As filed with the Securities and Exchange Commission on July 31, 2000.
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. _29_
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 X
Amendment No. 31
USAA TAX EXEMPT FUND, INC.
(Exact Name of Registrant as Specified in Charter)
9800 FREDERICKSBURG ROAD, 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 Road
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)
___ on (August 1, 2000) pursuant to paragraph (b)
___ 60 days after filing pursuant to paragraph (a)(1)
_X_ 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.
Exhibit Index on Pages 286 - 288
Page 1 of 411
<PAGE>
USAA TAX EXEMPT FUND, INC.
CROSS REFERENCE SHEET
PART A
FORM N-1A ITEM NO. SECTION IN PROSPECTUS
1. Cover and Back Cover Pages................ Same
2. Risk/Return Summary: Investments, Risks,
and Performance.................. ...... Main Risks of Investing in These
Funds
Could the Value of Your
Investment in These Funds
Fluctuate
3. Risk/Return Summary: Fee Table........... Fees and Expenses
4. Investment Objectives, Principal
Investment Strategies, and
Related Risks........................... What Are Each Fund's Investment
Objectives and Main Strategies
Fund Investments
5. Management's Discussion of Fund
Performance............................. Not Applicable
6. Management, Organization, and Capital
Structure............................... Fund Management
7. Shareholder Information.................. How to Invest
Important Information About
Purchases and Redemptions
Exchanges
Shareholder Information
8. Distribution Arrangements................ Not Applicable
9. Financial Highlights Information......... Financial Highlights
<PAGE>
USAA TAX EXEMPT FUND, INC.
CROSS REFERENCE SHEET
PART B
FORM N-1A ITEM NO. SECTION IN STATEMENTS OF
ADDITIONAL INFORMATION
10. Cover Page and Table of Contents......... Same
11. Fund History............................. Description of Shares
12. Description of the Fund and Its
Investments and Risks.................. Investment Policies
Investment Restrictions
Special Risk Considerations
(California, New York, and
Virginia Funds SAIs only)
Portfolio Transactions
13. Management of the Fund................... Directors and Officers of the
Company
14. Control Persons and Principal
Holders of Securities................... Directors and Officers of the
Company
15. Investment Advisory and Other Services... Directors and Officers of the
Company
The Company's Manager
General Information
16. Brokerage Allocation and Other
Practices............................... Portfolio Transactions
17. Capital Stock and Other
Securities.............................. Description of Shares
18. Purchase, Redemption, and Pricing
of Shares............................... Valuation of Securities
Conditions of Purchase and
Redemption
Additional Information
Regarding Redemption of Shares
Investment Plans
19. Taxation of the Fund..................... Tax Considerations (Long-Term,
Intermediate-Term, Short-Term
and Tax 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)
20. Underwriters............................. The Company's Manager
21. Calculation of Performance Data.......... Calculation of Performance Data
22. Financial Statements..................... Cover Page
<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 NATIONAL
TAX-EXEMPT FUNDS
USAA LONG-TERM FUND
USAA INTERMEDIATE-TERM FUND
USAA SHORT-TERM FUND
USAA TAX EXEMPT MONEY MARKET FUND
PROSPECTUS
AUGUST 1, 2000
As with other mutual funds, the Securities and Exchange Commission has not
approved or disapproved of these Funds' shares or determined whether this
Prospectus is accurate or complete. Anyone who tells you otherwise is
committing a crime.
TABLE OF CONTENTS
What Are Each Fund's Investment Objectives and Main Strategies?......... 2
Main Risks of Investing in These Funds.................................. 2
Are These Funds for You?................................................ 3
Could the Value of Your Investment in These Funds Fluctuate?............ 5
Fees and Expenses....................................................... 10
Fund Investments........................................................ 11
Fund Management......................................................... 20
Using Mutual Funds in an Investment Program............................. 21
How to Invest........................................................... 22
Important Information About Purchases and Redemptions................... 26
Exchanges............................................................... 27
Shareholder Information................................................. 28
Financial Highlights.................................................... 31
Appendix A ............................................................. 35
Appendix B ............................................................. 37
Appendix C.............................................................. 38
<PAGE>
USAA Investment Management Company manages these Funds. For easier reading,
USAA Investment Management Company will be referred to as "we" or "us"
throughout the Prospectus.
WHAT ARE EACH FUND'S INVESTMENT
OBJECTIVES AND MAIN STRATEGIES?
Each Fund has 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. Each Fund
has separate investment policies to achieve its objective.
The LONG-TERM, INTERMEDIATE-TERM, AND SHORT-TERM FUNDS invest primarily in
investment-grade, tax-exempt securities differentiated by maturity limitations.
The dollar-weighted average portfolio maturity forthe Long-Term Fund is ten
years or more, the Intermediate-Term Fundis between three and ten years, and
the Short-Term Fund is three yearsor less.
The TAX EXEMPT MONEY MARKET FUND invests in high-quality, tax-exempt securities
with maturities of 397 days or less.
Because any investment involves risk, there is no assurance that the Funds'
objectives will be achieved. See FUND INVESTMENTS on page 11for more
information.
MAIN RISKS OF INVESTING IN THESE FUNDS
The two main risks of investing in these Funds are credit risk and market risk.
As with other mutual funds, losing money is also a risk of investing in these
Funds.
* CREDIT RISK involves the possibility that a borrower cannot make timely
interest and principal payments on its securities.
* MARKET RISK involves the possibility that the value of each Fund's
investments will decline because of an increase in interest
rates, or to adverse changes in supply and demand for municipal
securities, or other market factors.
IF INTEREST RATES INCREASE: the yield of each Fund may increase and the market
value of the Long-Term, Intermediate-Term, and Short-Term Funds' securities
will likely decline, adversely affecting the net asset value and total return.
2
<PAGE>
IF INTEREST RATES DECREASE: the yield of each Fund may decrease and the market
value of the Long-Term, Intermediate-Term, and Short-Term Funds' securities may
increase, which would likely increase the Funds' net asset value and total
return. The Tax Exempt Money Market Fund's total return may decrease.
Other risks of investing in these Funds include call risk and structural risk.
As you consider an investment in these Funds, you should also take into account
your tolerance for the daily fluctuations of the financial markets and whether
you can afford to leave your money in the investment for long periods of time
to ride out down periods.
An investment in any of these Funds is not a deposit of USAA Federal Savings
Bank, or any other bank, and is not insured or guaranteed by the Federal
Deposit Insurance Corporation or any other government agency. Although the Tax
Exempt Money Market Fund seeks to preserve the value of your investment at $1
per share, it is possible to lose money by investing in that Fund.
Look for this symbol [CAUTION LIGHT GRAPHIC] throughout the Prospectus. We use
it to mark more detailed information about the risks you will face as a Fund
shareholder.
ARE THESE FUNDS FOR YOU?
Any of these Funds might be appropriate as part of your investment portfolio
if . . .
* You are looking for current income that is exempt from federal
income taxes.
* You are looking for a fixed income investment in bonds to
balance your stock portfolio.
Any of these Funds MAY NOT be appropriate as part of your investment portfolio
if . . .
* You are seeking an appropriate investment for an IRA, through a 401(k)
plan or 403(b) plan, or other tax-sheltered account.
* Your current tax situation does not allow you to benefit from tax-exempt
income.
Long-Term Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are willing to accept moderate risk.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You are unwilling to take greater risk for long-term goals.
3
<PAGE>
Intermediate-Term Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are willing to accept low to moderate risk.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You are unwilling to take greater risk for intermediate-term goals.
Short-Term Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are looking for a short-term investment.
* You are looking for an investment that is low risk.
* You would like checkwriting privileges on the account.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* Your primary goal is to maximize long-term growth.
* You need a high total return to achieve your goals.
Tax Exempt Money Market Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You need to preserve principal.
* You want a low-risk investment.
* You need your money back within a short period.
* You would like checkwriting privileges on the account.
* You are looking for an investment in a money market fund to balance
your stock or long-term bond portfolio.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You need a high total return to achieve your goals.
* Your primary goal is long-term growth.
Each Fund by itself does not constitute a balanced investment program.
Diversifying your investments may improve your long-run investment return and
lower the volatility of your overall investment portfolio.
4
<PAGE>
COULD THE VALUE OF YOUR INVESTMENT
IN THESE FUNDS FLUCTUATE?
Yes, it could. In fact, the value of your investment in the Long-Term,
Intermediate-Term, or Short-Term Funds will fluctuate with the changing market
values of the investments in these Funds. We manage the Tax Exempt Money Market
Fund in accordance with strict Securities and Exchange Commission (SEC)
guidelines designed to preserve the Fund's value at $1 per share, although, of
course, we cannot guarantee that the value will remain at $1 per share.
The value of the securities in which the Long-Term, Intermediate-Term, and
Short-Term Funds invest typically fluctuates inversely with changes in the
general level of 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. The following bar charts
illustrate the Funds' volatility and performance from year to year for each
full calendar year over the past ten years.
TOTAL RETURN
All mutual funds must use the same formula to calculate total return.
[SIDE BAR]
TOTAL RETURN MEASURES THE PRICE CHANGE IN A SHARE ASSUMING THE REINVESTMENT OF
ALL DIVIDEND INCOME AND CAPITAL GAIN DISTRIBUTIONS.
Long-Term Fund
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1990 6.55%
1991 12.38%
1992 8.62%
1993 12.51%
1994 -7.92%
1995 18.58%
1996 4.47%
1997 10.38%
1998 5.97%
1999 -5.04%
THE LONG-TERM FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD ENDED JUNE 30,
2000, WAS 4.09%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 7.77% (quarter ending March 31, 1995) and the lowest total return
for a quarter was -5.55% (quarter ending March 31, 1994).
5
<PAGE>
Intermediate-Term Fund
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1990 6.72%
1991 11.14%
1992 8.49%
1993 11.47%
1994 -4.03%
1995 15.07%
1996 4.49%
1997 9.39%
1998 6.32%
1999 -2.61%
THE INTERMEDIATE-TERM FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD ENDED
JUNE 30, 2000, WAS 3.72%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 5.50% (quarter ending March 31, 1995) and the lowest total return
for a quarter was -4.63% (quarter ending March 31, 1994).
Short-Term Fund
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1990 5.87%
1991 7.70%
1992 5.96%
1993 5.52%
1994 .82%
1995 8.11%
1996 4.44%
1997 5.85%
1998 4.95%
1999 1.64%
THE SHORT-TERM FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD ENDED JUNE 30,
2000, WAS 2.36%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 2.57% (quarter ending March 31, 1995) and the lowest total return
for a quarter was -1.05% (quarter ending March 31, 1994).
6
<PAGE>
Long-, Intermediate-, and Short-Term Funds
The table below shows how each Fund's average annual total returns for the
one-, five-, and ten-year periods, as well as the life of the Fund, compared to
those of a broad-based securities market index. Remember, historical
performance does not necessarily indicate what will happen in the future.
========================================================================
Average Annual
Total Returns
(for the period ending Past Past Past Life of
December 31, 1999) 1 Year 5 Years 10 Years Fund
------------------------------------------------------------------------
Long-Term Fund -5.04% 6.59% 6.37% 9.18%
------------------------------------------------------------------------
Intermediate-Term Fund -2.61% 6.37% 6.49% 8.34%
------------------------------------------------------------------------
Short-Term Fund 1.64% 4.98% 5.06% 6.02%
------------------------------------------------------------------------
Lehman Brothers
Municipal Bond Index* -2.06% 6.91% 6.89% 9.86%
========================================================================
*THE LEHMAN BROTHERS MUNICIPAL BOND INDEX IS AN UNMANAGED BENCHMARK OF TOTAL
RETURN PERFORMANCE FOR THE LONG-TERM, INVESTMENT-GRADE, TAX-EXEMPT BOND
MARKET.
Tax Exempt Money Market Fund
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1990 6.07%
1991 4.80%
1992 3.12%
1993 2.38%
1994 2.64%
1995 3.70%
1996 3.34%
1997 3.46%
1998 3.37%
1999 3.15%
THE TAX EXEMPT MONEY MARKET FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD
ENDED JUNE 30, 2000, WAS 1.86%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 1.56% (quarter ending December 31, 1990) and the lowest total
return for a quarter was .54% (quarter ending March 31, 1994).
7
<PAGE>
The table below shows the Fund's average annual total returns for the one-,
five-, and ten-year periods, as well as the life of the Fund. Remember,
historical performance does not necessarily indicate what will happen in the
future.
================================================================
Average Annual
Total Returns
(for the period ending Past Past Past Life of
December 31, 1999) 1 Year 5 Years 10 Years Fund
----------------------------------------------------------------
Tax Exempt Money
Market Fund 3.15% 3.40% 3.60% 4.26%
================================================================
YIELD
All mutual funds must use the same formulas to calculate yield and effective
yield.
[SIDE BAR]
YIELD IS ANNUALIZED NET INCOME OF THE FUND DURING A SPECIFIED PERIOD AS A
PERCENTAGE OF THE FUND'S SHARE PRICE.
Long-, Intermediate-, and Short-Term Funds
The Long-, Intermediate-, and Short-Term Funds may advertise performance in
terms of a 30-day yield quotation or a tax-equivalent yield. The Funds' 30-day
yields for the period ended December 31, 1999, were as follows:
-----------------------------------
Long-Term Fund 5.65%
Intermediate-Term Fund 5.18%
Short-Term Fund 4.44%
-----------------------------------
[SIDE BAR]
EFFECTIVE YIELD IS CALCULATED SIMILAR TO THE YIELD, HOWEVER WHEN ANNUALIZED,
THE INCOME EARNED IS ASSUMED TO BE REINVESTED.
Tax Exempt Money Market Fund
The Tax Exempt Money Market Fund typically advertises performance in terms of a
7-day yield and effective yield or a tax-equivalent yield and may advertise
total return. The 7-day yield quotation more closely reflects current earnings
of the Fund than the total return quotation. The effective yield will be
slightly higher than the yield because of the compounding effect of the assumed
reinvestment. Current yields 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. The Fund's 7-day yield for the period
ended December 31, 1999, was 4.32%.
TAX-EQUIVALENT YIELD
Investors use tax-equivalent yields to compare taxable and tax-exempt fixed
income investments using a common yield measure. The tax-equivalent yield is
the yield that a fully taxable investment must generate to earn the same
"take-home" yield as a tax-exempt investment. The calculation
8
<PAGE>
depends upon your federal marginal income tax rate and assumes that an investor
can fully itemize deductions on his or her federal tax return. The higher your
marginal tax bracket, the higher will be the tax-equivalent yield and the more
valuable is the Fund's tax exemption.
For example, if you assume a federal marginal tax rate of 36%, the Funds'
tax-equivalent yields for the period ending December 31, 1999, would be as
follows:
==============================================================
Tax Equivalent
Yield Yield
--------------------------------------------------------------
Long-Term Fund (30 day) 5.65% 8.83%
Intermediate-Term Fund (30 day) 5.18% 8.09%
Short-Term Fund (30 day) 4.44% 6.94%
Tax Exempt Money Market Fund (7 day) 4.32% 6.75%
==============================================================
Using the example, to exceed the 30-day yield of the Long-Term Fund onan
after-tax basis, you must find a fully taxable investment that yields more than
8.83%. Likewise, to exceed the 7-day yield of the Tax Exempt Money Market Fund,
you must find a fully taxable investment that yields more than 6.75%.
For more information on calculating tax-equivalent yields, see APPENDIX B on
page 37.
Please consider performance information in light of the Funds' investment
objectives and policies and market conditions during the reported time periods.
The value of your shares may go up or down. For the most current price, yield,
and return information for these Funds, you may call USAA TouchLine(R) at
1-800-531-8777. Press 1 for the Mutual Fund Menu, press 1 again for prices,
yields, and returns. Then, press 43# for the Long-Term Fund, press 44# for the
Intermediate-Term Fund, press 45# for the Short-Term Fund, or press 46# for the
Tax Exempt Money Market Fund when asked for a Fund Code. You may also access
this information through our usaa.com(SM) Internet web site once your account
has been established.
[SIDE BAR]
[TOUCHLINE(R) GRAPHIC]
TouchLine(R)
1-800-531-8777
press
1
then
1
then
4, 6, #
Additionally, you may find the most current price of your shares in the
business section of your newspaper in the mutual fund section under the heading
"USAA Group" and then the following symbols:
[SIDE BAR]
Newspaper
Symbols:
TxELT
TxElt
TxESh
---------------------------------------
Long-Term Fund - "TXELT"
Intermediate-Term Fund - "TXEIT"
Short-Term Fund - "TXESH"
---------------------------------------
9
<PAGE>
If you prefer to obtain this information from an on-line computer service, you
can do so by using the following ticker symbols:
[SIDE BAR]
Ticker
Symbols:
USTEX
USATX
USSTX
USEXX
-------------------------------------------
Long-Term Fund - "USTEX"
Intermediate-Term Fund - "USATX"
Short-Term Fund - "USSTX"
Tax Exempt Money Market Fund - "USEXX"
-------------------------------------------
FEES AND EXPENSES
This summary shows what it will cost you, directly and indirectly, to invest in
these Funds.
Shareholder Transaction Expenses-- (Direct Costs)
There are no fees or sales loads charged to your account when you buy or sell
Fund shares. However, if you sell shares and request your money by wire
transfer, there is a $12 domestic wire fee and a $35 foreign wire fee. (Your
bank may also charge a fee for receiving wires.)
Annual Fund Operating Expenses-- (Indirect Costs)
Fund expenses come out of the Funds' assets and are reflected in the Funds'
share prices and dividends. "Other Expenses" include expenses such as custodian
and transfer agent fees. The figures below show actual expenses during the past
fiscal year ended March 31, 2000, and are calculated as a percentage of average
net assets.
[SIDE BAR]
12b-1 FEES - SOME MUTUAL FUNDS CHARGE THESE FEES TO PAY FOR ADVERTISING AND
OTHER COST OF SELLING FUND SHARES.
===================================================================
Long-Term Intermediate-
Fund Term Fund
-------------------------------------------------------------------
Management Fees .28% .28%
Distribution (12b-1) Fees None None
Other Expenses .08% .08%
--- ----
Total Annual Fund
Operating Expenses .36% .36%
==== ====
===================================================================
Short-Term Tax Exempt Money
Fund Market Fund
-------------------------------------------------------------------
Management Fees .28% .28%
Distribution (12b-1) Fees None None
Other Expenses .10% .10%
---- ----
Total Annual Fund
Operating Expenses .38% .38%
==== ====
===================================================================
10
<PAGE>
Example of Effect of the Funds' Operating Expenses
This example is intended to help you compare the cost of investing in one of
the Funds with the cost of investing in other mutual funds. Although your
actual costs may be higher or lower, you would pay the following expenses on a
$10,000 investment, assuming (1) 5% annual return, (2) the Fund's operating
expenses remain the same, and (3) you redeem all of your shares at the end of
those periods shown.
==============================================================
One Three Five Ten
Year Years Years Years
--------------------------------------------------------------
Long-Term Fund $ 37 $ 116 $ 202 $ 456
Intermediate-Term Fund 37 116 202 456
Short-Term Fund 39 122 213 480
Tax Exempt Money Market Fund 39 122 213 480
==============================================================
FUND INVESTMENTS
Principal Investment Strategies and Risks
Q What is each Fund's principal investment strategy?
A Each Fund's principal strategy is the investment of its assets in
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.
These securities include municipal debt obligations that have been
issued by states and their political subdivisions, and duly constituted
state and local authorities and corporations as well as securities
issued by certain U.S. territories or possessions, such as Puerto Rico,
the Virgin Islands, and Guam. Tax-exempt securities are issued to fund
public infrastructure projects such as streets and highways, schools,
water and sewer systems, hospitals, and airports. 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.
Because the projects benefit the public, Congress has granted exemption
from federal income taxes for the interest income arising from these
securities.
11
<PAGE>
Q What types of tax-exempt securities will be included in each Fund's
portfolio?
A Each Fund's assets may be invested in any of the following tax-exempt
securities:
* 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;
* SYNTHETIC INSTRUMENTS, which combine a municipality's long-term
obligation to pay interes and principal with the obligation of a
third party to repurchase the instrument on short notice; and
* INDUSTRIAL DEVELOPMENT BONDS issued by or on behalf of public
authorities to obtain funds for privately operated facilities.
As a temporary defensive measure because of market, economic, political,
or other conditions, we may invest up to 100% of each Fund's assets in
short-term securities whether or not they are exempt from federal income
tax. To the extent that these temporary investments produce taxable
income, that income may result in that Fund not fully achieving its
investment objective during the time it is in this temporary defensive
posture.
Q What are the principal risks associated with investments in tax-exempt
securities?
A The two principal risks of investing in tax-exempt securities are credit
risk and market risk.
[CAUTION LIGHT GRAPHIC]
CREDIT RISK. The bonds in each Fund's portfolio are subject to credit
risk. Credit Risk is the possibility that an issuer of a fixed income
security will fail to make timely payments of interest or principal. We
attempt to minimize the Funds' credit risks by investing in securities
considered at least investment grade at the time of purchase.
Nevertheless, even investment-grade securities are subject to some
credit risk. In addition, the ratings of
12
<PAGE>
securities are estimates by the rating agencies of the credit quality of
the securities. The ratings may not take into account every risk related
to whether interest or principal will be repaid on a timely basis.
When evaluating potential investments for the Funds, our analysts also
independently assess credit risk and its impact on the Funds'
portfolios. Securities in the lowest investment grade ratings category
(BBB) have speculative characteristics. Changes in economic conditions
or other circumstances are more likely to lead to a weakened capability
to make principal and interest payments on these securities than is the
case for higher-rated securities.
[CAUTION LIGHT GRAPHIC]
MARKET RISK. As a mutual fund investing in bonds, the Funds are subject
to the risk that the market value of the bonds will decline because of
rising interest rates. Bond prices are linked to the prevailing market
interest rates. In general, when interest rates rise, bond prices fall
and when interest rates fall, bond prices rise. The price volatility of
a bond also depends on its maturity. Generally, the longer the maturity
of a bond, the greater its sensitivity to interest rates. To compensate
investors for this higher market risk, bonds with longer maturities
generally offer higher yields than bonds with shorter maturities.
Q What other risks are associated with investments in tax-exempt
securities?
A Two other risks that are applicable to certain tax-exempt securities are
call risk and structural risk.
[CAUTION LIGHT GRAPHIC]
CALL RISK. Many municipal bonds may be "called," or redeemed, by the
issuer before the stated maturity. During a period of declining interest
rates, an issuer would call, or refinance, a higher yielding bond for
the same reason that a homeowner would refinance a home mortgage.
Interest rates must drop sufficiently so that the savings more than
offset the cost of refinancing.
Intermediate- and long-term municipal bonds have the greatest call risk,
because most municipal bonds may not be called until after ten years
from the date of issue. The period of "call protection" may be longer or
shorter than ten years, but regardless, bonds purchased closest to the
date of issue will have the most call protection. Typically, bonds with
original maturities of ten years or less are not callable.
13
<PAGE>
Although investors certainly appreciate the rise in bond prices when
interest rates drop, falling interest rates create the environment
necessary to "call" the higher-yielding bonds from your Fund. When bonds
are called, the Fund is impacted in several ways. Most likely, we must
reinvest the bond-call proceeds at lower interest rates. The Fund's
income may drop as a result. The Fund may also realize a taxable capital
gain.
[CAUTION LIGHT GRAPHIC]
STRUCTURAL RISK. Some tax-exempt securities, referred to as "synthetic
instruments," are created by combining a long-term municipal bond with a
right to sell the instrument back to the remarketer or liquidity
provider for repurchase on short notice, referred to as a "tender
option." Usually, the tender option is backed by a letter of credit or
similar guarantee from a bank. The guarantee, however, is typically
conditional, which means that the bank is not required to pay under the
guarantee if thereis a default by the municipality or if certain other
events occur. These types of instruments involve special risks, referred
to as "structural risk." For example, because of the structure of a
synthetic instrument, there is a risk that the instrument will lose its
tax-exempt treatment or that we will not be able to exercise our tender
option. We will not purchase a synthetic instrument unless counsel has
issued an opinion that the instrument is entitled to tax-exempt
treatment. In addition, we will not purchase a synthetic instrument for
the Tax-Exempt Money Market Fund unless we believe there is only minimal
risk that we will not be able to exercise our tender option at all
times.
Q What are the differences between the Long-Term, Intermediate-Term, and
Short-Term Funds?
A The differences in the Funds are in the average weighted maturities of
all the securities in the portfolios. Generally, the longer the
maturity, the higher the yield and the greater theprice 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
14
<PAGE>
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 Statement of
Additional Information.
Q Are each Fund's investments diversified in many different issuers?
A Each Fund is considered diversified under the federal securities laws.
With respect to the Long-Term Fund, the Intermediate-Term Fund, and the
Short-Term Fund, this means that we will not invest more than 5% in any
one issuer with respect to 75% of the Funds' assets. With respect to the
remaining 25% of the Funds' assets, we could invest more than 5% in any
one, or more, issuers.
With respect to the Tax Exempt Money Market Fund, we will not generally
invest more than 5% of the Fund's assets in any one or more issuers.
Also, strict SEC guidelines do not permit us to invest, with respect to
75% of the Fund's assets, greater than 10% of the Fund's assets in
securities issued by or subject to guarantees by the same institution.
Purchases of securities issued or guaranteed by the U.S. government or
its agencies or instrumentalities are not counted toward these
limitations.
We also may not invest more than 25% of the Funds' 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
that are based, directly or indirectly, on the credit of private
entities of any one industry. However, we reserve the right to invest
more than 25% of the Funds' assets in tax-exempt industrial revenue
bonds. The 25% industry limitation does not apply to general obligation
bonds or bonds that are escrowed in U.S. government securities.
Q Do the Funds purchase bonds guaranteed by bond insurance?
A Yes. Some of the bonds we purchase for the Funds are secured by bond
insurance that guarantees scheduled principal and interest payments. In
addition, we may purchase bond insurance for individual uninsured
securities when we believe it will provide a net economic benefit to the
shareholders.
15
<PAGE>
Q Will an portion of the distributions from the Funds be subject to
federal income taxes?
A During normal market conditions, at least 80% of each Fund's annual
income will be excluded from gross income for federal income tax
purposes. This policy may only be changed by a shareholder vote. We
expect that any taxable interest income distributed will be minimal.
However, gains and losses from trading securities that occur during the
normal course of managing a fund may create net capital gain
distributions. The Internal Revenue Code presently treats these
distributions differently than tax-exempt interest income in the
following ways:
* Distributions of net short-term capital gains are taxable as
ordinary income.
* Distributions of net long-term capital gains are taxable as
long-term capital gains, regardless of the length of time you have
held the Fund shares.
* Both short-term and long-term capital gains are taxable whether
received in cash or reinvested in additional shares.
Q Will income from the Funds be subject to the federal alternative minimum
tax (AMT) for individuals?
A During normal market conditions, at least 80% of each Fund's annual
income will be excluded from the calculation of the federal alternative
minimum tax (AMT) for individuals. This policy may only be changed by a
shareholder vote. Since inception, the Funds have not distributed any
income that is subject to the federal AMT for individuals, and we do not
intend to invest in securities subject to the federal AMT. However, of
course, changes in federal tax laws or other unforeseen circumstances
could result in income subject to the federal AMT for individuals.
Long-, Intermediate-, and Short-Term Funds
Q What is the credit quality of the Funds' investments?
A Under normal market conditions, we will invest each Fund's assets so
that at least 50% of the total market value of the tax-exempt securities
are rated within the three highest long-term rating categories (A or
higher) by Moody's Investors Service
16
<PAGE>
(Moody's), Standard & Poor's Ratings Group (S&P), or Fitch Information,
Inc. (Fitch), in the highest short-term rating category by Moody's, S&P,
or Fitch. If a security is not rated by these rating agencies, we must
determine that the security is of equivalent investment quality.
In no event will we purchase a security for a Fund unless it is rated at
least investment grade at the time of purchase. Investment-grade
securities are those securities rated within the four highest long-term
rating categories by Moody's (Baa or higher), S&P, or Fitch (BBB or
higher), or in the two highest short-term rating categories by these
rating agencies. If unrated by these agencies, we must determine that
the securities are of equivalent investment quality.
On occasion, we may purchase a credit rating on a particular security
when we believe it will provide a net economic benefit to the
shareholders.
You will find a complete description of the above tax-exempt ratings in
the Funds' Statement of Additional Information.
Q What happens if the rating of a security is downgraded to below
investment grade?
A We will determine whether it is in the best interest of a Fund's
shareholders to continue to hold the security in the Fund's portfolio.
If downgrades result in more than 5% of the Fund's net assets being
invested in securities that are less than investment-grade quality, we
will take immediate action to reduce a Fund's holdings in such
securities to 5% or less of a Fund's net assets, unless otherwise
directed by the Fund'sBoard of Directors.
Q How are the decisions to buy and sell securities made?
A We manage tax-exempt funds based on the common sense premise that our
investors value tax-exempt income over taxable capital gain
distributions. When weighing the decision to buy or sell a security, we
strive to balance the value of the tax-exempt income, the credit risk of
the issuer, and the price volatility of the bond.
17
<PAGE>
Tax Exempt Money Market Fund
Q What is the credit quality of the Fund's investments?
A The Fund's investments consist of securities meeting the requirements to
qualify as "eligible securities" under the SEC rules applicable to money
market funds. In general, an eligible security is defined as a security
that is:
* issued or guaranteed by the U.S. government or any agency or
instrumentality thereof, including "prerefunded" and "escrowed to
maturity" tax-exempt securities;
* rated or subject to a guarantee that is 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;
* unrated but issued by an issuer or guaranteed by a guarantor that
has other comparable short-term debt obligations so rated; or
* unrated but determined by us to be of comparable quality.
In addition, we must consider whether a particular investment presents
minimal credit risk.
Q Who are the Nationally Recognized Statistical Rating Organizations?
A Current NRSROs include:
* Moody's Investors Service;
* Standard & Poor's Ratings Group;
* Fitch Information, Inc.; and
* Thompson BankWatch.
Q What happens if the rating of a security is downgraded?
A If the rating of a security is downgraded after purchase, we will
determine whether it is in the best interest of the Fund's shareholders
to continue to hold the security in the Fund's portfolio.
18
<PAGE>
Q Will the Fund always maintain a net asset value of $1 per share?
[SIDE BAR]
DOLLAR WEIGHTED AVERAGE PORTFOLIO MATURITY IS OBTAINED BY MULTIPLYING THE DOLLAR
VALUE OF EACH INVESTMENT BY THE NUMBER OF DAYS LEFT TO ITS MATURITY, THEN ADDING
THOSE FIGURES TOGETHER AND DIVIDING THE TOTAL BY THE DOLLAR VALUE OF THE FUND'S
PORTFOLIO.
A While we will endeavor to maintain a constant Fund net asset value of $1
per share, there is no assurance that we will be able to do so.
Remember, the shares are neither insured nor guaranteed by the U.S.
government. As such, the Fund carries some risk.
For example, there is always a risk that the issuer of a security held
by the Fund will fail to pay interest or principal when due. We attempt
to minimize this credit risk by investing only in securities rated in
one of the two highest categories for short-term securities, or, if not
rated, of comparable quality, at the time of purchase. Additionally, we
will not purchase a security unless our analysts determine that the
security presents minimal credit risk.
There is also a risk that rising interest rates will cause the value of
the Fund's securities to decline. We attempt to minimize this interest
risk by limiting the maturity of each security to 397 days or less and
maintaining a dollar-weighted average portfolio maturity for the Fund of
90 days or less.
Finally, there is the possibility that one or more investments in the
Fund cease to be "eligible securities" resulting in the net asset value
ceasing to be $1 per share. For example, a guarantor on a security
failing to meet a contractual obligation could cause such a result.
Q How are the decisions to buy and sell securities made?
A We balance factors such as credit quality and maturity to purchase the
best relative value available in the market at any given time. While
rare, a decision to sell is usually based on a change in our credit
analysis or to take advantage of an opportunity to reinvest at a higher
yield.
For additional information about other securities in which we may invest each
of the Fund's assets, see APPENDIX A on page 35.
19
<PAGE>
FUND MANAGEMENT
USAA Investment Management Company serves as the manager and distributor of
these Funds. We are an affiliate of United Services Automobile Association
(USAA), a large, diversified financial services institution. As of the date of
this Prospectus, we had approximately $41 billion in total assets under
management. Our mailing address is 9800 Fredericksburg Road, San Antonio, TX
78288.
We provide management services to the Funds pursuant to an Advisory Agreement.
