notice to shareholders,
waive all or any portion of fees or agree to reimburse expenses incurred by a
Fund. Any such waiver or reimbursement may be terminated by the Manager at any
time without prior notice to shareholders. The Manager has voluntarily agreed to
limit each Fund's annual expenses to .50% of its ANA until August 1, 1998, and
will reimburse the Funds for all expenses in excess of the limitations.
For the last three fiscal years, management fees were as follows:
1995 1996 1997
---- ---- ----
Virginia Bond Fund $794,044 $869,725 $940,252
Virginia Money Market Fund $330,961 $354,537 $371,358
Because the expenses of the Virginia Money Market Fund exceeded the
Manager's voluntary expense limitation, in 1995, 1996, and 1997, the Manager did
not receive management fees of $58,402, $58,627, and $36,204, respectively, from
that Fund.
UNDERWRITER
The Company has an agreement with the Manager for exclusive underwriting and
distribution of the Funds' shares on a continuing best efforts basis. This
agreement provides that the Manager will receive no fee or other compensation
for such distribution services.
TRANSFER AGENT
The Transfer Agent performs transfer agent services for the Company under a
Transfer Agency Agreement. Services include maintenance of shareholder account
records, handling of communications with shareholders, distribution of Fund
dividends and production of reports with respect to account activity for
shareholders and the Company. For its services under the Transfer Agency
Agreement, each Fund pays the Transfer Agent an annual fixed fee of $26.00 per
account. This fee is subject to change at any time.
The fee to the Transfer Agent includes processing of all transactions and
correspondence. Fees are billed on a monthly basis at the rate of one-twelfth of
the annual fee. In addition, the Funds pay all out-of-pocket expenses of the
Transfer Agent and other expenses which are incurred at the specific direction
of the Company.
GENERAL INFORMATION
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 1713, Boston, MA 02105, is the
Company's Custodian. The Custodian is responsible for, among other things,
safeguarding and controlling the Company's cash and securities, handling the
receipt and delivery of securities and collecting interest on the Company's
investments.
COUNSEL
Goodwin, Procter & Hoar LLP, Exchange Place, Boston, MA 02109, will review
certain legal matters for the Company in connection with the shares offered by
the Prospectus.
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INDEPENDENT AUDITORS
KPMG Peat Marwick LLP, 112 East Pecan, Suite 2400, San Antonio, TX 78205, is the
Company's independent auditor. In this capacity, the firm is responsible for
auditing the annual financial statements of the Funds and reporting thereon.
FINANCIAL STATEMENTS
The financial statements of the Funds and the Independent Auditors' Report
thereon for the fiscal year ended March 31, 1997 are included in the Annual
Report to Shareholders of that date and are incorporated herein by reference.
The Manager will deliver a copy of the Annual Report free of charge with each
SAI requested.
CALCULATION OF PERFORMANCE DATA
Information regarding total return and yield of each Fund is provided under
PERFORMANCE INFORMATION in the Prospectus. See VALUATION OF SECURITIES herein
for a discussion of the manner in which each Fund's price per share is
calculated.
TOTAL RETURN
The Virginia Bond Fund may advertise performance in terms of average annual
total return for 1-, 5-, and 10- year periods, or for such lesser period as the
Fund has been in existence. Average annual total return is computed by finding
the average annual compounded rates of return over the periods that would equate
the initial amount invested to the ending redeemable value, according to the
following formula:
P(1 + T)N = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1-, 5-, or 10-year periods at
the end of the year or period
The calculation assumes all charges are deducted from the initial $1,000
payment and assumes all dividends and distributions by such Fund are reinvested
at the price stated in the Prospectus on the reinvestment dates during the
period, and includes all recurring fees that are charged to all shareholder
accounts.
The date of commencement of operations for the Virginia Bond Fund was
October 15, 1990. The Fund's average annual total returns for the periods ended
March 31, 1997 were:
1 year. . . . 5.82% 5 years . . . . 7.01% Since inception. . . . 7.80%
YIELD
The Virginia Bond Fund may advertise performance in terms of a 30-day yield
quotation. The 30-day yield quotation is computed by dividing the net investment
income per share earned during the period by the maximum offering price per
share on the last day of the period, according to the following formula:
YIELD = 2 left [ left ({a-b} over cd + 1 right)^6 - 1 right]
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursement)
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends
d = the maximum offering price per share on the last day of the
period
For purposes of the yield calculation, interest income is computed based
on the yield to maturity of each debt obligation in the Fund's portfolio and all
recurring charges are recognized.
The Fund's 30-day yield for the period ended March 31, 1997 was 5.57%.
YIELD - VIRGINIA MONEY MARKET FUND
When the Virginia Money Market Fund quotes a current annualized yield, it is
based on a specified recent seven-calendar-day period. It is computed by (1)
determining the net change, exclusive of capital changes, in the value of a
hypothetical preexisting account having a balance of one share at the beginning
of the period, (2) dividing the net change in account value by the value of the
account at the beginning of the base period to obtain the base return, then (3)
multiplying the base period return by 52.14 (365/7). The resulting yield figure
is carried to the nearest hundredth of one percent.
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The calculation includes (1) the value of additional shares purchased with
dividends on the original share, and dividends declared on both the original
share and any such additional shares, and (2) any fees charged to all
shareholder accounts, in proportion to the length of the base period and the
Fund's average account size.
The capital changes excluded from the calculation are realized capital
gains and losses from the sale of securities and unrealized appreciation and
depreciation. The Fund's effective (compounded) yield will be computed by
dividing the seven-day annualized yield as defined above by 365, adding 1 to the
quotient, raising the sum to the 365th power, and subtracting 1 from the result.
Current and effective yields fluctuate daily and will vary with factors
such as interest rates and the quality, length of maturities, and type of
investments in the portfolio.
Yield For 7-day Period Ended 3/31/97 . . . . 3.09%
Effective Yield For 7-day Period Ended 3/31/97 . . . . 3.14%
TAX EQUIVALENT YIELD
A tax-exempt mutual fund may provide more "take-home" income than a fully
taxable mutual fund after paying taxes. Calculating a "tax equivalent yield"
means converting a tax-exempt yield to a pretax equivalent so that a meaningful
comparison can be made between a tax-exempt municipal fund and a fully taxable
fund. The Virginia Money Market Fund may advertise performance in terms of a tax
equivalent yield based on the 7-day yield or effective yield and the Virginia
Bond Fund may advertise performance in terms of a 30-day tax equivalent yield.
To calculate a tax equivalent yield, the Virginia investor must know his
Effective Marginal Tax Rate or EMTR. Assuming an investor can fully itemize
deductions on his or her federal tax return, the EMTR is the sum of the Federal
marginal tax rate and the state marginal tax rate adjusted to reflect the
deductibility of state taxes from Federal taxable income. The formula for
computing the EMTR to compare with fully taxable securities subject to both
federal and state taxes is:
EMTR = Federal Marginal Tax Rate + [State Marginal Tax
Rate x (1-Federal Marginal Tax Rate)]
The tax equivalent yield is then computed by dividing the tax-exempt yield
of a fund by the complement of the EMTR. The complement, for example, of an EMTR
of 39.68% is 60.32%, that is (1.00-0.3968= 0.6032).
Tax Equivalent Yield = Tax Exempt Yield / (1-Effective Marginal Tax Rate)
Using a Federal marginal tax rate of 36% and state marginal tax rate of
5.75%, resulting in an EMTR of 39.68%, the tax equivalent yields for the
Virginia Bond and Virginia Money Market Funds for the period ended March 31,
1997 were 9.23% and 5.12%, respectively.
APPENDIX A - TAX-EXEMPT SECURITIES AND THEIR RATINGS
TAX-EXEMPT SECURITIES
Tax-exempt securities generally include debt obligations issued by states and
their political subdivisions, and duly constituted authorities and corporations,
to obtain funds to construct, repair or improve various public facilities such
as airports, bridges, highways, hospitals, housing, schools, streets, and water
and sewer works. Tax-exempt securities may also be issued to refinance
outstanding obligations as well as to obtain funds for general operating
expenses and for loans to other public institutions and facilities.
The two principal classifications of tax-exempt securities are "general
obligations" and "revenue" or "special tax" bonds. General obligation bonds are
secured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue or special tax bonds are payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise or other tax, but not
from general tax revenues. The Funds may also invest in tax-exempt private
activity bonds, which in most cases are revenue bonds and generally do not have
the pledge of the credit of the issuer. The payment of the principal and
interest on such industrial revenue bonds is dependent solely on the ability of
the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed as
security for such payment. There are, of course, many variations in the terms
of, and the security underlying tax-exempt securities. Short-term obligations
issued by states, cities, municipalities or municipal agencies, include Tax
Anticipation Notes, Revenue Anticipation Notes, Bond Anticipation Notes,
Construction Loan Notes and Short-Term Discount Notes.
The yields of tax-exempt securities depend on, among other things, general
money market conditions, conditions of the tax-exempt bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. (Moody's), Standard &
Poor's Ratings Group (S&P), Fitch Investors Service, Inc. (Fitch), Duff & Phelps
Inc., Thompson BankWatch, Inc., and IBCA Inc. represent their opinions of the
quality of the securities rated by them. It should be emphasized that such
ratings are general and are not absolute standards of quality. Consequently,
securities with the same
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maturity, coupon and rating may have different yields, while securities of the
same maturity and coupon but with different ratings may have the same yield. It
will be the responsibility of the Manager to appraise independently the
fundamental quality of the tax-exempt securities included in a Fund's portfolio.
RATINGS
EXCERPTS FROM MOODY'S BOND (TAX-EXEMPT SECURITIES) RATINGS:
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there
may be other elements present which make the long-term risk appear
somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in
the future.
Baa Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
NOTE: THOSE BONDS IN THE AA, A, AND BAA GROUPS WHICH MOODY'S BELIEVES POSSESS
THE STRONGEST INVESTMENT ATTRIBUTES ARE DESIGNATED BY THE SYMBOLS AA1, A1, AND
BAA1.
EXCERPTS OF MOODY'S RATINGS OF SHORT-TERM LOANS (STATE AND TAX-EXEMPT NOTES):
Moody's ratings for state and tax-exempt notes and other short-term obligations
are designated Moody's Investment Grade (MIG). Symbols used will be as follows:
MIG-1 This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or
demonstrated broadbased access to the market for refinancing.
MIG-2 This designation denotes high quality. Margins of protection are ample
although not so large as in the preceding group.
EXCERPTS OF MOODY'S RATING OF COMMERCIAL PAPER:
Prime-1 Issuers rated Prime-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the
following characteristics:
o Leading market positions in well-established industries.
o High rates of return on funds employed.
o Conservative capitalization structures with moderate reliance on
debt and ample asset protection.
o Broad margins in earning coverage of fixed financial charges and
high internal cash generation.
o Well-established access to a range of financial markets and
assured sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited
above but to a lesser degree. Earnings trends and coverage ratios,
while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
EXCERPTS FROM S&P'S BOND RATINGS:
AAA Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
AA Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small
degree.
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A Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher rated categories.
BBB Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher
rated categories.
PLUS (+) OR MINUS (-): THE RATINGS FROM AA TO BBB MAY BE MODIFIED BY THE
ADDITION OF A PLUS OR MINUS SIGN TO SHOW RELATIVE STANDING WITHIN THE MAJOR
RATING CATEGORIES.
EXCERPTS OF S&P'S RATINGS OF TAX-EXEMPT NOTES:
SP-1 Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term
of the notes.
EXCERPTS OF S&P'S RATING OF COMMERCIAL PAPER:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus (+)
sign designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high
as for issues designated A-1.
EXCERPTS OF FITCH'S RATINGS OF BONDS:
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated AAA. Because
bonds rated in the AAA and AA categories are not significantly
vulnerable to foreseeable future developments, short-term debt of
these issuers is generally rated F-1+.
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse
changes in economic conditions and circumstances than bonds with
higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on
these bonds, and therefore, impair timely payment. The likelihood
that the ratings of these bonds will fall below investment grade is
higher than for bonds with higher ratings.
PLUS (+) AND MINUS (-): PLUS AND MINUS SIGNS ARE USED WITH A RATING SYMBOL TO
INDICATE THE RELATIVE POSITION OF A CREDIT WITHIN THE RATING CATEGORY. PLUS AND
MINUS SIGNS, HOWEVER, ARE NOT USED IN THE AAA CATEGORY.
EXCERPTS OF FITCH'S RATINGS TO COMMERCIAL PAPER, CERTIFICATES OF DEPOSIT AN
TAX-EXEMPT NOTES:
F-1+ Exceptionally strong credit quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely
payment.
F-1 Very strong credit quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues
rated F-1+.
F-2 Good credit quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payments, but the margin of safety is
not as great as for issues assigned F-1+ and F-1 ratings.
EXCERPTS FROM DUFF & PHELPS LONG-TERM RATING SCALE:
AAA Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA High credit quality. Protection factors are strong. Risk is modest
but may vary slightly from time to time because of economic
conditions.
A Protection factors are average but adequate. However, risk factors
are more variable and greater in periods of economic stress.
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BBB Below average protection factors but still considered sufficient for
prudent investment. Considerable variability in risk during economic
cycles.
EXCERPTS FROM DUFF & PHELPS COMMERCIAL PAPER RATING SCALE:
D-1+ Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of
funds, is outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations.
D-1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors. Risk
factors are minor.
D-1- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are
very small.
D-2 Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge
total financing requirements, access to capital markets is good. Risk
factors are small.
THOMPSON BANKWATCH, INC.
TBW-1 The highest category; indicates a very high likelihood that principal
and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated TBW-1.
TBW-3 The lowest investment grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal
and external) than those with higher ratings, the capacity to service
principal and interest in a timely fashion is considered adequate.
IBCA INC.
A1 Obligations supported by the highest capacity for timely repayment.
Where issues possess a particularly strong credit feature, a rating
of A1+ is assigned.
A2 Obligations supported by a satisfactory capacity for timely repayment
although such capacity may be susceptible to adverse changes in
business, economic or financial conditions.
A3 Obligations supported by an adequate capacity for timely repayment.
Such capacity is more susceptible to adverse changes in business,
economic or financial conditions than for obligations in higher
categories.
B Obligations for which the capacity for timely repayment is
susceptible to adverse changes in business, economic or financial
conditions.
Obligations for which there is a high risk of default or which are
currently in default.
APPENDIX B - COMPARISON OF PORTFOLIO PERFORMANCE
Occasionally, we may make comparisons in advertising and sales literature
between the Funds contained in this SAI and other Funds in the USAA Family of
Funds. These comparisons may include such topics as risk and reward, investment
objectives, investment strategies, and performance.
Fund performance also may be compared to the performance of broad groups
of mutual funds with similar investment goals or unmanaged indexes of comparable
securities. Evaluations of Fund performance made by independent sources may be
used in advertisements concerning the Fund, including reprints of, or selections
from, editorials or articles about the Fund. The Fund or its performance may
also be compared to products and services not constituting securities subject to
registration under the Securities Act of 1933 such as, but not limited to,
certificates of deposit and money market accounts. Sources for performance
information and articles about the Fund may include the following:
AAII JOURNAL, a monthly association magazine for members of the American
Association of Individual Investors.
ARIZONA REPUBLIC, a newspaper which may cover financial and investment news.
AUSTIN AMERICAN-STATESMAN, a newspaper which may cover financial news.
BARRON'S, a Dow Jones and Company, Inc. business and financial weekly that
periodically reviews mutual fund performance data.
THE BOND BUYER, a daily newspaper which covers bond market news.
BUSINESS WEEK, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds.
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<PAGE>
CHICAGO TRIBUNE, a newspaper which may cover financial news.
CONSUMER REPORTS, a monthly magazine which from time to time reports on
companies in the mutual fund industry.
DALLAS MORNING NEWS, a newspaper which may cover financial news.
DENVER POST, a newspaper which may quote financial news.
FINANCIAL PLANNING, a monthly magazine that periodically features companies in
the mutual fund industry.
FINANCIAL SERVICES WEEK, a weekly newspaper which covers financial news.
FINANCIAL WORLD, a monthly magazine which may periodically review mutual fund
companies.
FORBES, a national business publication that periodically reports the
performance of companies in the mutual fund industry.
FORTUNE, a national business publication that periodically rates the performance
of a variety of mutual funds.
FUND ACTION, a mutual fund news report.
HOUSTON CHRONICLE, a newspaper which may cover financial news.
HOUSTON POST, a newspaper which may cover financial news.
IBC/DONOGHUE'S MONEYLETTER, a biweekly newsletter which covers financial news
and from time to time rates specific mutual funds.
IBC'S MONEY MARKET INSIGHT, a monthly money market industry analysis prepared by
IBC USA, Inc.
INCOME AND SAFETY, a monthly newsletter that rates mutual funds.
INVESTECH, a bimonthly investment newsletter.
INVESTMENT ADVISOR, a monthly publication directed primarily to the advisor
community; includes ranking of mutual funds using a proprietary methodology.
INVESTMENT COMPANY INSTITUTE, a national association of the American Investment
Company industry.
INVESTOR'S BUSINESS DAILY, a newspaper which covers financial news.
KIPLINGER'S PERSONAL FINANCE MAGAZINE, a monthly investment advisory publication
that periodically features the performance of a variety of securities.
LIPPER ANALYTICAL SERVICES, INC.'S FIXED INCOME FUND PERFORMANCE ANALYSIS, a
monthly publication of industry-wide mutual fund performance averages by type of
fund.
LIPPER ANALYTICAL SERVICES, INC.'S MUTUAL FUND PERFORMANCE ANALYSIS, a weekly
and quarterly publication of industry-wide mutual fund performance averages by
type of fund.
LOS ANGELES TIMES, a newspaper which may cover financial news.
LOUIS RUKEYSER'S WALL STREET, a publication for investors.
MEDICAL ECONOMICS, a monthly magazine providing information to the medical
profession.
MONEY, a monthly magazine that features the performance of both specific funds
and the mutual fund industry as a whole.
MONEY FUND REPORT, a weekly publication of the Donoghue Organization, Inc.,
reporting on the performance of the nation's money market funds, summarizing
money market fund activity, and including certain averages as performance
benchmarks, specifically: (1) Taxable Money Fund Averages: "100% U.S. Treasury"
and "First Tier" and (2) Tax-Free Money Fund Averages: "Stockbroker and General
Purpose" and "State Specific Stockbroker and General Purpose."
MORNINGSTAR 5 STAR INVESTOR, a monthly newsletter which covers financial news
and rates mutual funds produced by Morningstar, Inc. (a data service which
tracks open-end mutual funds).
MUNI BOND FUND REPORT, a monthly newsletter which covers news on the municipal
bond market and features performance data for municipal bond mutual funds.
MUNIWEEK, a weekly newspaper which covers news on the municipal bond market.
MUTUAL FUND FORECASTER, a monthly newsletter that ranks mutual funds.
MUTUAL FUND INVESTING, a newsletter covering mutual funds.
MUTUAL FUND PERFORMANCE REPORT, a monthly publication of industry-wide mutual
fund averages produced by Morningstar, Inc.
MUTUAL FUNDS MAGAZINE, a monthly publication reporting on mutual fund investing.
21
<PAGE>
MUTUAL FUND SOURCE BOOK, an annual publication produced by Morningstar, Inc.
which describes and rates mutual funds.
MUTUAL FUND VALUES, a biweekly guidebook to mutual funds produced by
Morningstar, Inc.
NEWSWEEK, a national business weekly.
NEW YORK TIMES, a newspaper which may cover financial news.
NO LOAD FUND INVESTOR, a newsletter covering companies in the mutual fund
industry.
PERSONAL INVESTOR, a monthly magazine which from time to time features mutual
fund companies and the mutual fund industry.
SAN ANTONIO BUSINESS JOURNAL, a weekly newspaper that periodically covers mutual
fund companies as well as financial news.
SAN ANTONIO EXPRESS-NEWS, a newspaper which may cover financial news.
SAN FRANCISCO CHRONICLE, a newspaper which may cover financial news.
SMART MONEY, a monthly magazine featuring news and articles on investing and
mutual funds.
USA TODAY, a newspaper which may cover financial news.
U.S. NEWS AND WORLD REPORT, a national business weekly that periodically reports
mutual fund performance data.
WALL STREET JOURNAL, a Dow Jones and Company, Inc. newspaper which covers
financial news.
WASHINGTON POST, a newspaper which may cover financial news.
WEISENBERGER MUTUAL FUNDS INVESTMENT REPORT, a monthly newsletter that reports
on both specific mutual fund companies and the mutual fund industry as a whole.
WORTH, a magazine which covers financial and investment subjects including
mutual funds.
YOUR MONEY, a monthly magazine directed towards the novice investor.
In addition to the sources above, performance of our Funds may also be
tracked by Lipper Analytical Services, Inc. Each Fund will be compared to
Lipper's appropriate fund category according to objective and portfolio
holdings. The Virginia Bond Fund will be compared to funds in Lipper's Virginia
tax-exempt bond funds category, and the Virginia Money Market Fund to funds in
Lipper's Virginia short-term tax-exempt bond funds category. Footnotes in
advertisements and other sales literature will include the time period
applicable for any rankings used.
For comparative purposes, unmanaged indices of comparable securities or
economic data may be cited. Examples include the following:
- Shearson Lehman Hutton Bond Indices, indices of fixed-rate debt issues
rated investment grade or higher which can be found in the BOND MARKET
REPORT.
- Bond Buyer Indices, indices of debt of varying maturities including revenue
bonds, general obligation bonds, and U.S. Treasury bonds which can be found
in MUNIWEEK and THE BOND BUYER.
Other sources for total return and other performance data which may be
used by the Fund or by those publications listed previously are Morningstar,
Inc., Schabaker Investment Management, and Investment Company Data, Inc. These
are services that collect and compile data on mutual fund companies.
22
<PAGE>
APPENDIX C - TAXABLE EQUIVALENT YIELD TABLE
COMBINED FEDERAL AND VIRGINIA STATE INCOME TAX RATES
Assuming a Federal
Marginal Tax Rate of: 28% 31% 36% 39.6%
and a State Rate of: 5.75% 5.75% 5.75% 5.75%
The Effective Marginal
Tax Rate would be: 32.140% (a) 34.968% (b) 39.680% (c) 43.073% (d)
To Match a Double
Tax Free Yield of: A Fully Taxable Investment Would Have to Pay You:
2.00% 2.95% 3.08% 3.32% 3.51%
3.00% 4.42% 4.61% 4.97% 5.27%
4.00% 5.89% 6.15% 6.63% 7.03%
5.00% 7.37% 7.69% 8.29% 8.78%
6.00% 8.84% 9.23% 9.95% 10.54%
7.00% 10.32% 10.76% 11.60% 12.30%
(a)FEDERAL RATE OF 28% + (VIRGINIA STATE RATE OF 5.75% x (1 - 28%))
(b)FEDERAL RATE OF 31% + (VIRGINIA STATE RATE OF 5.75% x (1 - 31%))
(c)FEDERAL RATE OF 36% + (VIRGINIA STATE RATE OF 5.75% x (1 - 36%))
(d)FEDERAL RATE OF 39.6% + (VIRGINIA STATE RATE OF 5.75% x (1 - 39.6%))
THIS TABLE IS A HYPOTHETICAL ILLUSTRATION AND SHOULD NOT BE CONSIDERED AN
INDICATION OF FUND PERFORMANCE OF ANY OF THE USAA FAMILY OF FUNDS.
THESE RATES WERE SELECTED AS EXEMPLARY RATES THAT WOULD BE RELEVANT TO MOST
TAXPAYERS.
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APPENDIX D - DOLLAR-COST AVERAGING
Dollar-cost averaging is a systematic investing method which can be used by
investors as a disciplined technique for investing. A fixed amount of money is
invested in a security (such as a stock or mutual fund) on a regular basis over
a period of time, regardless of whether securities markets are moving up or
down.
This practice reduces average share costs to the investor who acquires
more shares in periods of lower securities prices and fewer shares in periods of
higher prices.
While dollar-cost averaging does not assure a profit or protect against
loss in declining markets, this investment strategy is an effective way to help
calm the effect of fluctuations in the financial markets. Systematic investing
involves continuous investment in securities regardless of fluctuating price
levels of such securities. Investors should consider their financial ability to
continue purchases through periods of low and high price levels.
As the following chart illustrates, dollar-cost averaging tends to keep
the overall cost of shares lower. This example is for illustration only, and
different trends would result in different average costs.
HOW DOLLAR-COST AVERAGING WORKS
$100 Invested Regularly for 5 Periods
Market Trend
-----------------------------------------------------------------
Down Up Mixed
-----------------------------------------------------------------
Share Shares Share Shares Share Shares
Investment Price Purchased Price Purchased Price Purchased
------------------- --------------------- ------------------
$100 10 10 6 16.67 10 10
100 9 11.1 7 14.29 9 11.1
100 8 12.5 7 14.29 8 12.5
100 8 12.5 9 11.1 9 11.1
100 6 16.67 10 10 10 10
---- -- ---- -- ---- --- ---
$500 ***41 62.77 ***39 66.35 ***46 54.7
*Avg. Cost: $7.97 *Avg. Cost: $7.54 *Avg. Cost: $9.14
----- ----- -----
**Avg. Price: $8.20 **Avg. Price:$7.80 **Avg Price: $9.20
----- ----- -----
* Average Cost is the total amount invested divided by number of shares
purchased.
** Average Price is the sum of the prices paid divided by number of purchases.
*** Cumulative total of share prices used to compute average prices.
17004-0897
24
<PAGE>
USAA TAX EXEMPT FUND, INC.
PART C. OTHER INFORMATION
Item 24. FINANCIAL STATEMENTS AND EXHIBITS
(a) Financial Statements:
Financial Statements included in Parts A and B (Prospectuses and
Statements of Additional Information) of this Registration Statement.
Financial Statements and Independent Auditors' Reports are
incorporated by reference to the USAA Tax Exempt Fund, Inc.
(including the Long- Term, Intermediate-Term, Short-Term, and Tax
Exempt Money Market Funds') and the USAA California, New York, and
Virginia Funds' Annual Reports to Shareholders for fiscal year ended
March 31, 1997.
(b) Exhibits:
EXHIBIT NO. DESCRIPTION OF EXHIBITS
1 (a) Articles of Incorporation dated November 13, 1981 (1)
(b) Articles of Amendment to Articles of Incorporation dated
December 18, 1981 (1)
(c) Articles Supplementary dated December 21, 1983 (1)
(d) Articles of Amendment to Articles of Incorporation dated
July 17, 1984 (1)
(e) Articles Supplementary dated July 27, 1984 (1)
(f) Articles Supplementary dated August 1, 1985 (1)
(g) Articles Supplementary dated January 17, 1986 (1)
(h) Articles Supplementary dated September 15, 1988 (1)
(i) Articles Supplementary dated May 18, 1989 (1)
(j) Articles Supplementary dated August 24, 1989 (1)
(k) Articles Supplementary dated January 29, 1990 (1)
(l) Articles Supplementary dated July 25, 1990 (1)
(m) Articles Supplementary dated May 2, 1991 (1)
(n) Articles Supplementary dated September 9, 1991 (1)
(o) Articles Supplementary dated May 12, 1992 (1)
(p) Articles of Amendment to Articles of Incorporation dated
July 22, 1992 (1)
(q) Articles Supplementary dated October 28, 1992 (1)
(r) Articles Supplementary dated January 28, 1993 (1)
(s) Articles Supplementary dated March 23, 1993 (1)
(t) Articles Supplementary dated May 5, 1993 (1)
(u) Articles Supplementary dated November 8, 1993 (1)
(v) Articles Supplementary dated January 18, 1994 (1)
(w) Articles Supplementary dated April 11, 1994 (1)
(x) Articles Supplementary dated July 9, 1997 (filed herewith)
2 Bylaws as amended March 12, 1996 (2)
3 Voting trust agreement - Not Applicable
4 Specimen Certificates for Shares of
(a) Short-Term Fund (1)
(b) Intermediate-Term Fund (1)
(c) Long-Term Fund (1)
(d) Tax Exempt Money Market Fund (1)
(e) California Bond Fund (1)
(f) California Money Market Fund (1)
(g) New York Bond Fund (1)
(h) New York Money Market Fund (1)
(i) Virginia Bond Fund (1)
(j) Virginia Money Market Fund (1)
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EXHIBIT NO. DESCRIPTION OF EXHIBITS
5 (a) Advisory Agreement dated July 20, 1990 (1)
(b) Letter Agreement dated July 26, 1990 adding New York Bond
Fund, New York Money Market Fund, Virginia Bond Fund, and
Virginia Money Market Fund (1)
6 (a) Underwriting Agreement dated July 25, 1990 (1)
(b) Letter Agreement dated July 26, 1990 adding New York Bond
Fund, New York Money Market Fund, Virginia Bond Fund, and
Virginia Money Market Fund (1)
7 Not Applicable
8 (a) Custodian Agreement dated June 23, 1989 (1)
(b) Letter Agreement dated July 26, 1990 adding New York Bond
Fund, New York Money Market Fund, Virginia Bond Fund, and
Virginia Money Market Fund (1)
(c) Subcustodian Agreement dated March 24, 1994 (3)
9 (a) Transfer Agency Agreement dated January 23, 1992 (1)
(b) Amendments dated May 3, 1995 to Transfer Agency Agreement Fee
Schedules for Tax Exempt Money Market Fund, California
Money Market Fund, New York Money Market Fund, and
Virginia Money Market Fund (1)
(c) Master Revolving Credit Facility Agreement with USAA
Capital Corporation dated January 14, 1997 (filed herewith)
(d) Master Revolving Credit Facility Agreement with
NationsBank of Texas dated January 15, 1997 (filed
herewith)
10 (a) Opinion of Counsel (1)
(b) Opinion and Consent of Counsel with respect to the California
Bond Fund and Virginia Bond Fund (filed herewith)
(c) Consent of Counsel with respect to Long-Term Fund,
Intermediate-Term Fund, Short-Term Fund, Tax Exempt
Money Market Fund, California Money Market Fund, New
York Bond Fund, New York Money Market Fund, and Virginia
Money Market Fund (filed herewith)
11 Independent Auditors' Consent (filed herewith)
12 Financial statements omitted from prospectuses - Not
Applicable
13 Subscriptions and Investment Letters
(a) Short-Term Fund, Intermediate-Term Fund, and High-Yield
Fund dated December 7, 1981 (1)
(b) California Bond Fund and California Money Market Fund dated
June 23, 1989 and June 26, 1989 (1)
(c) New York Bond Fund, New York Money Market Fund, Virginia
Bond Fund, and Virginia Money Market Fund dated
September 5, 1990 (1)
14 Prototype Plans - Not Applicable
15 12b-1 Plans - Not Applicable
16 Schedule for Computation of Performance Quotation (1)
17 Financial Data Schedules
(a) Long-Term Fund (filed herewith)
(b) Intermediate-Term Fund (filed herewith)
(c) Short-Term Fund (filed herewith)
(d) Tax Exempt Money Market Fund (filed herewith)
(e) California Bond Fund (filed herewith)
(f) California Money Market Fund (filed herewith)
(g) New York Bond Fund (filed herewith)
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EXHIBIT NO. DESCRIPTION OF EXHIBITS
(h) New York Money Market Fund (filed herewith)
(i) Virginia Bond Fund (filed herewith)
(j) Virginia Money Market Fund (filed herewith)
18 Plan Adopting Multiple Class of Shares - Not Applicable
19 Powers of Attorney
(a) Powers of Attorney for Michael J.C. Roth, Sherron A. Kirk,
John W. Saunders, Jr., George E. Brown, Howard L. Freeman,
Jr., and Richard A. Zucker dated June 25, 1993 (1)
(b) Power of Attorney for Barbara B. Dreeben dated
July 12, 1995 (1)
(c) Power of Attorney for Robert G. Davis dated July 9, 1997
(filed herewith)
(d) Power of Attorney for Robert L. Mason dated July 9, 1997
(filed herewith)
- --------------------------
(1) Previously filed with Post-Effective Amendment No. 23 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
July 24, 1995.
(2) Previously filed with Post-Effective Amendment No. 24 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
May 22, 1996.
(3) Previously filed with Post-Effective Amendment No. 25 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
July 25, 1996.
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Item 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
Information pertaining to persons controlled by or under common
control with Registrant is hereby incorporated by reference to the
section captioned "Management of the Company" in the Prospectus and
the section captioned "Directors and Officers of the Company" in the
Statement of Additional Information.
Item 26. NUMBER OF HOLDERS OF SECURITIES
Set forth below are the number of record holders, as of June 30,
1997, of each class of securities of the Registrant.
TITLE OF CLASS NUMBER OF RECORD HOLDERS
Long-Term Fund 35,926
Intermediate-Term Fund 36,825
Short-Term Fund 21,017
Tax Exempt Money Market Fund 33,886
California Bond Fund 8,440
California Money Market Fund 7,246
New York Bond Fund 1,589
New York Money Market Fund 1,313
Virginia Bond Fund 7,216
Virginia Money Market Fund 3,819
Item 27. INDEMNIFICATION
Protection for the liability of the adviser and underwriter and for
the officers and directors of the Registrant is provided by two
methods:
(a) THE DIRECTOR AND OFFICER LIABILITY POLICY. This policy covers all
losses incurred by the Registrant, its adviser and its underwriter
from any claim made against those entities or persons during the
policy period by any shareholder or former shareholder of the Fund by
reason of any alleged negligent act, error or omission committed in
connection with the administration of the investments of said
Registrant.
(b) STATUTORY INDEMNIFICATION PROVISIONS. Under Section 2-418 of the
Maryland General Corporation Law, the Registrant is authorized to
indemnify any past or present director, officer, agent or employee
against judgments, penalties, fines, settlements and reasonable
expenses actually incurred by him in connection with any proceeding
in which he is a party by reason of having served as a director,
officer, agent or employee, if he acted in good faith and reasonably
believed (i) in the case of conduct in his official capacity with the
Registrant, that his conduct was in the best interests of the
Registrant, or (ii) in all other cases, that hi conduct was at least
not opposed to the best interests of the Registrant. In the case of
any criminal proceeding, said director, officer, agent or employee
must in addition have had no reasonable cause to believe that his
conduct was unlawful. In the case of a proceeding by or in the right
of the Registrant, indemnification may only be made against
reasonable expenses and may not be made in respect of any proceeding
in which the director, officer, agent or employee shall have been
adjudged to be liable to the Registrant. The termination of any
proceeding by judgment, order, settlement, conviction, or upon a plea
of nolo contendere or its equivalent creates a rebuttable presumption
that the director, officer, agent or employee did not meet the
requisite standard of conduct for indemnification. No indemnification
may be made in respect of any proceeding charging improper personal
benefit to the director, officer, agent or employee whether or not
involving action in such person's official capacity, if such person
was adjudged to be liable on the basis that improper personal benefit
was received. If such director, officer, agent or employee is
successful, on the merits or otherwise, in defense of any such
proceeding against him, he shall be indemnified against the
reasonable expenses incurred by him (unless such indemnification is
limited by the Registrant's charter, which it is not). Additionally,
a court of appropriate jurisdiction may order indemnification in
certain circumstances, even if the appropriate standard of conduct
set forth above was not met. Indemnification may not be made unless
uthorized in the specific case after determination that the
applicable standard of conduct has been met. Such determination shall
be made by either: (i) the board of directors by either (x) a
majority vote of a quorum consisting of directors not parties to the
proceeding or (y) if such quorum cannot be obtained, then by a
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majority vote of a committee of the board consisting solely of two or
more directors not at the time parties to such proceeding who were
duly designated to act in the matter by a majority vote of the full
board in which the designated directors who are parties may
participate; (ii) special legal counsel selected by the board of
directors or a committee of the board by vote as set forth in (i)
above, or, if the requisite quorum of the board cannot be obtained
therefor and the committee cannot be established, by a majority vote
of the full board in which directors who are parties may participate;
or (iii) the stockholders.
Reasonable expenses may be reimbursed or paid by the Registrant in
advance of final disposition of a proceeding after a determination,
made in accordance with the procedures set forth in the preceding
paragraph, that the facts then known to those making the
determination would not preclude indemnification under the applicable
standards provided the Registrant receives (i) a written affirmation
of the good faith belief of the person seeking indemnification that
the applicable standard of conduct necessary for indemnification has
been met, and (ii) a written undertaking to repay the advanced sums
if it is ultimately determined that the applicable standard of
conduct has not been met.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the Registrant's
Articles of Incorporation or otherwise, the Registrant has been
advised that, in the opinion of the Securities and Exchange
Commission, such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a
director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, then the Registrant will, unless in the
opinion of its counsel the matter has been settled by a controlling
precedent, submit to a court of appropriate jurisdiction the question
of whether indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication
of such issue.