We are responsible for managing the Funds' portfolios (including placement of
brokerage orders) and their business affairs, subject to the authority of and
supervision by the Funds' Board of Directors. For our services, the Funds pay
us an annual fee. This fee, which is accrued daily and paid monthly, is
computed as a percentage of average net assets. The fee for each Fund was
computed and paid at twenty-eight one-hundredths of one percent (.28%) of
average net assets for the fiscal year ended March 31, 2000. We also provide
services related to selling the Funds' shares and receive no compensation for
those services.
Portfolio Managers
LONG-TERM FUND
[PHOTOGRAPH]
Robert R. Pariseau
Robert R. Pariseau, Assistant Vice President of Fixed Income Mutual Fund
Portfolios, has managed the Fund since November 1999. He has 16 years
investment management experience working for us. Mr. Pariseau earned the
Chartered Financial Analyst designation in 1987 and is a member of the
Associationfor Investment Management and Research, the San Antonio Financial
Analysts Society, Inc., and the National Federation of Municipal Analysts. He
holds an MBA from Lindenwood College and a BS from the U.S. Naval Academy.
INTERMEDIATE-TERM AND SHORT-TERM FUNDS
[PHOTOGRAPH]
Clifford A. Gladson
Clifford A. Gladson, Vice President of Mutual Fund Portfolios,has managed the
Funds since April 1993 and April 1994, respectively. He has 13 years investment
management experience and has worked for us for ten years. Mr. Gladson earned
the Chartered Financial Analyst designation in 1990 and is a member of the
Association for Investment Management and Research, the San Antonio Financial
Analysts Society, Inc., and the National Federation of Municipal Analysts. He
holds an MS from the University of Wisconsin, Milwaukee and a BS from Marquette
University.
20
<PAGE>
TAX EXEMPT MONEY MARKET FUND
[PHOTOGRAPH]
Anthony M. Era, Jr.
Anthony M. Era, Jr., Assistant Vice President of Money Market Funds, has
managed the Fund since February 2000. He has 13 years investment management
experience and has worked for us for 12 years. Mr. Era is a member of the
Association for Investment Management and Research, the San Antonio Financial
Analysts Society, Inc., and the Bank and Financial Analysts of New York. He
holds a Master's Degree in Finance from the University of Texas, at San Antonio
and a BA from Creighton University, Omaha, Nebraska.
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 diversified
portfolio. That portfolio is managed by investment professionals, relieving you
of the need to make individual stock or bond selections. You also enjoy
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,
you own 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, you are giving up some
investment decisions, but must still make others. The decisions you don't have
to make are those involved with choosing individual securities. We will perform
that function. In addition, we will arrange for the safekeeping of securities,
auditing the annual financial statements, and daily valuation of the Fund, as
well as other functions.
You, however, retain at least part of the responsibility for an equally
important decision. This decision involves determining a portfolio of mutual
funds that balances your investment goals with your tolerance for risk. It is
likely that this decision may include the use of more than one fund of the USAA
Family of Funds.
For example, assume you wish to pursue the higher yields usually available in
the long-term bond market, but you are also concerned about the possible price
swings of the long-term bonds. You could divide your 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.
21
<PAGE>
This is just one way you could combine funds to fit your own risk and reward
goals.
III. USAA's Family of Funds
We offer you another alternative with our asset strategy funds listed in
APPENDIX C under asset allocation on page 38. These unique mutual funds provide
a professionally managed, diversified investment portfolio within a mutual
fund. Designed for the individual who prefers to delegate the asset allocation
process to an investment manager, their structure achieves diversification
across a number of investment categories.
Whether you prefer to create your own mix of mutual funds or use a USAA Asset
Strategy Fund, the USAA Family of Funds provides a broad range of choices
covering just about any investor's investment objectives. Our member service
representatives stand ready to assist you with your choices and to help you
craft a portfolio to meet your needs. Refer to APPENDIX C on page 38 for a
complete list of the USAA Family of No-Load Mutual Funds.
HOW TO INVEST
Purchase of Shares
OPENING AN ACCOUNT
You may open an account and make an investment as described below by mail, in
person, bank wire, phone, or on the Internet. A complete, signed application is
required to open your initial account. However, after you open your initial
account with us, you will not need to fill out another application to invest in
another Fund unless the registration is different.
TAX ID NUMBER
Each shareholder named on the account must provide a social security number or
tax identification number to avoid possible withholding requirements.
EFFECTIVE DATE
When you make a purchase, your purchase price will be the net asset value (NAV)
per share next determined after we receive your request in proper form. Each
Fund's NAV is determined at the close of the regular trading session (generally
4:00 p.m. Eastern Time) of the New York Stock Exchange (NYSE) each day the NYSE
is open. If we receive your request and payment prior to that time, your
purchase price will be the NAV per share determined for that day. If we receive
your request or payment after the NAV per share is calculated, the purchase
will be effective on the next business day.
22
<PAGE>
If you plan to purchase Fund shares with a foreign check, we suggest you
convert your foreign check to U.S. dollars prior to investment in a Fund. This
will avoid a potential four- to six-week delay in the effective date of your
purchase. Furthermore, a bank charge may be assessed in the clearing process,
which will be deducted from the amount of the purchase.
MINIMUM INVESTMENTS
INITIAL PURCHASE
[MONEY GRAPHIC]
* $3,000
ADDITIONAL PURCHASES
* $50 (Except on transfers from brokerage accounts into the Tax Exempt Money
Market Fund, which are exempt from the minimum). Employees of USAA and its
affiliated companies may add to an account through payroll deduction for
as little as $25 per pay period with a $3,000 initial investment.
HOW TO PURCHASE
MAIL
[ENVELOPE GRAPHIC]
* To open an account, send your application and check to:
USAA Investment Management Company
9800 Fredericksburg Road
San Antonio, TX 78288
* To add to your account, send your check and the deposit stub that
accompanies your Fund's transaction confirmation to the Transfer Agent:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
IN PERSON
[HANDSHAKE GRAPHIC]
* To open an account, bring your application and check to our San Antonio
investment sales and service office at:
USAA Federal Savings Bank
10750 Robert F. McDermott Freeway
San Antonio, TX 78288
23
<PAGE>
BANK WIRE
[BANK WIRE GRAPHIC]
* To open or add to your 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 Tax Exempt Fund Name
USAA Account Number: 69384998
Shareholder(s) Name(s)
Shareholder(s) Mutual Fund Account Number
ELECTRONIC FUNDS TRANSFER (EFT)
[CALENDAR GRAPHIC]
* Additional purchases on a regular basis can be deducted from a bank
account, paycheck, income-producing investment, or USAA money market fund
account. Sign up for these services when opening an account or call
1-800-531-8448 to add these services.
PHONE 1-800-531-8448 (IN SAN ANTONIO, 456-7202)
[TELEPHONE GRAPHIC]
* If you have an existing USAA mutual fund account and would like to open a
new account or exchange to another USAA Fund, call for instructions. To
open an account by phone, the new account must have the same registration
as your existing account.
USAA TOUCHLINE(R)1-800-531-8777 (IN SAN ANTONIO, 498-8777)
[TOUCHLINE GRAPHIC]
* In addition to obtaining account balance information, last transactions,
current fund prices, and return information for your Fund, you can use USAA
TouchLine(R) from any touch-tone phone to access your Fund account to make
selected purchases, exchange to another USAA Fund, or make redemptions.
This service is available with an Electronic Services Agreement (ESA) and
EFT Buy/Sell authorization on file.
INTERNET ACCESS - USAA.COM(SM)
[COMPUTER GRAPHIC]
* You can use your personal computer to perform certain mutual fund
transactions by accessing our web site. To establish access to your
account, you will need to call 1-800-461-3507 to obtain a registration
number and personal identification number (PIN). Once you have established
Internet access to your account, you will be able to open a new mutual fund
account within an existing registration, exchange to another USAA Fund,
make redemptions, review account activity, check balances, and more. To
place orders by Internet, an ESA and EFT Buy/Sell authorization must be on
file.
24
<PAGE>
Redemption of Shares
You may redeem Fund shares by any of the methods described below on any day the
NAV per share is calculated. Redemptions are effective on the day instructions
are received in a manner as described below. However, if instructions are
received after the NAV per share calculation (generally 4:00 p.m. Eastern
Time), your redemption will be effective on the next business day.
We will send you your money within seven days after the effective date of
redemption. Payment for redemption of shares purchased by EFT or check is sent
after the EFT or check 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. For federal
income tax purposes, a redemption is a taxable event; and as such, you may
realize a capital gain or loss. Such capital gains or losses are based on the
difference between your cost basis in the shares and the price received upon
redemption.
In addition, the Funds may elect to suspend the redemption of shares or
postpone the date of payment in limited circumstances.
HOW TO REDEEM
MAIL, IN PERSON, FAX, TELEGRAM, TELEPHONE, TOUCHLINE(R), OR INTERNET
[FAX MACHINE GRAPHIC]
* Send your written instructions to:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
* Visit a member service representative at our San Antonio investment sales and
service office at USAA Federal Savings Bank.
* Send a signed fax to 1-800-292-8177, or send a telegram to USAA Shareholder
Account Services.
* Calltoll free 1-800-531-8448 (in San Antonio, 456-7202) to speak with a
member service representative.
* Call toll free 1-800-531-8777 (in San Antonio, 498-8777) to access our
24-hour USAA TouchLine(R) service.
* Access our Internet web site at usaa.com(SM).
Telephone redemption privileges are 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. Before
any discussion regarding your account, the following information is obtained:
(1) USAA number and/or account number, (2) the name(s) on the account
registration, and (3) social security/tax
25
<PAGE>
identification number or date of birth of the registered account owner(s) for
the account registration. Additionally, all telephone communications with you
are recorded and confirmations of account transactions are sent to the address
of record. If you were issued stock certificates for your shares, redemption by
telephone, fax, telegram, or Internet is not available.
CHECKWRITING
[CHECKBOOK GRAPHIC]
* Checks can be issued for the Short-Term Fund and Tax Exempt Money Market
Fund accounts. Return a signed signature card, which accompanies your
application, or request a signature card separately and return it to:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
You will not be charged for the use of checks or any subsequent reorders. Your
checkwriting privilege is subject to State Street Bank and Trust Company's
rules and regulations governing checking accounts. You may write checks in the
amount of $250 or more. Checks written for less than $250 will be returned
unpaid. Because the value of your account changes daily as dividends accrue,
you may not write a check to close your account. Remember, writing a check on
your Short-Term Fund results in a taxable event and is therefore reportable for
federal tax purposes.
IMPORTANT INFORMATION ABOUT
PURCHASES AND REDEMPTIONS
INVESTOR'S GUIDE to USAA Mutual Fund Services
[INVESTOR GUIDE GRAPHIC]
Upon your initial investment with us, you will receive the INVESTOR'S GUIDE to
help you get the most out of your USAA mutual fund account and to assist you in
your role as an investor. In the INVESTOR'S GUIDE, you will find additional
information on purchases, redemptions, and methods of payment. You will also
find in-depth information on automatic investment plans, shareholder statements
and reports, and other useful information.
Account Balance
USAA Shareholder Account Services (SAS), the Funds' transfer agent, may assess
annually a small balance account fee of $12 to each shareholder account with a
balance of less than $2,000 at the time of assessment. The fee will reduce
total transfer agency fees paid by the Fund to SAS. 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/UTMA); (3) all (non-IRA) money
market fund accounts; (4) any
26
<PAGE>
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).
Fund Rights
Each Fund reserves the right to:
* reject purchase or exchange orders when in the best interest of the Fund;
* limit or discontinue the offering of shares of the Fund without notice to
the shareholders;
* 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); however, this 1% charge
will not be imposed upon shareholdersunless authorized by the Fund's Board
of Directors and the required notice has been given to shareholders;
* require a signature guarantee for transactions or changes in account
information in those instances where the appropriateness of a signature
authorization is in question (the Statement of Additional Information
contains information on acceptable guarantors);
* redeem an account with less than 50 full shares, with certain limitations.
EXCHANGES
Exchange Privilege
The exchange privilege is automatic 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 the shares to be acquired are
offered in your state of residence. Exchanges made through USAA TouchLine(R)
and the Internet require an ESA and EFT Buy/Sell authorization on file. After
we receive the exchange orders, the Funds' transfer agent will simultaneously
process exchange redemptions and purchases at the share prices next determined.
The investment minimums applicable to share purchases also apply to exchanges.
For federal income tax purposes, an exchange between Funds is a taxable event;
and as such, you may realize a capital gain or loss. Such capital gains or
losses are based on the difference between your cost basis in the shares and
the price received upon exchange.
The Funds have undertaken certain procedures regarding telephone transactions
as described on page 25.
27
<PAGE>
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. The limit on
exchanges out of any Fund in the USAA Family of Funds for each account is six
per calendar year (except 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). However, each Fund reserves the right to reject a
shareholder's purchase or exchange orders into a Fund at any time when in the
best interest of the Fund.
SHAREHOLDER INFORMATION
Share Price Calculation
[SIDE BAR]
NAV PER SHARE
EQUALS
TOTAL ASSETS
MINUS
LIABILITIES
DIVIDED BY
# OF SHARES
OUTSTANDING
The price at which you purchase and redeem Fund shares is equal to the net
asset value (NAV) per share determined on the effective date of the purchase or
redemption. You may buy and sell Fund shares at the NAV per share without a
sales charge. Each Fund's NAV per share is calculated at the close of the
regular trading session of the NYSE, which is usually 4:00 p.m. Eastern Time.
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 Funds' Board of Directors. Securities that cannot be
valued by the pricing service, and all other assets, are valued in good faith
at fair value using methods we have determined under the general supervision of
the Funds' Board of Directors. In addition, securities purchased with
maturities of 60 days or less and all securitiesof the Tax Exempt Money Market
Fund are stated at amortized cost, which approximates market value.
For additional information on how securities are valued, see VALUATION OF
SECURITIES in the Funds' Statement of Additional Information.
Dividends and Distributions
Net investment income of each Fund is accrued daily and paid on the last
business day of the month. Dividends shall begin accruing on shares purchased
the day following the effective date and shall continue to accrue to the
effective date of redemption. Any net capital gain distribution usually occurs
within 60 days of the March 31 fiscal year end, which would be somewhere around
the end of May. The Funds will make additional payments to shareholders, if
necessary, to avoid the imposition of any federal income or excise tax.
28
<PAGE>
We will automatically reinvest all income dividends and capital gain
distributions in each Fund unless you instruct us differently. The share price
will be the NAV of the Fund shares computed on the ex-dividend date. Any
capital gain distributions paid by the Tax Exempt Funds (except the Tax Exempt
Money Market Fund) will reduce the NAV per share by the amount of the dividend
or distribution on the ex-dividend date. You should consider carefully the
effects of purchasing shares of a Fund shortly before any capital gain
distribution. Some or all of these distributions are subject to taxes.
We will invest any dividend or distribution payment returned to us in your
account at the then-current NAV per share. Dividend and distribution checks
become void six months from the date on the check. The amount of the voided
check will be invested in your account at the then-current NAV per share.
Federal Taxes
This tax information is quite general and refers to the federal income tax
provisions in effect as of the date of this Prospectus. While we manage the
Funds so that at least 80% of each Fund's annual income will be exempt from
federal income taxes, we may invest up to 20% of the Funds' assets in
securities that generate income not exempt from federal or state income taxes.
Because interest income may be exempt for federal income tax purposes, it does
not necessarily mean that the interest income may be exempt under the income or
other tax laws of any state or local taxing authority. As discussed earlier on
page 16, capital gains distributed by a Fund may be taxable. Note that the
Taxpayer Relief Act of 1997 and the technical provisions adopted by the IRS
Restructuring and Reform Act of 1998 may affect the status and treatment of
certain distributions shareholders receive from the Funds. Because each
investor's tax circumstances are unique and because the tax laws are subject to
change, we recommend that you consult your tax adviser about your investment.
WITHHOLDING - Federal law requires each Fund 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,
* underreports dividend or interest income, or
* fails to certify that he or she is not subject to withholding.
29
<PAGE>
To avoid this withholding requirement, you must certify, on your application or
on a separate Form W-9 supplied by the Funds' transfer agent, that your tax
identification number is correct and you are not currently subject to backup
withholding.
REPORTING - Each Fund will report information to you annually concerning the
tax status of dividends and distributions for federal income tax purposes,
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.
Future Shareholder Mailings
Through our ongoing efforts to help reduce Fund expenses, each household will
receive a single copy of these Funds' most recent financial reports and
prospectus even if you or a family member own more than one account in the
Funds. For many of you, this eliminates duplicate copies, saving paper, and
postage costs to the Funds. However, if you would like to receive individual
copies, please call us and we will begin your individual delivery within 30
days.
30
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights tables are intended to help you understand the Funds'
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned (or lost) on an
investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been audited by KPMG LLP, whose report,
along with the Funds' financial statements, are included in the Annual Report,
which is available upon request.
Long-Term Fund:
Year Ended March 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
----------------------------------------------------------
Net asset value at
beginning of period $ 13.92 $ 14.00 $ 13.22 $ 13.17 $ 12.96
Net investment income .76 .76 .78 .79 .79
Net realized and
unrealized gain (loss) (1.17) (.08) .78 .05 .21
Distributions from
net investment income (.76) (.76) (.78) (.79) (.79)
----------------------------------------------------------
Net asset value at
end of period $ 12.75 $ 13.92 $ 14.00 $ 13.22 $ 13.17
==========================================================
Total return (%)* (2.95) 4.98 12.04 6.51 7.88
Net assets at end of
period (000) $1,935,892 $2,168,242 $2,042,525 $1,822,436 $1,804,116
Ratio of expenses
to average net
assets (%) .36 .36 .36 .37 .37
Ratio of net
investment income
to average net
assets (%) 5.77 5.44 5.65 5.95 5.99
Portfolio turnover (%) 29.04 29.56 35.20 40.78 53.25
---------------
* Assumes reinvestment of all dividend income distributions during the period.
31
<PAGE>
Financial Highlights (cont.)
Intermediate-Term Bond Fund:
Year Ended March 31,
---------------------------------------------------------
2000 1999 1998 1997 1996
---------------------------------------------------------
Net asset value at
beginning of period $ 13.39 $ 13.38 $ 12.77 $ 12.77 $ 12.50
Net investment income .69 .70 .71 .72 .71
Net realized and
unrealized gain (loss) (.81) .01 .61 - .27
Distributions from
net investment income (.69) (.70) (.71) (.72) (.71)
---------------------------------------------------------
Net asset value at
end of period $ 12.58 $ 13.39 $ 13.38 $ 12.77 $ 12.77
==========================================================
Total return (%)* (.84) 5.42 10.59 5.80 7.97
Net assets at end
of period (000) $2,123,310 $2,344,401 $2,039,505 $1,725,684 $1,660,039
Ratio of expenses to
average net assets (%) .36 .36 .37 .37 .38
Ratio of net investment
income to average net
assets (%) 5.39 5.21 5.42 5.65 5.54
Portfolio turnover (%) 10.46 11.85 7.87 23.05 27.51
-----------
* Assumes reinvestment of all dividend income distributions during the period.
32
<PAGE>
Financial Highlights
Short-Term Bond Fund:
Year Ended March 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
----------------------------------------------------------
Net asset value at
beginning of period $ 13.39 $ 13.38 $ 12.77 $ 12.77 $ 12.50
Net investment income .69 .70 .71 .72 .71
Net realized and
unrealized gain (loss) (.81) .01 .61 - .27
Distributions from net
investment income (.69) (.70) (.71) (.72) (.71)
----------------------------------------------------------
Net asset value at
end of period $ 12.58 $ 13.39 $ 13.38 $ 12.77 $ 12.77
==========================================================
Total return (%)* (.84) 5.42 10.59 5.80 7.97
Net assets at end
of period (000) $2,123,310 $2,344,401 $2,039,505 $1,725,684 $1,660,039
Ratio of expenses to
average net assets (%) .36 .36 .37 .37 .38
Ratio of net investment
income to average net
assets (%) 5.39 5.21 5.42 5.65 5.54
Portfolio turnover (%) 10.46 11.85 7.87 23.05 27.51
-----------
* Assumes reinvestment of all dividend income distributions during the period.
33
<PAGE>
Financial Highlights
Tax-Exempt Money Market Fund:
Year Ended March 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
----------------------------------------------------------
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .03 .03 .03 .03 .04
Distributions from net
investment income (.03) (.03) (.03) (.03) (.04)
----------------------------------------------------------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
==========================================================
Total return (%)* 3.27 3.26 3.48 3.30 3.65
Net assets at end of
period (000) $1,863,214 $1,767,036 $1,631,785 $1,565,634 $1,529,176
Ratio of expenses to
average net assets (%) .38 .38 .38 .39 .40
Ratio of net investment
income to average net
assets (%) 3.24 3.21 3.42 3.25 3.59
--------------
* Assumes reinvestment of all dividend income distributions during the period.
34
<PAGE>
APPENDIX A
THE FOLLOWING ARE DESCRIPTIONS OF CERTAIN TYPES OF SECURITIES IN WHICH WE MAY
INVEST EACH FUND'S ASSETS:
VARIABLE RATE SECURITIES
We may invest a Fund's assets 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 the Fund depending on the proportion of such
securities held.
* Because the interest rates of variable rate securities are periodically
adjusted to reflect current market rates, their market value is less
affected by changes in prevailing interest rates than the market value of
securities with fixed interest rates.
* The market value of a variable rate security 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
We may invest a Fund's assets in tax-exempt securities (including securities
with variable interest rates) that 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 Bond Funds, maturity for put bonds is deemed to be the date on
which 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
We may invest a Fund's assets 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.
SYNTHETIC INSTRUMENTS
We may invest a Fund's assets in tender option bonds, bond receipts, and
similar synthetic municipal instruments. A synthetic instrument is a security
created by combining an intermediate or long-term municipal bond with a right
to sell the instrument back to the remarketer or liquidity provider for
repurchase on short notice. This right to sell is commonly referred to as a
tender option. Usually, the tender option is backed by a conditional guarantee
or letter of credit from a bank or other financial institution. Under its
terms, the guarantee may expire if the municipality defaults on payments of
interest or principal on the underlying bond, if the credit rating of the
municipality is downgraded, or
35
<PAGE>
if the instrument (or the underlying bond) loses its tax-exempt treatment.
Synthetic instruments involve structural risks that could adversely affect the
value of the instrument or could result in a Fund holding an instrument for a
longer period of time than originally anticipated.
WHEN-ISSUED SECURITIES
We may invest a Fund's assets in new securities offered on a when-issued basis.
* 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.
MUNICIPAL LEASE OBLIGATIONS
We may invest a Fund's assets in a variety of instruments commonly referred to
as municipal lease obligations, including leases and certificates of
participation in such leases and contracts.
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.
ILLIQUID SECURITIES
We may invest up to 15% of the Long-Term, Intermediate-Term, and Short-Term
Funds' net assets and up to 10% of the Tax Exempt Money Market Fund's net
assets in securities that are illiquid. Illiquid securities are those
securities which cannot be disposed of in the ordinary course of business,
seven days or less, at approximately the same value at which the Fund has
valued the securities.
Lease obligations and certain put bonds subject to restrictions on transfer may
be determined to be liquid in accordance with the guidelines established by the
Funds' Board of Directors.
In determining the liquidity of a lease obligation, we 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 we may
determine to be relevant to such determination.
In determining the liquidity of put bonds with restrictions on transfer, we
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.
36
<PAGE>
APPENDIX B
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%
-------------------------------------------------------------------------------
2.50% 3.47% 3.62% 3.91% 4.14%
-------------------------------------------------------------------------------
3.00% 4.17% 4.35% 4.69% 4.97%
-------------------------------------------------------------------------------
3.50% 4.86% 5.07% 5.47% 5.79%
-------------------------------------------------------------------------------
4.00% 5.56% 5.80% 6.25% 6.62%
-------------------------------------------------------------------------------
4.50% 6.25% 6.52% 7.03% 7.45%
-------------------------------------------------------------------------------
5.00% 6.94% 7.25% 7.81% 8.28%
-------------------------------------------------------------------------------
5.50% 7.64% 7.97% 8.59% 9.11%
-------------------------------------------------------------------------------
6.00% 8.33% 8.70% 9.38% 9.93%
-------------------------------------------------------------------------------
6.50% 9.03% 9.42% 10.16% 10.76%
-------------------------------------------------------------------------------
7.00% 9.72% 10.14% 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 EXAMPLES THAT WOULD BE RELEVANT TO MOST TAXPAYERS.
FOR A FURTHER EXPLANATION ON CALCULATING TAX-EQUIVALENT YIELDS, SEE THE FUNDS'
STATEMENT OF ADDITIONAL INFORMATION.
37
<PAGE>
APPENDIX C
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 you with the opportunity to formulate your own investment program. You
may exchange any shares you hold in any one USAA Fund for shares in any other
USAA Fund, subject to the limitations described earlier. For more complete
information about the mutual funds managed and distributed by USAA Investment
Management Company, including charges and operating expenses, call us for a
Prospectus. Read it carefully before you invest. Mutual fund operating expenses
apply and continue throughout the life of the Fund.
FUND TYPE/NAME RISK
==============================================
CAPITAL APPRECIATION
----------------------------------------------
Aggressive Growth Very high
Emerging Markets Very high
First Start Growth Moderate to high
Gold Very high
Growth Moderate to high
Growth & Income Moderate
International Moderate to high
S&P 500 Index Moderate
Science & Technology Very high
Small Cap Stock Very high
World Growth Moderate to high
----------------------------------------------
ASSET ALLOCATION
----------------------------------------------
Balanced Strategy Moderate
Cornerstone Strategy Moderate
Growth and Tax Strategy Moderate
Growth Strategy Moderate to high
Income Strategy Low to moderate
----------------------------------------------
INCOME -- TAXABLE
----------------------------------------------
GNMA Low to moderate
High-Yield Opportunities High
Income Moderate
Income Stock Moderate
Intermediate-Term Bond Low to moderate
Short-Term Bond Low
----------------------------------------------
INCOME -- TAX EXEMPT
----------------------------------------------
Long-Term Moderate
Intermediate-Term Low to moderate
Short-Term Low
State Bond/Income Moderate
----------------------------------------------
MONEY MARKET
----------------------------------------------
Money Market Low
Tax Exempt Money Market Low
Treasury Money Market Trust Low
State Money Market Low
==============================================
FOREIGN INVESTING IS SUBJECT TO ADDITIONAL RISKS, SUCH AS CURRENCY
FLUCTUATIONS, MARKET ILLIQUIDITY, AND POLITICAL INSTABILITY.
S&P(R) 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.
SOME INCOME MAY BE SUBJECT TO STATE OR LOCAL TAXES.
CALIFORNIA, FLORIDA, NEW YORK, AND VIRGINIA FUNDS ARE OFFERED ONLY TO
RESIDENTS OF THOSE STATES.
AN INVESTMENT IN A MONEY MARKET FUND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE
THE VALUE OF YOUR INVESTMENT AT $1 PER SHARE, IT IS POSSIBLE TO LOSE MONEY
BY INVESTING IN THE FUND.
THE SCIENCE & TECHNOLOGY FUND MAY BE MORE VOLATILE THAN A FUND THAT
DIVERSIFIES ACROSS MANY INDUSTRIES.
38
<PAGE>
NOTES
39
<PAGE>
If you would like more information about the Funds, you may call 1-800-531-8181
to request a free copy of the Funds' Statement of Additional Information (SAI),
Annual or Semiannual Reports, or to ask other questions about the Funds. The
SAI has been filed with the Securities and Exchange Commission (SEC) and is
legally a part of this Prospectus. In the Funds' Annual Report, you will find
a discussion of the market conditions and investment strategies that
significantly affected each Fund's performance during the last fiscal year.
To view these documents, along with other related documents, you can visit the
EDGAR database on the SEC's Internet web site (www.sec.gov) or the Commission's
Public Reference Room in Washington, D.C. Information on the operation of the
Public Reference room can be obtained by calling 1-202-942-8090. Additionally,
copies of this information can be obtained, after paying a duplicating fee, by
electronic request at the e-mail address: [email protected] or by writing the
Public Reference Section of the Commission, Washington, D.C. 20549-0102.
===============================================================================
INVESTMENT ADVISER, UNDERWRITER, AND DISTRIBUTOR
USAA Investment Management Company
9800 Fredericksburg Road
San Antonio, Texas 78288
------------------------------------------------------------
TRANSFER AGENT CUSTODIAN
USAA Shareholder Account Services State Street Bank and Trust Company
9800 Fredericksburg Road P.O. Box 1713
San Antonio, Texas 78288 Boston, Massachusetts 02105
------------------------------------------------------------
TELEPHONE ASSISTANCE HOURS
Call toll free - Central Time
Monday - Friday 6:00 a.m. to 10:00 p.m.
Saturday 8:30 a.m. to 5:00 p.m.
Sunday 11:30 a.m. to 8:00 p.m.
------------------------------------------------------------
FOR ADDITIONAL INFORMATION ON MUTUAL FUNDS
1-800-531-8181 (in San Antonio, 456-7200)
For account servicing, exchanges, or redemptions
1-800-531-8448 (in San Antonio, 456-7202)
------------------------------------------------------------
RECORDED MUTUAL FUND PRICE QUOTES
24-Hour Service (from any phone)
1-800-531-8066 (in San Antonio, 498-8066)
------------------------------------------------------------
MUTUAL FUND USAA TOUCHLINE(R)
(from touch-tone phones only)
For account balance, last transaction, fund prices,
or to exchange/redeem fund shares
1-800-531-8777 (in San Antonio, 498-8777)
------------------------------------------------------------
INTERNET ACCESS
usaa.com(SM)
===============================================================================
Investment Company Act File no. 811-3333
<PAGE>
Part A
Prospectus for the
California Bond and
California Money Market Funds
<PAGE>
USAA CALIFORNIA FUNDS
USAA CALIFORNIA BOND FUND
USAA CALIFORNIA MONEY MARKET FUND
PROSPECTUS
AUGUST 1, 2000
Shares of the California Funds are offered only to California residents. The
delivery of this Prospectus is not an offer in any state where shares of the
California Funds may not lawfully be made.
As with other mutual funds, the Securities and Exchange Commission has not
approved or disapproved of either of these Fund's shares or determined whether
this Prospectus is accurate or complete. Anyone who tells you otherwise is
committing a crime.
TABLE OF CONTENTS
What Are Each Fund's Investment Objectives and Main Strategies?......... 2
Main Risks of Investing in These Funds.................................. 2
Are These Funds for You?................................................ 3
Could the Value of Your Investment in These Funds Fluctuate?............ 4
Fees and Expenses....................................................... 8
Fund Investments........................................................ 9
Fund Management......................................................... 19
Using Mutual Funds in an Investment Program............................. 20
How to Invest........................................................... 22
Important Information About Purchases and Redemptions................... 26
Exchanges............................................................... 27
Shareholder Information................................................. 27
Financial Highlights.................................................... 31
Appendix A ............................................................. 33
Appendix B ............................................................. 36
Appendix C.............................................................. 37
1
<PAGE>
USAA Investment Management Company manages these Funds. For easier reading,
USAA Investment Management Company will be referred to as "we" or "us"
throughout the Prospectus.
WHAT ARE EACH FUND'S INVESTMENT
OBJECTIVES AND MAIN STRATEGIES?
Each Fund has 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 dollar-weighted average portfolio
maturity is not restricted, but is expected to be greater than ten years.
The CALIFORNIA MONEY MARKET FUND invests in high-quality, California tax-exempt
securities with maturities of 397 days or less.
Because any investment involves risk, there is no assurance that the Funds'
objectives will be achieved. See FUND INVESTMENTS on page 9 for more
information.
MAIN RISKS OF INVESTING IN THESE FUNDS
The two primary risks of investing in these Funds are credit risk and market
risk. As with other mutual funds, losing money is also a risk of investing in
these Funds.
* CREDIT RISK involves the possibility that a borrower cannot make timely
interest and principal payments on its securities.
* MARKET RISK involves the possibility that the value of each Fund's
investments will decline because of an increase in interest rates, or to
adverse changes in supply and demand for municipal securities, or other
market factors.
The credit and market risks may be magnified because each Fund concentrates in
California tax-exempt securities.
IF INTEREST RATES INCREASE: the yield of each Fund may increase and the market
value of the California Bond Fund's securities will likely decline, adversely
affecting the net asset value and total return.
2
<PAGE>
IF INTEREST RATES DECREASE: the yield of each Fund may decrease and the market
value of the California Bond Fund's securities may increase, which would likely
increase the Fund's net asset value and total return. The California Money
Market Fund's total return may decrease.
Other risks of investing in either Fund include call risk and structural risk.
As you consider an investment in either Fund, you should also take into account
your tolerance for the daily fluctuations of the financial markets and whether
you can afford to leave your money in the investment for long periods of time
to ride out down periods.