Item 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Information pertaining to business and other connections of the
Registrant's investment adviser is hereby incorporated by reference
to the section of the Prospectus captioned "Management of the
Company" and to the section of the Statement of Additional
Information captioned "Directors and Officers of the Company."
Item 29. PRINCIPAL UNDERWRITERS
(a) USAA Investment Management Company (the "Adviser") acts as principal
underwriter and distributor of the Registrant's shares on a
best-efforts basis and receives no fee or commission for its
underwriting services. The Adviser, wholly owned by United Services
Automobile Association, also serves as principal underwriter for USAA
Mutual Fund, Inc., USAA Investment Trust, and USAA State Tax-Free
Trust.
(b) Following is information concerning directors and executive officers
of USAA Investment Management Company.
NAME AND PRINCIPAL POSITION AND OFFICES POSITION AND OFFICES
BUSINESS ADDRESS WITH UNDERWRITER WITH REGISTRANT
Robert G. Davis Director and Chairman Director and
9800 Fredericksburg Rd. of the Board of Chairman of the
San Antonio, TX 78288 Directors Board of Directors
Michael J.C. Roth Chief Executive Officer, President, Director
9800 Fredericksburg Rd. President, Director, and and Vice Chairman
San Antonio, TX 78288 Vice Chairman of the of the Board of
Board of Directors Directors
John W. Saunders, Jr. Senior Vice President, Vice President
9800 Fredericksburg Rd. Fixed Income Investments, and Director
San Antonio, TX 78288 and Director
C-5
<PAGE>
Harry W. Miller Senior Vice President, None
9800 Fredericksburg Rd. Equity Investments,
San Antonio, TX 78288 and Director
John J. Dallahan Senior Vice President, None
9800 Fredericksburg Rd. Investment Services
San Antonio, TX 78288
Carl W. Shirley Senior Vice President, None
9800 Fredericksburg Rd. Insurance Company Portfolios
San Antonio, TX 78288
Michael D. Wagner Vice President, Secretary Secretary
9800 Fredericksburg Rd. and Counsel
San Antonio, TX 78288
Sherron A. Kirk Vice President and Treasurer
9800 Fredericksburg Rd. Controller
San Antonio, TX 78288
Alex M. Ciccone Vice President, Assistant
9800 Fredericksburg Rd. Compliance Secretary
San Antonio, TX 78288
(c) Not Applicable.
Item 30. LOCATION OF ACCOUNTS AND RECORDS
The following entities prepare, maintain and preserve the records
required by Section 31(a) of the Investment Company Act of 1940 (the
"1940 Act") for the Registrant. These services are provided to the
Registrant through written agreements between the parties to the
effect that such services will be provided to the Registrant for such
periods prescribed by the Rules and Regulations of the Securities and
Exchange Commission under the 1940 Act and such records are the
property of the entity required to maintain and preserve such records
and will be surrendered promptly on request:
USAA Investment Management Company
9800 Fredericksburg Rd.
San Antonio, Texas 78288
USAA Shareholder Account Services
10750 Robert F. McDermott Freeway
San Antonio, Texas 78288
State Street Bank and Trust Company
1776 Heritage Drive
North Quincy, Massachusetts 02171
Item 31. MANAGEMENT SERVICES
Not Applicable.
Item 32. UNDERTAKING
The Registrant hereby undertakes, if requested to do so by the
holders of at least 10% of the Registrant's outstanding shares, to
call a meeting of shareholders for the purpose of voting upon the
question of removal of a Director or Directors and to assist in
communications with other shareholders as required by Section 16(c)
of the Investment Company Act of 1940.
The Registrant hereby undertakes to provide each person to whom a
prospectus is delivered a copy of the Registrant's latest annual
report(s) to shareholders upon request and without charge.
C-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Registration Statement pursuant to
Rule 485(b) under the securities Act of 1933 and has duly caused this amendment
to its Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of San Antonio and State of Texas on the
9th day of July, 1997.
USAA TAX EXEMPT FUND, INC.
/S/ MICHAEL J.C. ROTH
----------------------------------
Michael J.C. Roth
President
Pursuant to the requirements of the Securities Act of 1933, this amendment
to its Registration Statement has been signed below by the following persons in
the capacities and on the date indicated.
(Signature) (Title) (Date)
/S/ ROBERT G. DAVIS Chairman of the July 9, 1997
- ----------------------------- Board of Director
Robert G. Davis
/S/ MICHAEL J.C. ROTH Vice Chairman of the Board July 9, 1997
- ----------------------------- of Directors and President
Michael J.C. Roth (Principal Executive Officer)
/S/ SHERRON A. KIRK Treasurer (Principal July 9, 1997
- ----------------------------- Financial and
Sherron A. Kirk Accounting Officer)
/S/ JOHN W. SAUNDERS, JR. Director July 9, 1997
- -----------------------------
John W. Saunders, Jr.
/S/ ROBERT L. MASON Director July 9, 1997
- -----------------------------
Robert L. Mason
/S/ HOWARD L. FREEMAN, JR. Director July 9, 1997
- -----------------------------
Howard L. Freeman, Jr.
/S/ RICHARD A. ZUCKER Director July 9, 1997
- -----------------------------
Richard A. Zucker
/S/ BARBARA B. DREEBEN Director July 9, 1997
- -----------------------------
Barbara B. Dreeben
C-7
<PAGE>
Exhibit Index
EXHIBIT ITEM PAGE NO. *
1 (a) Articles of Incorporation dated November 13, 1981 (1)
(b) Articles of Amendment to Articles of Incorporation
dated December 18, 1981 (1)
(c) Articles Supplementary dated December 21, 1983 (1)
(d) Articles of Amendment to Articles of Incorporation
dated July 17, 1984 (1)
(e) Articles Supplementary dated July 27, 1984 (1)
(f) Articles Supplementary dated August 1, 1985 (1)
(g) Articles Supplementary dated January 17, 1986 (1)
(h) Articles Supplementary dated September 15, 1988 (1)
(i) Articles Supplementary dated May 18, 1989 (1)
(j) Articles Supplementary dated August 24, 1989 (1)
(k) Articles Supplementary dated January 29, 1990 (1)
(l) Articles Supplementary dated July 25, 1990 (1)
(m) Articles Supplementary dated May 2, 1991 (1)
(n) Articles Supplementary dated September 9, 1991 (1)
(o) Articles Supplementary dated May 12, 1992 (1)
(p) Articles of Amendment to Articles of Incorporation
dated July 22, 1992 (1)
(q) Articles Supplementary dated October 28, 1992 (1)
(r) Articles Supplementary dated January 28, 1993 (1)
(s) Articles Supplementary dated March 23, 1993 (1)
(t) Articles Supplementary dated May 5, 1993 (1)
(u) Articles Supplementary dated November 8, 1993 (1)
(v) Articles Supplementary dated January 18, 1994 (1)
(w) Articles Supplementary dated April 11, 1994 (1)
(x) Articles Supplementary dated July 9, 1997 (filed herewith) 243
2 Bylaws as amended March 12, 1996 (2)
3 Voting trust agreement - Not Applicable
4 Specimen Certificates for Shares of
(a) Short-Term Fund (1)
(b) Intermediate-Term Fund (1)
(c) Long-Term Fund (1)
(d) Tax Exempt Money Market Fund (1)
(e) California Bond Fund (1)
(f) California Money Market Fund (1)
(g) New York Bond Fund (1)
(h) New York Money Market Fund (1)
(i) Virginia Bond Fund (1)
(j) Virginia Money Market Fund (1)
5 (a) Advisory Agreement dated July 20, 1990 (1)
(b) Letter Agreement dated July 26, 1990 adding New York Bond
Fund, New York Money Market Fund, Virginia Bond Fund,
and Virginia Money Market Fund (1)
6 (a) Underwriting Agreement dated July 25, 1990 (1)
(b) Letter Agreement dated July 26, 1990 adding New York Bond
Fund, New York Money Market Fund, Virginia Bond Fund,
and Virginia Money Market Fund (1)
7 Not Applicable
C-8
<PAGE>
Exhibit Index, cont.
EXHIBIT ITEM PAGE NO. *
8 (a) Custodian Agreement dated June 23, 1989 (1)
(b) Letter Agreement dated July 26, 1990 adding New York Bond
Fund, New York Money Market Fund, Virginia Bond Fund,
and Virginia Money Market Fund (1)
(c) Subcustodian Agreement dated March 24, 1994 (3)
9 (a) Transfer Agency Agreement dated January 23, 1992 (1)
(b) Amendments dated May 3, 1995 to Transfer Agency Agreement
Fee Schedules for Tax Exempt Money Market Fund, California
Money Market Fund, New York Money Market Fund, and
Virginia Money Market Fund (1)
(c) Master Revolving Credit Facility Agreement with USAA Capital
Corporation dated January 14, 1997 (filed herewith) 247
(d) Master Revolving Credit Facility Agreement with NationsBank
of Texas dated January 15, 1997 (filed herewith) 270
10 (a) Opinion of Counsel (1)
(b) Opinion and Consent of Counsel with respect to the California
Bond Fund and Virginia Bond Fund (filed herewith) 298
(c) Consent of Counsel with respect to Long-Term Fund,
Intermediate-Term Fund, Short-Term Fund, Tax Exempt
Money Market Fund, California Money Market Fund, New
York Bond Fund, New York Money Market Fund, and Virginia
Money Market Fund (filed herewith) 300
11 Independent Auditors' Consent (filed herewith) 302
12 Financial statements omitted from prospectuses - Not Applicable
13 Subscriptions and Investment Letters
(a) Short-Term Fund, Intermediate-Term Fund, and High-Yield
Fund dated December 7, 1981 (1)
(b) California Bond Fund and California Money Market Fund dated
June 23, 1989 and June 26, 1989 (1)
(c) New York Bond Fund, New York Money Market Fund, Virginia
Bond Fund, and Virginia Money Market Fund dated
September 5, 1990 (1)
14 Prototype Plans - Not Applicable
15 12b-1 Plans - Not Applicable
16 Schedule for Computation of Performance Quotation (1)
17 Financial Data Schedules
(a) Long-Term Fund (filed herewith) 304
(b) Intermediate-Term Fund (filed herewith) 306
(c) Short-Term Fund (filed herewith) 308
(d) Tax Exempt Money Market Fund (filed herewith) 310
(e) California Bond Fund (filed herewith) 312
(f) California Money Market Fund (filed herewith) 314
(g) New York Bond Fund (filed herewith) 316
(h) New York Money Market Fund (filed herewith) 318
(i) Virginia Bond Fund (filed herewith) 320
(j) Virginia Money Market Fund (filed herewith) 322
18 Plan Adopting Multiple Class of Shares - Not Applicable
C-9
<PAGE>
Exhibit Index, cont.
EXHIBIT ITEM PAGE NO. *
19 Powers of Attorney
(a) Powers of Attorney for Michael J.C. Roth, Sherron A. Kirk,
John W. Saunders, Jr., George E. Brown, Howard L. Freeman,
Jr., and Richard A. Zucker dated June 25, 1993 (1)
(b) Power of Attorney for Barbara B. Dreeben dated July 12, 1995 (1)
(c) Power of Attorney for Robert G. Davis dated July 9, 1997
(filed herewith) 324
(d) Power of Attorney for Robert L. Mason dated July 9, 1997
(filed herewith) 326
- -----------------------
(1) Previously filed with Post-Effective Amendment No. 23 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
July 24, 1995.
(2) Previously filed with Post-Effective Amendment No. 24 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
May 22, 1996.
(3) Previously filed with Post-Effective Amendment No. 25 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
July 25, 1997.
- --------------------------------------------------------
* Refers to sequentially numbered pages
C-10
<PAGE>
USAA TAX EXEMPT FUND, INC.
Articles Supplementary
USAA Tax Exempt Fund, Inc., a Maryland Corporation, having its
principal office in San Antonio, Texas (the "Corporation"), hereby certifies to
the State Department of Assessments and Taxation of Maryland that:
FIRST: The Corporation is registered as an open-end investment company
under the Investment Company Act of 1940.
SECOND: (a) In accordance with Section 2-105(c) of the Maryland General
Corporation Law, the Board of Directors has heretofore authorized the issuance
of 5,000,000,000 shares of capital stock of the Corporation ($.01 par value per
share).
(b) In accordance with Section 2-105(c) of the Maryland General
Corporation Law and pursuant to authority expressly vested in the Board of
Directors by the Articles of Incorporation of the Corporation, the Board of
Directors hereby increases the aggregate number of shares of stock of the
classes of shares designated as the California Bond Fund and the Virginia Bond
Fund by classifying an additional 10,000,000 shares of the authorized and
unissued stock of the Corporation into the California Bond Fund and by
classifying an additional 10,000,000 shares of the authorized and unissued stock
of the Corporation into the Virginia Bond Fund.
THIRD: The additional shares of the California Bond Fund and the Virginia
Bond Fund shall have the preferences, rights, voting powers, restrictions,
limitations as to dividends, qualifications, and terms and conditions as are
described in Article VI of the Articles of Incorporation.
FOURTH: (a) As of immediately before and after the increase in the total
number of shares classified as shares of the California Bond Fund and the
Virginia Bond Fund, the total number of shares of stock of all classes that the
Corporation had and has authority to issue was and is 5,000,000,000 shares ($.01
par value per share).
(b) Before the increase in the total number of shares classified
as shares of the California Bond Fund and the Virginia Bond Fund, there were
classified 175,000,000 shares of the Long-Term Fund, 170,000,000 shares of the
Intermediate-Term Fund, 135,000,000 shares of the Short- Term Fund,
2,600,000,000 shares of the Tax Exempt Money Market Fund, 50,000,000 shares of
the California Bond Fund, 425,000,000 shares of the California Money Market
Fund, 25,000,000 shares of the New York Bond Fund, 100,000,000 shares of the New
York Money Market Fund, 35,000,000 shares of the Virginia Bond Fund and
175,000,000 shares of the Virginia Money Market Fund.
<PAGE>
(c) After the increase in the total number of shares classified as
shares of the California Bond Fund and the Virginia Bond Fund, there are
classified 175,000,000 shares of the Long- Term Fund, 170,000,000 shares of the
Intermediate-Term Fund, 135,000,000 shares of the Short-Term Fund, 2,600,000,000
shares of the Tax Exempt Money Market Fund, 60,000,000 shares of the California
Bond Fund, 425,000,000 shares of the California Money Market Fund, 25,000,000
shares of the New York Bond Fund, 100,000,000 shares of the New York Money
Market Fund, 45,000,000 shares of the Virginia Bond Fund and 175,000,000 shares
of the Virginia Money Market Fund.
(d) As of immediately before and after the increase in the total
number of shares classified as shares of the California Bond Fund and the
Virginia Bond Fund, the aggregate par value of all shares of all classes of
stock authorized to be issued by the Corporation was and is $50,000,000.
IN WITNESS WHEREOF, USAA Tax Exempt Fund, Inc. has caused these presents to be
signed in its name and on its behalf by its Vice President and witnessed by its
Assistant Secretary on July 9, 1997.
WITNESS: USAA TAX EXEMPT FUND, INC.
/S/ ALEX M. CICCONE /S/ JOHN W. SAUNDERS, JR.
- ------------------------- ------------------------------------
Alex M. Ciccone John W. Saunders, Jr
Assistant Secretary Vice President
<PAGE>
THE UNDERSIGNED, Vice President of USAA Tax Exempt Fund, Inc., who
executed on behalf of the Corporation the foregoing Articles Supplementary of
which this certificate is made a part, hereby acknowledges in the name and on
behalf of said Corporation the foregoing Articles Supplementary to be the
corporate act of said Corporation and hereby certifies that to the best of his
knowledge, information, and belief the matters and facts set forth therein with
respect to the authorization and approval thereof are true in all material
respects under the penalties of perjury.
USAA TAX EXEMPT FUND, INC.
/S/ JOHN W. SAUNDERS, JR.
- ------------------------------
John W. Saunders, Jr.
Vice President
EXHIBIT 9(c)
January 14, 1997
USAA Mutual Fund, Inc.,
USAA Investment Trust,
USAA Tax Exempt Fund, Inc., and
USAA State Tax-Free Trust, on behalf of and for the
benefit of the series
of funds comprising each such Borrower
as set forth on Schedule A hereto
9800 Fredericksburg Road
San Antonio, Texas 78288
Attention: Michael J.C. Roth, President
Gentlemen:
This Facility Agreement Letter (this "Agreement") sets forth the terms and
conditions for loans (each a "Loan" and collectively the "Loans") which USAA
Capital Corporation ("CAPCO") may from time to time make during the period
commencing January 14, 1997 and ending January 13, 1998 (the "Facility Period")
to USAA Mutual Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund, Inc.,
and USAA State Tax-Free Trust, and each investment company which may become a
party hereto pursuant to the terms of this Agreement (each a "Borrower" and
collectively the "Borrowers"), each of which is executing this Agreement on
behalf of and for the benefit of the series of funds comprising each such
Borrower as set forth on Schedule A hereto (as hereafter modified or amended in
accordance with the terms hereof) (each a "Fund" and collectively the "Funds"),
under a master revolving credit facility (the "Facility"). USAA Investment
Management Company is the Manager and Investment Advisor of each Fund. This
Agreement replaces in its entirety that certain Facility Agreement Letter dated
January 15, 1996, between the Borrowers and CAPCO. CAPCO and the Borrowers
hereby agree as follows:
1. Amount. The aggregate principal amount of the Loans which may be
advanced under this Facility shall not exceed, at any one time outstanding,
Seven Hundred Fifty Million Dollars ($750,000,000). The aggregate principal
amount of the Loans which may be borrowed by a Borrower for the benefit of a
particular Fund under this Facility shall not exceed the borrowing limit (the
"Borrowing Limit") on borrowings applicable to such Fund, as set forth on
Schedule A hereto.
2. Purpose and Limitations on Borrowings. Each Borrower will use the
proceeds of each Loan made to it solely for temporary or emergency purposes of
the Fund for whose benefit it is borrowing in accordance with such Fund's
Borrowing Limit (Schedule A) and prospectus in
<PAGE>
effect at the time of such Loan. Portfolio securities may not be purchased by a
Fund while there is a Loan outstanding under the Facility or any other facility,
if the aggregate amount of such Loan and any other such loan exceeds 5% of the
total assets of such Fund.
3. Borrowing Rate and Maturity of Loans. CAPCO may make Loans to a
Borrower and the principal amount of the Loans outstanding from time to time
shall bear interest at a rate per annum equal to the rate at which CAPCO obtains
funding in the capital markets plus a standard mark-up to cover CAPCO's
operating costs (not to exceed 8 basis points). Interest on the Loans shall be
calculated on the basis of a year of 360 days and the actual days elapsed but
shall not exceed the highest lawful rate. Each loan will be for an established
number of days agreed upon by the applicable Borrower and CAPCO. Notwithstanding
the above, all Loans to a Borrower shall be made available at a rate per annum
equal to the rate at which CAPCO would make loans to affiliates and
subsidiaries. Further, if the CAPCO rate exceeds the rate at which a Borrower
could obtain funds pursuant to the NationsBank of Texas, N.A. ("NationsBank")
364-day committed $100,000,000 Master Revolving Credit Facility, the Borrower
will in the absence of predominating circumstances, borrow from NationsBank. Any
past due principal and/or accrued interest shall bear interest at a rate per
annum equal to the aggregate of the Federal Funds Rate plus 1 percent (100 basis
points) and shall be payable on demand.
4. Advances, Payments, Prepayments and Readvances. Upon each Borrower's
request, and subject to the terms and conditions contained herein, CAPCO may
make Loans to each Borrower on behalf of and for the benefit of its respective
Fund(s) during the Facility Period, and each Borrower may at CAPCO's sole and
absolute discretion, borrow, repay and reborrow funds hereunder. The Loans shall
be evidenced by a duly executed and delivered Master Grid Promissory Note in the
form of Exhibit A. Each Loan shall be in an aggregate amount not less than One
Hundred Thousand United States Dollars (U.S. $100,000) and increments of One
Thousand United States Dollars (U.S. $1,000) in excess thereof. Payment of
principal and interest due with respect to each Loan shall be payable at the
maturity of such Loan and shall be made in funds immediately available to CAPCO
prior to 2 p.m. San Antonio time on the day such payment is due, or as CAPCO
shall otherwise direct from time to time and, subject to the terms and
conditions hereof, may be repaid with the proceeds of a new borrowing hereunder.
Notwithstanding any provision of this Agreement to the contrary, all Loans,
accrued but unpaid interest and other amounts payable hereunder shall be due and
payable upon termination of the Facility (whether by acceleration or otherwise).
5. Facility Fee. As this Facility is uncommitted, no facility
fee shall be charged by CAPCO.
6. Optional Termination. The Borrowers shall have the right
upon at least three (3) business days prior written notice to CAPCO, to
terminate the Facility.
<PAGE>
7. Mandatory Termination of the Facility. The Facility, unless extended
by written amendment, shall automatically terminate on the last day of the
Facility Period and any Loans then outstanding (together with accrued interest
thereon and any other amounts owing hereunder) shall be due and payable on such
date.
8. Uncommitted Facility. The Borrowers acknowledge that the Facility is
an uncommitted facility and that CAPCO shall have no obligation to make any Loan
requested during the Facility Period under this Agreement. Further, CAPCO shall
not make any Loan if this Facility has been terminated by the Borrowers, or if
at the time of a request for a Loan by a Borrower (on behalf of the applicable
Fund(s)) there exists any Event of Default or condition which, with the passage
of time or giving of notice, or both, would constitute or become an Event of
Default with respect to such Borrower (or such applicable Fund(s)).
9. Loan Requests. Each request for a Loan (each a "Borrowing Notice")
shall be in writing by the applicable Borrower(s), except that such Borrower(s)
may make an oral request (each an "Oral Request") provided that each Oral
Request shall be followed by a written Borrowing Notice within one business day.
Each Borrowing Notice shall specify the following terms (Terms") of the
requested Loan: (i) the date on which such Loan is to be disbursed, (ii) the
principal amount of such Loan, (iii) the Borrower(s) which are borrowing such
Loan and the amount of such Loan to be borrowed by each Borrower, (iv) the Funds
for whose benefit the loan is being borrowed and the amount of the Loan which is
for the benefit of each such Fund, and (v) the requested maturity date of the
Loan. Each Borrowing Notice shall also set forth the total assets of each Fund
for whose benefit a portion of the Loan is being borrowed as of the close of
business on the day immediately preceding the date of such Borrowing Notice.
Borrowing notices shall be delivered to CAPCO by 9:00 a.m. San Antonio time on
the day the Loan is requested to be made.
Each Borrowing Notice shall constitute a representation to CAPCO by the
applicable Borrower(s) that all of the representations and warranties in Section
12 hereof are true and correct as of such date and that no Event of Default or
other condition which with the passage of time or giving of notice, or both,
would result in an Event of Default, has occurred or is occurring.
10. Confirmations; Crediting of Funds; Reliance by CAPCO.
Upon receipt by CAPCO of a Borrowing Notice:
(a) CAPCO shall provide each applicable Borrower written
confirmation of the Terms of such Loan via facsimile or telecopy, as soon as
reasonably practicable; provided, however, that the failure to do so shall not
affect the obligation of any such Borrower;
(b) CAPCO shall make such Loan in accordance with the Terms by
transfer of the Loan amount in immediately available funds, to the account of
the applicable Borrower(s) as specified in Exhibit B to this Agreement or as
such Borrower(s) shall otherwise specify to CAPCO in a writing signed by an
Authorized Individual (as defined in Section 11) of such Borrower(s); and
<PAGE>
(c) CAPCO shall make appropriate entries on the Note or the
records of CAPCO to reflect the Terms of the Loan; provided, however, that the
failure to do so shall not affect the obligation of any Borrower.
CAPCO shall be entitled to rely upon and act hereunder pursuant to any Oral
Request which it reasonably believes to have been made by the applicable
Borrower through an Authorized Individual. If any Borrower believes that the
confirmation relating to any Loan contains any error or discrepancy from the
applicable Oral Request, such Borrower will promptly notify CAPCO thereof.
11. Borrowing Resolutions and Officers' Certificates. Prior to the
making of any Loan pursuant to this Agreement, the Borrowers shall have
delivered to CAPCO (a) the duly executed Note, (b) Resolutions of each
Borrower's Trustees or Board of Directors authorizing such Borrower to execute,
deliver and perform this Agreement and the Note on behalf of the applicable
Funds, (c) an Officer's Certificate in substantially the form set forth in
Exhibit D to this Agreement, authorizing certain individuals ("Authorized
Individuals"), to take on behalf of each Borrower (on behalf of the applicable
Funds) actions contemplated by this Agreement and the Note, and (d) the Opinion
of Counsel to USAA Investment Management Company, Manager and Advisor to the
Borrowers, with respect to such matters as CAPCO may reasonably request .
12. Representations and Warranties. In order to induce CAPCO to enter
into this Agreement and to make the Loans provided for hereunder, each Borrower
hereby makes with respect to itself, and as may be relevant, the series of Funds
comprising such Borrower, the following representations and warranties, which
shall survive the execution and delivery hereof and of the Note:
(a) Organization, Standing, etc. The Borrower is a corporation
or trust duly organized, validly existing, and in good standing under applicable
state laws and has all requisite corporate or trust power and authority to carry
on its respective businesses as now conducted and proposed to be conducted, to
enter into this Agreement and all other documents to be executed by it in
connection with the transactions contemplated hereby, to issue and borrow under
the Note and to carry out the terms hereof and thereof;
(b) Financial Information; Disclosure, etc. The Borrower has
furnished CAPCO with certain financial statements of such Borrower with respect
to itself and the applicable Funds, all of which such financial statements have
been prepared in accordance with generally accepted accounting principles
applied on a consistent basis and fairly present the financial position and
results of operations of such Borrower and the applicable Funds on the dates and
for the periods indicated. Neither this Agreement nor any financial statements,
reports or other documents or certificates furnished to CAPCO by such Borrower
or the applicable Funds in connection with the transactions contemplated hereby
contain any untrue statement of a material fact or omit to state
<PAGE>
any material fact necessary to make the statements contained herein or therein
in light of the circumstances when made not misleading;
(c) Authorization; Compliance with Other Instruments. The
execution, delivery and performance of this Agreement and the Note, and
borrowings hereunder, have been duly authorized by all necessary corporate or
trust action of the Borrower and will not result in any violation of or be in
conflict with or constitute a default under any term of the charter, by-laws or
trust agreement of such Borrower or the applicable Funds, or of any borrowing
restrictions or prospectus or statement of additional information of such
Borrower or the applicable Funds, or of any agreement, instrument, judgment,
decree, order, statute, rule or governmental regulation applicable to such
Borrower, or result in the creation of any mortgage, lien, charge or encumbrance
upon any of the properties or assets of such Borrower or the applicable Funds
pursuant to any such term. The Borrower and the applicable Funds are not in
violation of any term of their respective charter, by-laws or trust agreement,
and such Borrower and the applicable Funds are not in violation of any material
term of any agreement or instrument to which they are a party, or to the best of
such Borrower's knowledge, of any judgment, decree, order, statute, rule or
governmental regulation applicable to them;
(d) SEC Compliance. The Borrower and the applicable Funds are
in compliance in all material respects with all federal and state securities or
similar laws and regulations, including all material rules, regulations and
administrative orders of the Securities and Exchange Commission (the ASEC") and
applicable Blue Sky authorities. The Borrower and the applicable Funds are in
compliance in all material respects with all of the provisions of the Investment
Company Act of 1940, and such Borrower has filed all reports with the SEC that
are required of it or the applicable Funds;
(e) Litigation. There is no action, suit or proceeding pending
or, to the best of the Borrower's knowledge, threatened against such Borrower or
the applicable Funds in any court or before any arbitrator or governmental body
which seeks to restrain any of the transactions contemplated by this Agreement
or which, if adversely determined, could have a material adverse effect on the
assets or business operations of such Borrower or the applicable Funds or the
ability of such Borrower and the applicable Funds to pay and perform their
obligations hereunder and under the Notes; and
(f) Borrowers' Relationship to Funds. The assets of each Fund
for whose benefit Loans are borrowed by the applicable Borrower are subject to
and liable for such Loans and are available (except as subordinated to
borrowings under the NationsBank committed facility) to the applicable Borrower
for the repayment of such Loans.
13. Affirmative Covenants of the Borrowers. Until such time as all
amounts of principal and interest due to CAPCO by a Borrower pursuant to any
Loan made to such Borrower
<PAGE>
is irrevocably paid in full, and until the Facility is terminated, such Borrower
(for itself and on behalf of its respective Funds) agrees:
(a) To deliver to CAPCO as soon as possible and in any event
within ninety (90) days after the end of each fiscal year of such Borrower and
the applicable Funds, Statements of Assets and Liabilities, Statements of
Operations and Statements of Changes in Net Assets of each applicable Fund for
such fiscal year, as set forth in each applicable Fund's Annual Report to
shareholders together with a calculation of the maximum amount which each
applicable Fund could borrow under its Borrowing Limit as of the end of such
fiscal year;
(b) To deliver to CAPCO as soon as available and in any event
within seventy-five (75) days after the end of each semiannual period of such
Borrower and the applicable Funds, Statements of Assets and Liabilities,
Statement of Operations and Statements of Changes in Net Assets of each
applicable Fund as of the end of such semiannual period, as set forth in each
applicable Fund's Semiannual Report to shareholders, together with a calculation
of the maximum amount which each applicable Fund could borrow under its
Borrowing Limit at the end of such semiannual period;
(c) To deliver to CAPCO prompt notice of the occurrence of any
event or condition which constitutes, or is likely to result in, a change in
such Borrower or any applicable Fund which could reasonably be expected to
materially adversely affect the ability of any applicable Fund to promptly repay
outstanding Loans made for its benefit or the ability of such Borrower to
perform its obligations under this Agreement or the Note;
(d) To do, or cause to be done, all things necessary to
preserve and keep in full force and effect the corporate or trust existence of
such Borrower and all permits, rights and privileges necessary for the conduct
of its businesses and to comply in all material respects with all applicable
laws, regulations and orders, including without limitation, all rules and
regulations promulgated by the SEC;
(e) To promptly notify CAPCO of any litigation, threatened
legal proceeding or investigation by a governmental authority which could
materially affect the ability of such Borrower or the applicable Funds to
promptly repay the outstanding Loans or otherwise perform their obligations
hereunder; and
(f) In the event a Loan for the benefit of a particular Fund
is not repaid in full within 10 days after the date it is borrowed , and until
such Loan is repaid in full, to deliver to CAPCO, within two business days after
each Friday occurring after such 10th day, a statement setting forth the total
assets of such Fund as of the close of business on each such Friday.
<PAGE>
14. Negative Covenants of the Borrowers. Until such time as all amounts
of principal and interest due to CAPCO by a Borrower pursuant to any Loan made
to such Borrower is irrevocably paid in full, and until the Facility is
terminated, such Borrower (for itself and on behalf of its respective Funds)
agrees:
(a) Not to incur any indebtedness for borrowed money (other
than pursuant to the One Hundred Million Dollar ($100,000,000) committed Master
Revolving Credit Facility with NationsBank and for overdrafts incurred at the
custodian of the Funds from time to time in the normal course of business)
except the Loans, without the prior written consent of CAPCO, which consent will
not be unreasonably withheld; and
(b) Not to dissolve or terminate its existence, or merge or
consolidate with any other person or entity, or sell all or substantially all of
its assets in a single transaction or series of related transactions (other than
assets consisting of margin stock), each without the prior written consent of
CAPCO, which consent will not be unreasonably withheld; provided that a Borrower
may without such consent merge, consolidate with, or purchase substantially all
of the assets of, or sell substantially all of its assets to, an affiliated
investment company or series thereof, as provided for in Rule 17a-8 of the
Investment Company Act of 1940.
15. Events of Default. If any of the following events
(each an "Event of Default") shall occur (it being understood that an Event
of Default with respect to one Fund or Borrower shall not constitute an Event
of Default with respect to any other Fund or Borrower):
(a) Any Borrower or Fund shall default in the payment of
principal or interest on any Loan or any other fee due hereunder for a period of
five (5) days after the same becomes due and payable, whether at maturity or
with respect to any Facility Fee at a date fixed for the payment thereof;
(b) Any Borrower or Fund shall default in the performance of
or compliance with any term contained in Section 13 hereof and such default
shall not have been remedied within thirty (30) days after written notice
thereof shall have been given such Borrower or Fund by CAPCO;
(c) Any Borrower or Fund shall default in the performance
of or compliance with any term contained in Section 14 hereof;
(d) Any Borrower or Fund shall default in the performance or
compliance with any other term contained herein and such default shall not have
been remedied within thirty (30) days after written notice thereof shall have
been given such Borrower or Fund by CAPCO;
(e) Any representation or warranty made by a Borrower or Fund
herein or pursuant hereto shall prove to have been false or incorrect in any
material respect when made;
<PAGE>
(f) USAA Investment Management Company or any successor
manager or investment adviser, provided that such successor in a wholly-owned
subsidiary of CAPCO, shall cease to be the Manager and Investment Advisor of
each Fund; or
(g) An event of default shall occur and be continuing under
any other facility; then, in any event, and at any time thereafter, if any Event
of Default shall be continuing, CAPCO may by written notice to the applicable
Borrower or Fund (i) terminate the Facility with respect to such Borrower or
Fund and (ii) declare the principal and interest in respect of any outstanding
Loans with respect to such Borrower or Fund, and all other amounts due hereunder
with respect to such Borrower or Fund, to be immediately due and payable
whereupon the principal and interest in respect thereof and all other amounts
due hereunder shall become forthwith due and payable without presentment,
demand, protest or other notice of any kind, all of which are expressly waived
by the Borrowers.
16. New Borrowers; New Funds. So long as no Event of Default or
condition which, with the passage of time or the giving of notice, or both,
would constitute or become an Event of Default has occurred and is continuing,
and with the prior consent of CAPCO, which consent will not be unreasonably
withheld:
(a) Any investment company that becomes part of the same
"group of investment companies" (as that term is defined in Rule 11a-3 under the
Investment Company Act of 1940) as the original Borrowers to this Agreement,
may, by submitting an amended Schedule A and Exhibit B to this Agreement to
CAPCO (which amended Schedule A and Exhibit B shall replace the corresponding
Schedule and Exhibit which are, then a part of this Agreement) and such other
documents as CAPCO may reasonably request, become a party to this Agreement and
may become a "Borrower" hereunder; and
(b) A Borrower may, by submitting an amended Schedule A and
Exhibit B to this Agreement to CAPCO (which amended Schedule A and Exhibit B
shall replace the corresponding Schedule and Exhibit which are then a part of
this Agreement), add additional Funds for whose benefit such Borrower may borrow
Loans. No such amendment of Schedule A to this Agreement shall amend the
Borrowing Limit applicable to any Fund without the prior approval of CAPCO.
17. Limited Recourse. CAPCO agrees (i) that any claim, liability, or
obligation arising hereunder or under the Note whether on account of the
principal of any Loan, interest thereon, or any other amount due hereunder or
thereunder shall be satisfied only from the assets of the specific Fund for
whose benefit a Loan is borrowed and in any event in an amount not to exceed the
outstanding principal amount of any Loan borrowed for such Fund's benefit,
together with accrued and unpaid interest due and owing thereon, and such Fund's
share of any other amount due
<PAGE>
hereunder and under the Note (as determined in accordance with the provisions
hereof) and (ii) that no assets of any fund shall be used to satisfy any claim,
liability, or obligation arising hereunder or under the Note with respect to the
outstanding principal amount of any Loan borrowed for the benefit of any other
Fund or any accrued and unpaid interest due and owing thereon or such other
Fund's share of any other amount due hereunder and under the Note (as determined
in accordance with the provisions hereof).