An investment in either Fund is not a deposit of USAA Federal Savings Bank, or
any other bank, and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency. Although the California
Money Market Fund seeks to preserve the value of your investment at $1 per
share, it is possible to lose money by investing in that Fund.
Look for this symbol [CAUTION LIGHT GRAPHIC] throughout the Prospectus. We use
it to mark more detailed information about the risks you will face as a Fund
shareholder.
ARE THESE FUNDS FOR YOU?
California Bond Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are looking for current income that is exempt from California State
and federal income taxes.
* You are willing to accept moderate risk.
* You are looking for an investment in bonds to balance your stock portfolio.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You are unwilling to take greater risk for intermediate-term goals.
* Your current tax situation does not allow you to benefit from tax-exempt
income.
* You are seeking an appropriate investment for an IRA, through a 401(k)
plan or 403(b) plan, or other tax-sheltered account.
3
<PAGE>
California Money Market Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are looking for current income that is exempt from California State
and federal income taxes.
* You need to preserve principal.
* You want a low-risk investment.
* You need your money back within a short period.
* You would like checkwriting privileges on the account.
* You are looking for an investment in a money market fund to balance your
stock or long-term bond portfolio.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You need a high total return to achieve your goals.
* Your primary goal is long-term growth.
* Your current tax situation does not allow you to benefit from tax-exempt
income.
Either Fund by itself does not constitute a balanced investment program.
Diversifying your investments may improve your long-run investment return and
lower the volatility of your overall investment portfolio.
COULD THE VALUE OF YOUR INVESTMENT
IN THESE FUNDS FLUCTUATE?
Yes, it could. In fact, the value of your investment in the California Bond
Fund will fluctuate with the changing market values of the investments in the
Fund. We manage the California Money Market Fund in accordance with strict
Securities and Exchange Commission (SEC) guidelines designed to preserve the
Fund's value at $1 per share, although, of course, we cannot guarantee that the
value will remain at $1 per share.
The value of the securities in which the California Bond Fund invests typically
fluctuates inversely with changes in the general level of 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. The following bar charts illustrate the Funds' volatility
and performance from year to year for each full calendar year over the past ten
years.
4
<PAGE>
TOTAL RETURN
All mutual funds must use the same formula to calculate total return.
California Bond Fund
[SIDE BAR]
TOTAL RETURN MEASURES THE PRICE CHANGE IN A SHARE ASSUMING THE REINVESTMENT OF
ALL DIVIDEND INCOME AND CAPITAL GAIN DISTRIBUTIONS.
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1990 8.17%
1991 10.90%
1992 8.29%
1993 12.74%
1994 -9.32%
1995 21.85%
1996 5.39%
1997 10.33%
1998 6.89%
1999 -5.22%
THE CALIFORNIA BOND FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD ENDED
JUNE 30, 2000, WAS 5.36%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 9.55% (quarter ending March 31, 1995) and the lowest total return
for a quarter was -7.06% (quarter ending March 31, 1994).
The table below shows how the Fund's average annual total returns for the one-,
five-, and ten-year periods, as well as the life of the Fund, compared to those
of a broad-based securities market index. Remember, historical performance does
not necessarily indicate what will happen in the future.
================================================================
Average Annual
Total Returns
(for the periods ending Past Past Past Life of
December 31, 1999) 1 Year 5 Years 10 Years Fund
----------------------------------------------------------------
California Bond Fund -5.22% 7.50% 6.66% 6.53%
----------------------------------------------------------------
Lehman Brothers
Municipal Bond Index* -2.06% 6.91% 6.89% 6.87%
================================================================
* THE LEHMAN BROTHERS MUNICIPAL BOND INDEX IS AN UNMANAGED BENCHMARK OF TOTAL
RETURN PERFORMANCE FOR THE LONG-TERM, INVESTMENT-GRADE, TAX-EXEMPT BOND
MARKET.
5
<PAGE>
California Money Market Fund
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1990 5.60%
1991 4.39%
1992 2.91%
1993 2.26%
1994 2.58%
1995 3.64%
1996 3.27%
1997 3.35%
1998 3.17%
1999 2.82%
THE CALIFORNIA MONEY MARKET FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD
ENDED JUNE 30, 2000, WAS 1.58%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 1.46% (quarter ending December 31, 1990) and the lowest total
return for a quarter was .51% (quarter ending March 1, 1994).
The table below shows the Fund's average annual total returns for the one-,
five-, and ten-year periods, as well as the life of the Fund. Remember,
historical performance does not necessarily indicate what will happen in the
future.
=================================================================
Average Annual
Total Returns
(for the periods ending Past Past Past Life of
December 31, 1999) 1 Year 5 Years 10 Years Fund
-----------------------------------------------------------------
California Money
Market Fund 2.82% 3.25% 3.39% 3.49%
=================================================================
YIELD
[SIDE BAR]
YIELD IS THE ANNUALIZED NET INCOME OF THE FUND DURING A SPECIFIED PERIOD AS A
PERCENTAGE OF THE FUND'S SHARE PRICE.
All mutual funds must use the same formulas to calculate yield and effective
yield.
California Bond Fund
The California Bond Fund may advertise performance in terms of a 30-day yield
quotation or a tax-equivalent yield. The Fund's 30-day yield for the period
ended December 31, 1999, was 5.11%.
6
<PAGE>
California Money Market Fund
[SIDE BAR]
EFFECTIVE YIELD IS CALCULATED SIMILAR TO THE YIELD, HOWEVER WHEN ANNUALIZED THE
INCOME EARNED IS ASSUMED TO BE REINVESTED.
The California Money Market Fund typically advertises performance in terms of a
7-day yield and effective yield or tax-equivalent yield and may advertise total
return. The 7-day yield quotation more closely reflects current earnings of the
Fund than the total return quotation. The effective yield will be slightly
higher than the yield because of the compounding effect of the assumed
reinvestment. Current yields 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. The Fund's 7-day yield for the period
ended December 31, 1999, was 3.75%.
TAX-EQUIVALENT YIELD
Investors use tax-equivalent yields to compare taxable and tax-exempt fixed
income investments using a common yield measure. The tax-equivalent yield is
the yield that a fully taxable investment must generate to earn the same
"take-home" yield as a tax-exempt investment. The calculation depends upon your
federal and California marginal income tax rates and assumes that an investor
can fully itemize deductions on his or her federal tax return. The higher your
marginal tax bracket, the higher will be the tax-equivalent yield and the more
valuable is the Fund's tax exemption.
For example, if you assume a federal marginal tax rate of 36% and a state
marginal tax rate of 9.30%, the Effective Marginal Tax Rate would be 41.95%.
Using this tax rate, the Funds' tax-equivalent yields for the period ending
December 31, 1999, would be as follows:
=============================================================
Tax-Equivalent
Yield Yield
-------------------------------------------------------------
California Bond Fund (30 day) 5.11% 8.80%
California Money Market Fund (7 day) 3.75% 6.46%
=============================================================
Using the example, to exceed the 30-day yield of the California Bond Fund on an
after-tax basis, you must find a fully taxable investment that yields more than
8.80%. Likewise, to exceed the 7-day yield of the California Money Market Fund,
you must find a fully taxable investment that yields more than 6.46%.
For more information on calculating tax-equivalent yields, see APPENDIX B on
page 36.
7
<PAGE>
[SIDE BAR]
[TOUCHLINE GRAPHIC]
TouchLine(R)
1-800-531-8777
PRESS
1
THEN
1
THEN
6, 1, #
Please consider performance information in light of the Funds' investment
objectives and policies and market conditions during the reported time periods.
The value of your shares may go up or down. For the most current price, yield,
and return information for these Funds, you may call USAA TouchLine(R) at
1-800-531-8777. Press 1 for the Mutual Fund Menu, press 1 again for prices,
yields, and returns. Then, press 60# for the California Bond Fund or press 61#
for the California Money Market Fund when asked for a Fund Code. You may also
access this information through our usaa.com(SM) Internet web site once your
account has been established.
[SIDE BAR]
California
Bond Fund
Newspaper
Symbol
CA Bd
Ticker
Symbols
USCBX
UCAXX
Additionally, you may find the most current price of your shares in the
business section of your newspaper in the mutual fund section under the heading
"USAA Group" and the symbol "CA Bd" for the California Bond Fund. If you prefer
to obtain this information from an on-line computer service, you can do so by
using the ticker symbol "USCBX" for the California Bond Fund or the ticker
symbol "UCAXX" for the California Money Market Fund.
FEES AND EXPENSES
This summary shows what it will cost you, directly and indirectly, to invest in
the Funds.
Shareholder Transaction Expenses-- (Direct Costs)
There are no fees or sales loads charged to your account when you buy or sell
Fund shares. However, if you sell shares and request your money by wire
transfer, there is a $12 domestic wire fee and a $35 foreign wire fee. (Your
bank may also charge a fee for receiving wires.)
Annual Fund Operating Expenses-- (Indirect Costs)
Fund expenses come out of the Funds' assets and are reflected in the Funds'
share prices and dividends. "Other Expenses" include expenses such as custodian
and transfer agent fees. The figures below show actual expenses during the past
fiscal year ended March 31, 2000, and are calculated as a percentage of average
net assets.
=================================================================
California California Money
Bond Fund Market Fund
-----------------------------------------------------------------
Management Fees .31% .31%
Distribution (12b-1) Fees None None
Other Expenses .08% .10%
---- ----
Total Annual Fund Operating Expenses .39% .41%
==== ====
=================================================================
[SIDE BAR]
12b-Fees- SOME MUTUAL FUNDS CHARGE THESE FEES TO PAY FOR ADVERTISING AND OTHER
COSTS OF SELLING FUND SHARES.
8
<PAGE>
Example of Effect of the Funds' Operating Expenses
This example is intended to help you compare the cost of investing in one of
the Funds with the cost of investing in other mutual funds. Although your
actual costs may be higher or lower, you would pay the following expenses on a
$10,000 investment, assuming (1) 5% annual return, (2) the Fund's operating
expenses remain the same, and (3) you redeem all of your shares at the end of
those periods shown.
=========================================================
California California Money
Bond Fund Market Fund
---------------------------------------------------------
1 year $ 40 $ 42
3 years 125 132
5 years 219 230
10 years 493 518
=========================================================
FUND INVESTMENTS
Principal Investment Strategies and Risks
Q What is each Fund's principal investment strategy?
A Each Fund's principal strategy is the investment of its assets in
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.
These securities include municipal debt obligations that have been
issued by California and its political subdivisions, and duly
constituted state and local authorities and corporations. We refer to
these securities as California tax-exempt securities. California
tax-exempt securities are issued to fund public infrastructure projects
such as streets and highways, schools, water and sewer systems,
hospitals, and airports. They 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.
Because the projects benefit the public, Congress has granted exemption
from federal income taxes for the interest income arising from these
securities. Likewise, the California Legislature has granted an
exemption from state personal income taxes for most California municipal
securities.
9
<PAGE>
Q What types of tax-exempt securities will be included in each Fund's
portfolio?
A Each Fund's assets may be invested in any of the following tax-exempt
securities:
* 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;
* SYNTHETIC INSTRUMENTS, which combine a municipality's long-term
obligation to pay interest and principal with the obligation of a
third party to repurchase the instrument on short notice; and
* INDUSTRIAL DEVELOPMENT BONDS issued by or on behalf of public
authorities to obtain funds for privately operated facilities.
As a temporary defensive measure because of market, economic, political,
or other conditions, we may invest up to 100% of each Fund's assets in
short-term securities whether or not they are exempt from federal income
tax and California State taxes. To the extent that these temporary
investments produce taxable income, that income may result in that Fund
not fully achieving its investment objective during the time it is in
this temporary defensive posture.
Q What are the principal risks associated with investments in tax-exempt
securities?
A The two principal risks of investing in tax-exempt securities are credit
risk and market risk.
[CAUTION LIGHT GRAPHIC]
CREDIT RISK. The bonds in each Fund's portfolio are subject to credit
risk. Credit risk is the possibility that an issuer of a fixed income
security will fail to make timely payments of interest or principal. We
attempt to minimize the Funds' credit risks by investing in securities
considered at least investment grade at the time of purchase.
Nevertheless, even investment-grade securities are subject to some
credit risk. In addition, the ratings of
10
<PAGE>
securities are estimates by the rating agencies of the credit quality of
the securities. The ratings may not take into account every risk
related to whether interest or principal will be repaid on a timely
basis.
When evaluating potential investments for the Funds, our analysts also
independently assess credit risk and its impact on the Funds'
portfolios. Securities in the lowest investment grade ratings category
(BBB) have speculative characteristics. Changes in economic conditions
or other circumstances are more likely to lead to a weakened capability
to make principal and interest payments on these securities than is the
case for higher-rated securities.
[CAUTION LIGHT GRAPHIC]
MARKET RISK. As a mutual fund investing in bonds, the Funds are subject
to the risk that the market value of the bonds will decline because of
rising interest rates. Bond prices are linked to the prevailing market
interest rates. In general, when interest rates rise, bond prices fall
and when interest rates fall, bond prices rise. The price volatility of
a bond also depends on its maturity. Generally, the longer the maturity
of a bond, the greater its sensitivity to interest rates. To compensate
investors for this higher market risk, bonds with longer maturities
generally offer higher yields than bonds with shorter maturities.
Q What other risks are associated with investments in tax-exempt
securities?
A Two other risks that are applicable to certain tax-exempt securities are
call risk and structural risk.
[CAUTION LIGHT GRAPHIC]
CALL RISK. Many municipal bonds may be "called," or redeemed, by the
issuer before the stated maturity. During a period of declining interest
rates, an issuer would call, or refinance, a higher yielding bond for
the same reason that a homeowner would refinance a home mortgage.
Interest rates must drop sufficiently so that the savings more than
offset the cost of refinancing.
Intermediate- and long-term municipal bonds have the greatest call risk,
because most municipal bonds may not be called until after ten years
from the date of issue. The period of "call protection" may be longer or
shorter than ten years, but regardless, bonds purchased closest to the
date of issue will have the most call protection. Typically, bonds with
original maturities of ten years or less are not callable.
11
<PAGE>
Although investors certainly appreciate the rise in bond prices when
interest rates drop, falling interest rates create the environment
necessary to "call" the higher-yielding bonds from your Fund. When bonds
are called, the Fund is impacted in several ways. Most likely, we must
reinvest the bond-call proceeds at lower interest rates. The Fund's
income may drop as a result. The Fund may also realize a taxable capital
gain.
[CAUTION LIGHT GRAPHIC]
STRUCTURAL RISK. Some tax-exempt securities, referred to as "synthetic
instruments," are created by combining a long-term municipal bond with a
right to sell the instrument back to the remarketer or liquidity
provider for repurchase on short notice, referred to as a "tender
option." Usually, the tender option is backed by a letter of credit or
similar guarantee from a bank. The guarantee, however, is typically
conditional, which means that the bank is not required to pay under the
guarantee if there is a default by the municipality or if certain other
events occur. These types of instruments involve special risks, referred
to as "structural risk." For example, because of the structure of a
synthetic instrument, there is a risk that the instrument will lose its
tax-exempt treatment or that we will not be able to exercise our tender
option. We will not purchase a synthetic instrument unless counsel has
issued an opinion that the instrument is entitled to tax-exempt
treatment. In addition, we will not purchase a synthetic instrument for
the California Money Market Fund unless we believe there is only minimal
risk that we will not be able to exercise our tender option at all
times.
Q What percentage of each Fund's assets will be invested in California
tax-exempt securities?
A During normal market conditions, at least 80% of each Fund's net assets
will consist of California tax-exempt securities. This policy may only
be changed by a shareholder vote.
In addition to California tax-exempt securities, securities issued by
certain U.S. territories and possessions such as Puerto Rico, the Virgin
Islands, and Guam are exempt from federal and state personal income
taxes; and as such, we may consider investing up to 20% of each Fund's
assets in these securities.
12
<PAGE>
Q Are each Fund's investments diversified in many different issuers?
A Each Fund is considered diversified under the federal securities laws.
This means we will not invest more than 5% in any one issuer with
respect to 75% of each Fund's assets. With respect to the remaining 25%
of each Fund's assets, we could invest more than 5% in any one, or more,
issuers. Purchases of securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities are not counted toward
the 5% limitation. Each Fund, of course, is concentrated geographically
through the purchase of California tax-exempt securities.
With respect to the California Money Market Fund, strict SEC guidelines
do not permit us to invest, with respect to 75% of the Fund's assets,
greater than 10% of the Fund's assets in securities issued by or subject
to guarantees by the same institution.
We also may not invest more than 25% of the Funds' 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
that are based, directly or indirectly, on the credit of private
entities of any one industry. However, we reserve the right to invest
more than 25% of the Funds' assets in tax-exempt industrial revenue
bonds. The 25% industry limitation does not apply to general obligation
bonds or bonds that are escrowed in U.S. government securities.
[CAUTION LIGHT GRAPHIC]
Q What are the potential risks associated with concentrating such a large
portion of each Fund's assets in one state?
A The Funds are subject to credit and market risks, as previously
described, which could be magnified by the Funds' concentration in
California issues. California tax-exempt securities may be affected by
political, economic, regulatory, or other developments that limit the
ability of California issuers to pay interest or repay principal in a
timely manner. Therefore, the Funds are affected by events within
California to a much greater degree than a more diversified national
fund.
A particular development may not directly relate to the Funds'
investments but nevertheless might depress the entire market for the
state's tax-exempt securities and therefore adversely impact the Funds'
valuation.
13
<PAGE>
An investment in the California Funds may be riskier than an investment
in other types of tax-exempt funds because of this concentration.
The following are examples of just some of the events that may depress
valuations for California tax-exempt securities for an extended period
of time:
* Changes in state laws, including voter referendums, that restrict
revenues or raise costs for issuers.
* Court decisions that affect a category of municipal bonds, such as
municipal lease obligations or electric utilities.
* Natural disasters such as floods, storms, hurricanes, droughts,
fires, or earthquakes.
* Bankruptcy or financial distress of a prominent municipal issuer
within the state.
* Economic issues that impact critical industries or large employers or
that weaken real estate prices.
* Reductions in federal or state financial aid.
* Imbalance in the supply and demand for the state's municipal
securities.
* Developments that may change the tax treatment of California
tax-exempt securities.
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
tax-exempt securities are summarized in the Statement of Additional
Information under SPECIAL RISK CONSIDERATIONS.
Q Do the Funds purchase bonds guaranteed by bond insurance?
A Yes. Some of the bonds we purchase for the Funds are secured by bond
insurance that guarantees scheduled principal and interest payments. In
addition, we may purchase bond insurance for individual uninsured
securities when we believe it will provide a net economic benefit to the
shareholders.
14
<PAGE>
Q Will any portion of the distributions from the Funds be subject to
federal income taxes?
A During normal market conditions, at least 80% of each Fund's annual
income will be excluded from gross income for federal income tax
purposes and will be exempt from California State income taxes. This
policy may only be changed by a shareholder vote. We expect that any
taxable interest income distributed will be minimal.
However, gains and losses from trading securities that occur during the
normal course of managing a fund may create net capital gain
distributions. The Internal Revenue Code presently treats these
distributions differently than tax-exempt interest income in the
following ways:
* Distributions of net short-term capital gains are taxable as ordinary
income.
* Distributions of net long-term capital gains are taxable as long-term
capital gains, regardless of the length of time you have held the
Fund shares
* Both short-term and long-term capital gains are taxable whether
received in cash or reinvested in additional shares.
Q Will income from the Funds be subject to the federal alternative minimum
tax (AMT) for individuals?
A During normal market conditions, at least 80% of each Fund's annual
income will be excluded from the calculation of the federal alternative
minimum tax (AMT) for individuals. This policy may only be changed by a
shareholder vote. Since inception, the Funds have not distributed any
income that is subject to the federal AMT for individuals, and we do not
intend to invest in securities subject to the federal AMT. However, of
course, changes in federal tax laws or other unforeseen circumstances
could result in income subject to the federal AMT for individuals.
15
<PAGE>
California Bond Fund
Q What is the credit quality of the Fund's investments?
A Under normal market conditions, we will invest the Fund's assets so that
at least 50% of the total market value of the tax-exempt securities are
rated within the three highest long-term rating categories (A or higher)
by Moody's Investors Service (Moody's), Standard & Poor's Ratings Group
(S&P), or Fitch Information, Inc. (Fitch) or in the highest short-term
rating category by Moody's, S&P, or Fitch. If a security is not rated by
these rating agencies, we must determine that the security is of
equivalent investment quality.
In no event will we purchase a security for the Fund unless it is rated
at least investment grade at the time of purchase. Investment-grade
securities are those securities rated with in the four highest long-term
rating categories by Moody's (Baa or higher), S&P, or Fitch (BBB or
higher), or in the two highest short-term rating categories by these
rating agencies. If unrated by these agencies, we must determine that
the securities are of equivalent investment quality.
On occasion, we may purchase a credit rating on a particular security
when we believe it will provide a net economic benefit to the
shareholders.
You will find a complete description of the above tax-exempt ratings in
the Fund's Statement of Additional Information.
Q What happens if the rating of a security is downgraded below investment
grade?
A We will determine whether it is in the best interest of the Fund's
shareholders to continue to hold the security in the Fund's portfolio.
If downgrades result in more than 5% of the Fund's net assets being
invested in securities that are less than investment-grade quality, we
will take immediate action to reduce the Fund's holdings in such
securities to 5% or less of the Fund's net assets, unless otherwise
directed by the Fund's Board of Directors.
16
<PAGE>
Q How are the decisions to buy and sell securities made?
A We manage tax-exempt funds based on the common sense premise that our
investors value tax-exempt income over taxable capital gain
distributions. When weighing the decision to buy or sell a security, we
strive to balance the value of the tax-exempt income, the credit risk of
the issuer, and the price volatility of the bond.
Q What is the Fund's average portfolio maturity and how is it calculated?
A While the Fund's average portfolio maturity is not restricted, we expect
it to be greater than ten years. To determine a security's maturity for
purposes of calculating the Fund's average portfolio maturity, we may
estimate the expected time in which the security's principal is to be
paid. This can be substantially shorter than its stated final maturity.
For more information on the method of calculating the Fund's average
weighted portfolio maturity, see INVESTMENT POLICIES in the Fund's
Statement of Additional Information.
California Money Market Fund
Q What is the credit quality of the Fund's investments?
A The Fund's investments consist of securities meeting the requirements to
qualify as "eligible securities" under the SEC rules applicable to money
market funds. In general, an eligible security is defined as a security
that is:
* issued or guaranteed by the U.S. government or any agency or
instrumentality thereof, including "prerefunded" and "escrowed to
maturity" tax-exempt securities;
* rated or subject to a guarantee that is 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;
17
<PAGE>
* unrated but issued by an issuer or guaranteed by a guarantor that
has other comparable short-term debt obligations so rated; or
* unrated but determined by us to be of comparable quality.
In addition, we must consider whether a particular investment presents
minimal credit risk.
Q Who are the Nationally Recognized Statistical Rating Organizations?
A Current NRSROs include:
* Moody's Investors Service;
* Standard & Poor's Ratings Group;
* Fitch Information, Inc.; and
* Thompson BankWatch.
Q What happens if the rating of a security is downgraded?
A If the rating of a security is downgraded after purchase, we will
determine whether it is in the best interest of the Fund's shareholders
to continue to hold the security in the Fund's portfolio.
Q Will the Fund always maintain a net asset value of $1 per share?
[SIDE BAR]
DOLLAR WEIGHTED AVERAGE PORTFOLIO MATURITY IS OBTAINED BY MULTIPLYING THE
DOLLAR VALUE OF EACH INVESTMENT BY THE NUMBER OF DAYS LEFT TO ITS MATURITY,
THEN ADDING THOSE FIGURES TOGETHER AND DIVIDING THE TOTAL BY THE DOLLAR VALUE
OF THE FUND'S PORTFOLIO.
A While we will endeavor to maintain a constant Fund net asset value of $1
per share, there is no assurance that we will be able to do so.
Remember, the shares are neither insured nor guaranteed by the U.S.
government. As such, the Fund carries some risk.
For example, there is always a risk that the issuer of a security held
by the Fund will fail to pay interest or principal when due. We attempt
to minimize this credit risk by investing only in securities rated in
one of the two highest categories for short-term securities, or, if not
rated, of comparable quality, at the time of purchase. Additionally, we
will not purchase a security unless our analysts determine that the
security presents minimal credit risk.
There is also a risk that rising interest rates will cause the value of
the Fund's securities to decline. We attempt to minimize this interest
risk by limiting the maturity of each security to 397 days or less and
maintaining a dollar-weighted average portfolio maturity for the Fund of
90 days or less.
18
<PAGE>
Finally, there is the possibility that one or more investments in the
Fund cease to be "eligible securities" resulting in the net asset value
ceasing to be $1 per share. For example, a guarantor on a security
failing to meet a contractual obligation could cause such a result.
Q How are the decisions to buy and sell securities made?
A We balance factors such as credit quality and maturity to purchase the
best relative value available in the market at any given time. While
rare, a decision to sell is usually based on a change in our credit
analysis or to take advantage of an opportunity to reinvest at a higher
yield.
For additional information about other securities in which we may invest each
Fund's assets, see APPENDIX A on page 33.
FUND MANAGEMENT
USAA Investment Management Company serves as the manager and distributor of
these Funds. We are an affiliate of United Services Automobile Association
(USAA), a large, diversified financial services institution. As of the date of
this Prospectus, we had approximately $41 billion in total assets under
management. Our mailing address is 9800 Fredericksburg Road, San Antonio, TX
78288.
We provide management services to the Funds pursuant to an Advisory Agreement.
We are responsible for managing the Funds' portfolios (including placement of
brokerage orders) and their business affairs, subject to the authority of and
supervision by the Funds' Board of Directors. For our services, the Funds pay
us an annual fee. This fee, which is accrued daily and paid monthly, is
computed as a percentage of the aggregate average net assets of both Funds
combined. This fee is allocated between the Funds based on the relative net
assets of each. The fee is computed at one-half of one percent (.50%) of the
first $50 million of average net assets, two-fifths of one percent (.40%) for
that portion of average net assets over $50 million but not over $100 million,
and three-tenths of one percent (.30%) for that portion of average net assets
over $100 million. The fees we received for the fiscal year ended March 31,
2000, were equal to .31% of average net assets for the California Bond Fund and
.31% of average net assets for the California Money Market Fund. We also
provide services related to selling the Funds' shares and receive no
compensation for those services.
19
<PAGE>
Portfolio Managers
CALIFORNIA BOND FUND
[PHOTOGRAPH]
Robert R. Pariseau
Robert R. Pariseau, Assistant Vice President of Fixed Income Mutual Fund
Portfolios, has managed the Fund since May 1995.He has 16 years investment
management experience working for us. Mr. Pariseau earned the Chartered
Financial Analyst designation in 1987 and is a member of the Association for
Investment Management and Research, the San Antonio Financial Analysts Society,
Inc., and the National Federation of Municipal Analysts. He holds an MBA from
Lindenwood College and a BS from the U.S. Naval Academy.
CALIFORNIA MONEY MARKET FUND
[PHOTOGRAPH]
Regina G. Shafer
Regina G. Shafer, Assistant Vice President of Money Market Funds, has managed
the Fund since April 1999. She has five years investment management experience
and has worked for us for nine years. Ms. Shafer is a Certified Public
Accountant and earned the Chartered Financial Analyst designation in 1998.
She is a member of the Association for Investment Management and Research and
the San Antonio Financial Analysts Society, Inc. She holds an MBA from the
University of Texas at San Antonio and a BBA from Southwest Texas State
University.
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 diversified
portfolio. That portfolio is managed by investment professionals, relieving you
of the need to make individual stock or bond selections. You also enjoy
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,
you own an investment that in earlier times would have been available only to
very wealthy people.
20
<PAGE>
II. Using Funds in an Investment Program
In choosing a mutual fund as an investment vehicle, you are giving up some
investment decisions, but must still make others. The decisions you don't have
to make are those involved with choosing individual securities. We will perform
that function. In addition, we will arrange for the safekeeping of securities,
auditing the annual financial statements, and daily valuation of the Fund, as
well as other functions.
You, however, retain at least part of the responsibility for an equally
important decision. This decision involves determining a portfolio of mutual
funds that balances your investment goals with your tolerance for risk. It is
likely that this decision may include the use of more than one fund of the USAA
Family of Funds.
For example, assume you wish to pursue the higher yields usually available in
the long-term bond market, but you are also concerned about the possible price
swings of the long-term bonds. You could divide your 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 way you could combine funds
to fit your own risk and reward goals.
III. USAA's Family of Funds
We offer you another alternative with our asset strategy funds listed in
APPENDIX C under asset allocation on page 37. These unique mutual funds provide
a professionally managed, diversified investment portfolio within a mutual
fund. Designed for the individual who prefers to delegate the asset allocation
process to an investment manager, their structure achieves diversification
across a number of investment categories.
Whether you prefer to create your own mix of mutual funds or use a USAA Asset
Strategy Fund, the USAA Family of Funds provides a broad range of choices
covering just about any investor's investment objectives. Our member service
representatives stand ready to assist you with your choices and to help you
craft a portfolio to meet your needs. Refer to APPENDIX C on page 37 for a
complete list of the USAA Family of No-Load Mutual Funds.
21
<PAGE>
HOW TO INVEST
Purchase of Shares
OPENING AN ACCOUNT
You may open an account and make an investment as described below by mail, in
person, bank wire, phone, or on the Internet. A complete, signed application is
required to open your initial account. However, after you open your initial
account with us, you will not need to fill out another application to invest in
another Fund unless the registration is different.
TAX ID NUMBER
Each shareholder named on the account must provide a social security number or
tax identification number to avoid possible withholding requirements.
EFFECTIVE DATE
When you make a purchase, your purchase price will be the net asset value (NAV)
per share next determined after we receive your request in proper form. Each
Fund's NAV is determined at the close of the regular trading session (generally
4:00 p.m. Eastern Time) of the New York Stock Exchange (NYSE) each day the NYSE
is open. If we receive your request and payment prior to that time, your
purchase price will be the NAV per share determined for that day. If we receive
your request or payment after the NAV per share is calculated, the purchase
will be effective on the next business day.
If you plan to purchase Fund shares with a foreign check, we suggest you
convert your foreign check to U.S. dollars prior to investment in a Fund. This
will avoid a potential four- to six-week delay in the effective date of your
purchase. Furthermore, a bank charge may be assessed in the clearing process,
which will be deducted from the amount of the purchase.
MINIMUM INVESTMENTS
INITIAL PURCHASE
[MONEY GRAPHIC]
* $3,000
ADDITIONAL PURCHASES
* $50 (Except on transfers from brokerage accounts into the California Money
Market Fund, which are exempt from the minimum). Employees of USAA and its
affiliated companies may add to an account through payroll deduction for
as little as $25 per pay period with a $3,000 initial investment.
22
<PAGE>
HOW TO PURCHASE
MAIL
[ENVELOPE GRAPHIC]
* To open an account, send your application and check to:
USAA Investment Management Company
9800 Fredericksburg Road
San Antonio, TX 78288
* To add to your account, send your check and the deposit stub that
accompanies your Fund's transaction confirmation to the Transfer Agent:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
IN PERSON
[HANDSHAKE GRAPHIC]
* To open an account, bring your application and check to our San Antonio
investment sales and service office at:
USAA Federal Savings Bank
10750 Robert F. McDermott Freeway
San Antonio, TX 78288
BANK WIRE
[BANK WIRE GRAPHIC]
* To open or add to your 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 California Fund Name
USAA Account Number: 69384998
Shareholder(s) Name(s)
Shareholder(s) Mutual Fund Account Number
ELECTRONIC FUNDS TRANSFER (EFT)
[CALENDAR GRAPHIC]
* Additional purchases on a regular basis can be deducted from a bank
account, paycheck, income-producing investment, or USAA money market fund
account. Sign up for these services when opening an account or call
1-800-531-8448 to add these services.
PHONE 1-800-531-8448 (IN SAN ANTONIO, 456-7202)
[TELEPHONE GRAPHIC]
* If you have an existing USAA mutual fund account and would like to open a
new account or exchange to another USAA Fund, call for instructions. To
open an account by phone, the new account must have the same registration
as your existing account.
23
<PAGE>
USAA TOUCHLINE(R)1-800-531-8777 (IN SAN ANTONIO, 498-8777)
[TOUCHLINE GRAPHIC]
* In addition to obtaining account balance information, last transactions,
current fund prices, and return information for your Fund, you can use
USAA TouchLine(R) from any touch-tone phone to access your Fund account to
make selected purchases, exchange to another USAA Fund, or make
redemptions. This service is available with an Electronic Services
Agreement (ESA) and EFT Buy/Sell authorization on file.