18. Remedies on Default. In case any one or more Events of Default
shall occur and be continuing, CAPCO may proceed to protect and enforce its
rights by an action at law, suit in equity or other appropriate proceedings,
against the applicable Borrower(s) and/or Fund(s), as the case may be. In the
case of a default in the payment of any principal or interest on any Loan or in
the payment of any fee due hereunder, the relevant Fund(s) (to be allocated
among such Funds as the Borrowers deem appropriate) shall pay to CAPCO such
further amount as shall be sufficient to cover the cost and expense of
collection, including, without limitation, reasonable attorney's fees and
expenses.
19. No Waiver of Remedies. No course of dealing or failure or delay on
the part of CAPCO in exercising any right or remedy hereunder or under the Note
shall constitute a waiver of any right or remedy hereunder or under the Note,
nor shall any partial exercise of any right or remedy hereunder or under the
Note preclude any further exercise thereof or the exercise of any other right or
remedy hereunder or under the Note. Such rights and remedies expressly provided
are cumulative and not exclusive of any rights or remedies which CAPCO would
otherwise have.
20. Expenses. The Fund(s) (to be allocated among the Funds as the
Borrowers deem appropriate) shall pay on demand all reasonable out-of-pocket
costs and expenses (including reasonable attorney's fees and expenses) incurred
by CAPCO in connection with the collection and any other enforcement proceedings
of or regarding this Agreement, any Loan or the Note.
21. Benefit of Agreement. This Agreement and the Note shall be binding
upon and inure for the benefit of and be enforceable by the respective
successors and assigns of the parties hereto; provided that no party to this
Agreement or the Note may assign any of its rights hereunder or thereunder
without the prior written consent of the other parties.
22. Notices. All notices hereunder and all written, facsimile or
telecopied confirmations of Oral Requests made hereunder shall be sent to the
Borrowers as indicated on Exhibit B and to CAPCO as indicated on Exhibit C.
23. Modifications. No provision of this Agreement or the Note may be
waived, modified or discharged except by mutual written agreement of all
parties. THIS WRITTEN LOAN AGREEMENT AND THE NOTE REPRESENT THE FINAL AGREEMENT
BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR,
<PAGE>
CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO
UNWRITTEN AGREEMENTS BETWEEN THE PARTIES.
24. Governing Law and Jurisdiction. This Agreement shall be governed by
and construed in accordance with the laws of the state of Texas without regard
to the choice of law provisions thereof.
25. Trust Disclaimer. Neither the shareholders, trustees, officers,
employees and other agents of any Borrower or Fund shall be personally bound by
or liable for any indebtedness, liability or obligation hereunder or under the
Note nor shall resort be had to their private property for the satisfaction of
any obligation or claim hereunder.
If this letter correctly reflects your agreement with us, please execute both
copies hereof and return one to us, whereupon this Agreement shall be binding
upon the Borrowers, the Funds and CAPCO.
Sincerely,
USAA CAPITAL CORPORATION
By: /s/ Laurie B. Blank
----------------------------
Laurie B. Blank
Assistant Vice President-Treasurer
AGREED AND ACCEPTED this 14th Day of January, 1997.
USAA MUTUAL FUND, INC.,
on behalf of and for the benefit
of its series of Funds as set
forth on Schedule A to this Agreement
By: /s/ Michael J.C. Roth
----------------------------
Michael J.C. Roth
President
<PAGE>
USAA INVESTMENT TRUST,
on behalf of and for the benefit
of its series of Funds as set
forth on Schedule A to this Agreement
By: /s/ Michael J.C. Roth
----------------------------
Michael J.C. Roth
President
USAA TAX EXEMPT FUND, INC.,
on behalf of and for the benefit
of its series of Funds as set
forth on Schedule A to this Agreement
By: /s/ Michael J.C. Roth
----------------------------
Michael J.C. Roth
President
USAA STATE TAX-FREE TRUST,
on behalf of and for the benefit
of its series of Funds as set
forth on Schedule A to this Agreement
By: /s/ Michael J.C. Roth
----------------------------
Michael J.C. Roth
President
<PAGE>
SCHEDULE A
FUNDS FOR WHOSE BENEFIT LOANS CAN
BE BORROWED UNDER FACILITY AGREEMENT
AND BORROWING LIMIT
Borrower Funds Borrowing Limit
USAA Mutual Fund, Inc. USAA Aggressive Growth 5% of Total Assets
USAA Growth & Income "
USAA Income Stock "
USAA Short-Term Bond "
USAA Money Market "
USAA Growth "
USAA Income "
USAA S&P 500 Index "
USAA Investment Trust USAA Cornerstone Strategy "
USAA Gold "
USAA International "
USAA World Growth "
USAA GNMA Trust "
USAA Treasury Money Market Trust "
USAA Emerging Markets "
USAA Growth and Tax Strategy "
USAA Balanced Strategy "
USAA Growth Strategy "
USAA Income Strategy "
USAA Tax Exempt Fund, Inc. USAA Long-Term "
USAA Intermediate-Term "
USAA Short-Term "
USAA Tax Exempt Money Market "
USAA California Bond "
USAA California Money Market "
USAA New York Bond "
USAA New York Money Market "
USAA Virginia Bond "
USAA Virginia Money Market "
USAA State Tax-Free Trust USAA Florida Tax-Free Income "
USAA Florida Tax-Free Money Market "
USAA Texas Tax-Free Income "
USAA Texas Tax-Free Money Market "
<PAGE>
EXHIBIT A
MASTER GRID PROMISSORY NOTE
U.S. $750,000,000 Dated: January 14, 1997
FOR VALUE RECEIVED, each of the undersigned (each a "Borrower" and
collectively the "Borrowers"), severally and not jointly, on behalf of and for
the benefit of the series of funds comprising each such Borrower as listed on
Schedule A to the Agreement as defined below (each a "Fund" and collectively the
"Funds") promises to pay to the order of USAA Capital Corporation ("APCO") at
CAPCO's office located at 9800 Fredericksburg Road, San Antonio, Texas 78288, in
lawful money of the United States of America, in immediately available funds,
the principal amount of all Loans made by CAPCO to such Borrower for the benefit
of the applicable Funds under the Facility Agreement Letter dated January 14,
1997 (as amended or modified, the "Agreement"), among the Borrowers and CAPCO,
together with interest thereon at the rate or rates set forth in the Agreement.
All payments of interest and principal outstanding shall be made in accordance
with the terms of the Agreement.
This Note evidences Loans made pursuant to, and is entitled to the
benefits of, the Agreement. Terms not defined in this Note shall be as set forth
in the Agreement.
CAPCO is authorized to endorse the particulars of each Loan evidenced
hereby on the attached Schedule and to attach additional Schedules as necessary,
provided that the failure of CAPCO to do so or to do so accurately shall not
affect the obligations of any Borrower (or the Fund for whose benefit it is
borrowing) hereunder.
Each Borrower waives all claims to presentment, demand, protest, and
notice of dishonor. Each Borrower agrees to pay all reasonable costs of
collection, including reasonable attorney's fees in connection with the
enforcement of this Note.
CAPCO hereby agrees (i) that any claim, liability, or obligation
arising hereunder or under the Agreement whether on account of the principal of
any Loan, interest thereon, or any other amount due hereunder or thereunder
shall be satisfied only from the assets of the specific Fund for whose benefit a
Loan is borrowed and in any event in an amount not to exceed the outstanding
principal amount of any Loan borrowed for such Fund's benefit, together with
accrued and unpaid interest due and owing thereon, and such Fund's share of any
other amount due hereunder and under the Agreement (as determined in accordance
with the provisions of the Agreement) and (ii) that no assets of any Fund shall
be used to satisfy any claim, liability, or obligation arising hereunder or
under the Agreement with respect to the outstanding principal amount of any Loan
borrowed for the benefit of any other Fund or any accrued and unpaid interest
due and owing
<PAGE>
thereon or such other Fund's share of any other amount due hereunder and under
the Agreement (as determined in accordance with the provisions of the
Agreement).
Neither the shareholders, trustees, officers, employees and other
agents of any Borrower or Fund shall be personally bound by or liable for any
indebtedness, liability or obligation hereunder or under the Note nor shall
resort be had to their private property for the satisfaction of any obligation
or claim hereunder.
Loans under the Agreement and this Note are subordinated to loans made
under the $100,000,000 364-day committed Mater Revolving Credit Facility
Agreement between the Borrowers and NationsBank of Texas, N.A. (NationsBank),
dated January 15, 1997, in the manner and to the extent set forth in the
Agreement among the Borrowers, CAPCO and NationsBank, dated January 15, 1997.
This Note shall be governed by the laws of the state of Texas.
USAA MUTUAL FUND, INC., on
behalf of and for the
benefit of its series of
Funds as set forth on
Schedule A to the Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
USAA INVESTMENT TRUST,
on behalf of and for the benefit
of its series of Funds as set forth
on Schedule A to the Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
<PAGE>
USAA TAX EXEMPT FUND, INC.,
on behalf of and for the
benefit of its series of
Funds as set forth on
Schedule A to the Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
USAA STATE TAX-FREE TRUST,
on behalf of and for the
benefit of its series of
Funds as set forth on
Schedule A to the Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
.16901
<PAGE>
LOANS AND PAYMENT OF PRINCIPAL
This schedule (grid) is attached to and made a part of the Promissory Note dated
January 14, 1997, executed by USAA MUTUAL FUND, INC., USAA INVESTMENT TRUST,
USAA TAX EXEMPT FUND, INC. AND USAA STATE TAX-FREE TRUST on behalf of and for
the benefit of the series of funds comprising each such Borrower payable to the
order of USAA CAPITAL CORPORATION.
[The following Information is Listed in Grid]
Date of Loan
Borrower and Fund
Amount of Loan
Type of Rate and Interest Rate on Date of Borrowing
Amount of Principal Repaid
Date of Repayment
Other Expenses
Notation made by
<PAGE>
EXHIBIT B
USAA CAPITAL CORPORATION
MASTER REVOLVING
CREDIT FACILITY AGREEMENT
BORROWER INFORMATION SHEET
BORROWER: USAA MUTUAL FUND, INC., USAA INVESTMENT TRUST, USAA TAX
EXEMPT FUND, INC. AND USAA STATE TAX-FREE TRUST
ADDRESS FOR NOTICES AND OTHER COMMUNICATIONS TO THE BORROWER:
9800 Fredericksburg Road
San Antonio, Texas 78288 (For Federal Express, 78240)
Attention: John W. Saunders, Jr.
Senior Vice President,
Fixed Income Investments
Telephone: (210) 498-7320
Telecopy: (210) 498-5689
Harry W. Miller
Senior Vice President,
Equity Investments
Telephone: (210) 498-7344
Telecopy: (210) 498-7332
ADDRESS FOR BORROWING AND PAYMENTS:
9800 Fredericksburg Road
San Antonio, Texas 78288
Attention: Dean R. Pantzar
Telephone: (210) 498-7472
Telecopy: (210) 498-0382 or 498-7819
Telex: 767424
INSTRUCTIONS FOR PAYMENTS TO BORROWER:
WE PAY VIA: X FED FUNDS CHIPS
<PAGE>
TO: (PLEASE PLACE BANK NAME, CORRESPONDENT NAME (IF APPLICABLE),
CHIPS AND/OR FED FUNDS ACCOUNT NUMBER BELOW)
State Street Bank and Trust Company, Boston, Massachusetts
ABA #011-00-0028
USAA MUTUAL FUND, INC.
USAA Aggressive Growth Fund Acct.# 6938-502-9
USAA Growth & Income Fund Acct.# 6938-519-3
USAA Income Stock Fund Acct.# 6938-495-6
USAA Short-Term Bond Fund Acct.# 6938-517-7
USAA Money Market Fund Acct.# 6938-498-0
USAA Growth Fund Acct.# 6938-490-7
USAA Income Fund Acct.# 6938-494-9
USAA S&P 500 Index Fund Acct.#6938-478-2
USAA INVESTMENT TRUST
USAA Cornerstone Strategy Fund Acct.# 6938-487-3
USAA Gold Fund Acct.# 6938-488-1
USAA International Fund Acct.# 6938-497-2
USAA World Growth Fund Acct.# 6938-504-5
USAA GNMA Trust Acct.# 6938-486-5
USAA Treasury Money Market Trust Acct.# 6938-493-1
USAA Emerging Markets Fund Acct.# 6938-501-1
USAA Growth and Tax Strategy Fund Acct.# 6938-509-4
<PAGE>
USAA Balanced Strategy Fund Acct.# 6938-507-8
USAA Growth Strategy Fund Acct.# 6938-510-2
USAA Income Strategy Fund Acct.# 6938-508-6
USAA TAX EXEMPT FUND, INC.
USAA Long-Term Fund Acct.# 6938-492-3
USAA Intermediate-Term Fund Acct.# 6938-496-4
USAA Short-Term Fund Acct.# 6938-500-3
USAA Tax Exempt Money Market Fund Acct.# 6938-514-4
USAA California Bond Fund Acct.# 6938-489-9
USAA California Money Market Fund Acct.# 6938-491-5
USAA New York Bond Fund Acct.# 6938-503-7
USAA New York Money Market Fund Acct.# 6938-511-0
USAA Virginia Bond Fund Acct.# 6938-512-8
USAA Virginia Money Market Fund Acct.# 6938-513-6
USAA STATE TAX-FREE TRUST
USAA Florida Tax-Free Income Fund Acct.# 6938-473-3
USAA Florida Tax-Free Money Market Fund Acct.# 6938-467-5
USAA Texas Tax-Free Income Fund Acct.# 6938-602-7
USAA Texas Tax-Free Money Market Fund Acct.# 6938-601-9
.16901
<PAGE>
EXHIBIT C
ADDRESS FOR USAA CAPITAL CORPORATION
USAA Capital Corporation
9800 Fredericksburg Road
San Antonio, Texas 78288
Attention: Laurie B. Blank
Telephone No.: (210) 498-0825
Telecopy No.: (210) 498-6566
.16901
<PAGE>
EXHIBIT D
OFFICER'S CERTIFICATE
The undersigned hereby certifies that he is the duly elected Secretary of USAA
Mutual Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund, Inc. and USAA
State Tax-Free Trust and that he is authorized to execute this Certificate on
behalf of USAA Mutual Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund,
Inc. and USAA State Tax-Free Trust. The undersigned hereby further certifies to
the following:
The following individuals are duly authorized to act on behalf of USAA Mutual
Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund, Inc. and USAA State
Tax-Free Trust, by transmitting telephonic, telex, or telecopy instructions and
other communications with regard to borrowing and payments pursuant to the
uncommitted Master Revolving Credit Agreement with USAA Capital Corporation. The
signature set opposite the name of each individual below is that individual's
genuine signature.
NAME OFFICE SIGNATURE
Michael J.C. Roth President /s/ Michael J.C., Roth
-------------------------
John W. Saunders, Jr. Senior Vice President,
Fixed Income Investments /s/ John W. Saunders, Jr.
-------------------------
Harry W. Miller Senior Vice President,
Equity Investments /s/ Harry W. Miller
-------------------------
Kenneth E. Willmann Vice President,
Mutual Fund Portfolios /s/ Kenneth E. Willmann
-------------------------
David G. Peebles Vice President,
Equity Investments /s/ David G. Peebles
-------------------------
Sherron A. Kirk Vice President,
Controller /s/ Sherron A. Kirk
-------------------------
Dean R. Pantzar Executive Director,
Mutual Fund Accounting /s/ Dean R. Pantzar
-------------------------
IN WITNESS WHEREOF, I have executed this Certificate as of this 14th day of
January, 1997.
/s/ Michael D. Wagner
-------------------------
MICHAEL D. WAGNER
Secretary
<PAGE>
I, Michael J.C. Roth, President of USAA Mutual Fund, Inc., USAA Investment
Trust, USAA Tax Exempt Fund, Inc. And USAA State Tax-Free Trust hereby certify
that Michael D. Wagner is, and has been at all times since a date prior to the
date of this Certificate, the duly elected, qualified, and acting Secretary of
USAA Mutual Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund, Inc. And
USAA State Tax-Free Trust and that the signature set forth above is his true and
correct signature.
DATE: January 14, 1997 /s/ Michael J.C. Roth
-------------------------
MICHAEL J. C. ROTH
President
.16901
<PAGE>
EXHIBIT 9(d)
January 15, 1997
USAA Mutual Fund, Inc.,
USAA Investment Trust,
USAA Tax Exempt Fund, Inc., and
USAA State Tax-Free Trust, on behalf
of and for the benefit of the series
of funds comprising each such Borrower
as set forth on Schedule A hereto
9800 Fredericksburg Road
San Antonio, Texas 78288
Attention: Michael J.C. Roth, President
Gentlemen:
This Facility Agreement Letter (this "Agreement") sets forth the terms and
conditions for loans (each a "Loan" and collectively the "Loans") which
NationsBank of Texas, N.A. (the "Bank") agrees to make during the period
commencing January 15, 1997 and ending January 14, 1998 (the "Facility Period")
to USAA Mutual Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund, Inc.,
and USAA State Tax-Free Trust, and each investment company which may become a
party hereto pursuant to the terms of this Agreement (each a "Borrower" and
collectively the "Borrowers"), each of which is executing this Agreement on
behalf of and for the benefit of the series of funds comprising each such
Borrower as set forth on Schedule A hereto (as hereafter modified or amended in
accordance with the terms hereof) (each a "Fund" and collectively the "Funds"),
under a master revolving credit facility (the "Facility"). This Agreement
replaces in its entirety that certain Facility Agreement Letter dated January
16, 1996, as heretofore amended or modified, between the Borrowers and the Bank.
The Bank and the Borrowers hereby agree as follows:
1. Amount. The aggregate principal amount of the Loans to be advanced
under this Facility shall not exceed, at any one time outstanding, One Hundred
Million United States Dollars (U.S. $100,000,000) (the "Commitment"). The
aggregate principal amount of the Loans which may be
<PAGE>
borrowed by a Borrower for the benefit of a particular Fund under the Facility
and the Other Facility (hereinafter defined) shall not exceed the percentage
(the "Borrowing Limit") of the total assets of such Fund as set forth on
Schedule A hereto.
2. Purpose and Limitations on Borrowings. Each Borrower will use the
proceeds of each Loan made to it solely for temporary or emergency purposes of
the Fund for whose benefit it is borrowing in accordance with such Fund's
Borrowing Limit and prospectus in effect at the time of such Loan. Portfolio
securities may not be purchased by a Fund while there is a Loan outstanding
under the Facility and/or a loan outstanding under the Other Facility for the
benefit of such Fund, if the aggregate amount of such Loan and such other loan
exceeds 5% of the total assets of such Fund. The Borrowers will not, and will
not permit any Fund to, directly or indirectly, use any proceeds of any Loan for
any purpose which would violate any provision of any applicable statute,
regulation, order or restriction, including, without limitation, Regulation U,
Regulation T, Regulation X or any other regulation of the Board of Governors of
the Federal Reserve System or the Securities Exchange Act of 1934, as amended.
If requested by the Bank, the Borrowers will promptly furnish the Bank with a
statement in conformity with the requirements of Federal Reserve Form U-1 as
referred to in Regulation U.
3. Borrowing Rate and Maturity of Loans. The principal amount of the
Loans outstanding from time to time shall bear interest at a rate per annum
equal to, at the option of the applicable Borrower(s), (i) the aggregate of the
Federal Funds Rate (as defined below) plus .125 of one percent (1%) (12.5 basis
points) or (ii) the aggregate of the London Interbank Offered Rate (as defined
below) plus 12.5 basis points. The rate of interest payable on such outstanding
amounts shall change on each date that the Federal Funds Rate shall change.
Interest on the Loans shall be calculated on the basis of a year of 360 days and
the actual days elapsed but shall not exceed the highest lawful rate. Each Loan
will be for an established number of days to be agreed upon by the applicable
Borrower(s) and the Bank and, in the absence of such agreement, will mature on
the earlier of three months after the date of such Loan or the last day of the
Facility Period. The term "Federal Funds Rate," as used herein, shall mean the
overnight rate for Federal funds transactions between member banks of the
Federal Reserve System, as published by the Federal Reserve Bank of New York or,
if not so published, as determined in good faith by the Bank in accordance with
its customary
<PAGE>
practices; and the term "London Interbank Offered Rate," as used herein, shall
mean the rate per annum at which United States dollar deposits are offered by
the Bank in the London interbank market at approximately 11:00 a.m. London time
two business days prior to the first day of the interest period (of 7 or 14 days
or one, two or three months as selected by the Borrower(s)) for which the London
Interbank Offered Rate is to be in effect, as adjusted by the Bank in good faith
and in accordance with its customary practices for any reserve costs imposed on
the Bank under Federal Reserve Board Regulation D with respect to "Euro-currency
Liabilities". The London Interbank Offered Rate shall not be available hereunder
if it would be unlawful for the Bank to make or maintain Loans based on such
rate or if such rate does not, in the good faith judgment of the Bank, fairly
reflect the cost to the Bank of making or maintaining Loans. The London
Interbank Offered Rate shall not be available for any interest period which, if
such rate were available, would begin after the occurrence and during the
continuation of an Event of Default (as defined below). Any past due principal
and/or accrued interest shall bear interest at a rate per annum equal to the
aggregate of the Federal Funds Rate plus 1.125 percent (112.5 basis points) and
shall be payable on demand. If the applicable Borrowers do not affirmatively
elect to have a Loan or Loans bear interest based on the London Interbank
Offered Rate at least two business days prior to the first day of a possible
interest period applicable thereto, such Loan or Loans shall bear interest based
on the Federal Funds Rate until such election is affirmatively made.
4. Advances, Payments, Prepayments and Readvances. Upon each Borrower's
request, and subject to the terms and conditions contained herein, the Bank
shall make Loans to each Borrower on behalf of and for the benefit of its
respective Fund(s) during the Facility Period, and each Borrower may borrow,
repay and reborrow funds hereunder. The Loans shall be evidenced by a duly
executed and delivered Master Grid Promissory Note in the form of Exhibit A.
Each Loan shall be in an aggregate amount not less than One Hundred Thousand
United States Dollars (U.S. $100,000) and increments of One Thousand United
States Dollars (U.S. $1,000) in excess thereof. Payment of principal and
interest due with respect to each Loan shall be payable at the maturity of such
Loan and shall be made in funds immediately available to the Bank prior to 2
p.m. Dallas time on the day such payment is due, or as the Bank shall otherwise
direct from time to time and, subject to the terms and conditions hereof, may be
repaid with the proceeds of a new borrowing hereunder. Notwithstanding any
provision of
<PAGE>
this Agreement to the contrary, all Loans, accrued but unpaid interest and other
amounts payable hereunder shall be due and payable upon termination of the
Facility (whether by acceleration or otherwise). If any Loan bearing interest
based on the London Interbank Offered Rate is repaid or prepaid other than on
the last day of an interest period applicable thereto, the Fund which is the
beneficiary of such Loan shall pay to the Bank promptly upon demand such amount
as the Bank determines in good faith is necessary to compensate the Bank for any
reasonable cost or expense incurred by the Bank as a result of such repayment or
prepayment in connection with the reemployment of funds in an amount equal to
such repayment or prepayment. Whenever the Bank seeks to assess for any such
cost or expense it will provide a certificate as the Borrower(s) shall
reasonably request.
5. Facility Fee. Beginning with the date of this Agreement and until such
time as all Loans have been irrevocably repaid to the Bank in full, and the Bank
is no longer obligated to make Loans, the Funds (to be allocated among the Funds
as the Borrowers deem appropriate) shall pay to the Bank a facility fee (the
"Facility Fee") in the amount of .05 of one percent (5 basis points) of the
amount of the Commitment, as it may be reduced pursuant to section 6. The
Facility Fee shall be payable quarterly in arrears beginning March 31, 1997, and
upon termination of the Facility (whether by acceleration or otherwise).
6. Optional Termination or Reduction of Commitment. The Borrowers shall
have the right upon at least three (3) business days prior written notice to the
Bank, to terminate or reduce the unused portion of the Commitment. Any such
reduction of the Commitment shall be in the amount of Five Million United States
Dollars (U.S. $5,000,000) or any larger integral multiple of One Million United
States Dollars (U.S. $1,000,000) (except that any reduction may be in the
aggregate amount of the unused Commitment). Accrued fees with respect to the
terminated Commitment shall be payable to the Bank on the effective date of such
termination.
7. Mandatory Termination of Commitment. The Commitment shall
automatically terminate on the last day of the Facility Period and any Loans
then outstanding (together with accrued interest thereon and any other amounts
owing hereunder) shall be due and payable on such date.
8. Committed Facility. The Bank acknowledges that the Facility is a
committed facility and that the Bank shall be obligated to make any Loan
<PAGE>
requested during the Facility Period under this Agreement, subject to the terms
and conditions hereof; provided, however, that the Bank shall not be obligated
to make any Loan if this Facility has been terminated by the Borrowers, or if at
the time of a request for a Loan by a Borrower (on behalf of the applicable
Fund(s)) there exists any Event of Default or condition which, with the passage
of time or giving of notice, or both, would constitute or become an Event of
Default with respect to such Borrower (or such applicable Fund(s)).
9. Loan Requests. Each request for a Loan (each a "Borrowing Notice")
shall be in writing by the applicable Borrower(s), except that such Borrower(s)
may make an oral request (each an "Oral Request") provided that each Oral
Request shall be followed by a written Borrowing Notice within one business day.
Each Borrowing Notice shall specify the following terms ("Terms") of the
requested Loan: (i) the date on which such Loan is to be disbursed, (ii) the
principal amount of such Loan, (iii) the Borrower(s) which are borrowing such
Loan and the amount of such Loan to be borrowed by each Borrower, (iv) the Funds
for whose benefit the Loan is being borrowed and the amount of the Loan which is
for the benefit of each such Fund, (v) whether such Loan shall bear interest at
the Federal Funds Rate or the London Interbank Offered Rate, and (vi) the
requested maturity date of the Loan. Each Borrowing Notice shall also set forth
the total assets of each Fund for whose benefit a portion of the Loan is being
borrowed as of the close of business on the day immediately preceding the date
of such Borrowing Notice. Borrowing Notices shall be delivered to the Bank by
1:00 p.m. Dallas time on the day the Loan is requested to be made if such Loan
is to bear interest based on the Federal Funds Rate or by 10:00 a.m. Dallas time
on the second business day before the Loan is requested to be made if such Loan
is to bear interest based on the London Interbank Offered Rate.
Each Borrowing Notice shall constitute a representation to the Bank by the
applicable Borrower(s) that all of the representations and warranties in Section
12 hereof are true and correct as of such date and that no Event of Default or
other condition which with the passage of time or giving of notice, or both,
would result in an Event of Default, has occurred or is occurring.
10. Confirmations; Crediting of Funds; Reliance by the Bank. Upon receipt
by the Bank of a Borrowing Notice:
<PAGE>
(a) The Bank shall send each applicable Borrower written
confirmation of the Terms of such Loan via facsimile or telecopy, as soon
as reasonably practicable; provided, however, that the failure to do so
shall not affect the obligation of any such Borrower;
(b) The Bank shall make such Loan in accordance with the Terms
by transfer of the Loan amount in immediately available funds, to the
account of the applicable Borrower(s) as specified in Exhibit B to this
Agreement or as such Borrower(s) shall otherwise specify to the Bank in a
writing signed by an Authorized Individual (as defined in Section 11) of
such Borrower(s) and sent to the Bank via facsimile or telecopy; and
(c) The Bank shall make appropriate entries on the Note or the
records of the Bank to reflect the Terms of the Loan; provided, however,
that the failure to do so shall not affect the obligation of any
Borrower.
The Bank shall be entitled to rely upon and act hereunder pursuant to any Oral
Request which it reasonably believes to have been made by the applicable
Borrower through an Authorized Individual. If any Borrower believes that the
confirmation relating to any Loan contains any error or discrepancy from the
applicable Oral Request, such Borrower will promptly notify the Bank thereof.
11. Borrowing Resolutions and Officers' Certificates; Subordination
Agreement. Prior to the making of any Loan pursuant to this Agreement, the
Borrowers shall have delivered to the Bank (a) the duly executed Note, (b)
resolutions of each Borrower's Trustees or Board of Directors authorizing such
Borrower to execute, deliver and perform this Agreement and the Note on behalf
of the applicable Funds, (c) an Officer's Certificate in substantially the form
set forth in Exhibit D to this Agreement, authorizing certain individuals
("Authorized Individuals"), to take on behalf of each Borrower (on behalf of the
applicable Funds) actions contemplated by this Agreement and the Note, (d) a
subordination agreement in substantially the form set forth in Exhibit E to this
Agreement, and (e) the opinion of counsel to USAA Investment Management Company,
manager and advisor to the Borrowers, with respect to such matters as the Bank
may reasonably request.
<PAGE>
12. Representations and Warranties. In order to induce the Bank to enter
into this Agreement and to make the Loans provided for hereunder, each Borrower
hereby makes with respect to itself, and as may be relevant, the series of Funds
comprising such Borrower the following representations and warranties, which
shall survive the execution and delivery hereof and of the Note:
(a) Organization, Standing, etc. The Borrower is a corporation
or trust duly organized, validly existing, and in good standing under
applicable state laws and has all requisite corporate or trust power and
authority to carry on its respective businesses as now conducted and
proposed to be conducted, to enter into this Agreement and all other
documents to be executed by it in connection with the transactions
contemplated hereby, to issue and borrow under the Note and to carry out
the terms hereof and thereof;
(b) Financial Information; Disclosure, etc. The Borrower has
furnished the Bank with certain financial statements of such Borrower
with respect to itself and the applicable Funds, all of which such
financial statements have been prepared in accordance with generally
accepted accounting principles applied on a consistent basis and fairly
present the financial position and results of operations of such Borrower
and the applicable Funds on the dates and for the periods indicated.
Neither this Agreement nor any financial statements, reports or other
documents or certificates furnished to the Bank by such Borrower or the
applicable Funds in connection with the transactions contemplated hereby
contain any untrue statement of a material fact or omit to state any
material fact necessary to make the statements contained herein or
therein in light of the circumstances when made not misleading;
(c) Authorization; Compliance with Other Instruments. The
execution, delivery and performance of this Agreement and the Note, and
borrowings hereunder, have been duly authorized by all necessary
corporate or trust action of the Borrower and will not result in any
violation of or be in conflict with or constitute a default under any
term of the charter, by-laws or trust agreement of such Borrower or the
applicable Funds, or of any borrowing restrictions or prospectus or
statement of additional information of such Borrower or the applicable
Funds, or of any agreement, instrument, judgment, decree, order, statute,
rule or governmental regulation applicable to such Borrower, or
<PAGE>
result in the creation of any mortgage, lien, charge or encumbrance upon
any of the properties or assets of such Borrower or the applicable Funds
pursuant to any such term. The Borrower and the applicable Funds are not
in violation of any term of their respective charter, by-laws or trust
agreement, and such Borrower and the applicable Funds are not in
violation of any material term of any agreement or instrument to which
they are a party, or to the best of such Borrower's knowledge, of any
judgment, decree, order, statute, rule or governmental regulation
applicable to them;
(d) SEC Compliance. The Borrower and the applicable Funds are in
compliance in all material respects with all federal and state securities
or similar laws and regulations, including all material rules,
regulations and administrative orders of the Securities and Exchange
Commission (the "SEC") and applicable Blue Sky authorities. The Borrower
and the applicable Funds are in compliance in all material respects with
all of the provisions of the Investment Company Act of 1940, and such
Borrower has filed all reports with the SEC that are required of it or
the applicable Funds;
(e) Litigation. There is no action, suit or proceeding pending
or, to the best of the Borrower's knowledge, threatened against such
Borrower or the applicable Funds in any court or before any arbitrator or
governmental body which seeks to restrain any of the transactions
contemplated by this Agreement or which, if adversely determined, could
have a material adverse effect on the assets or business operations of
such Borrower or the applicable Funds or the ability of such Borrower and
the applicable Funds to pay and perform their obligations hereunder and
under the Notes; and
(f) Borrowers' Relationship to Funds. The assets of each Fund
for whose benefit Loans are borrowed by the applicable Borrower are
subject to and liable for such Loans and are available to the applicable
Borrower for the repayment of such Loans.
13. Affirmative Covenants of the Borrowers. Until such time as all
amounts of principal and interest due to the Bank by a Borrower pursuant to any
Loan made to such Borrower is irrevocably paid in full, and until the Bank is no
longer obligated to make Loans to such Borrower, such Borrower (for itself and
on behalf of its respective Funds) agrees:
<PAGE>
(a) To deliver to the Bank as soon as possible and in any event
within ninety (90) days after the end of each fiscal year of such
Borrower and the applicable Funds, Statements of Assets and Liabilities,
Statements of Operations and Statements of Changes in Net Assets of each
applicable Fund for such fiscal year, as set forth in each applicable
Fund's Annual Report to shareholders together with a calculation of the
maximum amount which each applicable Fund could borrow under its
Borrowing Limit as of the end of such fiscal year;
(b) To deliver to the Bank as soon as available and in any event
within seventy-five (75) days after the end of each semiannual period of
such Borrower and the applicable Funds, Statements of Assets and
Liabilities, Statements of Operations and Statements of Changes in Net
Assets of each applicable Fund as of the end of such semiannual period,
as set forth in each applicable Fund's Semiannual Report to shareholders,
together with a calculation of the maximum amount which each applicable
Fund could borrow under its Borrowing Limit at the end of such semiannual
period;
(c) To deliver to the Bank prompt notice of the occurrence of
any event or condition which constitutes, or is likely to result in, a
change in such Borrower or any applicable Fund which could reasonably be
expected to materially adversely affect the ability of any applicable
Fund to promptly repay outstanding Loans made for its benefit or the
ability of such Borrower to perform its obligations under this Agreement
or the Note;
(d) To do, or cause to be done, all things necessary to preserve
and keep in full force and effect the corporate or trust existence of
such Borrower and all permits, rights and privileges necessary for the
conduct of its businesses and to comply in all material respects with all
applicable laws, regulations and orders, including without limitation,
all rules and regulations promulgated by the SEC;
(e) To promptly notify the Bank of any litigation, threatened
legal proceeding or investigation by a governmental authority which could
materially affect the ability of such Borrower or the applicable Funds to
promptly repay the outstanding Loans or otherwise perform their
obligations hereunder; and
<PAGE>
(f) In the event a Loan for the benefit of a particular Fund is
not repaid in full within 10 days after the date it is borrowed, and
until such Loan is repaid in full, to deliver to the Bank, within two
business days after each Friday occurring after such 10th day, a
statement setting forth the total assets of such Fund as of the close of
business on each such Friday.
14. Negative Covenants of the Borrowers. Until such time as all amounts
of principal and interest due to the Bank by a Borrower pursuant to any Loan
made to such Borrower is irrevocably paid in full, and until the Bank is no
longer obligated to make Loans to such Borrower, such Borrower (for itself and
on behalf of its respective Funds) agrees:
(a) Not to incur any indebtedness for borrowed money (other than
pursuant to a $750,000,000 uncommitted master revolving credit facility
with USAA Capital Corporation (the "Other Facility") and overdrafts
incurred at the custodian of the Funds from time to time in the ordinary
course of business) except the Loans, without the prior written consent
of the Bank, which consent will not be unreasonably withheld; and
(b) Not to dissolve or terminate its existence, or merge or
consolidate with any other person or entity, or sell all or substantially
all of its assets in a single transaction or series of related
transactions (other than assets consisting of margin stock), each without
the prior written consent of the Bank, which consent will not be
unreasonably withheld; provided that a Borrower may without such consent
merge, consolidate with, or purchase substantially all of the assets of,
or sell substantially all of its assets to, an affiliated investment
company or series thereof, as provided for in Rule 17a-8 of the
Investment Company Act of 1940.