INTERNET ACCESS - USAA.COM(SM)
[COMPUTER GRAPHIC]
* You can use your personal computer to perform certain mutual fund
transactions by accessing our web site. To establish access to your
account, you will need to call 1-800-461-3507 to obtain a registration
number and personal identification number (PIN). Once you have established
Internet access to your account, you will be able to open a new mutual
fund account within an existing registration, exchange to another USAA
Fund, make redemptions, review account activity, check balances, and more.
To place orders by Internet, an ESA and EFT Buy/Sell authorization must be
on file.
Redemption of Shares
You may redeem Fund shares by any of the methods described below on any day the
NAV per share is calculated. Redemptions are effective on the day instructions
are received in a manner as described below. However, if instructions are
received after the NAV per share calculation (generally 4:00 p.m. Eastern
Time), your redemption will be effective on the next business day.
We will send you your money within seven days after the effective date of
redemption. Payment for redemption of shares purchased by EFT or check is sent
after the EFT or check 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. For federal
income tax purposes, a redemption is a taxable event; and as such, you may
realize a capital gain or loss. Such capital gains or losses are based on the
difference between your cost basis in the shares and the price received upon
redemption.
In addition, the Funds may elect to suspend the redemption of shares or
postpone the date of payment in limited circumstances.
24
<PAGE>
HOW TO REDEEM
MAIL, IN PERSON, FAX, TELEGRAM, TELEPHONE, TOUCHLINE(R), OR INTERNET
[FAX MACHINE GRAPHIC]
* Send your written instructions to:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
* Visit a member service representative at our San Antonio investment sales
and service office at USAA Federal Savings Bank.
* Send a signed fax to 1-800-292-8177, or send a telegram to USAA
Shareholder Account Services.
* Call toll free 1-800-531-8448 (in San Antonio, 456-7202) to speak with a
member service representative.
* Call toll free 1-800-531-8777 (in San Antonio, 498-8777) to access our
24-hour USAA TouchLine(R) service.
* Access our Internet web site at usaa.com(SM).
Telephone redemption privileges are 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. Before
any discussion regarding your account, the following information is obtained:
(1) USAA number and/or account number, (2) the name(s) on the account
registration, and (3) social security/tax identification number or date of
birth of the registered account owner(s) for the account registration.
Additionally, all telephone communications with you are recorded and
confirmations of account transactions are sent to the address of record. If you
were issued stock certificates for your shares, redemption by telephone, fax,
telegram, or Internet is not available.
CHECKWRITING
[CHECKBOOK GRAPHIC]
* Checks can be issued for your California Money Market Fund account. Return
a signed signature card, which accompanies your application, or request a
signature card separately and return it to:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
You will not be charged for the use of checks or any subsequent reorders. Your
checkwriting privilege is subject to State Street Bank and Trust Company's
rules and regulations governing checking accounts. You may write checks in the
amount of $250 or more. Checks written for less than $250 will be returned
unpaid. Because the value of your account changes daily as dividends accrue,
you may not write a check to close your account.
25
<PAGE>
IMPORTANT INFORMATION ABOUT
PURCHASES AND REDEMPTIONS
INVESTOR'S GUIDE to USAA Mutual Fund Services
[INVESTORS GUIDE GRAPHIC]
Upon your initial investment with us, you will receive the INVESTOR'S GUIDE to
help you get the most out of your USAA mutual fund account and to assist you in
your role as an investor. In the INVESTOR'S GUIDE, you will find additional
information on purchases, redemptions, and methods of payment. You will also
find in-depth information on automatic investment plans, shareholder statements
and reports, and other useful information.
Account Balance
USAA Shareholder Account Services (SAS), the Funds' transfer agent, may assess
annually a small balance account fee of $12 to each shareholder account with a
balance of less than $2,000 at the time of assessment. The fee will reduce
total transfer agency fees paid by the Fund to SAS. 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/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).
Fund Rights
Each Fund reserves the right to:
* reject purchase or exchange orders when in the best interest of the Fund;
* limit or discontinue the offering of shares of the Fund without notice to
the shareholders;
* 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); however, this 1%
charge will not be imposed upon shareholders unless authorized by the
Fund's Board of Directors and the required notice has been given to
shareholders;
* require a signature guarantee for transactions or changes in account
information in those instances where the appropriateness of a signature
authorization is in question (the Statement of Additional Information
contains information on acceptable guarantors);
* redeem an account with less than 50 full shares, with certain limitations.
26
<PAGE>
EXCHANGES
Exchange Privilege
The exchange privilege is automatic 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 the shares to be acquired are
offered in your state of residence. Only California residents may exchange into
a California Fund. Exchanges made through USAA TouchLine(R) and the Internet
require an ESA and EFT Buy/Sell authorization on file. After we receive the
exchange orders, the Funds' transfer agent will simultaneously process exchange
redemptions and purchases at the share prices next determined. The investment
minimums applicable to share purchases also apply to exchanges. For federal
income tax purposes, an exchange between Funds is a taxable event; and as such,
you may realize a capital gain or loss. Such capital gains or losses are based
on the difference between your cost basis in the shares and the price received
upon exchange.
The Funds have undertaken certain procedures regarding telephone transactions
as described on page 25.
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. The limit on
exchanges out of any Fund in the USAA Family of Funds for each account is six
per calendar year (except 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). However, each Fund reserves the right to reject a
shareholder's purchase or exchange orders into a Fund at any time when in the
best interest of the Fund.
SHAREHOLDER INFORMATION
Share Price Calculation
[SIDE BAR]
NAV PER SHARE
EQUALS
TOTAL ASSETS
MINUS
LIABILITIES
DIVIDED BY
# OF SHARES
OUTSTANDING
The price at which you purchase and redeem Fund shares is equal to the net
asset value (NAV) per share determined on the effective date of the purchase or
redemption. You may buy and sell Fund shares at the NAV per share without a
sales charge. Each Fund's NAV per share is calculated at the close of the
regular trading session of the NYSE, which is usually 4:00 p.m. Eastern Time.
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 Fund's
Board of Directors. Securities that cannot be valued by the pricing
27
<PAGE>
service, and all other assets, are valued in good faith at fair value using
methods we have determined under the general supervision of the Fund's Board of
Directors. In addition, securities with maturities of 60 days or less and all
securities of the California Money Market Fund are stated at amortized cost,
which approximates market value.
For additional information on how securities are valued, see VALUATION OF
SECURITIES in the Funds' Statement of Additional Information.
Dividends and Distributions
Net investment income of each Fund is accrued daily and paid on the last
business day of the month. Dividends shall begin accruing on shares purchased
the day following the effective date and shall continue to accrue to the
effective date of redemption. Any net capital gain distribution usually occurs
within 60 days of the March 31 fiscal year end, which would be somewhere around
the end of May. The Funds will make additional payments to shareholders, if
necessary, to avoid the imposition of any federal income or excise tax.
We will automatically reinvest all income dividends and capital gain
distributions in the Fund unless you instruct us differently. The share price
will be the NAV of the Fund shares computed on the ex-dividend date. Any
capital gain distributions paid by the California Bond Fund will reduce the NAV
per share by the amount of the dividend or distribution on the ex-dividend
date. You should consider carefully the effects of purchasing shares of the
California Bond Fund shortly before any capital gain distribution. Some or all
of these distributions are subject to taxes. If you become a resident of a
state other than California, we will mail a check for proceeds of income
dividends to you monthly.
We will invest any dividend or distribution payment returned to us in your
account at the then-current NAV per share. Dividend and distribution checks
become void six months from the date on the check. The amount of the voided
check will be invested in your account at the then-current NAV per share.
Federal Taxes
This tax information is quite general and refers to the federal income tax
provisions in effect as of the date of this Prospectus. While we manage the
Funds so that at least 80% of each Fund's annual income will be exempt from
federal or state income taxes, we may invest up to 20% of the Funds' assets in
securities that generate income not exempt from federal or state income taxes.
Because interest income may be exempt for federal income tax purposes, it does
not necessarily mean that the interest income may be
28
<PAGE>
exempt under the income or other tax laws of any state or local taxing
authority. As discussed earlier on page 15, capital gains distributed by a Fund
may be taxable. Note that the Taxpayer Relief Act of 1997 and the technical
provisions adopted by the IRS Restructuring and Reform Act of 1998 may affect
the status and treatment of certain distributions shareholders receive from the
Funds. Because each investor's tax circumstances are unique and because the tax
laws are subject to change, we recommend that you consult your tax adviser
about your investment.
WITHHOLDING - Federal law requires each Fund 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,
* underreports dividend or interest income, or
* fails to certify that he or she 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 Funds' transfer agent, that your tax
identification number is correct and you are not currently subject to backup
withholding.
REPORTING - Each Fund will report information to you annually concerning the
tax status of dividends and distributions for federal income tax purposes,
including the portion of the dividends constituting interest on private
activity bonds and the percentage and source of interest income earned on
tax-exempt securities held by the Funds during the preceding year.
California Taxation
The following 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. As a
potential investor in the Funds, you should consult your tax adviser with
specific reference to your own tax situations.
California law relating to the taxation of regulated investment companies was
generally conformed to federal law effective January 1, 1998. 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 ("Tax-Exempt Obligations") will be
exempt from California personal income tax (although not from the California
franchise tax) if, as of the
29
<PAGE>
close of each quarter, at least 50% of the value of each Fund's assets consist
of Tax-Exempt Obligations. 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 that 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 Funds, will not be deductible by the shareholder for California personal
income tax purposes.
Future Shareholder Mailings
Through our ongoing efforts to help reduce Fund expenses, each household will
receive a single copy of these Funds' most recent financial reports and
prospectus even if you or a family member own more than one account in the
Funds. For many of you, this eliminates duplicate copies, saving paper, and
postage costs to the Funds. However, if you would like to receive individual
copies, please call us and we will begin your individual delivery within 30
days.
30
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights tables are intended to help you understand the Funds'
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned (or lost) on an
investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been audited by KPMG LLP, whose report,
along with the Funds' financial statements, are included in the Annual Report,
which is available upon request.
California Bond Fund:
Year Ended March 31,
-------------------------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------
Net asset value at
beginning of period $ 11.29 $ 11.17 $ 10.50 $ 10.43 $ 10.10
Net investment income .58 .59 .60 .61 .60
Net realized and
unrealized gain (loss) (.91) .12 .67 .07 .33
Distributions from net
investment income (.58) (.59) (.60) (.61) (.60)
-------------------------------------------------------
Net asset value at
end of period $ 10.38 $ 11.29 $ 11.17 $ 10.50 $ 10.43
=======================================================
Total return (%)* (2.91) 6.46 12.33 6.60 9.35
Net assets at end of
period (000) $ 576,707 $ 641,653 $ 533,747 $ 440,231 $ 409,180
Ratio of expenses to
average net assets (%) .39 .39 .40 .41 .42
Ratio of net investment
income to average net
assets (%) 5.43 5.21 5.47 5.74 5.74
Portfolio turnover (%) 48.46 7.20 20.16 23.72 23.09
---------------------
* Assumes reinvestment of all dividend income distributions during the period.
31
<PAGE>
Financial Highlights (cont.)
California Money Market Fund:
Year Ended March 31,
-------------------------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .03 .03 .03 .03 .04
Distributions from net
investment income (.03) (.03) (.03) (.03) (.04)
-------------------------------------------------------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
=======================================================
Total return (%)* 2.86 3.03 3.35 3.23 3.58
Net assets at end of
period (000) $ 425,235 $ 439,208 $ 431,754 $ 341,128 $ 296,349
Ratio of expenses to
average net assets (%) .41 .42 .41 .45 .47
Ratio of net investment
income to average net
assets (%) 2.83 2.99 3.30 3.19 3.52
-----------------
* Assumes reinvestment of all dividend income distributions during the period.
32
<PAGE>
APPENDIX A
THE FOLLOWING ARE DESCRIPTIONS OF CERTAIN TYPES OF SECURITIES IN WHICH WE MAY
INVEST EACH FUND'S ASSETS:
VARIABLE RATE SECURITIES
We may invest a Fund's assets 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 the Fund depending on the proportion of such
securities held.
* Because the interest rates of variable rate securities are periodically
adjusted to reflect current market rates, their market value is less
affected by changes in prevailing interest rates than the market value of
securities with fixed interest rates.
* The market value of a variable rate security 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
We may invest a Fund's assets in tax-exempt securities (including securities
with variable interest rates) that 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
We may invest a Fund's assets 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.
33
<PAGE>
SYNTHETIC INSTRUMENTS
We may invest a Fund's assets in tender option bonds, bond receipts, and
similar synthetic municipal instruments. A synthetic instrument is a security
created by combining an intermediate or long-term municipal bond with a right
to sell the instrument back to the remarketer or liquidity provider for
repurchase on short notice. This right to sell is commonly referred to as a
tender option. Usually, the tender option is backed by a conditional guarantee
or letter of credit from a bank or other financial institution. Under its
terms, the guarantee may expire if the municipality defaults on payments of
interest or principal on the underlying bond, if the credit rating of the
municipality is downgraded, or if the instrument (or the underlying bond) loses
its tax-exempt treatment. Synthetic instruments involve structural risks that
could adversely affect the value of the instrument or could result in a Fund
holding an instrument for a longer period of time than originally anticipated.
WHEN-ISSUED SECURITIES
We may invest a Fund's assets in new securities offered on a when-issued basis.
* 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.
MUNICIPAL LEASE OBLIGATIONS
We may invest a Fund's assets in a variety of instruments commonly referred to
as municipal lease obligations, including leases and certificates of
participation in such leases and contracts.
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.
ILLIQUID SECURITIES
We may invest up to 15% of the California Bond Fund's net assets and up to 10%
of the California Money Market Fund's net assets in securities that are
illiquid. Illiquid securities are those securities which cannot be disposed of
in the ordinary course of business, seven days or less, at approximately the
same value at which the Fund has valued the securities.
Lease obligations and certain put bonds subject to restrictions on transfer may
be determined to be liquid in accordance with the guidelines established by the
Funds' Board of Directors.
34
<PAGE>
In determining the liquidity of a lease obligation, we 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 we may
determine to be relevant to such determination.
In determining the liquidity of put bonds with restrictions on transfer, we
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.
35
<PAGE>
APPENDIX B
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%
-------------------------------------------------------------------------------
2.50% 3.77% 3.99% 4.31% 4.56%
-------------------------------------------------------------------------------
3.00% 4.53% 4.79% 5.17% 5.48%
-------------------------------------------------------------------------------
3.50% 5.28% 5.59% 6.03% 6.39%
-------------------------------------------------------------------------------
4.00% 6.04% 6.39% 6.89% 7.30%
-------------------------------------------------------------------------------
4.50% 6.79% 7.19% 7.75% 8.21%
-------------------------------------------------------------------------------
5.00% 7.55% 7.99% 8.61% 9.13%
-------------------------------------------------------------------------------
5.50% 8.30% 8.79% 9.47% 10.04%
-------------------------------------------------------------------------------
6.00% 9.06% 9.59% 10.34% 10.95%
-------------------------------------------------------------------------------
6.50% 9.81% 10.39% 11.20% 11.86%
-------------------------------------------------------------------------------
7.00% 10.57% 11.19% 12.06% 12.78%
===============================================================================
-------------
(a) Federal Rate of 28% + (California State Rate of 8.0% x (1-28%))
(b) Federal Rate of 31% + (California State Rate of 9.3% x (1-31%))
(c) Federal Rate 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 EXAMPLES THAT WOULD BE RELEVANT TO MOST TAXPAYERS.
FOR A FURTHER EXPLANATION ON CALCULATING TAX-EQUIVALENT YIELDS, SEE THE FUNDS'
STATEMENT OF ADDITIONAL INFORMATION.
36
<PAGE>
APPENDIX C
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 you with the opportunity to formulate your own investment program. You
may exchange any shares you hold in any one USAA Fund for shares in any other
USAA Fund, subject to the limitations described earlier. For more complete
information about the mutual funds managed and distributed by USAA Investment
Management Company, including charges and operating expenses, call us for a
Prospectus. Read it carefully before you invest. Mutual fund operating expenses
apply and continue throughout the life of the Fund.
FUND TYPE/NAME RISK
==============================================
CAPITAL APPRECIATION
----------------------------------------------
Aggressive Growth Very high
Emerging Markets Very high
First Start Growth Moderate to high
Gold Very high
Growth Moderate to high
Growth & Income Moderate
International Moderate to high
S&P 500 Index Moderate
Science & Technology Very high
Small Cap Stock Very high
World Growth Moderate to high
----------------------------------------------
ASSET ALLOCATION
----------------------------------------------
Balanced Strategy Moderate
Cornerstone Strategy Moderate
Growth and Tax Strategy Moderate
Growth Strategy Moderate to high
Income Strategy Low to moderate
----------------------------------------------
INCOME -- TAXABLE
----------------------------------------------
GNMA Low to moderate
High-Yield Opportunities High
Income Moderate
Income Stock Moderate
Intermediate-Term Bond Low to moderate
Short-Term Bond Low
----------------------------------------------
INCOME -- TAX EXEMPT
----------------------------------------------
Long-Term Moderate
Intermediate-Term Low to moderate
Short-Term Low
State Bond/Income Moderate
----------------------------------------------
MONEY MARKET
----------------------------------------------
Money Market Low
Tax Exempt Money Market Low
Treasury Money Market Trust Low
State Money Market Low
==============================================
FOREIGN INVESTING IS SUBJECT TO ADDITIONAL RISKS, SUCH AS CURRENCY
FLUCTUATIONS, MARKET ILLIQUIDITY, AND POLITICAL INSTABILITY.
S&P(R) 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.
SOME INCOME MAY BE SUBJECT TO STATE OR LOCAL TAXES.
CALIFORNIA, FLORIDA, NEW YORK, AND VIRGINIA FUNDS ARE OFFERED ONLY TO
RESIDENTS OF THOSE STATES.
AN INVESTMENT IN A MONEY MARKET FUND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE
THE VALUE OF YOUR INVESTMENT AT $1 PER SHARE, IT IS POSSIBLE TO LOSE MONEY
BY INVESTING IN THE FUND.
THE SCIENCE & TECHNOLOGY FUND MAY BE MORE VOLATILE THAN A FUND THAT
DIVERSIFIES ACROSS MANY INDUSTRIES.
37
<PAGE>
NOTES
38
<PAGE>
NOTES
39
<PAGE>
If you would like more information about the Funds, you may call 1-800-531-8181
to request a free copy of the Funds' Statement of Additional Information (SAI),
Annual or Semiannual Report, or to ask other questions about the Funds. The SAI
has been filed with the Securities and Exchange Commission (SEC) and is legally
a part of this Prospectus. In the Funds' Annual Report, you will find a
discussion of the market conditions and investment strategies that
significantly affected each Fund's performance during the last fiscal year.
To view these documents, along with other related documents, you can visit the
EDGAR database on the SEC's Internet web site (www.sec.gov) or the Commission's
Public Reference Room in Washington, D.C. Information on the operation of the
Public Reference Room can be obtained by calling 1-202-942-8090. Additionally,
copies of this information can be obtained, after paying a duplicating fee, by
electronic request at the following e-mail address: [email protected] or by
writing the Public Reference Section of the Commission, Washington, D.C.
20549-0102.
===============================================================================
INVESTMENT ADVISER, UNDERWRITER, AND DISTRIBUTOR
USAA Investment Management Company
9800 Fredericksburg Road
San Antonio, Texas 78288
--------------------------------------------------------------
TRANSFER AGENT CUSTODIAN
USAA Shareholder Account Services State Street Bank and Trust Company
9800 Fredericksburg Road P.O. Box 1713
San Antonio, Texas 78288 Boston, Massachusetts 02105
--------------------------------------------------------------
TELEPHONE ASSISTANCE HOURS
Call toll free - Central Time
Monday - Friday 6:00 a.m. to 10:00 p.m.
Saturday 8:30 a.m. to 5:00 p.m.
Sunday 11:30 a.m. to 8:00 p.m.
--------------------------------------------------------------
FOR ADDITIONAL INFORMATION ON MUTUAL FUNDS
1-800-531-8181 (in San Antonio, 456-7200)
For account servicing, exchanges, or redemptions
1-800-531-8448 (in San Antonio, 456-7202)
--------------------------------------------------------------
RECORDED MUTUAL FUND PRICE QUOTES
24-Hour Service (from any phone)
1-800-531-8066 (in San Antonio, 498-8066)
--------------------------------------------------------------
MUTUAL FUND USAA TOUCHLINE(R)
(from touch-tone phones only)
For account balance, last transaction, fund prices,
or to exchange/redeem fund shares
1-800-531-8777 (in San Antonio, 498-8777)
--------------------------------------------------------------
INTERNET ACCESS
usaa.com(SM)
===============================================================================
Investment Company Act File No. 811-333
40
<PAGE>
Part A
Prospectus for the
New York Bond and
New York Money Market Funds
<PAGE>
USAA NEW YORK FUNDS
USAA NEW YORK BOND FUND
USAA NEW YORK MONEY MARKET FUND
PROSPECTUS
AUGUST 1, 2000
Shares of the New York Funds are offered only to New York residents. The
delivery of this Prospectus is not an offer in any state where shares of the
New York Funds may not lawfully be made.
As with other mutual funds, the Securities and Exchange Commission has not
approved or disapproved of either of these Fund's shares or determined whether
this Prospectus is accurate or complete. Anyone who tells you otherwise is
committing a crime.
TABLE OF CONTENTS
What Are Each Fund's Investment Objectives and Main Strategies?........ 2
Main Risks of Investing in These Funds................................. 2
Are These Funds for You?............................................... 3
Could the Value of Your Investment in These Funds Fluctuate?........... 4
Fees and Expenses...................................................... 8
Fund Investments....................................................... 9
Fund Management........................................................ 19
Using Mutual Funds in an Investment Program............................ 20
How to Invest.......................................................... 22
Important Information About Purchases and Redemptions.................. 26
Exchanges.............................................................. 27
Shareholder Information................................................ 28
Financial Highlights................................................... 31
Appendix A ............................................................ 33
Appendix B ............................................................ 35
Appendix C............................................................. 37
<PAGE>
USAA Investment Management Company manages these Funds. For easier reading,
USAA Investment Management Company will be referred to as "we" or "us"
throughout the Prospectus.
WHAT ARE EACH FUND'S INVESTMENT
OBJECTIVES AND MAIN STRATEGIES?
Each Fund has a common objective of providing New York investors with a high
level of current interest income that is exempt from federal income tax 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 dollar-weighted average portfolio
maturity is not restricted, but is expected to be greater than ten years.
The NEW YORK MONEY MARKET FUND invests in high-quality, New York tax-exempt
securities with maturities of 397 days or less.
Because any investment involves risk, there is no assurance that the Funds'
objectives will be achieved. See FUND INVESTMENTS on page 9 for more
information.
MAIN RISKS OF INVESTING IN THESE FUNDS
The two primary risks of investing in these Funds are credit risk and market
risk. As with other mutual funds, losing money is also a risk of investing in
these Funds.
* CREDIT RISK involves the possibility that a borrower cannot make timely
interest and principal payments on its securities.
* MARKET RISK involves the possibility that the value of each Fund's
investments will decline because of an increase in interest rates, or to
adverse changes in supply and demand for municipal securities, or other
market factors.
These credit and market risks may be magnified because each Fund concentrates
in New York tax-exempt securities.
IF INTEREST RATES INCREASE: the yield of each Fund may increase and the market
value of the New York Bond Fund's securities will likely decline, adversely
affecting the net asset value and total return.
2
<PAGE>
IF INTEREST RATES DECREASE: the yield of each Fund may decrease and the market
value of the New York Bond Fund's securities may increase, which would likely
increase the Fund's net asset value and total return. The New York Money Market
Fund's total return may decrease.
Other risks of investing in either Fund include call risk and structural risk.
As you consider an investment in either Fund, you should also take into account
your tolerance for the daily fluctuations of the financial markets and whether
you can afford to leave your money in the investment for long periods of time
to ride out down periods.
An investment in either Fund is not a deposit of USAA Federal Savings Bank, or
any other bank, and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency. Although the New York
Money Market Fund seeks to preserve the value of your investment at $1 per
share, it is possible to lose money by investing in that Fund.
Look for this symbol [CAUTION LIGHT GRAPHIC] throughout the Prospectus. We use
it to mark more detailed information about the risks you will face as a Fund
shareholder.
ARE THESE FUNDS FOR YOU?
New York Bond Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are looking for current income that is exempt from New York State and
City personal income taxes and federal income taxes.
* You are willing to accept moderate risk.
* You are looking for an investment in bonds to balance your stock
portfolio.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You are unwilling to take greater risk for intermediate-term goals.
* Your current tax situation does not allow you to benefit from tax-exempt
income.
* You are seeking an appropriate investment for an IRA, through a 401(k)
plan or 403(b) plan, or other tax-sheltered account.
3
<PAGE>
New York Money Market Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are looking for current income that is exempt from New York State and
City personal income taxes and federal income taxes.
* You need to preserve principal.
* You want a low-risk investment.
* You need your money back within a short period.
* You would like checkwriting privileges on the account.
* You are looking for an investment in a money market fund to balance your
stock or long-term bond portfolio.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You need a high total return to achieve your goals.
* Your primary goal is long-term growth.
* Your current tax situation does not allow you to benefit from tax-exempt
income.
Either Fund by itself does not constitute a balanced investment program.
Diversifying your investments may improve your long-run investment return and
lower the volatility of your overall investment portfolio.
COULD THE VALUE OF YOUR INVESTMENT
IN THESE FUNDS FLUCTUATE?
Yes, it could. In fact, the value of your investment in the New York Bond Fund
will fluctuate with the changing market values of the investments in the Fund.
We manage the New York Money Market Fund in accordance with strict Securities
and Exchange Commission (SEC) guidelines designed to preserve the Fund's value
at $1 per share, although, of course, we cannot guarantee that the value will
remain at $1 per share.
The value of the securities in which the New York Bond Fund invests typically
fluctuates inversely with changes in the general level of 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. The following bar charts illustrate the Funds' volatility
and performance from year to year for each full calendar year since the Funds'
inception.
4
<PAGE>
TOTAL RETURN
All mutual funds must use the same formula to calculate total return.
New York Bond Fund
[SIDE BAR]
TOTAL RETURN MEASURES THE PRICE CHANGE IN A SHARE ASSUMING THE REINVESTMENT OF
ALL DIVIDEND INCOME AND CAPITAL GAIN DISTRIBUTIONS.
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1991* 13.77%
1992 8.96%
1993 13.47%
1994 -9.04%
1995 18.07%
1996 3.73%
1997 10.64%
1998 6.68%
1999 -5.08%
* Fund began operations on October 15, 1990.
THE NEW YORK BOND FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD ENDED JUNE
30, 2000, WAS 5.53%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 7.50% (quarter ending March 31, 1995) and the lowest total return
for a quarter was -7.25% (quarter ending March 31, 1994).
The table below shows how the Fund's average annual total returns for the one-
and five-year periods, as well as the life of the Fund, compared to those of a
broad-based securities market index. Remember, historical performance does not
necessarily indicate what will happen in the future.
=================================================================
Average Annual
Total Returns Since Fund's
(for the periods ending Past Past Inception on
December 31, 1999) 1 Year 5 Years October 15, 1990
-----------------------------------------------------------------
New York Bond Fund -5.08% 6.53% 6.88%
-----------------------------------------------------------------
Lehman Brothers
Municipal Bond Index* -2.06% 6.91% 7.08%
=================================================================
* THE LEHMAN BROTHERS MUNICIPAL BOND INDEX IS AN UNMANAGED BENCHMARK OF TOTAL
RETURN PERFORMANCE FOR THE LONG-TERM, INVESTMENT-GRADE, TAX-EXEMPT BOND
MARKET.
5
<PAGE>
New York Money Market Fund
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1991* 4.16%
1992 2.75%
1993 2.04%
1994 2.39%
1995 3.59%
1996 3.20%
1997 3.28%
1998 3.05%
1999 2.85%
*Fund began operations on October 15, 1990.
THE NEW YORK MONEY MARKET FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD
ENDED JUNE 30, 2000, WAS 1.76%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 1.13% (quarter ending March 31, 1991) and the lowest total return
for a quarter was .46% (quarter ending March 31, 1994).
The table below shows the Fund's average annual total returns for the one- and
five-year periods, as well as the life of the Fund. Remember, historical
performance does not necessarily indicate what will happen in the future.
======================================================================
Average Annual
Total Returns Since Fund's
(for the periods ending Past Past Inception on
December 31, 1999) 1 Year 5 Years October 15, 1990
----------------------------------------------------------------------
New York Money Market Fund 2.85% 3.19% 3.07%
======================================================================
YIELD
[SIDE BAR]
YIELD IS THE ANNUALIZED NET INCOME OF THE FUND DURING A SPECIFIED PERIOD AS A
PERCENTAGE OF THE FUND'S SHARE PRICE.
All mutual funds must use the same formulas to calculate yield and effective
yield.
New York Bond Fund
The New York Bond Fund may advertise performance in terms of a 30-day yield
quotation or a tax-equivalent yield. The Fund's 30-day yield for the period
ended December 31, 1999, was 5.27%.
6
<PAGE>
New York Money Market Fund
[SIDE BAR]
EFFECTIVE YIELD IS CALCULATED SIMILAR TO THE YIELD, HOWEVER, WHEN ANNUALIZED,
THE INCOME EARNED IS ASSUMED TO BE REINVESTED.
The New York Money Market Fund typically advertises performance in terms of a
7-day yield and effective yield or tax-equivalent yield and may advertise total
return. The 7-day yield quotation more closely reflects current earnings of the
Fund than the total return quotation. The effective yield will be slightly
higher than the yield because of the compounding effect of the assumed
reinvestment. Current yields 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. The Fund's 7-day yield for the period
ended December 31, 1999, was 3.88%.
TAX-EQUIVALENT YIELD
Investors use tax-equivalent yields to compare taxable and tax-exempt fixed
income investments using a common yield measure. The tax-equivalent yield is
the yield that a fully taxable investment must generate to earn the same
"take-home" yield as a tax-exempt investment. The calculation depends upon your
federal and New York marginal income tax rates and assumes that an investor can
fully itemize deductions on his or her federal tax return. The higher your
marginal tax bracket, the higher will be the tax-equivalent yield and the more
valuable is the Fund's tax exemption.
For example, if you assume a federal marginal tax rate of 36% and a state and
city marginal tax rate of 10.63%, the Effective Marginal Tax Rate would be
42.80%. Using this tax rate, the Funds' tax-equivalent yields for the period
ending December 31, 1999, would be as follows:
================================================================
Tax-Equivalent
Yield Yield
----------------------------------------------------------------
New York Bond Fund (30 day) 5.27% 9.21%
New York Money Market Fund (7 day) 3.88% 6.78%
================================================================
Using the example, to exceed the 30-day yield of the New York Bond Fund on an
after-tax basis, you must find a fully taxable investment that yields more than
9.21%. Likewise, to exceed the 7-day yield of the New York Money Market Fund,
you must find a fully taxable investment that yields more than 6.78%.
For more information on calculating tax-equivalent yields, see APPENDIX B on
page 35.
7
<PAGE>
[SIDE BAR]
[TOUCHLINE GRAPHIC]
TOUCHLINE(R)
1-800-531-8777
PRESS
1
THEN
1
THEN
6, 3, #
Please consider performance information in light of the Funds' investment
objectives and policies and market conditions during the reported time periods.
The value of your shares may go up or down. For the most current price, yield,
and return information for these Funds, you may call USAA TouchLine(R) at
1-800-531-8777. Press 1 for the Mutual Fund Menu, press 1 again for prices,
yields, and returns. Then, press 62# for the New York Bond Fund or press 63#
for the New York Money Market Fund when asked for a Fund Code. You may also
access this information through our usaa.com(SM) Internet web site once your
account has been established.
[SIDE BAR]
New York
Bond
Fund
Newspaper
Symbol
NYBd
Ticker
Symbols
USNYX
UNYXX
Additionally, you may find the most current price of your shares in the
business section of your newspaper in the mutual fund section under the heading
"USAA Group" and the symbol "NYBd" for the New York Bond Fund. If you prefer to
obtain this information from an on-line computer service, you can do so by
using the ticker symbol "USNYX" for the New York Bond Fund or the ticker symbol
"UNYXX" for the New York Money Market Fund.
FEES AND EXPENSES
This summary shows what it will cost you, directly and indirectly, to invest in
the Funds.