15. Events of Default. If any of the following events (each an "Event of
Default") shall occur (it being understood that an Event of Default with respect
to one Fund or Borrower shall not constitute an Event of Default with respect to
any other Fund or Borrower):
(a) Any Borrower or Fund shall default in the payment of
principal or interest on any Loan or any other fee due hereunder for a
<PAGE>
period of five (5) days after the same becomes due and payable, whether
at maturity or with respect to the Facility Fee at a date fixed for the
payment thereof;
(b) Any Borrower or Fund shall default in the performance of or
compliance with any term contained in Section 13 hereof and such default
shall not have been remedied within thirty (30) days after written notice
thereof shall have been given such Borrower or Fund by the Bank;
(c) Any Borrower or Fund shall default in the performance of or
compliance with any term contained in Section 14 hereof;
(d) Any Borrower or Fund shall default in the performance or
compliance with any other term contained herein and such default shall
not have been remedied within thirty (30) days after written notice
thereof shall have been given such Borrower or Fund by the Bank;
(e) Any representation or warranty made by a Borrower or Fund
herein or pursuant hereto shall prove to have been false or incorrect in
any material respect when made;
(f) USAA Investment Management Company or any successor manager
or investment adviser, provided that such successor is a wholly-owned
subsidiary of USAA Capital Corporation, shall cease to be the Manager and
investment advisor of each Fund; or
(g) An event of default shall occur and be continuing under the
Other Facility;
then, in any event, and at any time thereafter, if any Event of Default shall be
continuing, the Bank may by written notice to the applicable Borrower or Fund
(i) terminate its commitment to make any Loan hereunder, whereupon said
commitment shall forthwith terminate without any other notice of any kind with
respect to such Borrower or Fund and (ii) declare the principal and interest in
respect of any outstanding Loans with respect to such Borrower or Fund, and all
other amounts due hereunder with respect to such Borrower or Fund, to be
immediately due and payable whereupon the principal and interest in respect
thereof and all other amounts due hereunder shall become
<PAGE>
forthwith due and payable without presentment, demand, protest or other notice
of any kind, all of which are expressly waived by the Borrowers.
16. New Borrowers; New Funds. So long as no Event of Default or condition
which, with the passage of time or the giving of notice, or both, would
constitute or become an Event of Default has occurred and is continuing, and
with the prior consent of the Bank, which consent will not be unreasonably
withheld:
(a) Any investment company that becomes part of the same "group
of investment companies" (as that term is defined in Rule 11a-3 under the
Investment Company Act of 1940) as the original Borrowers to this
Agreement, may, by submitting an amended Schedule A and Exhibit B to this
Agreement to the Bank (which amended Schedule A and Exhibit B shall
replace the Schedule A and Exhibit B which are then a part of this
Agreement) and such other documents as the Bank may reasonably request,
become a party to this Agreement and may become a "Borrower" hereunder;
and
(b) A Borrower may, by submitting an amended Schedule A and
Exhibit B to this Agreement to the Bank (which amended Schedule A and
Exhibit B shall replace the Schedule A and Exhibit B which are then a
part of this Agreement), add additional Funds for whose benefit such
Borrower may borrow Loans. No such amendment of Schedule A to this
Agreement shall amend the Borrowing Limit applicable to any Fund without
the prior consent of the Bank.
17. Limited Recourse. The Bank agrees (i) that any claim, liability, or
obligation arising hereunder or under the Note whether on account of the
principal of any Loan, interest thereon, or any other amount due hereunder or
thereunder shall be satisfied only from the assets of the specific Fund for
whose benefit a Loan is borrowed and in any event in an amount not to exceed the
outstanding principal amount of any Loan borrowed for such Fund's benefit,
together with accrued and unpaid interest due and owing thereon, and such Fund's
share of any other amount due hereunder and under the Note (as determined in
accordance with the provisions hereof) and (ii) that no assets of any Fund shall
be used to satisfy any claim, liability, or obligation arising hereunder or
under the Note with respect to the outstanding principal amount of any Loan
borrowed for the benefit of any other Fund or any accrued and unpaid interest
due and owing thereon or
<PAGE>
such other Fund's share of any other amount due hereunder and under the Note (as
determined in accordance with the provisions hereof).
18. Remedies on Default. In case any one or more Events of Default shall
occur and be continuing, the Bank may proceed to protect and enforce its rights
by an action at law, suit in equity or other appropriate proceedings, against
the applicable Borrower(s) and/or Fund(s), as the case may be. In the case of a
default in the payment of any principal or interest on any Loan or in the
payment of any fee due hereunder, the relevant Fund(s) (to be allocated among
such Funds as the Borrowers deem appropriate) shall pay to the Bank such further
amount as shall be sufficient to cover the cost and expense of collection,
including, without limitation, reasonable attorney's fees and expenses.
19. No Waiver of Remedies. No course of dealing or failure or delay on
the part of the Bank in exercising any right or remedy hereunder or under the
Note shall constitute a waiver of any right or remedy hereunder or under the
Note, nor shall any partial exercise of any right or remedy hereunder or under
the Note preclude any further exercise thereof or the exercise of any other
right or remedy hereunder or under the Note. Such rights and remedies expressly
provided are cumulative and not exclusive of any rights or remedies which the
Bank would otherwise have.
20. Expenses. The Fund(s) (to be allocated among the Funds as the
Borrowers deem appropriate) shall pay on demand all reasonable out-of-pocket
costs and expenses (including reasonable attorney's fees and expenses) incurred
by the Bank in connection with the collection and any other enforcement
proceedings of or regarding this Agreement, any Loan or the Note.
21. Benefit of Agreement. This Agreement and the Note shall be binding
upon and inure for the benefit of and be enforceable by the respective
successors and assigns of the parties hereto; provided that no party to this
Agreement or the Note may assign any of its rights hereunder or thereunder
without the prior written consent of the other parties. The Bank may not sell
participations and subparticipations in all or any part of the Loans made
hereunder without the prior consent of the Borrowers, which consent shall not be
unreasonably withheld.
<PAGE>
22. Notices. All notices hereunder and all written, facsimiled or
telecopied confirmations of Oral Requests made hereunder shall be sent to the
Borrowers as indicated on Exhibit B and to the Bank as indicated on Exhibit C.
Written communications shall be deemed to have been duly given and made as
follows: If sent by mail, seventy-two (72) hours after deposit in the mail with
first-class postage prepaid, addressed as provided in Exhibit B (the Borrowers)
and Exhibit C (the Bank); and in the case of facsimile or telecopy, when the
facsimile or telecopy is received if on a business day or otherwise on the next
business day.
23. Modifications. No provision of this Agreement or the Note may be
waived, modified or discharged except by mutual written agreement of all
parties. THIS WRITTEN LOAN AGREEMENT AND THE NOTE REPRESENT THE FINAL AGREEMENT
BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR,
CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO
UNWRITTEN AGREEMENTS BETWEEN THE PARTIES.
24. Increased Cost and Reduced Return. If at any time after the date
hereof, the Bank (which shall include, for purposes of this Section, any
corporation controlling the Bank) determines that the adoption or modification
of any applicable law regarding the Bank's required levels of reserves, other
than the reserve requirement taken into account when computing the London
Interbank Offered Rate as provided in Section 3, or capital (including any
allocation of capital requirements or conditions), or similar requirements, or
any interpretation or administration thereof by a governmental body or
compliance by the Bank with any of such requirements, has or would have the
effect of (a) increasing the Bank's costs relating to the Loans, or (b) reducing
the yield or rate of return of the Bank on the Loans, to a level below that
which the Bank could have achieved but for the adoption or modification of any
such requirements, the Funds (to be allocated among the Funds as the Borrowers
deem appropriate) shall, within fifteen (15) days of any request by the Bank,
pay to the Bank such additional amounts as (in the Bank's sole judgment, after
good faith and reasonable computation) will compensate the Bank for such
increase in costs or reduction in yield or rate of return of the Bank. Whenever
the Bank shall seek compensation for any increase in costs or reduction in yield
or rate of return, the Bank shall provide a certificate as the Borrower(s) shall
reasonably request. Failure by the Bank to demand payment within 90 days
<PAGE>
of any additional amounts payable hereunder shall constitute a waiver of the
Bank's right to demand payment of such amounts at any subsequent time. Nothing
herein contained shall be construed or so operate as to require the Borrowers or
the Funds to pay any interest, fees, costs or charges greater than is permitted
by applicable law.
25. Governing Law and Jurisdiction. This Agreement shall be governed by
and construed in accordance with the laws of the state of Texas without regard
to the choice of law provisions thereof.
26. Trust Disclaimer. Neither the shareholders, trustees, officers,
employees and other agents of any Borrower or Fund shall be personally bound by
or liable for any indebtedness, liability or obligation hereunder or under the
Note nor shall resort be had to their private property for the satisfaction of
any obligation or claim hereunder.
If this letter correctly reflects your agreement with us, please execute both
copies hereof and return one to us, whereupon this Agreement shall be binding
upon the Borrowers, the Funds and the Bank.
Sincerely,
NATIONSBANK OF TEXAS, N.A.
By: /s/ Kate Salletly
-----------------
Title: Senior Vice President
AGREED AND ACCEPTED:
USAA MUTUAL FUND, INC.,
on behalf of and for the benefit
of its series of Funds as set
forth on Schedule A to this Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
<PAGE>
USAA INVESTMENT TRUST,
on behalf of and for the benefi
of its series of Funds as set
forth on Schedule A to this Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
USAA TAX EXEMPT FUND, INC.,
on behalf of and for the benefit
of its series of Funds as set
forth on Schedule A to this Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
USAA STATE TAX-FREE TRUST,
on behalf of and for the benefit
of its series of Funds as set
forth on Schedule A to this Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
<PAGE>
SCHEDULE A
FUNDS FOR WHOSE BENEFIT LOANS CAN
BE BORROWED UNDER FACILITY AGREEMENT
AND BORROWING LIMIT
Maximum Percent of the
Total Assets Which Can
Be Borrowed Under Facility
Borrower Funds Agreement and Other Facility
USAA Mutual Fund, Inc. USAA Aggressive Growth 25%
USAA Growth & Income 25
USAA Income Stock 25
USAA Short-Term Bond 25
USAA Money Market 25
USAA Growth 25
USAA Income 25
USAA S&P 500 Index 25
USAA Investment Trust USAA Cornerstone Strateg 25
USAA Gold 25
USAA International 25
USAA World Growth 25
USAA GNMA Trust 25
USAA Treasury Money Market Trust 25
USAA Emerging Markets 25
USAA Growth and Tax Strategy 25
USAA Growth Strategy 25
USAA Income Strategy 25
USAA Balanced Strategy 25
USAA Tax Exempt Fund, Inc. USAA Long-Term 15
USAA Intermediate-Term 15
USAA Short-Term 15
USAA Tax Exempt Money Market 15
USAA California Bond 15
USAA California Money Market 15
USAA New York Bond 15
USAA New York Money Market 15
USAA Virginia Bond 15
USAA Virginia Money Market 15
USAA State Tax-Free Trust USAA Florida Tax-Free Income 15
USAA Florida Tax-Free Money Market 15
USAA Texas Tax-Free Income 15
USAA Texas Tax-Free Money Market 15
<PAGE>
EXHIBIT A
MASTER GRID PROMISSORY NOTE
U.S. $100,000,000 Dated: January 15, 1997
FOR VALUE RECEIVED, each of the undersigned (each a "Borrower" and
collectively the "Borrowers"), severally and not jointly, on behalf of and for
the benefit of the series of funds comprising each such Borrower as listed on
Schedule A to the Agreement as defined below (each a "Fund" and collectively the
"Funds") promises to pay to the order of NATIONSBANK OF TEXAS, N.A. (the "Bank")
at the Bank's office located at 901 Main Street, Dallas, Dallas County, Texas
75202, in lawful money of the United States of America, in immediately available
funds, the principal amount of all Loans made by the Bank to such Borrower for
the benefit of the applicable Funds under the Facility Agreement Letter dated
January 15, 1997 (as amended or modified, the "Agreement"), among the Borrowers
and the Bank, together with interest thereon at the rate or rates set forth in
the Agreement. All payments of interest and principal outstanding shall be made
in accordance with the terms of the Agreement.
This Note evidences Loans made pursuant to, and is entitled to the
benefits of, the Agreement. Terms not defined in this Note shall be as set forth
in the Agreement.
The Bank is authorized to endorse the particulars of each Loan
evidenced hereby on the attached Schedule and to attach additional Schedules as
necessary, provided that the failure of the Bank to do so or to do so accurately
shall not affect the obligations of any Borrower (or the Fund for whose benefit
it is borrowing) hereunder.
Each Borrower waives all claims to presentment, demand, protest, and
notice of dishonor. Each Borrower agrees to pay all reasonable costs of
collection, including reasonable attorney's fees in connection with the
enforcement of this Note.
The Bank hereby agrees (i) that any claim, liability, or obligation
arising hereunder or under the Agreement whether on account of the principal of
any Loan, interest thereon, or any other amount due hereunder or thereunder
shall be satisfied only from the assets of the specific Fund for whose benefit a
Loan is borrowed and in any event in an amount not to exceed the outstanding
principal amount of any Loan borrowed for such Fund's benefit, together with
accrued and unpaid interest due and owing thereon, and such Fund's share of any
other amount due hereunder and under the Agreement (as determined in accordance
with the provisions of the Agreement) and (ii) that no assets of any Fund shall
be used to satisfy any claim, liability, or obligation arising hereunder or
under the Agreement with respect to the outstanding principal amount of any Loan
borrowed for the benefit of any other Fund or any accrued and unpaid interest
due and owing thereon or such other Fund's share of any other amount due
hereunder and under the Agreement (as determined in accordance with the
provisions of the Agreement).
<PAGE>
Neither the shareholders, trustees, officers, employees and other
agents of any Borrower or Fund shall be personally bound by or liable for any
indebtedness, liability or obligation hereunder or under the Note nor shall
resort be had to their private property for the satisfaction of any obligation
or claim hereunder.
This Note shall be governed by the laws of the state of Texas.
USAA MUTUAL FUND, INC., on
behalf of and for the
benefit of its series of
Funds as set forth on
Schedule A to the Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
USAA INVESTMENT TRUST,
on behalf of and for the
benefit of its series of
Funds as set forth
on Schedule A to the
Agreement
By: /s/ Michale J.C. Roth
---------------------
Michael J.C. Roth
President
USAA TAX EXEMPT FUND, INC.,
on behalf of and for the
benefit of its series of
Funds as set forth on
Schedule A to the Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
USAA STATE TAX-FREE TRUST,
on behalf of and for the
benefit of its series of
Funds as set forth on
Schedule A to the Agreement
By: /s/ Michael J.C. Roth
---------------------
Michael J.C. Roth
President
<PAGE>
LOANS AND PAYMENT OF PRINCIPAL
This schedule (grid) is attached to and made a part of the Promissory Note dated
January 15, 1997, executed by USAA MUTUAL FUND, INC., USAA INVESTMENT TRUST,
USAA TAX EXEMPT FUND, INC. AND USAA STATE TAX-FREE TRUST on behalf of and for
the benefit of the series of funds comprising each such Borrower payable to the
order of NATIONSBANK OF TEXAS, N.A.
[The following Information is Listed in Grid]
Date of Loan
Borrower and Fund
Amount of Loan
Type of Rate and Interest Rate on Date of Borrowing
Amount of Principal Repaid
Date of Repayment
Other Expenses
Notation made by
<PAGE>
EXHIBIT B
NATIONSBANK OF TEXAS, N.A.
MASTER REVOLVING
CREDIT FACILITY AGREEMENT
BORROWER INFORMATION SHEET
BORROWER: USAA MUTUAL FUND, INC., USAA INVESTMENT TRUST, USAA TAX
EXEMPT FUND, INC. AND USAA STATE TAX-FREE TRUST
ADDRESS FOR NOTICES AND OTHER COMMUNICATIONS TO THE BORROWER:
9800 Fredericksburg Road
San Antonio, Texas 78288
(for Federal Express, 78240)
Attention: John W. Saunders, Jr.
Senior Vice President,
Fixed Income Investments
Telephone: (210) 498-7320
Telecopy: (210) 498-5689
Harry W. Miller
Senior Vice President,
Equity Investments
Telephone: (210) 498-7344
Telecopy: (210) 498-7332
ADDRESS FOR BORROWING AND PAYMENTS:
9800 Fredericksburg Road
San Antonio, Texas 78288
(for Federal Express, 78240)
Attention: Dean R. Pantzar
Telephone: (210) 498-7472
Telecopy: (210) 498-0382 or 498-7819
Telex: 767424
INSTRUCTIONS FOR PAYMENTS TO BORROWER:
WE PAY VIA: X FED FUNDS CHIPS
<PAGE>
TO: (PLEASE PLACE BANK NAME, CORESPONDENT NAME (IF APPLICABLE), CHIPS
AND/OR FED FUNDS ACCOUNT NUMBER BELOW)
State Street Bank and Trust Company, Boston, Massachusetts
ABA #011-00-0028
USAA MUTUAL FUND, INC.
USAA Aggressive Growth Fund Acct.# 6938-502-9
USAA Growth & Income Fund Acct.# 6938-519-3
USAA Income Stock Fund Acct.# 6938-495-6
USAA Short-Term Bond Fund Acct.# 6938-517-7
USAA Money Market Fund Acct.# 6938-498-0
USAA Growth Fund Acct.# 6938-490-7
USAA Income Fund Acct.# 6938-494-9
USAA S&P 500 Index Fund Acct.# 6938-478-2
USAA INVESTMENT TRUST
USAA Cornerstone Strategy Fund Acct.# 6938-487-3
USAA Gold Fund Acct.# 6938-488-1
USAA International Fund Acct.# 6938-497-2
USAA World Growth Fund Acct.# 6938-504-5
USAA GNMA Trust Acct.# 6938-486-5
USAA Treasury Money Market Trust Acct.# 6938-493-1
USAA Emerging Markets Fund Acct.# 6938-501-1
USAA Growth and Tax Strategy Fund Acct.# 6938-509-4
USAA Growth Strategy Fund Acct.# 6938-510-2
<PAGE>
USAA Income Strategy Fund Acct.# 6938-508-6
USAA Balanced Strategy Fund Acct.# 6938-507-8
USAA TAX EXEMPT FUND, INC.
USAA Long-Term Fund Acct.# 6938-492-3
USAA Intermediate-Term Fund Acct.# 6938-496-4
USAA Short-Term Fund Acct.# 6938-500-3
USAA Tax Exempt Money Market Fund Acct.# 6938-514-4
USAA California Bond Fund Acct.# 6938-489-9
USAA California Money Market Fund Acct.# 6938-491-5
USAA New York Bond Fund Acct.# 6938-503-7
USAA New York Money Market Fund Acct.# 6938-511-0
USAA Virginia Bond Fund Acct.# 6938-512-8
USAA Virginia Money Market Fund Acct.# 6938-513-6
USAA STATE TAX-FREE TRUST
USAA Florida Tax-Free Income Fund Acct.# 6938-473-3
USAA Florida Tax-Free Money Market Fund Acct.# 6938-467-5
USAA Texas Tax-Free Income Fund Acct.# 6938-602-7
USAA Texas Tax-Free Money Market Fund Acct.# 6938-601-9
<PAGE>
EXHIBIT C
ADDRESS FOR THE BANK
NationsBank of Texas, N.A.