Shareholder Transaction Expenses-- (Direct Costs)
There are no fees or sales loads charged to your account when you buy or sell
Fund shares. However, if you sell shares and request your money by wire
transfer, there is a $12 domestic wire fee and a $35 foreign wire fee. (Your
bank may also charge a fee for receiving wires.)
Annual Fund Operating Expenses-- (Indirect Costs)
Fund expenses come out of the Funds' assets and are reflected in the Funds'
share prices and dividends. "Other Expenses" include expenses such as custodian
and transfer agent fees. The figures below show actual expenses before waivers,
if any, during the past fiscal year ended March 31, 2000, and are calculated as
a percentage of average net assets (ANA).
[SIDE BAR]
12b-1 Fees - SOME MUTUAL FUNDS CHARGE THESE FEES TO PAY FOR ADVERTISING AND
OTHER COSTS OF SELLING FUND SHARES.
=====================================================================
New York New York Money
Bond Fund Market Fund
---------------------------------------------------------------------
Management Fees .39% .39%
Distribution (12b-1) Fees None None
Other Expenses .18% .19%
---- ----
Total Annual Fund Operating Expenses* .57% .58%
==== ====
=====================================================================
8
<PAGE>
-------------
* During the year, we voluntarily limited each Fund's Total Annual Fund
Operating Expenses to .50% as follows:
=====================================================================
NEW YORK NEW YORK MONEY
BOND FUND MARKET FUND
---------------------------------------------------------------------
Total Annual Fund Operating Expenses .57% .58%
Reimbursement from USAA Investment
Management Company (.07%) (.08%)
----- -----
Actual Fund Operating Expenses
After Reimbursement .50% .50%
==== ====
======================================================================
We have again voluntarily agreed to limit each Fund's annual expenses to
.50% of its ANA and will reimburse the Funds for all expenses in excess of
that amount until August 1, 2001.
Example of Effect of the Funds' Operating Expenses
This example is intended to help you compare the cost of investing in one of
the Funds with the cost of investing in other mutual funds. Although your
actual costs may be higher or lower, you would pay the following expenses on a
$10,000 investment, assuming (1) 5% annual return, (2) the Fund's operating
expenses (before any applicable reimbursement) remain the same, and (3) you
redeem all of your shares at the end of those periods shown.
===========================================================
New York New York Money
Bond Fund Market Fund
-----------------------------------------------------------
1 year $ 58 $ 59
3 years 183 186
5 years 318 324
10 years 714 726
===========================================================
FUND INVESTMENTS
Principal Investment Strategies and Risks
Q What is each Fund's principal investment strategy?
A Each Fund's principal strategy is the investment of its assets in
securities 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.
9
<PAGE>
These securities include municipal debt obligations that have been
issued by New York and its political subdivisions, and duly constituted
state and local authorities and corporations. We refer to these
securities as New York tax-exempt securities. New York tax-exempt
securities are issued to fund public infrastructure projects such as
streets and highways, schools, water and sewer systems, hospitals, and
airports. They 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.
Because the projects benefit the public, Congress has granted exemption
from federal income taxes for the interest income arising from these
securities. Likewise, the New York Legislature has granted an exemption
from state and city personal income taxes for most New York municipal
securities.
Q What types of tax-exempt securities will be included in each Fund's
portfolio?
A Each Fund's assets may be invested in any of the following tax-exempt
securities:
* 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;
* SYNTHETIC INSTRUMENTS, which combine a municipality's long-term
obligation to pay interest and principal with the obligation of a
third party to repurchase the instrument on short notice; and
* INDUSTRIAL DEVELOPMENT BONDS issued by or on behalf of public
authorities to obtain funds for privately operated facilities.
As a temporary defensive measure because of market, economic, political,
or other conditions, we may invest up to 100% of each Fund's assets in
short-term securities whether or not they are
10
<PAGE>
exempt from federal income tax and New York State and New York City
personal income taxes. To the extent that these temporary investments
produce taxable income, that income may result in that Fund not fully
achieving its investment objective during the time it is in this
temporary defensive posture.
Q What are the principal risks associated with investments in tax-exempt
securities?
A The two principal risks of investing in tax-exempt securities are credit
risk and market risk.
[CAUTION LIGHT GRAPHIC]
CREDIT RISK. The bonds in each Fund's portfolio are subject to credit
risk. Credit Risk is the possibility that an issuer of a fixed income
security will fail to make timely payments of interest or principal. We
attempt to minimize the Funds' credit risks by investing in securities
considered at least investment grade at the time of purchase.
Nevertheless, even investment-grade securities are subject to some
credit risk. In addition, the ratings of securities are estimates by the
rating agencies of the credit quality of the securities. The ratings may
not take into account every risk related to whether interest or
principal will be repaid on a timely basis.
When evaluating potential investments for the Funds, our analysts also
independently assess credit risk and its impact on the Funds'
portfolios. Securities in the lowest investment grade ratings category
(BBB) have speculative characteristics. Changes in economic conditions
or other circumstances are more likely to lead to a weakened capability
to make principal and interest payments on these securities than is the
case for higher-rated securities.
[CAUTION LIGHT GRAPHIC]
MARKET RISK. As a mutual fund investing in bonds, the Funds are subject
to the risk that the market value of the bonds will decline because of
rising interest rates. Bond prices are linked to the prevailing market
interest rates. In general, when interest rates rise, bond prices fall
and when interest rates fall, bond prices rise. The price volatility of
a bond also depends on its maturity. Generally, the longer the maturity
of a bond, the greater its sensitivity to interest rates. To compensate
investors for this higher market risk, bonds with longer maturities
generally offer higher yields than bonds with shorter maturities.
11
<PAGE>
Q What other risks are associate with investments in tax-exempt
securities?
A Two other risks that are applicable to certain tax-exempt securities are
call risk and structural risk.
[CAUTION LIGHT GRAPHIC]
CALL RISK. Many municipal bonds may be "called," or redeemed, by the
issuer before the stated maturity. During a period of declining interest
rates, an issuer would call, or refinance, a higher yielding bond for
the same reason that a homeowner would refinance a home mortgage.
Interest rates must drop sufficiently so that the savings more than
offset the cost of refinancing.
Intermediate- and long-term municipal bonds have the greatest call risk,
because most municipal bonds may not be called until after ten years
from the date of issue. The period of "call protection" may be longer or
shorter than ten years, but regardless, bonds purchased closest to the
date of issue will have the most call protection. Typically, bonds with
original maturities of ten years or less are not callable.
Although investors certainly appreciate the rise in bond prices when
interest rates drop, falling interest rates create the environment
necessary to "call" the higher-yielding bonds from your Fund. When bonds
are called, the Fund is impacted in several ways. Most likely, we must
reinvest the bond-call proceeds at lower interest rates. The Fund's
income may drop as a result. The Fund may also realize a taxable capital
gain.
[CAUTION LIGHT GRAPHIC]
STRUCTURAL RISK. Some tax-exempt securities, referred to as "synthetic
instruments," are created by combining a long-term municipal bond with a
right to sell the instrument back to the remarketer or liquidity
provider for repurchase on short notice, referred to as a "tender
option." Usually, the tender option is backed by a letter of credit or
similar guarantee from a bank. The guarantee, however, is typically
conditional, which means that the bank is not required to pay under the
guarantee if there is a default by the municipality or if certain other
events occur. These types of instruments involve special risks, referred
to as "structural risk." For example, because of the structure of a
synthetic instrument, there is a risk that the instrument will lose its
tax-exempt treatment or that we will not be able to exercise our tender
option. We will not purchase a synthetic instrument unless counsel has
issued an opinion that the instrument is entitled to tax-exempt
treatment. In addition, we will not
12
<PAGE>
purchase a synthetic instrument for the New York Money Market Fund
unless we believe there is only minimal risk that we will not be able to
exercise our tender option at all times.
Q What percentage of each Fund's assets will be invested in New York
tax-exempt securities?
A During normal market conditions, at least 80% of each Fund's net assets
will consist of New York tax-exempt securities. This policy may only be
changed by a shareholder vote.
In addition to New York tax-exempt securities, securities issued by
certain U.S. territories and possessions such as Puerto Rico, the Virgin
Islands, and Guam are exempt from federal income tax and New York State
and City personal income taxes; and as such, we may consider investing
up to 20% of each Fund's assets in these securities.
Q Are each Fund's investments diversified in many different issuers?
A Each Fund is considered diversified under the federal securities laws.
This means that we will not invest more than 5% in any one issuer with
respect to 75% of each Fund's assets. With respect to the remaining 25%
of each Fund's assets, we could invest more than 5% in any one, or more,
issuers. Purchases of securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities are not counted toward
the 5% limitation. Each Fund, of course, is concentrated geographically
through the purchase of New York tax-exempt securities.
With respect to the New York Money Market Fund, strict SEC guidelines do
not permit us to invest, with respect to 75% of the Fund's assets,
greater than 10% of the Fund's assets in securities issued by or subject
to guarantees by the same institution.
We also may not invest more than 25% of the Funds' 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
that are based, directly or indirectly, on the credit of private
entities of any one industry. However, we reserve the right to invest
more than 25% of the Funds' assets in tax-exempt industrial revenue
bonds. The 25% industry limitation does not apply to general obligation
bonds or bonds that are escrowed in U.S. government securities.
13
<PAGE>
[CAUTION LIGHT GRAPHIC]
Q What are the potential risks associated with concentrating such a large
portion of each Fund's assets in one state?
A The Funds are subject to credit and market risks, as previously
described, which could be magnified by the Funds' concentration in New
York issues. New York tax-exempt securities may be affected by
political, economic, regulatory, or other developments that limit the
ability of New York issuers to pay interest or repay principal in a
timely manner. Therefore, the Funds are affected by events within New
York to a much greater degree than a more diversified national fund.
A particular development may not directly relate to the Funds'
investments but nevertheless might depress the entire market for the
state's tax-exempt securities and therefore adversely impact the Funds'
valuation.
An investment in the New York Funds may be riskier than an investment in
other types of tax-exempt funds because of this concentration.
The following are examples of just some of the events that may depress
valuations for New York tax-exempt securities for an extended period of
time:
* Changes in state laws, including voter referendums, that restrict
revenues or raise costs for issuers.
* Court decisions that affect a category of municipal bonds, such as
municipal lease obligations or electric utilities.
* Natural or other disasters such as floods, storms, hurricanes,
droughts, fires, or earthquakes.
* Bankruptcy or financial distress of a prominent municipal issuer
within the state.
* Economic issues that impact critical industries or large employers or
that weaken real estate prices.
* Reductions in federal or state financial aid.
* Imbalance in the supply and demand for the state's municipal
securities.
* Developments that may change the tax treatment of New York tax-exempt
securities.
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.
14
<PAGE>
Other considerations affecting the Funds' investments in New York
tax-exempt securities are summarized in the Statement of Additional
Information under SPECIAL RISK CONSIDERATIONS.
Q Do the Funds purchase bonds guaranteed by bond insurance?
A Yes. Some of the bonds we purchase for the Funds are secured by bond
insurance that guarantees scheduled principal and interest payments. In
addition, we may purchase bond insurance for individual uninsured
securities when we believe it will provide a net economic benefit to the
shareholders.
Q Will any portion of the distributions from the Funds be subject to
federal income taxes?
A During normal market conditions, at least 80% of each Fund's annual
income will be excluded from gross income for federal income tax
purposes and will also be exempt from New York State and City personal
income taxes. This policy may only be changed by a shareholder vote. We
expect that any taxable interest income distributed will be minimal.
However, gains and losses from trading securities that occur during the
normal course of managing a fund may create net capital gain
distributions. The Internal Revenue Code presently treats these
distributions differently than tax-exempt interest income in the
following ways:
* Distributions of net short-term capital gains are taxable as ordinary
income.
* Distributions of net long-term capital gains are taxable as
long-term capital gains, regardless of the length of time you have
held the Fund shares.
* Both short-term and long-term capital gains are taxable whether
received in cash or reinvested in additional shares.
Q Will income from the Funds be subject to the federal alternative minimum
tax (AMT) for individuals?
A During normal market conditions, at least 80% of each Fund's annual
income will be excluded from the calculation of the federal alternative
minimum tax (AMT) for individuals. This policy may only be changed by a
shareholder vote. Since inception, the Funds have not distributed any
income that is subject to the federal AMT for individuals, and we do not
intend to invest in securities subject to the federal AMT. However, of
15
<PAGE>
course, changes in federal tax laws or other unforeseen circumstances
could result in income subject to the federal AMT for individuals.
New York Bond Fund
Q What is the credit quality of the Fund's investments?
A Under normal market conditions, we will invest the Fund's assets so that
at least 50% of the total market value of the tax-exempt securities are
rated within the three highest long-term rating categories (A or higher)
by Moody's Investors Service (Moody's), Standard & Poor's Ratings Group
(S&P), or Fitch Information, Inc. (Fitch) or in the highest short-term
rating category by Moody's, S&P, or Fitch. If a security is not rated by
those rating agencies, we must determine that the security is of
equivalent investment quality.
In no event will we purchase a security for the Fund unless it is rated
at least investment grade at the time of purchase. Investment-grade
securities are those securities rated within the four highest long-term
rating categories by Moody's (Baa or higher), S&P, or Fitch (BBB or
higher), or in the two highest short-term rating categories by these
rating agencies. If unrated by these agencies, we must determine that
the securities are of equivalent investment quality.
On occasion, we may purchase a credit rating on a particular security
when we believe it will provide a net economic benefit to the
shareholders.
You will find a complete description of the above tax-exempt ratings in
the Fund's Statement of Additional Information.
Q What happens if the rating of a security is downgraded to below
investment grade?
A We will determine whether it is in the best interest of the Fund's
shareholders to continue to hold the security in the Fund's portfolio.
If downgrades result in more than 5% of the Fund's net assets being
invested in securities that are less than investment-grade quality, we
will take immediate action to reduce the Fund's holdings in such
securities to 5% or less of the Fund's net assets, unless otherwise
directed by the Fund's Board of Directors.
16
<PAGE>
Q How are the decisions to buy and sell securities made?
A We manage tax-exempt funds based on the common sense premise that our
investors value tax-exempt income over taxable capital gain
distributions. When weighing the decision to buy or sell a security, we
strive to balance the value of the tax-exempt income, the credit risk of
the issuer, and the price volatility of the bond.
Q What is the Fund's average portfolio maturity and how is it calculated?
A While the Fund's average portfolio maturity is not restricted, we expect
it to be greater than ten years. To determine a security's maturity for
purposes of calculating the Fund's average portfolio maturity, we may
estimate the expected time in which the security's principal is to be
paid. This can be substantially shorter than its stated final maturity.
For more information on the method of calculating the Fund's average
weighted portfolio maturity, see INVESTMENT POLICIES in the Fund's
Statement of Additional Information.
New York Money Market Fund
Q What is the credit quality of the Fund's investments?
A The Fund's investments consist of securities meeting the requirements to
qualify as "eligible securities" under the SEC rules applicable to money
market funds. In general, an eligible security is defined as a security
that is:
* issued or guaranteed by the U.S. government or any agency or
instrumentality thereof, including "prerefunded" and "escrowed to
maturity" tax-exempt securities;
* rated or subject to a guarantee that is 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;
* unrated but issued by an issuer or guaranteed by a guarantor that
has other comparable short-term debt obligations so rated; or
* unrated but determined by us to be of comparable quality.
17
<PAGE>
In addition, we must consider whether a particular investment presents
minimal credit risk.
Q Who are the Nationally Recognized Statistical Rating Organizations?
A Current NRSROs include:
* Moody's Investors Service;
* Standard & Poor's Ratings Group;
* Fitch Information, Inc.; and
* Thompson BankWatch.
Q What happens if the rating of a security is downgraded?
A If the rating of a security is downgraded after purchase, we will
determine whether it is in the best interest of the Fund's shareholders
to continue to hold the security in the Fund's portfolio.
Q Will the Fund always maintain a net asset value of $1 per share?
[SIDE BAR]
DOLLAR-WEIGHTED AVERAGE PORTFOLIO MATURITY IS OBTAINED BY MULTIPLYING THE
DOLLAR VALUE OF EACH INVESTMENT BY THE NUMBER OF DAYS LEFT TO ITS MATURITY,
THEN ADDING THOSE FIGURES TOGETHER AND DIVIDING THE TOTAL BY THE DOLLAR VALUE
OF THE FUND'S PORTFOLIO.
A While we will endeavor to maintain a constant Fund net asset value of $1
per share, there is no assurance that we will be able to do so.
Remember, the shares are neither insured nor guaranteed by the U.S.
government. As such, the Fund carries some risk.
For example, there is always a risk that the issuer of a security held
by the Fund will fail to pay interest or principal when due. We attempt
to minimize this credit risk by investing only in securities rated in
one of the two highest categories for short-term securities, or, if not
rated, of comparable quality, at the time of purchase. Additionally, we
will not purchase a security unless our analysts determine that the
security presents minimal credit risk.
There is also a risk that rising interest rates will cause the value of
the Fund's securities to decline. We attempt to minimize this interest
risk by limiting the maturity of each security to 397 days or less and
maintaining a dollar-weighted average portfolio maturity for the Fund of
90 days or less.
Finally, there is the possibility that one or more investments in the
Fund cease to be "eligible securities" resulting in the net asset value
ceasing to be $1 per share. For example, a guarantor on a security
failing to meet a contractual obligation could cause such a result.
18
<PAGE>
Q How are the decisions to buy and sell securities made?
A We balance factors such as credit quality and maturity to purchase the
best relative value available in the market at any given time. While
rare, a decision to sell is usually based on a change in our credit
analysis or to take advantage of an opportunity to reinvest at a higher
yield.
For additional information about other securities in which we may invest each
of the Fund's assets, see APPENDIX A on page 33.
FUND MANAGEMENT
USAA Investment Management Company serves as the manager and distributor of
these Funds. We are an affiliate of United Services Automobile Association
(USAA), a large, diversified financial services institution. As of the date of
this Prospectus, we had approximately $41 billion in total assets under
management. Our mailing address is 9800 Fredericksburg Road, San Antonio, TX
78288.
We provide management services to the Funds pursuant to an Advisory Agreement.
We are responsible for managing the Funds' portfolios (including placement of
brokerage orders) and their business affairs, subject to the authority of and
supervision by the Funds' Board of Directors. For our services, the Funds pay
us an annual fee. This fee, which is accrued daily and paid monthly, is
computed as a percentage of the aggregate average net assets of both Funds
combined. This fee is allocated between the Funds based on the relative net
assets of each. The fee is computed at one-half of one percent (.50%) of the
first $50 million of average net assets, two-fifths of one percent (.40%) for
that portion of average net assets over $50 million but not over $100 million,
and three-tenths of one percent (.30%) for that portion of average net assets
over $100 million. The fees we received for the fiscal year ended March 31,
2000, net of reimbursements, were equal to .32% of average net assets for the
New York Bond Fund and .31% of average net assets for the New York Money Market
Fund. We also provide services related to selling the Funds' shares and receive
no compensation for those services.
19
<PAGE>
Portfolio Managers
NEW YORK BOND FUND
[PHOTOGRAPH]
Clifford A. Gladson
Clifford A. Gladson, Vice President of Mutual Fund Portfolios, has managed the
Fund since November 1999. He has 12 years investment management experience and
has worked for us for nine years. Mr. Gladson earned the Chartered Financial
Analyst designation in 1990 and is a member of the Association for Investment
Management and Research, the San Antonio Financial Analysts Society, Inc., and
the National Federation of Municipal Analysts. He holds an MS from the
University of Wisconsin, Milwaukee and a BS from Marquette University.
NEW YORK MONEY MARKET FUND
[PHOTOGRAPH]
Regina G. Shafer
Regina G. Shafer, Assistant Vice President of Money Market Funds, has managed
the Fund since November 1999. She has five years investment management
experience and has worked for us for nine years. Ms. Shafer is a Certified
Public Accountant and earned the Chartered Financial Analyst designation in
1998. She is a member of the Association for Investment Management and Research
and the San Antonio Financial Analysts Society, Inc. She holds an MBA from the
University of Texas at San Antonio and a BBA from Southwest Texas State
University.
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 diversified
portfolio. That portfolio is managed by investment professionals, relieving you
of the need to make individual stock or bond selections. You also enjoy
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,
you own an investment that in earlier times would have been available only to
very wealthy people.
20
<PAGE>
II. Using Funds in an Investment Program
In choosing a mutual fund as an investment vehicle, you are giving up some
investment decisions, but must still make others. The decisions you don't have
to make are those involved with choosing individual securities. We will perform
that function. In addition, we will arrange for the safekeeping of securities,
auditing the annual financial statements, and daily valuation of the Fund, as
well as other functions.
You, however, retain at least part of the responsibility for an equally
important decision. This decision involves determining a portfolio of mutual
funds that balances your investment goals with your tolerance for risk. It is
likely that this decision may include the use of more than one fund of the USAA
Family of Funds.
For example, assume you wish to pursue the higher yields usually available in
the long-term bond market, but you are also concerned about the possible price
swings of the long-term bonds. You could divide your 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 way you could combine funds
to fit your own risk and reward goals.
III. USAA's Family of Funds
We offer you another alternative with our asset strategy funds listed in
APPENDIX C under asset allocation on page 37. These unique mutual funds provide
a professionally managed, diversified investment portfolio within a mutual
fund. Designed for the individual who prefers to delegate the asset allocation
process to an investment manager, their structure achieves diversification
across a number of investment categories.
Whether you prefer to create your own mix of mutual funds or use a USAA Asset
Strategy Fund, the USAA Family of Funds provides a broad range of choices
covering just about any investor's investment objectives. Our member service
representatives stand ready to assist you with your choices and to help you
craft a portfolio to meet your needs. Refer to APPENDIX C on page 37 for a
complete list of the USAA Family of No-Load Mutual Funds.
21
<PAGE>
HOW TO INVEST
Purchase of Shares
OPENING AN ACCOUNT
You may open an account and make an investment as described below by mail, in
person, bank wire, phone, or on the Internet. A complete, signed application is
required to open your initial account. However, after you open your initial
account with us, you will not need to fill out another application to invest in
another Fund unless the registration is different.
TAX ID NUMBER
Each shareholder named on the account must provide a social security number or
tax identification number to avoid possible withholding requirements.
EFFECTIVE DATE
When you make a purchase, your purchase price will be the net asset value (NAV)
per share next determined after we receive your request in proper form. Each
Fund's NAV is determined at the close of the regular trading session (generally
4:00 p.m. Eastern Time) of the New York Stock Exchange (NYSE) each day the NYSE
is open. If we receive your request and payment prior to that time, your
purchase price will be the NAV per share determined for that day. If we receive
your request or payment after the NAV per share is calculated, the purchase
will be effective on the next business day.
If you plan to purchase Fund shares with a foreign check, we suggest you
convert your foreign check to U.S. dollars prior to investment in a Fund. This
will avoid a potential four- to six-week delay in the effective date of your
purchase. Furthermore, a bank charge may be assessed in the clearing process,
which will be deducted from the amount of the purchase.
MINIMUM INVESTMENTS
INITIAL PURCHASE
[MONEY GRAPHIC]
* $3,000
ADDITIONAL PURCHASES
* $50 (Except on transfers from brokerage accounts into the New York Money
Market Fund, which are exempt from the minimum). Employees of USAA and its
affiliated companies may add to an account through payroll deduction for
as little as $25 per pay period with a $3,000 initial investment.
22
<PAGE>
HOW TO PURCHASE
MAIL
[ENVELOPE GRAPHIC]
* To open an account, send your application and check to:
USAA Investment Management Company
9800 Fredericksburg Road
San Antonio, TX 78288
* To add to your account, send your check and the deposit stub that
accompanies your Fund's transaction confirmation to the Transfer Agent:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
IN PERSON
[HANDSHAKE GRAPHIC]
* To open an account, bring your application and check to our San Antonio
investment sales and service office at:
USAA Federal Savings Bank
10750 Robert F. McDermott Freeway
San Antonio, TX 78288
BANK WIRE
[BANK WIRE]
* To open or add to your 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 New York Fund Name
USAA Account Number: 69384998
Shareholder(s) Name(s)
Shareholder(s) Mutual Fund Account Number
ELECTRONIC FUNDS TRANSFER (EFT)
[CALENDAR GRAPHIC]
* Additional purchases on a regular basis can be deducted from a bank
account, paycheck, income-producing investment, or USAA money market fund
account. Sign up for these services when opening an account or call
1-800-531-8448 to add these services.
PHONE 1-800-531-8448 (IN SAN ANTONIO, 456-7202)
[TELEPHONE GRAPHIC]
* If you have an existing USAA mutual fund account and would like to open a
new account or exchange to another USAA Fund, call for instructions. To
open an account by phone, the new account must have the same registration
as your existing account.
23
<PAGE>
USAA TOUCHLINE(R)1-800-531-8777 (IN SAN ANTONIO, 498-8777)
[TOUCHLINE GRAPHIC]
* In addition to obtaining account balance information, last transactions,
current fund prices, and return information for your Fund, you can use
USAA TouchLine(R) from any touch-tone phone to access your Fund account
to make selected purchases, exchange to another USAA Fund, or make
redemptions. This service is available with an Electronic Services
Agreement (ESA) and EFT Buy/Sell authorization on file.
INTERNET ACCESS - USAA.COM(SM)
[COMPUTER GRAPHIC]
* You can use your personal computer to perform certain mutual fund
transactions by accessing our web site. To establish access to your
account, you will need to call 1-800-461-3507 to obtain a registration
number and personal identification number (PIN). Once you have
established Internet access to your account, you will be able to open a
new mutual fund account within an existing registration, exchange to
another USAA Fund, make redemptions, review account activity, check
balances, and more. To place orders by Internet, an ESA and EFT Buy/Sell
authorization must be on file.
Redemption of Shares
You may redeem Fund shares by any of the methods described below on any day the
NAV per share is calculated. Redemptions are effective on the day instructions
are received in a manner as described below. However, if instructions are
received after the NAV per share calculation (generally 4:00 p.m. Eastern
Time), your redemption will be effective on the next business day.
We will send you your money within seven days after the effective date of
redemption. Payment for redemption of shares purchased by EFT or check is sent
after the EFT or check 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. For federal
income tax purposes, a redemption is a taxable event; and as such, you may
realize a capital gain or loss. Such capital gains or losses are based on the
difference between your cost basis in the shares and the price received upon
redemption.
In addition, the Funds may elect to suspend the redemption of shares or
postpone the date of payment in limited circumstances.
24
<PAGE>
HOW TO REDEEM
MAIL, IN PERSON, FAX, TELEGRAM, TELEPHONE, TOUCHLINE(R), OR INTERNET
[FAX MACHINE GRAPHIC]
* Send your written instructions to:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
* Visit a member service representative at our San Antonio investment sales
and service office at USAA Federal Savings Bank.
* Send a signed fax to 1-800-292-8177, or send a telegram to USAA Shareholder
Account Services.
* Call toll free 1-800-531-8448 (in San Antonio, 456-7202) to speak with a
member service representative.
* Call toll free 1-800-531-8777 (in San Antonio, 498-8777) to access our
24-hour USAA TouchLine(R) service.
* Access our Internet web site at usaa.com(SM).
Telephone redemption privileges are 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. Before
any discussion regarding your account, the following information is obtained:
(1) USAA number and/or account number, (2) the name(s) on the account
registration, and (3) social security/tax identification number or date of
birth of the registered account owner(s) for the account registration.
Additionally, all telephone communications with you are recorded and
confirmations of account transactions are sent to the address of record. If you
were issued stock certificates for your shares, redemption by telephone, fax,
telegram, or Internet is not available.
CHECKWRITING
[CHECKBOOK GRAPHIC]
* Checks can be issued for your New York Money Market Fund account. Return a
signed signature card, which accompanies your application, or request a
signature card separately and return it to:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
You will not be charged for the use of checks or any subsequent reorders. Your
checkwriting privilege is subject to State Street Bank and Trust Company's
rules and regulations governing checking accounts. You may write checks in the
amount of $250 or more. Checks written for less than $250 will be returned
unpaid. Because the value of your account changes daily as dividends accrue,
you may not write a check to close your account.
25
<PAGE>
IMPORTANT INFORMATION ABOUT
PURCHASES AND REDEMPTIONS
INVESTOR'S GUIDE to USAA Mutual Fund Services
[INVESTORS GUIDE GRAPHIC]
Upon your initial investment with us, you will receive the INVESTOR'S GUIDE to
help you get the most out of your USAA mutual fund account and to assist you in
your role as an investor. In the INVESTOR'S GUIDE, you will find additional
information on purchases, redemptions, and methods of payment. You will also
find in-depth information on automatic investment plans, shareholder statements
and reports, and other useful information.
Account Balance
USAA Shareholder Account Services (SAS), the Funds' transfer agent, may assess
annually a small balance account fee of $12 to each shareholder account with a
balance of less than $2,000 at the time of assessment. The fee will reduce
total transfer agency fees paid by the Fund to SAS. 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/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).
Fund Rights
Each Fund reserves the right to:
* reject purchase or exchange orders when in the best interest of the Fund;
* limit or discontinue the offering of shares of the Fund without notice to
the shareholders;
* 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); however, this 1% charge
will not be imposed upon shareholders unless authorized by the Fund's Board
of Directors and the required notice has been given to shareholders;
26
<PAGE>
* require a signature guarantee for transactions or changes in account
information in those instances where the appropriateness of a signature
authorization is in question (the Statement of Additional Information
contains information on acceptable guarantors);
* redeem an account with less than 50 full shares, with certain limitations.
EXCHANGES
Exchange Privilege
The exchange privilege is automatic 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 the shares to be acquired are
offered in your state of residence. Only New York residents may exchange into a
New York Fund. Exchanges made through USAA TouchLine(R) and the Internet
require an ESA and EFT Buy/Sell authorization on file. After we receive the
exchange orders, the Funds' transfer agent will simultaneously process exchange
redemptions and purchases at the share prices next determined. The investment
minimums applicable to share purchases also apply to exchanges. For federal
income tax purposes, an exchange between Funds is a taxable event; and as such,
you may realize a capital gain or loss. Such capital gains or losses are based
on the difference between your cost basis in the shares and the price received
upon exchange.
The Funds have undertaken certain procedures regarding telephone transactions
as described on page 25.
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. The limit on
exchanges out of any Fund in the USAA Family of Funds for each account is six
per calendar year (except 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). However, each Fund reserves the right to reject a
shareholder's purchase or exchange orders into a Fund at any time when in the
best interest of the Fund.
27
<PAGE>
SHAREHOLDER INFORMATION
Share Price Calculation
[SIDE BAR]
NAV PER SHARE
EQUALS
TOTAL ASSETS
MINUS
LIABILITIES
DIVIDED BY
# OF SHARES
OUTSTANDING
The price at which you purchase and redeem Fund shares is equal to the net
asset value (NAV) per share determined on the effective date of the purchase or
redemption. You may buy and sell Fund shares at the NAV per share without a
sales charge. Each Fund's NAV per share is calculated at the close of the
regular trading session of the NYSE, which is usually 4:00 p.m. Eastern Time.
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 Funds'
Board of Directors. Securities that cannot be valued by the pricing service,
and all other assets, are valued in good faith at fair value using methods we
have determined under the general supervision of the Funds' Board of Directors.
In addition, securities with maturities of 60 days or less and all securities
of the New York Money Market Fund are stated at amortized cost, which
approximates market value.
For additional information on how securities are valued, see VALUATION OF
SECURITIES in the Funds' Statement of Additional Information.
Dividends and Distributions
Net investment income of each Fund is accrued daily and paid on the last
business day of the month. Dividends shall begin accruing on shares purchased
the day following the effective date and shall continue to accrue to the
effective date of redemption. Any net capital gain distribution usually occurs
within 60 days of the March 31 fiscal year end, which would be somewhere around
the end of May. The Funds will make additional payments to shareholders, if
necessary, to avoid the imposition of any federal income or excise tax.
We will automatically reinvest all income dividends and capital gain
distributions in the Fund unless you instruct us differently. The share price
will be the NAV of the Fund shares computed on the ex-dividend date. Any
capital gain distributions paid by the New York Bond Fund will reduce the NAV
per share by the amount of the dividend or distribution on the ex-dividend
date. You should consider carefully the effects of purchasing shares of the New
York Bond Fund shortly before any capital gain distribution. Some or all of
these distributions are subject to taxes. If you become a resident of a state
other than New York, we will mail a check for proceeds of income dividends to
you monthly.
28
<PAGE>
We will invest any dividend or distribution payment returned to us in your
account at the then-current NAV per share. Dividend and distribution checks
become void six months from the date on the check. The amount of the voided
check will be invested in your account at the then-current NAV per share.