901 Main Street
66th Floor
Dallas, Texas 75202
Attention: Greg Venker
Telephone No.: (214) 508-0584
Telecopy No.: (214) 508-0604
<PAGE>
EXHIBIT D
OFFICER'S CERTIFICATE
The undersigned hereby certifies that he is the duly elected Secretary of USAA
Mutual Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund, Inc. and USAA
State Tax-Free Trust and that he is authorized to execute this Certificate on
behalf of USAA Mutual Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund,
Inc. and USAA State Tax-Free Trust. The undersigned hereby further certifies to
the following:
The following individuals are duly authorized to act on behalf of USAA Mutual
Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund, Inc. and USAA State
Tax-Free Trust, by transmitting telephonic, telex, or telecopy instructions and
other communications with regard to borrowings and payments pursuant to the
Master Revolving Credit Facility Agreement with NationsBank of Texas, N.A. The
signature set opposite the name of each individual below is that individual's
genuine signature.
NAME OFFICE SIGNATURE
Michael J. C. Roth President /s/ Michael J.C. Roth
John W. Saunders, Jr. Senior Vice President
Fixed Income Investments /s/John W. Saunders, Jr.
Harry W. Miller Senior Vice President
Equity Investments /s/ Harry W. Miller
Kenneth E. Willmann Vice President
Mutual Fund Portfolios /s/ Kenneth E. Willmann
David G. Peebles Vice President
Equity Investments /s/ David G. Peebles
Sherron A. Kirk Vice President
Controller /s/ Sherron A. Kirk
Dean R. Pantzar Executive Director
Mutual Fund Accounting /s/ Dean R. Pantzar
<PAGE>
IN WITNESS WHEREOF, I have executed the Certificate as of this 15th day of
January, 1997.
/s/ Michael D. Wagner
---------------------
MICHAEL D. WAGNER
Secretary
I, Michael J. C. Roth, President of USAA Mutual Fund, Inc., USAA Investment
Trust, USAA Tax Exempt Fund, Inc. and USAA State Tax-Free Trust hereby certify
that Michael D. Wagner is, and has been at all times since a date prior to the
date of this Certificate, the duly elected, qualified, and acting Secretary of
USAA Mutual Fund, Inc., USAA Investment Trust, USAA Tax Exempt Fund, Inc. and
USAA State Tax-Free Trust and that the signature set forth above is his true and
correct signature.
DATE: January 15, 1997
/s/ Michael J.C. Roth
---------------------
MICHAEL J. C. ROTH
President
<PAGE>
EXHIBIT E
Subordination
NationsBank of Texas, N.A. Agreement
This is an agreement among:
Dated: January 15, 1997
- --------------------------------------------- ----------------------------------
Name and Address of Lender (Including County):
NationsBank of Texas, N.A.
901 Main Street
Dallas, Dallas County, Texas 75202
(Lender)
- ---------------------------------------------
Name and Address of Borrower:
USAA Mutual Fund, Inc.
USAA Investment Trust
USAA Tax Exempt Fund, Inc.
USAA State Tax-Free Trust
9800 Fredericksburg Road
San Antonio, TX 78288
(Debtor)
- ---------------------------------------------
Name and Address of Creditor:
USAA Capital Corporation
9800 Fredericksburg Road
San Antonio, Texas 78288
(Creditor)
- ---------------------------------------------
1. Background. Debtor is or may be indebted to Lender pursuant to that certain
Facility Agreement Letter dated January 15, 1997 between Debtor and Lender
("Senior Facility Agreement"). Debtor also is or may be indebted to Creditor
pursuant to that certain Facility Agreement Letter dated January 14, 1997
between Debtor and Creditor ("Subordinated Facility Agreement"). All debt
(as hereinafter defined) under the Senior Facility Agreement is hereinafter
referred to as "senior debt" and all debt (as hereinafter defined) under the
Subordinated Facility Agreement is hereinafter referred to as "subordinated
debt".
2. Definition of Debt. The term "debt" as used in the terms "senior debt" and
"subordinated debt" means all debts, obligations and liabilities, now or
hereafter existing, direct or indirect, absolute or contingent, joint or
several, secured or unsecured, due or not due, contractual or tortious,
liquidated or unliquidated, arising by operation of law or otherwise,
irrespective of the person in whose favor such debt may originally have been
created and regardless of the manner in which such debt has been or may
hereafter be acquired by Lender or Creditor, as the case may be, and
includes all costs incurred to obtain, preserve, perfect or enforce any
security interest, lien or mortgage, or to collect any debt or to maintain,
preserve, collect and enforce any collateral, and interest on such amounts.
3. Subordination of Debt. Until senior debt has been paid in full, Debtor will
not pay and Creditor will not accept any payment on subordinated debt at any
time that an Event of Default (as defined in the Senior Facility Agreement)
has occurred and is continuing in respect of senior debt. Anything of value
received by Creditor on account of subordinated debt in violation of this
agreement will be held by Creditor in trust and immediately will be turned
over to Lender in the form received to be applied by Lender on senior debt.
4. Remedies of Creditor. Until all senior debt has been paid in full, without
Lender's permission, Creditor will not be a party to any action or
proceeding against any person to recover subordinated debt. Upon written
request of Lender, Creditor will file any claim or proof of claim or take
any other action to collect subordinated debt in any bankruptcy,
receivership, liquidation, reorganization or other proceeding for relief of
debtors or in connection with Debtor's insolvency, or in liquidation or
marshaling of Debtor's assets or liabilities, or in any probate proceeding,
and if any distribution shall be made to Creditor, Creditor will hold the
same in trust for Lender and immediately pay to Lender, in the form received
to be applied on senior debt, all money or other assets received in any such
proceedings on account of subordinated debt until senior debt shall have
been paid in full. If Creditor shall fail to take any such action when
requested by Lender, Lender may enforce this agreement or as attorney in
fact for Creditor and Debtor may take any such action on Creditor's behalf.
Creditor hereby irrevocably appoints Lender Creditor's attorney in fact to
take any such action that Lender might request Creditor to take hereunder,
and to sue for, compromise, collect and receive all such money and other
assets and take any other action in Lender's own name or in Creditor's name
that Lender shall consider advisable for enforcement and collection of
subordinated debt, and to apply any amounts received on senior debt.
5. Modifications. At any time and from time to time, without Creditor's consent
or notice to Creditor and without liability to Creditor and without
releasing or impairing any of Lender's rights against Creditor or any of
Creditor's obligations hereunder, Lender may take additional or other
security for senior debt; release, exchange, subordinated or lose any
security for senior debt; release any person obligated on senior debt,
modify, amend or waive compliance with any agreement relating to senior
debt; grant any adjustment, indulgence or forbearance to, or compromise
with, any person liable for senior debt; neglect, delay, omit, fail or
refuse to take or prosecute any action for collection of any senior debt or
to foreclose upon any collateral or take or prosecute any action on any
agreement securing any senior debt.
6. Subordination of Liens. Creditor subordinates and makes inferior to any
security interests, liens or mortgages now or hereafter securing senior debt
all security interests, liens, or mortgages now or hereafter securing
subordinated debt. Any foreclosure against any property securing senior debt
shall foreclose, extinguish and discharge all security interests, liens and
mortgages securing subordinated debt, and any purchaser at any such
foreclosure sale shall take title to the property so sold free of all
security interest, liens and mortgages securing subordinated debt.
7. Statement of Subordination; Assignment by Creditor; Additional Instruments.
Debtor and Creditor will cause any instrument evidencing or securing
subordinated debt to bear upon its face a statement that such instrument is
subordinated to senior debt as set forth herein and will take all actions
and execute all documents appropriate to carry out this agreement. Creditor
will notify Lender not less than 10 days before any assignment of any
subordinated debt.
8. Assignment by Lender. Lender's rights under this agreement may be assigned
in connection with any assignment or transfer of any senior debt.
9. Venue. Debtor and Creditor agree that this agreement is performable in the
county of Lender's address set out above.
10. Cumulative Rights; Waivers. This instrument is cumulative of all other
rights and securities of the Lender. No waiver by Lender of any right
hereunder, with respect to a particular payment, shall affect or impair its
rights in any matters thereafter occurring.
11. Successors and Assigns. This instrument is binding upon and shall inure to
the benefit of the heirs, executors, administrators, successors and assigns
of each of the parties hereto, but Creditor covenants that it will not
assign subordinated debt, or any part thereof, without making the rights and
interests of the assignee subject in all respects to the terms of this
instrument.
12. Termination. This agreement shall terminate upon the termination of the
Senior Facility Agreement and repayment in full of the senior debt.
(Lender) (Debtor) (Creditor)
NationsBank of Texas, N.A. USAA Mutual Fund, Inc. USAA Capital Corporation
USAA Investment Trust
USAA Tax Exempt Fund, Inc.
USAA State Tax-Free Trust
By /s/ Kate Salletly By /s/ Michael J.C. Roth By /s/ Laurie B. Blank
- --------------------- -------------------------- -----------------------
Its Senior Vice President Its President Its Treasurer
EXHIBIT 10(b)
GOODWIN, PROCTER & HOAR LLP
COUNSELLORS AT LAW
EXCHANGE PLACE
BOSTON, MASSACHUSETTS 02109-2881
TELEPHONE (617) 570-1000
TELECOPIER (617) 523-1231
July 17, 1997
USAA Tax Exempt Fund, Inc.
USAA Building
9800 Fredericksburg Road
San Antonio, Texas 78288-0227
Gentlemen:
As counsel to USAA Tax Exempt Fund, Inc. (the "Company"), a Maryland
corporation, we have been asked to render our opinion with respect to the
issuance of shares of capital stock, $.01 par value per share, classified as
shares of the California Bond Fund and Virginia Bond Fund (the "Shares") of the
Company which have been established and designated in Articles of Incorporation
of the Company and Articles Supplementary to the Articles of Incorporation, as
amended (collectively, the "Articles"), all as more fully described in the
prospectuses and statements of additional information contained in
Post-Effective Amendment No. 26 (the "Amendment") to Registration Statement No.
2- 75093 (the "Registration Statement") filed by the Company.
We have examined the Articles of the Company, the By-Laws of the
Company, the minutes of certain meetings of the Board of Directors of the
Company, the prospectuses and statements of additional information contained in
the Amendment and such other documents, records and certificates as we deemed
necessary for the purposes of this opinion.
Based upon the foregoing, and assuming that not more than 60,000,000
shares of the California Bond Fund and 45,000,000 shares of the Virginia Bond
Fund will be issued and outstanding at any time, we are of the opinion that the
Shares will, when sold in accordance with the terms of the prospectuses and
statements of additional information relating to the Shares in effect at the
time of the sale, be legally issued, fully paid and non-assessable.
We also hereby consent to the reference to this firm in the
prospectuses under the heading "Legal Counsel" and in the statements of
additional information under the heading "General Information--Counsel" for the
California Bond Fund and Virginia Bond Fund which form a part of the Amendment
and to a copy of this opinion being filed as an exhibit to the Amendment.
Very truly yours,
/S/ GOODWIN, PROCTER & HOAR LLP
---------------------------------
GOODWIN, PROCTER & HOAR LLP
DOCSC\533370.1
<PAGE>
EXHIBIT 10(c)
GOODWIN, PROCTER & HOAR LLP
COUNSELLORS AT LAW
EXCHANGE PLACE
BOSTON, MASSACHUSETTS 02109-2881
TELEPHONE (617) 570-1000
TELECOPIER (617) 523-1231
July 17, 1997
USAA Tax Exempt Fund, Inc.
USAA Building
9800 Fredericksburg Road
San Antonio, Texas 78288-0227
Ladies and Gentlemen:
We hereby consent to the reference in Post-Effective Amendment No. 26
(the "Amendment") to the Registration Statement (No. 2-75093) on Form N-1A of
USAA Tax Exempt Fund, Inc. (the "Registrant"), a Maryland corporation, to our
opinion with respect to the legality of the shares of the Registrant
representing interests in the Long-Term Fund, Intermediate-Term Fund, Short-Term
Fund, Tax Exempt Money Market Fund, California Money Market Fund, New York Bond
Fund, New York Money Market Fund and Virginia Money Market Fund series of the
Registrant, which opinion was filed with Post-Effective Amendment No. 23 to the
Registration Statement.
We also hereby consent to the reference to this firm in the
prospectuses under the heading "Legal Counsel" and in the statements of
additional information under the heading "General Information--Counsel" which
form a part of the Amendment and to the filing of this consent as an exhibit to
the Amendment.
Very truly yours,
/S/ GOODWIN, PROCTER & HOAR LLP
----------------------------------
GOODWIN, PROCTER & HOAR LLP
DOCSC\533444.1
<PAGE>
The Shareholders and Board of Directors
USAA Tax Exempt Fund, Inc.
We consent to the use of our reports dated May 9, 1997 on the financial
statements of the Long-Term, Short-Term, Intermediate-Term, Tax Exempt Money
Market, California Bond, California Money Market, New York Bond, New York Money
Market, Virginia Bond, and Virginia Money Market Funds, separate Funds of USAA
Tax Exempt Fund, Inc. (the Company) as of and for the year ended March 31, 1997
included in the Company's Annual Reports to Shareholders for the year ended
March 31, 1997 incorporated herein by reference and to the references to our
firm under the headings "Financial Highlights" and "Independent Auditors" as
part of Post-Effective Amendment No. 26 under the Securities Act of 1933, as
amended, and Amendment No. 28 under the Investment Company Act of 1940, as
amended to the Company's Registration Statement on Form N-1A.
/S/ KPMG PEAT MARWICK LLP
----------------------------------
KPMG Peat Marwick LLP
San Antonio, Texas
July 18, 1997
<PAGE>
EXHIBIT 19(c)
POWER OF ATTORNEY
Know all men by these presents that the undersigned Director of USAA TAX
EXEMPT FUND, INC., a Maryland corporation (the "Company"), constitutes and
appoints Michael J.C. Roth, John W. Saunders, Jr. and Michael D. Wagner, and
each of them, as his true and lawful attorney-in-fact and agent, with full power
or substitution, for him and in his name, place and stead, in any and all
capacities to sign registration statements in his capacity as a Director of the
Fund on any form or forms filed under the Securities Act of 1933 and the
Investment Company Act of 1940 and any and all amendments thereto, with all
exhibits, instruments, and other documents necessary or appropriate in
connection with such filing and to file them with the Securities and Exchange
Commission or any other regulatory authority as may be necessary or desirable,
hereby ratifying and confirming all that said attorney-in-fact and agent or his
substitute, may lawfully do or cause to be done by virtue hereof.
/S/ ROBERT G. DAVIS 7/9/97
- ------------------------------- ---------------------------
Robert G. Davis, Director Date
<PAGE>
EXHIBIT 19(d)
POWER OF ATTORNEY
Know all men by these presents that the undersigned Director of USAA TAX
EXEMPT FUND, INC., a Maryland corporation (the "Company"), constitutes and
appoints Michael J.C. Roth, John W. Saunders, Jr. and Michael D. Wagner, and
each of them, as his true and lawful attorney-in-fact and agent, with full power
or substitution, for him and in his name, place and stead, in any and all
capacities to sign registration statements in his capacity as a Director of the
Fund on any form or forms filed under the Securities Act of 1933 and the
Investment Company Act of 1940 and any and all amendments thereto, with all
exhibits, instruments, and other documents necessary or appropriate in
connection with such filing and to file them with the Securities and Exchange
Commission or any other regulatory authority as may be necessary or desirable,
hereby ratifying and confirming all that said attorney-in-fact and agent or his
substitute, may lawfully do or cause to be done by virtue hereof.
/S/ ROBERT L. MASON 7/9/97
- -------------------------------- ---------------------------
Robert L. Mason, Director Date
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000356555
<NAME> USAA TAX EXEMPT FUND, INC.
<SERIES>
<NUMBER> 1
<NAME> LONG-TERM FUND
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-END> MAR-31-1997
<INVESTMENTS-AT-COST> 1,728,991
<INVESTMENTS-AT-VALUE> 1,812,745
<RECEIVABLES> 54,002
<ASSETS-OTHER> 733
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 1,867,480
<PAYABLE-FOR-SECURITIES> 39,200
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 5,844
<TOTAL-LIABILITIES> 45,044
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 1,785,807
<SHARES-COMMON-STOCK> 137,895
<SHARES-COMMON-PRIOR> 137,015
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (47,125)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 83,754
<NET-ASSETS> 1,822,436
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 116,511
<OTHER-INCOME> 0
<EXPENSES-NET> (6,790)
<NET-INVESTMENT-INCOME> 109,721
<REALIZED-GAINS-CURRENT> 4,215
<APPREC-INCREASE-CURRENT> 3,331
<NET-CHANGE-FROM-OPS> 117,267
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (109,721)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 51,727
<NUMBER-OF-SHARES-REDEEMED> (56,684)
<SHARES-REINVESTED> 5,837
<NET-CHANGE-IN-ASSETS> 18,320
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (51,340)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 5,168
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 6,790
<AVERAGE-NET-ASSETS> 1,842,113
<PER-SHARE-NAV-BEGIN> 13.17
<PER-SHARE-NII> 0.79
<PER-SHARE-GAIN-APPREC> 0.05
<PER-SHARE-DIVIDEND> (0.79)
<PER-SHARE-DISTRIBUTIONS> 0.00
<RETURNS-OF-CAPITAL> 0.00
<PER-SHARE-NAV-END> 13.22
<EXPENSE-RATIO> 0.37
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000356555
<NAME> USAA TAX EXEMPT FUND, INC.
<SERIES>
<NUMBER> 2
<NAME> INTERMEDIATE-TERM FUND
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-END> MAR-31-1997
<INVESTMENTS-AT-COST> 1,645,854
<INVESTMENTS-AT-VALUE> 1,698,547
<RECEIVABLES> 31,285
<ASSETS-OTHER> 980
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 1,730,812
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 5,128
<TOTAL-LIABILITIES> 5,128
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 1,676,020
<SHARES-COMMON-STOCK> 135,150
<SHARES-COMMON-PRIOR> 129,973
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (3,029)
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