Federal Taxes
This tax information is quite general and refers to the federal income tax
provisions in effect as of the date of this Prospectus. While we manage the
Funds so that at least 80% of each Fund's annual income will be exempt from
federal or state income taxes, we may invest up to 20% of the Funds' assets in
securities that generate income not exempt from federal income tax or New York
State and City personal income taxes. Because interest income may be exempt for
federal income tax purposes, it does not necessarily mean that the interest
income may be exempt under the income or other tax laws of any state or local
taxing authority. As discussed earlier on page 15, capital gains distributed by
a Fund may be taxable. Note that the Taxpayer Relief Act of 1997 and the
technical provisions adopted by the IRS Restructuring and Reform Act of 1998
may affect the status and treatment of certain distributions shareholders
receive from the Funds. Because each investor's tax circumstances are unique
and because the tax laws are subject to change, we recommend that you consult
your tax adviser about your investment.
WITHHOLDING - Federal law requires each Fund 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,
* underreports dividend or interest income, or
* fails to certify that he or she 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 Funds' transfer agent, that your tax
identification number is correct and you are not currently subject to backup
withholding.
REPORTING - Each Fund will report information to you annually concerning the
tax status of dividends and distributions for federal income tax purposes,
including the portion of the dividends constituting interest on private
activity bonds and the percentage and source of interest income earned on
tax-exempt securities held by the Fund during the preceding year.
29
<PAGE>
New York Taxation
The following 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. As a potential investor in the Funds, you
should consult your tax adviser with specific reference to your own tax
situations.
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 New York State corporate franchise tax or New York City general
corporation tax. Investment in a Fund, however, may result in liability for
state and/or local taxes for individual shareholders subject to taxation by
states other than New York State or cities other than New York City because the
exemption from New York State and New York City personal income taxes does not
prevent such other jurisdictions from taxing individual shareholders on
dividends received from the Funds. For New York State and New York City
personal income tax purposes, distributions of net long-term capital gains will
be taxable at the same rates as ordinary income. 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. You will receive an annual notification stating your portion of each
Fund's tax-exempt income attributable to qualified New York Municipal
Obligations.
Future Shareholder Mailings
Through our ongoing efforts to help reduce Fund expenses, each household will
receive a single copy of these Funds' most recent financial reports and
prospectus even if you or a family member own more than one account in the
Funds. For many of you, this eliminates duplicate copies, saving paper, and
postage costs to the Funds. However, if you would like to receive individual
copies, please call us and we will begin your individual delivery within 30
days.
30
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights tables are intended to help you understand the Funds'
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned (or lost) on an
investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been audited by KPMG LLP, whose report,
along with the Funds' financial statements, are included in the Annual Report,
which is available upon request.
New York Bond Fund:
Year Ended March 31,
--------------------------------------------------------
2000 1999 1998 1997 1996
--------------------------------------------------------
Net asset value at
beginning of period $ 11.66 $ 11.62 $ 10.94 $ 10.95 $ 10.77
Net investment income .61 .61 .63 .64 .63
Net realized and
unrealized gain (loss) (.87) .04 .68 (.01) .18
Distributions from net
investment income (.61) (.61) (.63) (.64) (.63)
--------------------------------------------------------
Net asset value at
end of period $ 10.79 $ 11.66 $ 11.62 $ 10.94 $ 10.95
--------------------------------------------------------
Total return (%)* (2.20) 5.73 12.24 5.89 7.67
Net assets at end of
period (000) $ 82,971 $ 88,480 $ 70,611 $ 58,035 $ 53,987
Ratio of expenses to
average net assets (%) .50 .50 .50 .50 .50
Ratio of expenses
to average net
assets excluding
reimbursements (%) .57 .58 .61 .66 .69
Ratio of net investment
income to average net
assets (%) 5.52 5.24 5.54 5.83 5.75
Portfolio turnover (%) 31.77 27.64 49.49 41.42 74.80
------------
* Assumes reinvestment of all dividend income distributions during the period.
31
<PAGE>
Financial Highlights (cont.)
New York Money Market Fund:
Year Ended March 31,
-------------------------------------------------------
2000 1999 1998 1997 1996
-------------------------------------------------------
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .03 .03 .03 .03 .04
Distributions from net
investment income (.03) (.03) (.03) (.03) (.04)
-------------------------------------------------------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
=======================================================
Total return (%)* 3.02 2.90 3.29 3.16 3.56
Net assets at end of
period (000) $ 77,948 $ 68,834 $ 62,226 $ 49,996 $ 45,554
Ratio of expenses to
average net assets (%) .50 .50 .50 .50 .50
Ratio of expenses to average
net assets excluding
reimbursements (%) .58 .60 .63 .69 .78
Ratio of net investment
income to average net
assets (%) 3.00 2.86 3.23 3.12 3.47
------------
* Assumes reinvestment of all dividend income distributions during the period.
32
<PAGE>
APPENDIX A
THE FOLLOWING ARE DESCRIPTIONS OF CERTAIN TYPES OF SECURITIES IN WHICH WE MAY
INVEST EACH FUND'S ASSETS:
VARIABLE RATE SECURITIES
We may invest a Fund's assets 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 the Fund depending on the proportion of such
securities held.
* Because the interest rates of variable rate securities are periodically
adjusted to reflect current market rates, their market value is less
affected by changes in prevailing interest rates than the market value of
securities with fixed interest rates.
* The market value of a variable rate security 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
We may invest a Fund's assets in tax-exempt securities (including securities
with variable interest rates) that 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
We may invest a Fund's assets 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.
SYNTHETIC INSTRUMENTS
We may invest a Fund's assets in tender option bonds, bond receipts, and
similar synthetic municipal instruments. A synthetic instrument is a security
created by combining an intermediate or long-term municipal bond with a right
to sell the instrument back to the remarketer or liquidity provider for
repurchase on short notice. This right to sell is commonly referred to as a
tender option. Usually, the tender option is backed by a conditional guarantee
or letter of credit from a bank or other financial institution. Under its
terms, the guarantee may expire if the municipality defaults on payments of
interest or principal on the underlying bond, if the credit rating of the
municipality is downgraded,
33
<PAGE>
or if the instrument (or the underlying bond) loses its tax-exempt treatment.
Synthetic instruments involve structural risks that could adversely affect the
value of the instrument or could result in a Fund holding an instrument for a
longer period of time than originally anticipated.
WHEN-ISSUED SECURITIES
We may invest a Fund's assets in new securities offered on a when-issued basis.
* 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.
MUNICIPAL LEASE OBLIGATIONS
We may invest a Fund's assets in a variety of instruments commonly referred to
as municipal lease obligations, including leases and certificates of
participation in such leases and contracts.
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.
ILLIQUID SECURITIES
We may invest up to 15% of the New York Bond Fund's net assets and up to 10% of
the New York Money Market Fund's net assets in securities that are illiquid.
Illiquid securities are those securities which cannot be disposed of in the
ordinary course of business, seven days or less, at approximately the same
value at which the Fund has valued the securities.
Lease obligations and certain put bonds subject to restrictions on transfer may
be determined to be liquid in accordance with the guidelines established by the
Funds' Board of Directors.
In determining the liquidity of a lease obligation, we 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 we may
determine to be relevant to such determination.
In determining the liquidity of put bonds with restrictions on transfer, we
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.
34
<PAGE>
APPENDIX B
Taxable-Equivalent Yield Table
COMBINED 2000 FEDERAL INCOME TAX AND
NEW YORK STATE PERSONAL INCOME TAX RATES
Assuming a Federal
Marginal Tax Rate of: 28% 31% 36% 39.6%
and a State Rate of: 6.85% 6.85% 6.85% 6.85%
The Effective Marginal
Tax Rate Would be: 32.9320%(a) 35.7265%(b) 40.3840%(c) 43.7374%(d)
To Match a Double
Tax-Free Yield of: A Fully Taxable Investment Would Have to Pay You:
===============================================================================
2.00% 2.98% 3.11% 3.35% 3.55%
-------------------------------------------------------------------------------
2.50% 3.73% 3.89% 4.19% 4.44%
-------------------------------------------------------------------------------
3.00% 4.47% 4.67% 5.03% 5.33%
-------------------------------------------------------------------------------
3.50% 5.22% 5.45% 5.87% 6.22%
-------------------------------------------------------------------------------
4.00% 5.96% 6.22% 6.71% 7.11%
-------------------------------------------------------------------------------
4.50% 6.71% 7.00% 7.55% 8.00%
-------------------------------------------------------------------------------
5.00% 7.46% 7.78% 8.39% 8.89%
-------------------------------------------------------------------------------
5.50% 8.20% 8.56% 9.23% 9.78%
-------------------------------------------------------------------------------
6.00% 8.95% 9.34% 10.06% 10.66%
-------------------------------------------------------------------------------
6.50% 9.69% 10.11% 10.90% 11.55%
-------------------------------------------------------------------------------
7.00% 10.44% 10.89% 11.74% 12.44%
===============================================================================
------------
(a) Federal Rate of 28% + (New York State Rate of 6.85% x (1-28%))
(b) Federal Rate of 31% + (New York State Rate of 6.85% x (1-31%))
(c) Federal Rate of 36% + (New York State Rate of 6.85% x (1-36%))
(d) Federal Rate of 39.6% + (New York State Rate of 6.85% 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 EXAMPLES THAT WOULD BE RELEVANT TO MOST TAXPAYERS.
FOR A FURTHER EXPLANATION ON CALCULATING TAX-EQUIVALENT YIELDS, SEE THE FUNDS'
STATEMENT OF ADDITIONAL INFORMATION.
35
<PAGE>
Taxable-Equivalent Yield Table
COMBINED 2000 FEDERAL INCOME TAX
AND NEW YORK STATE AND NEW YORK CITY
PERSONAL INCOME TAX RATES
Assuming a Federal
Marginal Tax Rate of: 28% 31% 36% 39.6%
and a Combined State
and City Rate of: 10.63% 10.63% 10.63% 10.63%
The Effective Marginal
Tax Rate Would be: 35.6536%(e) 38.3347%(f) 42.8032%(g) 46.0205%(h)
To Match a Triple
Tax-Free Yield of: A Fully Taxable Investment Would Have to Pay You:
===============================================================================
2.00% 3.11% 3.24% 3.50% 3.71%
-------------------------------------------------------------------------------
2.50% 3.89% 4.05% 4.37% 4.63%
-------------------------------------------------------------------------------
3.00% 4.66% 4.86% 5.25% 5.56%
-------------------------------------------------------------------------------
3.50% 5.44% 5.68% 6.12% 6.48%
-------------------------------------------------------------------------------
4.00% 6.22% 6.49% 6.99% 7.41%
-------------------------------------------------------------------------------
4.50% 6.99% 7.30% 7.87% 8.34%
-------------------------------------------------------------------------------
5.00% 7.77% 8.11% 8.74% 9.26%
-------------------------------------------------------------------------------
5.50% 8.55% 8.92% 9.62% 10.19%
-------------------------------------------------------------------------------
6.00% 9.32% 9.73% 10.49% 11.12%
-------------------------------------------------------------------------------
6.50% 10.10% 10.54% 11.36% 12.04
-------------------------------------------------------------------------------
7.00% 10.88% 11.35% 12.24% 12.97%
===============================================================================
-------------------
(e) Federal Rate of 28% + (New York State Rate of 6.85% + City Rate of 3.78 x
(1-28%))
(f) Federal Rate of 31% + (New York State Rate of 6.85% + City Rate of 3.78 x
(1-31%))
(g) Federal Rate of 36% + (New York State Rate of 6.85% + City Rate of 3.78 x
(1-36%))
(h) Federal Rate of 39.6% + (New York State Rate of 6.85% + City Rate of 3.78 x
(1-39.6%))
WHERE APPLICABLE, THE TABLE ASSUMES THE HIGHEST STATE AND CITY RATE
CORRESPONDING TO THE FEDERAL MARGINAL TAX RATE. AN INVESTOR'S TAX RATES MAY
EXCEED THE RATES SHOWN IN THE ABOVE TABLES IF SUCH INVESTOR DOES NOT ITEMIZE
DEDUCTIONS FOR FEDERAL INCOME TAX PURPOSES OR DUE TO THE REDUCTION OR POSSIBLE
ELIMINATION OF THE PERSONAL EXEMPTION DEDUCTION FOR HIGH-INCOME TAXPAYERS AND
AN OVERALL LIMIT ON ITEMIZED DEDUCTIONS. FOR TAXPAYERS WHO PAY ALTERNATIVE
MINIMUM TAX, TAX-FREE YIELDS MAY BE EQUIVALENT TO LOWER TAXABLE YIELDS THAN
THOSE SHOWN ABOVE. LIKEWISE, FOR SHAREHOLDERS WHO ARE SUBJECT TO INCOME
TAXATION BY STATES OTHER THAN NEW YORK, TAX-FREE YIELDS MAY BE EQUIVALENT TO
LOWER TAXABLE YIELDS THAN THOSE SHOWN ABOVE. THE ABOVE TABLES DO NOT APPLY TO
CORPORATE INVESTORS.
36
<PAGE>
APPENDIX C
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 you with the opportunity to formulate your own investment program. You
may exchange any shares you hold in any one USAA Fund for shares in any other
USAA Fund, subject to the limitations described earlier. For more complete
information about the mutual funds managed and distributed by USAA Investment
Management Company, including charges and operating expenses, call us for a
Prospectus. Read it carefully before you invest. Mutual fund operating expenses
apply and continue throughout the life of the Fund.
FUND TYPE/NAME RISK
==============================================
CAPITAL APPRECIATION
----------------------------------------------
Aggressive Growth Very high
Emerging Markets Very high
First Start Growth Moderate to high
Gold Very high
Growth Moderate to high
Growth & Income Moderate
International Moderate to high
S&P 500 Index Moderate
Science & Technology Very high
Small Cap Stock Very high
World Growth Moderate to high
----------------------------------------------
ASSET ALLOCATION
----------------------------------------------
Balanced Strategy Moderate
Cornerstone Strategy Moderate
Growth and Tax Strategy Moderate
Growth Strategy Moderate to high
Income Strategy Low to moderate
----------------------------------------------
INCOME -- TAXABLE
----------------------------------------------
GNMA Low to moderate
High-Yield Opportunities High
Income Moderate
Income Stock Moderate
Intermediate-Term Bond Low to moderate
Short-Term Bond Low
----------------------------------------------
INCOME -- TAX EXEMPT
----------------------------------------------
Long-Term Moderate
Intermediate-Term Low to moderate
Short-Term Low
State Bond/Income Moderate
----------------------------------------------
MONEY MARKET
----------------------------------------------
Money Market Low
Tax Exempt Money Market Low
Treasury Money Market Trust Low
State Money Market Low
==============================================
FOREIGN INVESTING IS SUBJECT TO ADDITIONAL RISKS, SUCH AS CURRENCY
FLUCTUATIONS, MARKET ILLIQUIDITY, AND POLITICAL INSTABILITY.
S&P(R) 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.
SOME INCOME MAY BE SUBJECT TO STATE OR LOCAL TAXES.
CALIFORNIA, FLORIDA, NEW YORK, AND VIRGINIA FUNDS ARE OFFERED ONLY TO
RESIDENTS OF THOSE STATES.
AN INVESTMENT IN A MONEY MARKET FUND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE
THE VALUE OF YOUR INVESTMENT AT $1 PER SHARE, IT IS POSSIBLE TO LOSE MONEY
BY INVESTING IN THE FUND.
THE SCIENCE & TECHNOLOGY FUND MAY BE MORE VOLATILE THAN A FUND THAT
DIVERSIFIES ACROSS MANY INDUSTRIES.
37
<PAGE>
NOTES
38
<PAGE>
NOTES
39
<PAGE>
If you would like more information about the Funds, you may call 1-800-531-8181
to request a free copy of the Funds' Statement of Additional Information (SAI),
Annual or Semiannual Report, or to ask other questions about the Funds. The SAI
has been filed with the Securities and Exchange Commission (SEC) and is legally
a part of this Prospectus. In the Funds' Annual Report, you will find a
discussion of the market conditions and investment strategies that
significantly affected each Fund's performance during the last fiscal year.
To view these documents, along with other related documents, you can visit the
EDGAR database on the SEC's Internet web site (www.sec.gov) or the Commission's
Public Reference Room in Washington, D.C. Information on the operation of the
Public Reference Room can be obtained by calling 1-202-942-8090. Additionally,
copies of this information can be obtained, after paying a duplicating fee, by
electronic request at the following e-mail address: [email protected] or by
writing the Public Reference Section of the Commission, Washington, D.C.
20549-0102.
===============================================================================
INVESTMENT ADVISER, UNDERWRITER, AND DISTRIBUTOR
USAA Investment Management Company
9800 Fredericksburg Road
San Antonio, Texas 78288
------------------------------------------------------------
TRANSFER AGENT CUSTODIAN
USAA Shareholder Account Services State Street Bank and Trust Company
9800 Fredericksburg Road P.O. Box 1713
San Antonio, Texas 78288 Boston, Massachusetts 02105
------------------------------------------------------------
TELEPHONE ASSISTANCE HOURS
Call toll free - Central Time
Monday - Friday 6:00 a.m. to 10:00 p.m.
Saturday 8:30 a.m. to 5:00 p.m.
Sunday 11:30 a.m. to 8:00 p.m.
------------------------------------------------------------
FOR ADDITIONAL INFORMATION ON MUTUAL FUNDS
1-800-531-8181 (in San Antonio, 456-7200)
For account servicing, exchanges, or redemptions
1-800-531-8448 (in San Antonio, 456-7202)
------------------------------------------------------------
RECORDED MUTUAL FUND PRICE QUOTES
24-Hour Service (from any phone)
1-800-531-8066 (in San Antonio, 498-8066)
------------------------------------------------------------
MUTUAL FUND USAA TOUCHLINE(R)
(from touch-tone phones only)
For account balance, last transaction, fund prices,
or to exchange/redeem fund shares
1-800-531-8777 (in San Antonio, 498-8777)
------------------------------------------------------------
INTERNET ACCESS
usaa.com(SM)
===============================================================================
Investment Company Act File No. 811-3333
<PAGE>
Part A
Prospectus for the
Virginia Bond and
Virginia Money Market Funds
<PAGE>
USAA VIRGINIA FUNDS
USAA VIRGINIA BOND FUND
USAA VIRGINIA MONEY MARKET FUND
PROSPECTUS
AUGUST 1, 2000
Shares of the Virginia Funds are offered only to Virginia residents. The
delivery of this Prospectus is not an offer in any state where shares of the
Virginia Funds may not lawfully be made.
As with other mutual funds, the Securities and Exchange Commission has not
approved or disapproved of either of these Fund's shares or determined whether
this Prospectus is accurate or complete. Anyone who tells you otherwise is
committing a crime.
TABLE OF CONTENTS
What Are Each Fund's Investment Objectives and Main Strategies?........ 2
Main Risks of Investing in These Funds................................. 2
Are These Funds for You?............................................... 3
Could the Value of Your Investment in These Funds Fluctuate?........... 4
Fees and Expenses...................................................... 8
Fund Investments....................................................... 9
Fund Management........................................................ 19
Using Mutual Funds in an Investment Program............................ 20
How to Invest.......................................................... 21
Important Information About Purchases and Redemptions.................. 25
Exchanges.............................................................. 26
Shareholder Information................................................ 27
Financial Highlights................................................... 30
Appendix A............................................................. 32
Appendix B ............................................................ 34
Appendix C............................................................. 35
<PAGE>
USAA Investment Management Company manages these Funds. For easier reading,
USAA Investment Management Company will be referred to as "we" or "us"
throughout the Prospectus.
WHAT ARE EACH FUND'S INVESTMENT
OBJECTIVES AND MAIN STRATEGIES?
Each Fund has 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 dollar-weighted average portfolio
maturity is not restricted, but is expected to be greater than ten years.
The VIRGINIA MONEY MARKET FUND invests in high-quality, Virginia tax-exempt
securities with maturities of 397 days or less.
Because any investment involves risk, there is no assurance that the Funds'
objectives will be achieved. See FUND INVESTMENTS on page 9 for more
information.
MAIN RISKS OF INVESTING IN THESE FUNDS
The two primary risks of investing in these Funds are credit risk and market
risk. As with other mutual funds, losing money is also a risk of investing in
these Funds.
* CREDIT RISK involves the possibility that a borrower cannot make timely
interest and principal payments on its securities.
* MARKET RISK involves the possibility that the value of each Fund's
investments will decline because of an increase in interest rates, or to
adverse changes in supply and demand for municipal securities, or other
market factors.
These credit and market risks may be magnified because each Fund concentrates
in Virginia tax-exempt securities.
IF INTEREST RATES INCREASE: the yield of each Fund may increase and the market
value of the Virginia Bond Fund's securities will likely decline, adversely
affecting the net asset value and total return.
2
<PAGE>
IF INTEREST RATES DECREASE: the yield of each Fund may decrease and the market
value of the Virginia Bond Fund's securities may increase, which would likely
increase the Fund's net asset value and total return. The Virginia Money Market
Fund's total return may decrease.
Other risks of investing in either Fund include call risk and structural risk.
As you consider an investment in either Fund, you should also take into account
your tolerance for the daily fluctuations of the financial markets and whether
you can afford to leave your money in the investment for long periods of time
to ride out down periods.
An investment in either Fund is not a deposit of USAA Federal Savings Bank, or
any other bank, and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency. Although the Virginia
Money Market Fund seeks to preserve the value of your investment at $1 per
share, it is possible to lose money by investing in that Fund.
Look for this symbol[CAUTION LIGHT GRAPHIC] throughout the Prospectus. We use
it to mark more detailed information about the risks you will face as a Fund
shareholder.
ARE THESE FUNDS FOR YOU?
Virginia Bond Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are looking for current income that is exempt from Virginia state and
federal income taxes.
* You are willing to accept moderate risk.
* You are looking for an investment in bonds to balance your stock
portfolio.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You are unwilling to take greater risk for intermediate-term goals.
* Your current tax situation does not allow you to benefit from tax-exempt
income.
* You are seeking an appropriate investment for an IRA, through a 401(k)
plan or 403(b) plan, or other tax-sheltered account.
3
<PAGE>
Virginia Money Market Fund
This Fund might be appropriate as part of your investment portfolio if . . .
* You are looking for current income that is exempt from Virginia state and
federal income taxes.
* You need to preserve principal.
* You want a low-risk investment.
* You need your money back within a short period.
* You would like checkwriting privileges on the account.
* You are looking for an investment in a money market fund to balance your
stock or long-term bond portfolio.
This Fund MAY NOT be appropriate as part of your investment portfolio if . . .
* You need a high total return to achieve your goals.
* Your primary goal is long-term growth.
* Your current tax situation does not allow you to benefit from tax-exempt
income.
Either Fund by itself does not constitute a balanced investment program.
Diversifying your investments may improve your long-run investment return and
lower the volatility of your overall investment portfolio.
COULD THE VALUE OF YOUR INVESTMENT
IN THESE FUNDS FLUCTUATE?
Yes, it could. In fact, the value of your investment in the Virginia Bond Fund
will fluctuate with the changing market values of the investments in the Fund.
We manage the Virginia Money Market Fund in accordance with strict Securities
and Exchange Commission (SEC) guidelines designed to preserve the Fund's value
at $1 per share, although, of course, we cannot guarantee that the value will
remain at $1 per share.
The value of the securities in which the Virginia Bond Fund invests typically
fluctuates inversely with changes in the general level of 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. The following bar charts illustrate the Funds' volatility
and performance from year to year for each full calendar year since the Funds'
inspection.
4
<PAGE>
TOTAL RETURN
All mutual funds must use the same formula to calculate total return.
Virginia Bond Fund
[SIDE BAR]
TOTAL RETURN MEASURES THE PRICE CHANGE IN A SHARE ASSUMING THE REINVESTMENT OF
ALL DIVIDEND INCOME AND CAPITAL GAIN DISTRIBUTIONS.
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1991* 11.72%
1992 8.49%
1993 12.67%
1994 -6.32%
1995 17.08%
1996 5.06%
1997 9.50%
1998 6.04%
1999 -4.63%
* Fund began operations on October 15, 1990.
THE VIRGINIA BOND FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD ENDED JUNE
30, 2000, WAS 5.20%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 7.72% (quarter ending March 31, 1995) and the lowest total return
for a quarter was -5.34% (quarter ending March 31, 1994).
The table below shows how the Fund's average annual total returns for the one-
and five-year periods, as well as the life of the Fund, compared to those of a
broad-based securities market index. Remember, historical performance does not
necessarily indicate what will happen in the future.
=================================================================
Average Annual
Total Returns Since Fund's
(for the periods ending Past Past inception
December 31, 1999) 1 Year 5 Years October 15, 1990
-----------------------------------------------------------------
Virginia Bond Fund -4.63% 6.38% 6.63%
-----------------------------------------------------------------
Lehman Brothers
Municipal Bond Index* -2.06% 6.91% 7.08%
=================================================================
*THE LEHMAN BROTHERS MUNICIPAL BOND INDEX IS AN UNMANAGED BENCHMARK OF TOTAL
RETURN PERFORMANCE FOR THE LONG-TERM, INVESTMENT-GRADE, TAX-EXEMPT BOND
MARKET.
5
<PAGE>
Virginia Money Market Fund
[BAR CHART]
CALENDAR YEAR TOTAL RETURN
1991* 4.50%
1992 2.91%
1993 2.20%
1994 2.54%
1995 3.52%
1996 3.17%
1997 3.31%
1998 3.14%
1999 2.88%
* Fund began operations on October 15, 1990.
THE VIRGINIA MONEY MARKET FUND'S TOTAL RETURN FOR THE SIX-MONTH PERIOD
ENDED JUNE 30, 2000, WAS 1.78%.
During the periods shown in the above bar chart, the highest total return for a
quarter was 1.20% (quarter ending March 31, 1991) and the lowest total return
for a quarter was .49% (quarter ending March 31, 1994).
The table below shows the Fund's average annual total returns for the one- and
five-year periods, as well as the life of the Fund. Remember, historical
performance does not necessarily indicate what will happen in the future.
===================================================================
Average Annual
Total Returns Since Fund's
(for the periods ending Past Past Inception on
December 31, 1999) 1 Year 5 Years October 15, 1990
-------------------------------------------------------------------
Virginia Money Market Fund 2.88% 3.20% 3.17%
===================================================================
YIELD
[SIDE BAR]
YIELD IS THE ANNUALIZED NET INCOME OF THE FUND DURING A SPECIFIED PERIOD AS A
PERCENTAGE OF THE FUND'S SHARE PRICE.
All mutual funds must use the same formulas to calculate yield and effective
yield.
Virginia Bond Fund
The Virginia Bond Fund may advertise performance in terms of a 30-day yield
quotation or a tax-equivalent yield. The Fund's 30-day yield for the period
ended December 31, 1999, was 5.41%.
6
<PAGE>
Virginia Money Market Fund
[SIDE BAR]
EFFECTIVE YIELD IS CALCULATED SIMILAR TO THE YIELD, HOWEVER, WHEN ANNUALIZED,
THE INCOME EARNED IS ASSUMED TO BE REINVESTED.
The Virginia Money Market Fund typically advertises performance in terms of a
7-day yield and effective yield or tax-equivalent yield and may advertise total
return. The 7-day yield quotation more closely reflects current earnings of the
Fund than the total return quotation. The effective yield will be slightly
higher than the yield because of the compounding effect of the assumed
reinvestment. Current yields 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. The Fund's 7-day yield for the period
ended December 31, 1999, was 4.07%.
TAX-EQUIVALENT YIELD
Investors use tax-equivalent yields to compare taxable and tax-exempt fixed
income investments using a common yield measure. The tax-equivalent yield is
the yield that a fully taxable investment must generate to earn the same
"take-home" yield as a tax-exempt investment. The calculation depends upon your
federal and Virginia marginal income tax rates and assumes that an investor can
fully itemize deductions on his or her federal tax return. The higher your
marginal tax bracket, the higher will be the tax-equivalent yield and the more
valuable is the Fund's tax exemption.
For example, if you assume a federal marginal tax rate of 36% and a state
marginal tax rate of 5.75%, the Effective Marginal Tax Rate would be 39.68%.
Using this tax rate, the Funds' tax-equivalent yields for the period ending
December 31, 1999, would be as follows:
===============================================================
Tax-Equivalent
Yield Yield
---------------------------------------------------------------
Virginia Bond Fund (30 day) 5.41% 8.97%
Virginia Money Market Fund (7 day) 4.07% 6.75%
===============================================================
Using the example, to exceed the 30-day yield of the Virginia Bond Fund on an
after-tax basis, you must find a fully taxable investment that yields more than
8.97%. Likewise, to exceed the 7-day yield of the Virginia Money Market Fund,
you must find a fully taxable investment that yields morethan 6.75%.
For more information on calculating tax-equivalent yields, see APPENDIX B on
page 34.
7
<PAGE>
[SIDE BAR]
[TOUCHLINE GRAPHIC]
TOUCHLINE(R)
1-800-531-8777
PRESS
1
THEN
1
THEN
6, 5, #
Please consider performance information in light of the Funds' investment
objectives and policies and market conditions during the reported time periods.
The value of your shares may go up or down. For the most current price, yield,
and return information for these Funds, you may call USAA TouchLine(R) at
1-800-531-8777. Press 1 for the Mutual Fund Menu, press 1 again for prices,
yields, and returns. Then, press 64# for the Virginia Bond Fund or press 65#
for the Virginia Money Market Fund when asked for a Fund Code. You may also
access this information through our usaa.com(SM) Internet web site once your
account has been established.
Additionally, you may find the most current price of your shares in the
business section of your newspaper in the mutual fund section under the heading
"USAA Group" and the symbol "VA Bd" for the Virginia Bond Fund. If you prefer
to obtain this information from an on-line computer service, you can do so by
using the ticker symbol "USVAX" for the Virginia Bond Fund or the ticker symbol
"UVAXX" for the Virginia Money Market Fund.
[SIDE BAR]
Virginia
Bond Fund
Newspaper
Symbol
VA Bd
Ticker
Symbols
USVAX
UVAXX
FEES AND EXPENSES
This summary shows what it will cost you, directly and indirectly, to invest in
the Funds.
Shareholder Transaction Expenses-- (Direct Costs)
There are no fees or sales loads charged to your account when you buy or sell
Fund shares. However, if you sell shares and request your money by wire
transfer, there is a $12 domestic wire fee and a $35 foreign wire fee. (Your
bank may also charge a fee for receiving wires.)
Annual Fund Operating Expenses-- (Indirect Costs)
Fund expenses come out of the Funds' assets and are reflected in the Funds'
share prices and dividends. "Other Expenses" include expenses such as custodian
and transfer agent fees. The figures below show actual expenses before waivers,
if any, during the past fiscal year ended March 31, 2000, and are calculated as
a percentage of average net assets (ANA).
[SIDE BAR]
12b-Fees - SOME MUTUAL FUNDS CHARGE THESE FEES TO PAY FOR ADVERTISING AND OTHER
COSTS OF SELLING FUND SHARES.
==================================================================
Virgina Virginia Money
Bond Fund Market Fund
Management Fees .33% .33%
Distribution (12b-1) Fees None None
Other Expenses .10% .17%
---- ----
Total Annual Fund Operating Expenses* .43% .50%
==== ====
==================================================================
------------------
* During the year, we voluntarily limited each Fund's Total Annual Fund
Operating Expenses to .50% of its ANA. However, the Total Fund Operating
Expenses for the Funds did not exceed the limitation, therefore, no
reimbursements were required.
8
<PAGE>
We have again voluntarily agreed to limit each Fund's annual expenses to
.50% of its ANA and will reimburse the Funds for all expenses in excess of
that amount until August 1, 2001.
Example of Effect of the Funds' Operating Expenses
This example is intended to help you compare the cost of investing in one of
the Funds with the cost of investing in other mutual funds. Although your
actual costs may be higher or lower, you would pay the following expenses on a
$10,000 investment, assuming (1) 5% annual return, (2) the Fund's operating
expenses (before any applicable reimbursement) remain the same, and (3) you
redeem all of your shares at the end of those periods shown.
===================================================================
Virginia Virginia Money
Bond Fund Market Fund
-------------------------------------------------------------------
1 year $ 44 $ 51
3 years 138 160
5 years 241 280
10 years 542 628
===================================================================
FUND INVESTMENTS
Principal Investment Strategies and Risks
Q What is each Fund's principal investment strategy?
A Each Fund's principal strategy is the investment of its assets in
securities 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.
These securities include municipal debt obligations that have been
issued by Virginia and its political subdivisions, and duly constituted
state and local authorities and corporations. We refer to these
securities as Virginia tax-exempt securities. Virginia tax-exempt
securities are issued to fund public infrastructure projects such as
streets and highways, schools, water and sewer systems, hospitals, and
airports. They 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.
9
<PAGE>
Because the projects benefit the public, Congress has granted exemption
from federal income taxes for the interest income arising from these
securities. Likewise, the Virginia Legislature has granted an exemption
from state personal income taxes for most Virginia municipal securities.
Q What types of tax-exempt securities will be included in each Fund's
portfolio?
A Each Fund's assets may be invested in any of the following tax-exempt
securities:
* 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;
* SYNTHETIC INSTRUMENTS, which combine a municipality's long-term
obligation to pay interest and principal with the obligation of a
third party to repurchase the instrument on short notice; and
* INDUSTRIAL DEVELOPMENT BONDS issued by or on behalf of public
authorities to obtain funds for privately operated facilities.
As a temporary defensive measure because of market, economic, political,
or other conditions, we may invest up to 100% of each Fund's assets in
short-term securities whether or not they are exempt from federal income
tax and Virginia state income taxes. To the extent that these temporary
investments produce taxable income, that income may result in that Fund
not fully achieving its investment objective during the time it is in
this temporary defensive posture.
Q What are the principal risks associated with investments in tax-exempt
securities?
A The two principal risks of investing in tax-exempt securities are credit
risk and market risk.
10
<PAGE>
[CAUTION LIGHT GRAPHIC]
CREDIT RISK. The bonds in each Fund's portfolio are subject to credit
risk. Credit risk is the possibility that an issuer of a fixed income
security will fail to make timely payments of interest or principal. We
attempt to minimize the Funds' credit risks by investing in securities
considered at least investment grade at the time of purchase.
Nevertheless, even investment-grade securities are subject to some
credit risk. In addition, the ratings of securities are estimates by the
rating agencies of the credit quality of the securities. The ratings may
not take into account every risk related to whether interest or
principal will be repaid on a timely basis.
When evaluating potential investments for the Funds, our analysts also
independently assess credit risk and its impact on the Funds'
portfolios. Securities in the lowest investment grade ratings category
(BBB) have speculative characteristics. Changes in economic conditions
or other circumstances are more likely to lead to a weakened capability
to make principal and interest payments on these securities than is the
case for higher-rated securities.
[CAUTION LIGHT GRAPHIC]
MARKET RISK. As a mutual fund investing in bonds, the Funds are subject
to the risk that the market value of the bonds will decline because of
rising interest rates. Bond prices are linked to the prevailing market
interest rates. In general, when interest rates rise, bond prices fall
and when interest rates fall, bond prices rise. The price volatility of
a bond also depends on its maturity. Generally, the longer the maturity
of a bond, the greater its sensitivity to interest rates. To compensate
investors for this higher market risk, bonds with longer maturities
generally offer higher yields than bonds with shorter maturities.
Q What other risks are associated with investments in tax-exempt
securities?
A Two other risks that are applicable to certain tax-exempt securities are
call risk and structural risk.
[CAUTION LIGHT GRAPHIC]
CALL RISK. Many municipal bonds may be "called," or redeemed, by the
issuer before the stated maturity. During a period of declining interest
rates, an issuer would call, or refinance, a higher yielding bond for
the same reason that a homeowner would refinance a home mortgage.
Interest rates must drop sufficiently so that the savings more than
offset the cost of refinancing.
11
<PAGE>
Intermediate- and long-term municipal bonds have the greatest call risk,
because most municipal bonds may not be called until after ten years
from the date of issue. The period of "call protection" may be longer or
shorter than ten years, but regardless, bonds purchased closest to the
date of issue will have the most call protection. Typically, bonds with
original maturities of ten years or less are not callable.
Although investors certainly appreciate the rise in bond prices when
interest rates drop, falling interest rates create the environment
necessary to "call" the higher-yielding bonds from your Fund. When bonds
are called, the Fund is impacted in several ways. Most likely, we must
reinvest the bond-call proceeds at lower interest rates. The Fund's
income may drop as a result. The Fund may also realize a taxable capital
gain.
{CAUTION LIGHT GRAPHIC]
STRUCTURAL RISK. Some tax-exempt securities, referred to as "synthetic
instruments," are created by combining a long-term municipal bond with a
right to sell the instrument back to the remarketer or liquidity
provider for repurchase on short notice, referred to as a "tender
option." Usually, the tender option is backed by a letter of credit or
similar guarantee from a bank. The guarantee, however, is typically
conditional, which means that the bank is not required to pay under the
guarantee if there is a default by the municipality or if certain other
events occur. These types of instruments involve special risks, referred
to as "structural risk." For example, because of the structure of a
synthetic instrument, there is a risk that the instrument will lose its
tax-exempt treatment or that we will not be able to exercise our tender
option. We will not purchase a synthetic instrument unless counsel has
issued an opinion that the instrument is entitled to tax-exempt
treatment. In addition, we will not purchase a synthetic instrument for
the Virginia Money Market Fund unless we believe there is only minimal
risk that we will not be able to exercise our tender option at all
times.
Q What percentage of each Fund's assets will be invested in Virginia
tax-exempt securities?
A During normal market conditions, at least 80% of each Fund's net assets
will consist of Virginia tax-exempt securities. This policy may only be
changed by a shareholder vote.
In addition to Virginia tax-exempt securities, securities issued by
certain U.S. territories and possessions such as Puerto Rico,
12
<PAGE>
the Virgin Islands, and Guam are exempt from federal and state personal
income taxes; and as such, we may consider investing up to 20% of each
Fund's assets in these securities.
Q Are each Fund's investments diversified in many different issuers?
A Each Fund is considered diversified under the federal securities laws.
This means that we will not invest more than 5% in any one issuer with
respect to 75% of each Fund's assets. With respect to the remaining 25%
of each Fund's assets, we could invest more than 5% in any one, or more,
issuers. Purchases of securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities are not counted toward
the 5% limitation. Each Fund, of course, is concentrated geographically
through the purchase of Virginia tax-exempt securities.
With respect to the Virginia Money Market Fund, strict SEC guidelines do
not permit us to invest, with respect to 75% of the Fund's assets,
greater than 10% of the Fund's assets in securities issued by or subject
to guarantees by the same institution.
We also may not invest more than 25% of the Funds' 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
that are based, directly or indirectly, on the credit of private
entities of any one industry. However, we reserve the right to invest
more than 25% of the Funds' assets in tax-exempt industrial revenue
bonds. The 25% industry limitation does not apply to general obligation
bonds or bonds that are escrowed in U.S. government securities.
[CAUTION LIGHT GRAPHIC]
Q What are the potential risks associated with concentrating such a large
portion of each Fund's assets in one state?
A The Funds are subject to credit and market risks, as previously
described, which could be magnified by the Funds' concentration in
Virginia issues. Virginia tax-exempt securities may be affected by
political, economic, regulatory, or other developments that limit the
ability of Virginia issuers to pay interest or repay principal in a
timely manner. Therefore, the Funds are affected by events within
Virginia to a much greater degree than a more diversified national fund.
13
<PAGE>
A particular development may not directly relate to the Funds'
investments but nevertheless might depress the entire market for the
state's tax-exempt securities and therefore adversely impact the Funds'
valuation.
An investment in the Virginia Funds may be riskier than an investment in
other types of tax-exempt funds because of this concentration.
The following are examples of just some of the events that may depress
valuations for Virginia tax-exempt securities for an extended period of
time:
* Changes in state laws, including voter referendums, that restrict
revenues or raise costs for issuers.
* Court decisions that affect a category of municipal bonds, such as
municipal lease obligations or electric utilities.
* Natural disasters such as floods, storms, hurricanes, droughts, fires,
or earthquakes.
* Bankruptcy or financial distress of a prominent municipal issuer
within the state.
* Economic issues that impact critical industries or large employers or
that weaken real estate prices.
* Reductions in federal or state financial aid.
* Imbalance in the supply and demand for the state's municipal
securities.
* Developments that may change the tax treatment of Virginia tax-exempt
securities.
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
tax-exempt securities are summarized in the Statement of Additional
information under SPECIAL RISK CONSIDERATIONS.
Q Do the Funds purchase bonds guaranteed by bond insurance?
A Yes. Some of the bonds we purchase for the Funds are secured by bond
insurance that guarantees scheduled principal and interest payments. In
addition, we may purchase bond insurance for individual uninsured
securities when we believe it will provide a net economic benefit to the
shareholders.
14
<PAGE>
Q Will any portion of the distributions from the Funds be subject to
federal income taxes?
A During normal market conditions, at least 80% of each Fund's annual
income will be excluded from gross income for federal income tax
purposes and will be exempt from Virginia state income taxes. This
policy may only be changed by a shareholder vote. We expect that any
taxable interest income distributed will be minimal.
However, gains and losses from trading securities that occur during the
normal course of managing a fund may create net capital gain
distributions. The Internal Revenue Code presently treats these
distributions differently than tax-exempt interest income in the
following ways:
* Distributions of net short-term capital gains are taxable as ordinary
income.
* Distributions of net long-term capital gains are taxable as
long-term capital gains, regardless of the length of time you have
held the Fund shares.
* Both short-term and long-term capital gains are taxable whether
received in cash or reinvested in additional shares.
Q Will income from the Funds be subject to the federal alternative minimum
tax (AMT) for individuals?
A During normal market conditions, at least 80% of each Fund's annual
income will be excluded from the calculation of the federal alternative
minimum tax (AMT) for individuals. This policy may only be changed by a
shareholder vote. Since inception, the Funds have not distributed any
income that is subject to the federal AMT for individuals, and we do not
intend to invest in securities subject to the federal AMT. However, of
course, changes in federal tax laws or other unforeseen circumstances
could result in income subject to the federal AMT for individuals.
15
<PAGE>
Virginia Bond Fund
Q What is the credit quality of the Fund's investments?
A Under normal market conditions, we will invest the Fund's assets so that
at least 50% of the total market value of the tax-exempt securities are
rated within the three highest long-term rating categories (A or higher)
by Moody's Investors Service (Moody's), Standard & Poor's Ratings Group
(S&P), or Fitch Information, Inc. (Fitch) or in the highest short-term
rating category by Moody's, S&P, or Fitch. If a security is not rated by
those rating agencies, we must determine that the security is of
equivalent investment quality.
In no event will we purchase a security for the Fund unless itis rated
at least investment grade at the time of purchase. Investment-grade
securities are those securities rated within the four highest long-term
rating categories by Moody's (Baaor higher), S&P, or Fitch (BBB or
higher), or in the two highest short-term rating categories by these
rating agencies. If unrated by these agencies, we must determine that
the securities are of equivalent investment quality.
On occasion, we may purchase a credit rating on a particular security
when we believe it will provide a net economic benefit to the
shareholders.
You will find a complete description of the above tax-exempt ratings in
the Fund's Statement of Additional Information.
Q What happens if the rating of a security is downgraded to below
investment grade?
A We will determine whether it is in the best interest of the Fund's
shareholders to continue to hold the security in the Fund's portfolio.
If downgrades result in more than 5% of the Fund's net assets being
invested in securities that are less than investment-grade quality, we
will take immediate action to reduce the Fund's holdings in such
securities to 5% or less of the Fund's net assets, unless otherwise
directed by the Fund's Board of Directors.
16
<PAGE>
Q How are the decisions to buy and sell securities made?
A We manage tax-exempt funds based on the common sense premise that our
investors value tax-exempt income over taxable capital gain
distributions. When weighing the decision to buy or sell a security, we
strive to balance the value of the tax-exempt income, the credit risk of
the issuer, and the price volatility of the bond.
Q What is the Fund's average portfolio maturity and how is it calculated?
A While the Fund's average portfolio maturity is not restricted, we expect
it to be greater than ten years. To determine a security's maturity for
purposes of calculating the Fund's average portfolio maturity, we may
estimate the expected time in which the security's principal is to be
paid. This can be substantially shorter than its stated final maturity.
For more information on the method of calculating the Fund's average
weighted portfolio maturity, see INVESTMENT POLICIES in the Fund's
Statement of Additional Information.
Virginia Money Market Fund
Q What is the credit quality of the Fund's investments?
A The Fund's investments consist of securities meeting the requirements to
qualify as "eligible securities" under the SEC rules applicable to money
market funds. In general, an eligible security is defined as a security
that is:
* issued or guaranteed by the U.S. government or any agency or
instrumentality thereof, including "prerefunded" and "escrowed to
maturity" tax-exempt securities;
* rated or subject to a guarantee that is 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;
* unrated but issued by an issuer or guaranteed by a guarantor that has
other comparable short-term debt obligations so rated; or
* unrated but determined by us to be of comparable quality.
In addition, we must consider whether a particular investment presents
minimal credit risk.
17
<PAGE>
Q Who are the Nationally Recognized Statistical Rating Organizations?
A Current NRSROs include:
* Moody's Investors Service;
* Standard & Poor's Ratings Group;
* Fitch Information, Inc.; and
* Thompson BankWatch.
Q What happens if the rating of a security is downgraded?
A If the rating of a security is downgraded after purchase, we will
determine whether it is in the best interest of the Fund's shareholders
to continue to hold the security in the Fund's portfolio.
Q Will the Fund always maintain a net asset value of $1 per share?
[SIDE BAR]
DOLLAR-WEIGHTED AVERAGE PORTFOLIO MATURITY IS OBTAINED BY MULTIPLYING THE
DOLLAR VALUE OF EACH INVESTMENT BY THE NUMBER OF DAYS LEFT TO ITS MATURITY,
THEN ADDING THOSE FIGURES TOGETHER AND DIVIDING THE TOTAL BY THE DOLLAR VALUE
OF THE FUND'S PORTFOLIO.
A While we will endeavor to maintain a constant Fund net asset value of $1
per share, there is no assurance that we will be able to do so.
Remember, the shares are neither insured nor guaranteed by the U.S.
government. As such, the Fund carries some risk.
For example, there is always a risk that the issuer of a security held
by the Fund will fail to pay interest or principal when due. We attempt
to minimize this credit risk by investing only in securities rated in
one of the two highest categories for short-term securities, or, if not
rated, of comparable quality, at the time of purchase. Additionally, we
will not purchase a security unless our analysts determine that the
security presents minimal credit risk.
There is also a risk that rising interest rates will cause the value of
the Fund's securities to decline. We attempt to minimize this interest
risk by limiting the maturity of each security to 397 days or less and
maintaining a dollar-weighted average portfolio maturity for the Fund of
90 days or less.
Finally, there is the possibility that one or more investments in the
Fund cease to be "eligible securities" resulting in the net asset value
ceasing to be $1 per share. For example, a guarantor on a security
failing to meet a contractual obligation could cause such a result.
18
<PAGE>
Q How are the decisions to buy and sell securities made?
A We balance factors such as credit quality and maturity to purchase the
best relative value available in the market at any given time. While
rare, a decision to sell is usually based on a change in our credit
analysis or to take advantage of an opportunity to reinvest at a higher
yield.
For additional information about other securities in which we may invest each
Fund's assets, see APPENDIX A on page 32.
FUND MANAGEMENT
USAA Investment Management Company serves as the manager and distributor of
these Funds. We are an affiliate of United Services Automobile Association
(USAA), a large, diversified financial services institution. As of the date of
this Prospectus, we had approximately $41 billion in total assets under
management. Our mailing address is 9800 Fredericksburg Road, San Antonio, TX
78288.
We provide management services to the Funds pursuant to an Advisory Agreement.
We are responsible for managing the Funds' portfolios (including placement of
brokerage orders) and their business affairs, subject to the authority of and
supervision by the Funds' Board of Directors. For our services, the Funds pay
us an annual fee. This fee, which is accrued daily and paid monthly, is
computed as a percentage of the aggregate average net assets of both Funds
combined. This fee is allocated between the Funds based on the relative net
assets of each. The fee is computed at one-half of one percent (.50%) of the
first $50 million of average net assets, two-fifths of one percent (.40%) for
that portion of average net assets over $50 million but not over $100 million,
and three-tenths of one percent (.30%) for that portion of average net assets
over $100 million. The fees we received for the fiscal year ended March 31,
2000, were equal to .33% of average net assets for the Virginia Bond Fund and
.33% of average net assets for the Virginia Money Market Fund. We also provide
services related to selling the Funds' shares and receive no compensation for
those services.
19
<PAGE>
Portfolio Managers
VIRGINIA BOND FUND
[PHOTOGRAPH]
Robert R. Pariseau
Robert R. Pariseau, Assistant Vice President of Fixed Income Mutual Fund
Portfolios, has managed the Fund since May 1995. He has 16 years investment
management experience working for us. Mr. Pariseau earned the Chartered
Financial Analyst designation in 1987 and is a member of the Association for
Investment Management and Research, the San Antonio Financial Analysts Society,
Inc., and the National Federation of Municipal Analysts. He holds an MBA from
Lindenwood College and a BS from the U.S. Naval Academy.
VIRGINIA MONEY MARKET FUND
[PHOTOGRAPH]
Regina G. Shafer
Regina G. Shafer, Assistant Vice President of Money Market Funds, has managed
the Fund since April 1999. She has five years investment management experience
and has worked for us for nine years. Ms. Shafer is a Certified Public
Accountant and earned the Chartered Financial Analyst designation in 1998. She
is a member of the Association for Investment Management and Research and the
San Antonio Financial Analysts Society, Inc. She holds an MBA from the
University of Texas at San Antonio and a BBA from Southwest Texas State
University.
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 diversified
portfolio. That portfolio is managed by investment professionals, relieving you
of the need to make individual stock or bond selections. You also enjoy
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,
you own 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, you are giving up some
investment decisions, but must still make others. The decisions you don't have
to make are those involved with choosing individual securities.
20
<PAGE>
We will perform that function. In addition, we will arrange for the safekeeping
of securities, auditing the annual financial statements, and daily valuation of
the Fund, as well as other functions.
You, however, retain at least part of the responsibility for an equally
important decision. This decision involves determining a portfolio of mutual
funds that balances your investment goals with your tolerance for risk. It is
likely that this decision may include the use of more than one fund of the USAA
Family of Funds.
For example, assume you wish to pursue the higher yields usually available in
the long-term bond market, but you are also concerned about the possible price
swings of the long-term bonds. You could divide your 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 way you could combine funds
to fit your own risk and reward goals.
III. USAA's Family of Funds
We offer you another alternative with our asset strategy funds listed in
APPENDIX C under asset allocation on page 35. These unique mutual funds provide
a professionally managed, diversified investment portfolio within a mutual
fund. Designed for the individual who prefers to delegate the asset allocation
process to an investment manager, their structure achieves diversification
across a number of investment categories.
Whether you prefer to create your own mix of mutual funds or use a USAA Asset
Strategy Fund, the USAA Family of Funds provides a broad range of choices
covering just about any investor's investment objectives. Our member service
representatives stand ready to assist you with your choices and to help you
craft a portfolio to meet your needs. Refer to APPENDIX C on page 35 for a
complete list of the USAA Family of No-Load Mutual Funds.
HOW TO INVEST
Purchase of Shares
OPENING AN ACCOUNT
You may open an account and make an investment as described below by mail, in
person, bank wire, phone, or on the Internet. A complete, signed application is
required to open your initial account. However, after you open your initial
account with us, you will not need to fill out another application to invest in
another Fund unless the registration is different.
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<PAGE>
TAX ID NUMBER
Each shareholder named on the account must provide a social security number or
tax identification number to avoid possible withholding requirements.
EFFECTIVE DATE
When you make a purchase, your purchase price will be the net asset value (NAV)
per share next determined after we receive your request in proper form. Each
Fund's NAV is determined at the close of the regular trading session (generally
4:00 p.m. Eastern Time) of the New York Stock Exchange (NYSE) each day the NYSE
is open. If we receive your request and payment prior to that time, your
purchase price will be the NAV per share determined for that day. If we receive
your request or payment after the NAV per share is calculated, the purchase
will be effective on the next business day.
If you plan to purchase Fund shares with a foreign check, we suggest you
convert your foreign check to U.S. dollars prior to investment in a Fund. This
will avoid a potential four- to six-week delay in the effective date of your
purchase. Furthermore, a bank charge may be assessed in the clearing process,
which will be deducted from the amount of the purchase.
MINIMUM INVESTMENTS
INITIAL PURCHASE
[MONEY GRAPHIC]
* $3,000
ADDITIONAL PURCHASES
* $50 (Except on transfers from brokerage accounts into the Virginia Money
Market Fund, which are exempt from the minimum). Employees of USAA and its
affiliated companies may add to an account through payroll deduction for as
little as $25 per pay period with a $3,000 initial investment.
HOW TO PURCHASE
MAIL
[ENVELOPE GRAPHIC]
* To open an account, send your application and check to:
USAA Investment Management Company
9800 Fredericksburg Road
San Antonio, TX 78288
* To add to your account, send your check and the deposit stub that
accompanies your Fund's transaction confirmation to theTransfer Agent:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
22
<PAGE>
IN PERSON
[HANKSHAKE GRAPHIC]
* To open an account, bring your application and check to our San Antonio
investment sales and service office at:
USAA Federal Savings Bank
10750 Robert F. McDermott Freeway
San Antonio, TX 78288
BANK WIRE
[BANK WIRE GRAPHIC]
* To open or add to your 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 Virginia Fund Name
USAA Account Number: 69384998
Shareholder(s) Name(s)
Shareholder(s) Mutual Fund Account Number
ELECTRONIC FUNDS TRANSFER (EFT)
[CALENDAR GRAPHIC]
* Additional purchases on a regular basis can be deducted from a bank
account, paycheck, income-producing investment, or USAA money market fund
account. Sign up for these services when opening an account or call
1-800-531-8448 to add these services.
PHONE 1-800-531-8448 (IN SAN ANTONIO, 456-7202)
[TELEPHONE GRAPHIC]
* If you have an existing USAA mutual fund account and would like to open a
new account or exchange to another USAA Fund, call for instructions. To
open an account by phone, the new account must have the same registration
as your existing account.
USAA TOUCHLINE(R)1-800-531-8777 (IN SAN ANTONIO, 498-8777)
[TOUCHLINE GRAPHIC]
* In addition to obtaining account balance information, last transactions,
current fund prices, and return information for your Fund, you can use USAA
TouchLine(R) from any touch-tone phone to access your Fund account to make
selected purchases, exchange to another USAA Fund, or make redemptions.
This service is available with an Electronic Services Agreement (ESA) and
EFT Buy/Sell authorization on file.
INTERNET ACCESS - USAA.COM(SM)
[COMPUTER GRAPHIC]
* You can use your personal computer to perform certain mutual fund
transactions by accessing our web site. To establish access to your
account, you will need to call 1-800-461-3507 to obtain a registration
number and personal identification number (PIN). Once you have
23
<PAGE>
established Internet access to your account, you will be able to open a new
mutual fund account within an existing registration, exchange to another
USAA Fund, make redemptions, review account activity, check balances, and
more. To place orders by Internet, an ESA and EFT Buy/Sell authorization
must be on file.
Redemption of Shares
You may redeem Fund shares by any of the methods described below on any day the
NAV per share is calculated. Redemptions are effective on the day instructions
are received in a manner as described below. However, if instructions are
received after the NAV per share calculation (generally 4:00 p.m. Eastern
Time), your redemption will be effective on the next business day.
We will send you your money within seven days after the effective date of
redemption. Payment for redemption of shares purchased by EFT or check is sent
after the EFT or check 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. For federal
income tax purposes, a redemption is a taxable event; and as such, you may
realize a capital gain or loss. Such capital gains or losses are based on the
difference between your cost basis in the shares and the price received upon
redemption.
In addition, the Funds may elect to suspend the redemption of shares or
postpone the date of payment in limited circumstances.
HOW TO REDEEM
MAIL, IN PERSON, FAX, TELEGRAM, TELEPHONE, TOUCHLINE(R), OR INTERNET
[FAX MACHINE GRAPHIC]
* Send your written instructions to:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
* Visit a member service representative at our San Antonio investment sales
and service office at USAA Federal Savings Bank.
* Send a signed fax to 1-800-292-8177, or send a telegram to USAA Shareholder
Account Services.
* Call toll free 1-800-531-8448 (in San Antonio, 456-7202) to speak with a
member service representative.
* Call toll free 1-800-531-8777 (in San Antonio, 498-8777) to access our
24-hour USAA TouchLine(R) service.
* Access our Internet web site at usaa.com(SM).
Telephone redemption privileges are 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
24
<PAGE>
does not, it may be liable for any losses due to unauthorized or fraudulent
instructions. Before any discussion regarding your account, the following
information is obtained: (1) USAA number and/or account number, (2) the name(s)
on the account registration, and (3) social security/tax identification number
or date of birth of the registered account owner(s) for the account
registration. Additionally, all telephone communications with you are recorded
and confirmations of account transactions are sent to the address of record. If
you were issued stock certificates for your shares, redemption by telephone,
fax, telegram, or Internet is not available.
CHECKWRITING
[CHECKBOOK GRAPHIC]
* Checks can be issued for your Virginia Money Market Fund account. Return a
signed signature card, which accompanies your application, or request a
signature card separately and return it to:
USAA Shareholder Account Services
9800 Fredericksburg Road
San Antonio, TX 78288
You will not be charged for the use of checks or any subsequent reorders. Your
checkwriting privilege is subject to State Street Bank and Trust Company's
rules and regulations governing checking accounts. You may write checks in the
amount of $250 or more. Checks written for less than $250 will be returned
unpaid. Because the value of your account changes daily as dividends accrue,
you may not write a check to close your account.
IMPORTANT INFORMATION ABOUT
PURCHASES AND REDEMPTIONS
INVESTOR'S GUIDE to USAA Mutual Fund Services
[INVESTORS GUIDE GRAPHIC]
Upon your initial investment with us, you will receive the INVESTOR'S GUIDE to
help you get the most out of your USAA mutual fund account and to assist you in
your role as an investor. In the INVESTOR'S GUIDE, you will find additional
information on purchases, redemptions, and methods of payment. You will also
find in-depth information on automatic investment plans, shareholder statements
and reports, and other useful information.
Account Balance
USAA Shareholder Account Services (SAS), the Funds' transfer agent, may assess
annually a small balance account fee of $12 to each shareholder account with a
balance of less than $2,000 at the time of assessment. The fee will reduce
total transfer agency fees paid by the Fund to SAS. 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
25
<PAGE>
Act (UGMA/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).
Fund Rights
Each Fund reserves the right to:
* reject purchase or exchange orders when in the best interest of the Fund;
* limit or discontinue the offering of shares of the Fund without notice to
the shareholders;
* 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); however, this 1% charge
will not be imposed upon shareholders unless authorized by the Fund's Board
of Directors and the required notice has been given to shareholders;
* require a signature guarantee for transactions or changes in account
information in those instances where the appropriateness of a signature
authorization is in question (the Statement of Additional Information
contains information on acceptable guarantors);
* redeem an account with less than 50 full shares, with certain limitations.
EXCHANGES
Exchange Privilege
The exchange privilege is automatic 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 the shares to be acquired are
offered in your state of residence. Only Virginia residents may exchange into a
Virginia Fund. Exchanges made through USAA TouchLine(R) and the Internet
require an ESA and EFT Buy/Sell authorization on file. After we receive the
exchange orders, the Funds' transfer agent will simultaneously process exchange
redemptions and purchases at the share prices next determined. The investment
minimums applicable to share purchases also apply to exchanges. For federal
income tax purposes, an exchange between Funds is a taxable event; and as such,
you may realize a capital gain or loss. Such capital gains or losses are based
on the difference between your cost basis in the shares and the price received
upon exchange.
26
<PAGE>
The Funds have undertaken certain procedures regarding telephone transactions
as described on page 24.
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. The limit on
exchanges out of any Fund in the USAA Family of Funds for each account is six
per calendar year (except 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). However, each Fund reserves the right to reject a
shareholder's purchase or exchange orders into a Fund at any time when in the
best interest of the Fund.
SHAREHOLDER INFORMATION
Share Price Calculation
[SIDE BAR]
NAV PER SHARE
EQUALS
TOTAL ASSETS
MINUS
LIABILITIES
DIVIDED BY
# OF SHARES
OUTSTANDING
The price at which you purchase and redeem Fund shares is equal to the net
asset value (NAV) per share determined on the effective date of the purchase or
redemption. You may buy and sell Fund shares at the NAV per share without a
sales charge. Each Fund's NAV per share is calculated at the close of the
regular trading session of the NYSE, which is usually 4:00 p.m. Eastern Time.
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 Funds'
Board of Directors. Securities that cannot be valued by the pricing service,
and all other assets, are valued in good faith at fair value using methods we
have determined under the general supervision of the Funds' Board of Directors.
In addition, securities with maturities of 60 days or less and all securities
of the Virginia Money Market Fund are stated at amortized cost, which
approximates market value.
For additional information on how securities are valued, see VALUATION OF
SECURITIES in the Funds' Statement of Additional Information.
Dividends and Distributions
Net investment income of each Fund is accrued daily and paid on the last
business day of the month. Dividends shall begin accruing on shares purchased
the day following the effective date and shall continue to accrue to the
effective date of redemption. Any net capital gain distribution usually occurs
within 60 days of the March 31 fiscal year end, which would be somewhere around
the end of May. The Funds will make additional payments to shareholders, if
necessary, to avoid the imposition of any federal income or excise tax.
27
<PAGE>
We will automatically reinvest all income dividends and capital gain
distributions in the Fund unless you instruct us differently. The share price
will be the NAV of the Fund shares computed on the ex-dividend date. Any
capital gain distributions paid by the Virginia Bond Fund will reduce the NAV
per share by the amount of the dividend or distribution on the ex-dividend
date. You should consider carefully the effects of purchasing shares of the
Virginia Bond Fund shortly before any capital gain distribution. Some or all of
these distributions are subject to taxes. If you become a resident of a state
other than Virginia, we will mail a check for proceeds of income dividends to
you monthly.
We will invest any dividend or distribution payment returned to us in your
account at the then-current NAV per share. Dividend and distribution checks
become void six months from the date on the check. The amount of the voided
check will be invested in your account at the then-current NAV per share.
Federal Taxes
This tax information is quite general and refers to the federal income tax
provisions in effect as of the date of this Prospectus. While we manage the
Funds so that at least 80% of each Fund's annual income will be exempt from
federal or state income taxes, we may invest up to 20% of the Funds' assets in
securities that generate income not exempt from federal or state income taxes.
Because interest income may be exempt for federal income tax purposes, it does
not necessarily mean that the interest income may be exempt under the income or
other tax laws of any state or local taxing authority. As discussed earlier on
page 15, capital gains distributed by a Fund may be taxable. Note that the
Taxpayer Relief Act of 1997 and the technical provisions adopted by the IRS
Restructuring and Reform Act of 1998 may affect the status and treatment of
certain distributions shareholders receive from the Funds. Because each
investor's tax circumstances are unique and because the tax laws are subject to
change, we recommend that you consult your tax adviser about your investment.
WITHHOLDING - Federal law requires each Fund 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,
* underreports dividend or interest income, or
* fails to certify that he or she 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 Funds' transfer agent, that your tax
identification number is correct and you are not currently subject to backup
withholding.
28
<PAGE>
REPORTING - Each Fund will report information to you annually concerning the
tax status of dividends and distributions for federal income tax purposes,
including the portion of the dividends constituting interest on private
activity bonds and the percentage and source of interest income earned on
tax-exempt securities held by the Fund during the preceding year.
Virginia Taxation
The following is only a summary of some of the important Virginia personal
income tax considerations generally affecting the Funds and their shareholders.
This discussion is not intended as a substitute for careful planning. As a
potential investor in the Funds, you should consult your tax adviser with
specific reference to your own tax situations.
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.
Distributions from the Funds and derived from long-term capital gains on the
sale or exchange by the Funds of obligations of the Commonwealth of Virginia,
any political subdivision or instrumentality of the Commonwealth, or the United
States will be exempt from Virginia income tax. Distributions from the Funds of
all other long-term capital gains and all short-term capital gains realized by
the Funds generally will be taxable to you regardless of how long you have held
the shares.
Future Shareholder Mailings
Through our ongoing efforts to help reduce Fund expenses, each household will
receive a single copy of these Funds' most recent financial reports and
prospectus even if you or a family member own more than one account in the
Funds. For many of you, this eliminates duplicate copies, saving paper, and
postage costs to the Funds. However, if you would like to receive individual
copies, please call us and we will begin your individual delivery within 30
days.
29
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights tables are intended to help you understand the Funds'
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned (or lost) on an
investment in the Fund (assuming reinvestment of all dividends and
distributions). This information has been audited by KPMG LLP, whose report,
along with the Funds' financial statements, are included in the Annual Report,
which is available upon request.
Virginia Bond Fund:
Year Ended March 31,
---------------------------------------------------------
2000 1999 1998 1997 1996
---------------------------------------------------------
Net asset value at
beginning of period $ 11.52 $ 11.49 $ 10.92 $ 10.93 $ 10.76
Net investment income .59 .60 .62 .63 .63
Net realized and
unrealized gain (loss) (.83) .03 .57 (.01) .17
Distributions from net
investment income (.59) (.60) (.62) (.63) (.63)
---------------------------------------------------------
Net asset value at
end of period $ 10.69 $ 11.52 $ 11.49 $ 10.92 $ 10.93
=========================================================
Total return (%)* (2.00) 5.62 11.13 5.82 7.57
Net assets at end of
period (000) $ 377,216 $ 402,352 $ 346,246 $ 292,914 $ 267,111
Ratio of expenses to
average net assets (%) .43 .43 .44 .46 .48
Ratio of net investment
income to average net
assets (%) 5.45 5.22 5.48 5.76 5.74
Portfolio turnover (%) 24.60 10.55 14.24 26.84 27.20
----------
* Assumes reinvestment of all dividend income distributions during the period.
30
<PAGE>
Financial Highlights (con't.)
Virginia Money Market Fund:
Year Ended March 31,
---------------------------------------------------------
2000 1999 1998 1997 1996
---------------------------------------------------------
Net asset value at
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Net investment income .03 .03 .03 .03 .03
Distributions from net
investment income (.03) (.03) (.03) (.03) (.03)
---------------------------------------------------------
Net asset value at
end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
=========================================================
Total return (%)* 3.06 2.98 3.34 3.14 3.42
Net assets at end of
period (000) $ 157,054 $ 138,416 $ 122,509 $ 113,330 $ 110,308
Ratio of expenses to
average net assets (%) .50 .50 .50 .50 .50
Ratio of expenses to
average net assets excluding
reimbursements (%) n/a .50 .51 .53 .55
Ratio of net investment
income to average net
assets (%) 3.04 2.93 3.29 3.10 3.36
----------------
* Assumes reinvestment of all dividend income distributions during the period.
31
<PAGE>
APPENDIX A
THE FOLLOWING ARE DESCRIPTIONS OF CERTAIN TYPES OF SECURITIES IN WHICH WE MAY
INVEST EACH FUND'S ASSETS:
VARIABLE RATE SECURITIES
We may invest a Fund's assets 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 the Fund depending on the proportion of such
securities held.
* Because the interest rates of variable rate securities are periodically
adjusted to reflect current market rates, their market value is less
affected by changes in prevailing interest rates than the market value of
securities with fixed interest rates.
* The market value of a variable rate security 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
We may invest a Fund's assets in tax-exempt securities (including securities
with variable interest rates) that 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
We may invest a Fund's assets 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.
SYNTHETIC INSTRUMENTS
We may invest a Fund's assets in tender option bonds, bond receipts, and
similar synthetic municipal instruments. A synthetic instrument is a security
created by combining an intermediate or long-term municipal bond with a right
to sell the instrument back to the remarketer or liquidity provider for
repurchase on short notice. This right to sell is commonly referred to as a
tender option. Usually, the tender option is backed by a conditional guarantee
or letter of credit from a bank or other financial institution. Under its
terms, the guarantee may expire if the municipality defaults on payments of
interest or
32
<PAGE>
principal on the underlying bond, if the credit rating of the municipality is
downgraded, or if the instrument (or the underlying bond) loses its tax-exempt
treatment. Synthetic instruments involve structural risks that could adversely
affect the value of the instrument or could result in a Fund holding an
instrument for a longer period of time than originally anticipated.
WHEN-ISSUED SECURITIES
We may invest a Fund's assets in new securities offered on a when-issued basis.
* 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.
MUNICIPAL LEASE OBLIGATIONS
We may invest a Fund's assets in a variety of instruments commonly referred to
as municipal lease obligations, including leases and certificates of
participation in such leases and contracts.
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.
ILLIQUID SECURITIES
We may invest up to 15% of the Virginia Bond Fund's net assets and up to 10% of
the Virginia Money Market Fund's net assets in securities that are illiquid.
Illiquid securities are those securities which cannot be disposed of in the
ordinary course of business, seven days or less, at approximately the same
value at which the Fund has valued the securities.
Lease obligations and certain put bonds subject to restrictions on transfer may
be determined to be liquid in accordance with the guidelines established by the
Funds' Board of Directors.
In determining the liquidity of a lease obligation, we 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 we may
determine to be relevant to such determination.
In determining the liquidity of put bonds with restrictions on transfer, we
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.
33
<PAGE>
APPENDIX B
Taxable-Equivalent Yield Table
COMBINED FEDERAL AND
VIRGINIA STATE INCOME TAX
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%
-------------------------------------------------------------------------------
2.50% 3.68% 3.84% 4.14% 4.39%
-------------------------------------------------------------------------------
3.00% 4.42% 4.61% 4.97% 5.27%
-------------------------------------------------------------------------------
3.50% 5.16% 5.38% 5.80% 6.15%
-------------------------------------------------------------------------------
4.00% 5.89% 6.15% 6.63% 7.03%
-------------------------------------------------------------------------------
4.50% 6.63% 6.92% 7.46% 7.90%
-------------------------------------------------------------------------------
5.00% 7.37% 7.69% 8.29% 8.78%
-------------------------------------------------------------------------------
5.50% 8.10% 8.46% 9.12% 9.66%
-------------------------------------------------------------------------------
6.00% 8.84% 9.23% 9.95% 10.54%
-------------------------------------------------------------------------------
6.50% 9.58% 10.00% 10.78% 11.42%
-------------------------------------------------------------------------------
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 EXAMPLES THAT WOULD BE RELEVANT TO MOST TAXPAYERS.
FOR A FURTHER EXPLANATION ON CALCULATING TAX-EQUIVALENT YIELDS, SEE THE FUNDS'
STATEMENT OF ADDITIONAL INFORMATION.
34
<PAGE>
APPENDIX C
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 you with the opportunity to formulate your own investment program. You
may exchange any shares you hold in any one USAA Fund for shares in any other
USAA Fund, subject to the limitations described earlier. For more complete
information about the mutual funds managed and distributed by USAA Investment
Management Company, including charges and operating expenses, call us for a
Prospectus. Read it carefully before you invest. Mutual fund operating expenses
apply and continue throughout the life of the Fund.
FUND TYPE/NAME RISK
==============================================
CAPITAL APPRECIATION
----------------------------------------------
Aggressive Growth Very high
Emerging Markets Very high
First Start Growth Moderate to high
Gold Very high
Growth Moderate to high
Growth & Income Moderate
International Moderate to high
S&P 500 Index Moderate
Science & Technology Very high
Small Cap Stock Very high
World Growth Moderate to high
----------------------------------------------
ASSET ALLOCATION
----------------------------------------------
Balanced Strategy Moderate
Cornerstone Strategy Moderate
Growth and Tax Strategy Moderate
Growth Strategy Moderate to high
Income Strategy Low to moderate
----------------------------------------------
INCOME -- TAXABLE
----------------------------------------------
GNMA Low to moderate
High-Yield Opportunities High
Income Moderate
Income Stock Moderate
Intermediate-Term Bond Low to moderate
Short-Term Bond Low
----------------------------------------------
INCOME -- TAX EXEMPT
----------------------------------------------
Long-Term Moderate
Intermediate-Term Low to moderate
Short-Term Low
State Bond/Income Moderate
----------------------------------------------
MONEY MARKET
----------------------------------------------
Money Market Low
Tax Exempt Money Market Low
Treasury Money Market Trust Low
State Money Market Low
==============================================
FOREIGN INVESTING IS SUBJECT TO ADDITIONAL RISKS, SUCH AS CURRENCY
FLUCTUATIONS, MARKET ILLIQUIDITY, AND POLITICAL INSTABILITY.
S&P(R) 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.
SOME INCOME MAY BE SUBJECT TO STATE OR LOCAL TAXES.
CALIFORNIA, FLORIDA, NEW YORK, AND VIRGINIA FUNDS ARE OFFERED ONLY TO
RESIDENTS OF THOSE STATES.
AN INVESTMENT IN A MONEY MARKET FUND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE
THE VALUE OF YOUR INVESTMENT AT $1 PER SHARE, IT IS POSSIBLE TO LOSE MONEY
BY INVESTING IN THE FUND.
THE SCIENCE & TECHNOLOGY FUND MAY BE MORE VOLATILE THAN A FUND THAT
DIVERSIFIES ACROSS MANY INDUSTRIES.
35
<PAGE>
If you would like more information about the Funds, you may call 1-800-531-8181
to request a free copy of the Funds' Statement of Additional Information (SAI),
Annual or Semiannual Report, or to ask other questions about the Funds. The SAI
has been filed with the Securities and Exchange Commission (SEC) and is legally
a part of this Prospectus. In the Funds' Annual Report, you will find a
discussion of the market conditions and investment strategies that
significantly affected each Fund's performance during the last fiscal year.
To view these documents, along with other related documents, you can visit the
EDGAR database on the SEC's Internet web site (www.sec.gov) or the Commission's
Public Reference Room in Washington, D.C. Information on the operation of the
Public Reference Room can be obtained by calling 1-202-942-8090. Additionally,
copies of this information can be obtained, after paying a duplicating fee, by
electronic request at the following e-mail address: [email protected] or by
writing the Public Reference Section of the Commission, Washington, D.C.
20549-0102.
===============================================================================
INVESTMENT ADVISER, UNDERWRITER, AND DISTRIBUTOR
USAA Investment Management Company
9800 Fredericksburg Road
San Antonio, Texas 78288
--------------------------------------------------------------
TRANSFER AGENT CUSTODIAN
USAA Shareholder Account Services State Street Bank and Trust Company
9800 Fredericksburg Road P.O. Box 1713
San Antonio, Texas 78288 Boston, Massachusetts 02105
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TELEPHONE ASSISTANCE HOURS
Call toll free - Central Time
Monday - Friday 6:00 a.m. to 10:00 p.m.
Saturday 8:30 a.m. to 5:00 p.m.
Sunday 11:30 a.m. to 8:00 p.m.
--------------------------------------------------------------
FOR ADDITIONAL INFORMATION ON MUTUAL FUNDS
1-800-531-8181 (in San Antonio, 456-7200)
For account servicing, exchanges, or redemptions
1-800-531-8448 (in San Antonio, 456-7202)
--------------------------------------------------------------
RECORDED MUTUAL FUND PRICE QUOTES
24-Hour Service (from any phone)
1-800-531-8066 (in San Antonio, 498-8066)
--------------------------------------------------------------
MUTUAL FUND USAA TOUCHLINE(R)
(from touch-tone phones only)
For account balance, last transaction, fund prices,
or to exchange/redeem fund shares
1-800-531-8777 (in San Antonio, 498-8777)
--------------------------------------------------------------
INTERNET ACCESS
usaa.com(SM)
===============================================================================
Investment Company Act File No. 811-3333
<PAGE>
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 USAA STATEMENT OF
EAGLE TAX EXEMPT ADDITIONAL INFORMATION
LOGO FUND, INC. AUGUST 1, 2000
-------------------------------------------------------------------------------
USAA TAX EXEMPT FUND, INC.
(LONG-TERM FUND, INTERMEDIATE-TERM FUND,
SHORT-TERM FUND, AND TAX EXEMPT MONEY MARKET FUND)
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 dated August 1, 2000, for the Funds
by writing to USAA Tax Exempt Fund, Inc., 9800 Fredericksburg Road, 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.
The financial statements of the Funds and the Independent Auditors' Report
thereon for the fiscal year ended March 31, 2000, are included in the
accompanying Annual Report to Shareholders of that date and are incorporated by
reference.
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TABLE OF CONTENTS
PAGE
2 Valuation of Securities
2 Conditions of Purchase and Redemption
3 Additional Information Regarding Redemption of Shares
4 Investment Plans
4 Investment Policies
6 Investment Restrictions
7 Portfolio Transactions
8 Description of Shares
8 Tax Considerations
10 Directors and Officers of the Company
13 The Company's Manager
15 General Information
15 Calculation of Performance Data
16 Appendix A - Tax-Exempt Securities and Their Ratings
19 Appendix B - Comparison of Fund Performance
22 Appendix C - 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 that 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. There can be no assurance, however, that the
Fund will at all times be able to maintain a constant $1 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 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 an NAV per
share by using available market quotations.
CONDITIONS OF PURCHASE AND REDEMPTION
NONPAYMENT
If any order to purchase shares is canceled due to nonpayment or if the Company
does not receive good funds either by check or electronic funds transfer, USAA
Shareholder Account Services (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 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 $25 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.
2
<PAGE>
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
The value of your 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 that 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 you.
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 your last known
address.
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 amounts 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. 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. You will
continue to earn dividends until the shares are redeemed by the presentation of
a check.
When a check is presented to the Transfer Agent for payment, a sufficient
number of full and fractional shares from your account will be redeemed to
cover the amount of the check. If the account balance 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 checkwriting privilege is 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 you for the use
of the checks or for subsequent reorders of checks.
The Company reserves the right to assess a processing fee against your
account for any redemption check not honored by a clearing or paying agent.
Currently, this fee is $25 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.
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. The Transfer Agent
will charge you $20 for each stop payment you request.
3
<PAGE>
INVESTMENT PLANS
The Company makes available the following investment plans 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 a non-governmental employer, an income-producing
investment, or an account with a participating financial institution.
DIRECT DEPOSIT PROGRAM - The monthly transfer of certain federal benefits to
directly purchase shares of a USAA mutual fund. Eligible federal benefits
include: Social Security, Supplemental Security Income, Veterans Compensation
and Pension, Civil Service Retirement Annuity, and Civil Service Survivor
Annuity.
GOVERNMENT ALLOTMENT - The transfer of military pay by the U.S. Government
Finance Center for the purchase of USAA mutual fund shares.
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. You may
initiate a "buy" or "sell" whenever you choose.
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.
Participation in these systematic purchase plans allows you to engage in
dollar-cost averaging. For additional information concerning the benefits of
dollar-cost averaging, see APPENDIX C.
SYSTEMATIC WITHDRAWAL PLAN
If you own shares having a net asset value of $5,000 or more in a single
investment account (accounts in different Funds cannot be aggregated for this
purpose), you 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,
you may choose to have withdrawals electronically deposited at your bank or
other financial institution. You may also elect to have checks mailed to a
designated address.
This 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. You may terminate
participation in the plan at any time. You are not charged 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 you select 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 your
investment and eventually exhaust the account. Reinvesting dividends and
distributions helps replenish the account. Because share values and net
investment income can fluctuate, you 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 your income tax return. Therefore, you should keep an accurate
record of any gain or loss on each withdrawal.
INVESTMENT POLICIES
The sections captioned WHAT ARE EACH FUND'S INVESTMENT OBJECTIVE AND MAIN
STRATEGIES? and FUND INVESTMENTS in the Prospectus describe the fundamental
investment objective(s) and the investment policies applicable to each Fund.
Each Fund's objective(s) cannot be changed without shareholder approval. 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 the results
of 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.
4
<PAGE>
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 that, 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.
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.
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
5
<PAGE>
(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.
TEMPORARY DEFENSIVE POLICY
Each Fund may on a temporary basis because of market, economic, political, or
other conditions, invest up to 100% of its assets in short-term securities
whether or not they are exempt from federal 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 RESTRICTIONS
The following investment restrictions have been adopted by the Company for 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;
(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.
6
<PAGE>
ADDITIONAL RESTRICTIONS
The following restrictions are not considered to be fundamental policies of the
Funds. The 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; or
(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. These research
services may also include access to research on third party data bases, such as
historical data on companies, financial statements, earnings history and
estimates and corporate releases; real-time quotes and financial news; research
on specific fixed income securities; research on international market news and
securities; and rating services on companies and industries. 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 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
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<PAGE>
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 1999 2000
---- ---- -----
Long-Term 29.56% 29.04%
Intermediate-Term 11.85% 10.46%
Short-Term 7.34% 18.88%
Portfolio turnover rates have been calculated excluding short-term
variable rate securities, which are those with put date intervals of less than
one year.
DESCRIPTION OF SHARES
The Funds are series of USAA Tax Exempt Fund, Inc. (the Company) and are
diversified. 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 series or funds. There are
ten mutual funds in the Company, 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.
Under the provisions of the Bylaws of the Company, no annual meeting of
shareholders is required. Thus, there will ordinarily be no shareholder meeting
unless required by the 1940 Act. Under certain circumstances, however,
shareholders may apply to the Directors for shareholder information to obtain
signatures to request a special shareholder meeting. The Company may fill
vacancies on the Board or appoint new Directors if the result is that at least
two-thirds of the Directors have still been elected by shareholders. Moreover,
pursuant to the Bylaws of the Company, any Director may be removed by the
affirmative vote of a majority of the outstanding Company shares; and holders
of 10% or more of the outstanding shares of the Company can require Directors
to call a meeting of shareholders for the purpose of voting on the removal of
one or more Directors. The Company will assist in communicating to other
shareholders about the meeting. 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 that 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.
8
<PAGE>
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) and (2) 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
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 includable 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 or she 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.
9
<PAGE>
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 eight Directors who supervise
the business affairs of the Company. 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 Road, San Antonio, TX 78288.
Robert G. Davis 1, 2
Director and Chairman of the Board of Directors
Age: 53
President and Chief Executive Officer of United Services Automobile Association
(USAA) (4/00-present); President and Chief Operating Officer of USAA
(6/99-3/00); Director of USAA (2/99-present); Deputy Chief Executive Officer
for Capital Management of USAA (6/98-5/99); 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);
President, Chief Executive Officer, Director, and Chairman of the Board of
Directors of USAA Financial Planning Network, Inc. (1/97-present); Executive
Vice President, Chief Operating Officer, Director, and Vice Chairman of the
Board of Directors of USAA Financial Planning Network, Inc. (6/96-12/96);
Special Assistant to Chairman, 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 serves as a
Director/Trustee and Chairman of the Boards of Directors/Trustees of each of
the remaining funds within the USAA Family of Funds; Director and Chairman of
the Boards of Directors of USAA Investment Management Company (IMCO), USAA
Federal Savings Bank, and USAA Real Estate Company.
Michael J.C. Roth 1, 2, 3
Director, President, and Vice Chairman of the Board of Directors
Age: 58
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, Director/Trustee, and Vice Chairman of the Boards of
Directors/Trustees of each of the remaining funds within the USAA Family of
Funds and USAA Shareholder Account Services; Director of USAA Life Insurance
Company; and Trustee and Vice Chairman of USAA Life Investment Trust.
David G. Peebles 1
Director and Vice President
Age: 60
Senior Vice President, Equity Investments, IMCO (11/98-present); Vice
President, Equity Investments, IMCO (2/88-11/98). Mr. Peebles serves as
Director/Trustee and Vice President of each of the remaining Funds within the
USAA Family of Funds; Director of IMCO; Senior Vice President of USAA
Shareholder Account Services; and Vice President of USAA Life Investment Trust.
10
<PAGE>
Barbara B. Dreeben 3, 4, 5
200 Patterson #1008
San Antonio, TX 78209
Director
Age: 55
President, Postal Addvantage (7/92-present); Consultant, Nancy Harkins
Stationer (8/91-12/95). Mrs. Dreeben serves as a Director/Trustee of each of
the remaining funds within the USAA Family of Funds.
Robert L. Mason, Ph.D. 3, 4, 5
12823 Queens Forest
San Antonio, TX 78230
Director
Age: 54
Staff Analyst, Southwest Research Institute (9/98-present); Manager,
Statistical Analysis Section, Southwest Research Institute (2/79-9/98). Dr.
Mason serves as a Director/Trustee of the remaining funds within each of the
USAA Family of Funds.
Michael F. Reimherr 3, 4, 5
128 East Arrowhead
San Antonio, Texas 78228
Director
Age: 54
President of Reimherr Business Consulting (5/95-present). Mr. Reimherr serves
as a Director/Trustee of each of the remaining Funds within the USAA Family of
Funds.
Laura T. Starks, Ph.D. 3, 4, 5
5405 Ridge Pal Drive
Austin, TX 78731
Director
Age: 50
Charles E and Sarah M Seay Regents Chair Professor of Finance, University of
Texas at Austin (9/96-present); Sarah Meadows Seay Regents, Professor of
Finance, University of Texas at Austin (9/94-9/96). Dr. Starks serves as a
Director/Trustee of each of the remaining funds within the USAA Family of
Funds.
Richard A. Zucker 2, 3, 4, 5
407 Arch Bluff
San Antonio, TX 78216
Director
Age: 57
Vice President, Beldon Roofing and Remodeling (1985-present). Mr. Zucker serves
as a Director/Trustee of each of the remaining funds within the USAA Family of
Funds.
Kenneth E. Willmann 1
Vice President
Age: 53
Senior Vice President, Fixed Income Investments, IMCO (12/99-present); Vice
President, Mutual Fund Portfolios, IMCO (09/94-12/99). Mr. Willmann serves as
Vice President of each of the remaining Funds within the USAA Family of Funds,
Director of IMCO, Senior Vice President of USAA Shareholder Account Services,
and Vice President of USAA Life Investment Trust.
Michael D. Wagner 1
Secretary
Age: 52
Senior Vice President, USAA Capital Corporation (CAPCO) General Counsel
(01/99-present); Vice President, Corporate Counsel, USAA (1982-01/99). Mr.
Wagner has held various positions in the legal department of USAA since
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<PAGE>
1970 and serves as Vice President, Secretary, and Counsel, IMCO and USAA
Shareholder Account Services; Secretary of each of the remaining funds within
the USAA Family of Funds; Vice President, Corporate Counsel for various other
USAA subsidiaries and affiliates.
Mark S. Howard 1
Assistant Secretary
Age: 36
Vice President, Securities Counsel & Compliance, IMCO (7/00-present); Assistant
Vice President, Securities Counsel, USAA (2/98-7/00); Executive Director,
Securities Counsel, USAA (9/96-2/98); Senior Associate Counsel, Securities
Counsel, USAA (5/95-8/96). Mr. Howard serves as Assistant Secretary for IMCO,
USAA Shareholder Account Services, USAA Financial Planning Network, Inc., each
of the remaining funds within the USAA Family of Funds, and for USAA Life
Investment Trust.
Sherron A. Kirk 1
Treasurer
Age: 55
Senior Vice President, Senior Financial Officer, IMCO (1/00-present); Vice
President, Senior Financial Officer, IMCO (8/98-1/00); Vice President,
Controller, IMCO (10/92-8/98). Ms. Kirk serves as Treasurer of each of the
remaining funds within the USAA Family of Funds; Vice President, Senior
Financial Officer of USAA Shareholder Account Services.
Roberto Galindo, Jr. 1
Assistant Treasurer
Age: 39
Executive Director, Mutual Fund Analysis & Support, IMCO (6/00-present);
Director, Mutual Fund Analysis, IMCO (9/99-6/00); Vice President, Portfolio
Administration, Founders Asset Management LLC (7/98-8/99); Assistant Vice
President, Director of Fund & Private Client Accounting, Founders Asset
Management LLC (7/93-7/98). Mr. Galindo serves as Assistant Treasurer for each
of the remaining funds within the USAA Family of Funds.
---------------------
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 individual is an executive officer of the Manager: Christopher W.
Claus, Senior Vice President, Investment Sales & Service. 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, 2000.
Name Aggregate Total Compensation
of Compensation from the USAA
Director from the Company Family of Funds (b)
-------- ----------------- -------------------
Robert G. Davis None (a) None (a)
Barbara B. Dreeben $ 9,698 $ 35,000
Howard L. Freeman, Jr. (c) $ 7,811 $ 28,500
Robert L. Mason $ 9,698 $ 35,000
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David G. Peebles None (a) None (a)
Michael F. Reimherr $ 1,887 $ 6,500
Michael J.C. Roth None (a) None (a)
John W. Saunders, Jr. (c) None (a) None (a)
Richard A. Zucker $ 9,698 $ 35,000
------------
(a) Robert G. Davis, Michael J.C. Roth, John W. Saunders, Jr., and David G.
Peebles 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, 2000, the USAA Family of Funds consisted of four registered
investment companies offering 38 individual funds. Each Director presently
serves as a Director or Trustee 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 available to the public only
through the purchase of certain variable annuity contracts and variable
life insurance policies offered by USAA Life Insurance Company. Mr. Roth
receives no compensation as Trustee of USAA Life Investment Trust.
(c) Effective December 31, 1999, John W. Saunders, Jr. and Howard L. Freeman,
Jr. retired from the Board of Trustees.
All of the above Directors are also Directors/Trustees of the other funds
within the USAA Family of Funds. No compensation is paid by any fund to any
Director/Trustee 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, 2000, 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.
As of June 30, 2000, USAA and its affiliates (including related employee
benefit plans) owned 4,027,257 shares (2.4%) of the Intermediate-Term Fund, and
no shares of the Long-Term, Short-Term and Tax Exempt Money Market Funds.
The following table identifies all persons, who as of June 30, 2000, held
of record or owned beneficially 5% or more of any of the Funds' shares.
Name and address
Title of Class of beneficial owner Percent of class
-------------- ------------------- ----------------
Short-Term Robert M Kommerstad 8.9%
Fund Lila M Kommerstad
Trst Kommerstad Family Trust
218 Deodar Ln
Bradbury, CA 91010-1011
Muir & Co 5.5%
C/O Frost National Bank Trust
Securities
P.O. Box 2479
San Antonio, TX 78298-2479
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, a wholly owned indirect subsidiary of United Services
Automobile Association (USAA), a large, diversified financial services
institution, was organized in May 1970 and 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 $41 billion, of which
approximately $29 billion were in mutual fund portfolios.
While the officers and employees of the Manager, as well as those of the
Funds, may engage in personal securities transactions, they are restricted by
the procedures in a Joint Code of Ethics adopted by the Manager and the Funds.
The Joint Code of Ethics was designed to ensure that the shareholders'
interests come before those of the individuals who manage their Funds. It also
prohibits the portfolio managers and other investment personnel from buying
securities in an initial public offering or from profiting from the purchase or
sale of the same security within 60 calendar days. Additionally,
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the Joint Code of Ethics requires the portfolio manager and other employees
with access information about the purchase or sale of securities by the Funds
to obtain approval before executing permitted personal trades. A copy of the
Joint Code of Ethics for the Manager has been filed with the SEC and is
available for public view.
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 FUND MANAGEMENT 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 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, 2001, 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 1998 1999 2000
---- ---- ---- ----
Long-Term $5,497,968 $5,953,274 $5,699,929
Intermediate-Term $5,238,815 $6,118,842 $6,253,931
Short-Term $2,442,108 $2,780,685 $2,821,544
Tax Exempt Money Market $4,292,183 $4,635,419 $5,066,048
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 $28.50 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, each Fund pays all out-of-pocket expenses of
the Transfer Agent and other expenses which are incurred at the specific
direction of the Company.
14
<PAGE>
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 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.
CALCULATION OF PERFORMANCE DATA
Information regarding the total return and yield of each Fund is provided under
COULD THE VALUE OF YOUR INVESTMENT IN THESE FUNDS FLUCTUATE? 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 3/31/00
1 5 10
Fund year years years
---- ---- ----- -----
Long-Term -2.95% 5.57% 6.62%
Intermediate-Term -0.84% 5.72% 6.64%
Short-Term 2.05% 4.66% 5.04%
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[((a-b)/(cd)+1)^6 -1]
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
15
<PAGE>
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, 2000, were
as follows:
Long-Term Fund . . . . 5.52%
Intermediate-Term Fund . . . . 5.12%
Short-Term Fund . . . . 4.42%
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 and income other than
investment income, 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 March 31, 2000, was 3.49%.
Effective Yield For 7-day Period Ended March 31, 2000, was 3.55%.
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, 2000 were 8.63%, 8.00%, 6.91%, and 5.45%,
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
16
<PAGE>
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 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 (Moody's), Standard & Poor's
Ratings Group (S&P), Fitch Information, Inc. (Fitch), and Thompson BankWatch
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.
1. LONG-TERM DEBT RATINGS:
MOODY'S INVESTOR SERVICES
Aaa Bonds that 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 that 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 that 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 that suggest a susceptibility to impairment
sometime in the future.
Baa Bonds that 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: MOODY'S APPLIES NUMERICAL MODIFIERS 1, 2, AND 3 IN EACH GENERIC RATING
CLASSIFICATION. THE MODIFIER 1 INDICATES THAT THE OBLIGATION RANKS IN THE
HIGHER END OF ITS GENERIC RATING CATEGORY, THE MODIFIER 2 INDICATES A MID-RANGE
RANKING, AND THE MODIFIER 3 INDICATES A RANKING IN THE LOWER END OF THAT
GENERIC RATING CATEGORY.
STANDARD & POOR'S RATINGS GROUP
AAA An obligation rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA An obligation rated AA differs from the highest rated issues only in
small degree. The obligor's capacity to meet its financial commitment
on the obligation is VERY STRONG.
A An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher rated categories. However, the obligor's
capacity to meet its financial commitment on the obligation is still
STRONG.
BBB An obligation rated BBB exhibits adequate capacity to pay interest and
repay principal. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
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.
FITCH INFORMATION, INC.
AAA Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong
capacity for timely payment of financial commitments. This capacity is
highly unlikely to be adversely affected by foreseeable events.
AA Very high credit quality. "AA" ratings denote a very low expectation
of credit risk. They indicate very strong capacity for timely payment
of financial commitments. This capacity is not significantly
vulnerable to foreseeable events.
17
<PAGE>
A High credit quality. "A" ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is
considered strong. This capacity may, nevertheless, be more vulnerable
to changes in circumstances or in economic conditions than is the case
for higher ratings.
BBB Good credit quality. "BBB" ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of
financial commitments is considered adequate, but adverse changes in
circumstances and in economic conditions are more likely to impair
this capacity. This is the lowest investment-grade category.
2. SHORT-TERM DEBT RATINGS:
MOODY'S STATE AND TAX-EXEMPT NOTES
MIG-1/VMIG1 This designation denotes best quality. There is present
strong protection by established cash flows, superior
liquidity support, or demonstrated broad-based access to the
market for refinancing.
MIG-2/VMIG2 This designation denotes high quality. Margins of protection
are ample although not so large as in the preceding group.
MOODY'S COMMERCIAL PAPER
Prime-1 Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the
following characteristics:
* Leading market positions in well-established industries.
* High rates of return on funds employed.
* Conservative capitalization structures with moderate reliance on
debt and ample asset protection.
* Broad margins in earning coverage of fixed financial charges and
high internal cash generation.
* Well-established access to a range of financial markets and
assured sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior 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, may be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
S&P 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.
S&P 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.
FITCH'S COMMERCIAL PAPER, CERTIFICATES OF DEPOSIT, AND TAX-EXEMPT NOTES
F1 Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit features.
F2 Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in
the case of the higher ratings.
F3 Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could
result in a reduction to non-investment grade.
THOMPSON BANKWATCH
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.
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<PAGE>
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.
APPENDIX B - COMPARISON OF PORTFOLIO PERFORMANCE
Occasionally, we may make comparisons in advertising and sales literature
between the Funds and other comparable funds in the industry. 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 but are not
restricted to the following:
AAII JOURNAL, a monthly association magazine for members of the American
Association of Individual Investors.
ARIZONA REPUBLIC, a newspaper that may cover financial and investment news.
AUSTIN AMERICAN-STATESMAN, a newspaper that 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 that covers bond market news.
BUSINESS WEEK, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds.
CDA/WEISENBERGER MUTUAL FUNDS INVESTMENT REPORT, a monthly newsletter that
reports on both specific mutual fund companies and the mutual fund industry as
a whole.
CHICAGO TRIBUNE, a newspaper that may cover financial news.
CONSUMER REPORTS, a monthly magazine that from time to time reports on
companies in the mutual fund industry.
DALLAS MORNING NEWS, a newspaper that may cover financial news.
DENVER POST, a newspaper that may quote financial news.
FINANCIAL PLANNING, a monthly magazine that periodically features companies in
the mutual fund industry.
FINANCIAL SERVICES WEEK, a weekly newspaper that covers financial news.
FINANCIAL WORLD, a monthly magazine that periodically features companies in the
mutual fund industry.
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 that may cover financial news.
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, the national association of the American
Investment Company industry.
INVESTOR'S BUSINESS DAILY, a newspaper that covers financial news.
KIPLINGER'S PERSONAL FINANCE MAGAZINE, a monthly investment advisory
publication that periodically features the performance of a variety of
securities.
19
<PAGE>
LIPPER, A REUTER'S COMPANY EQUITY FUND PERFORMANCE ANALYSIS, a weekly and
monthly publication of industry-wide mutual fund performance averages by type
of fund.
LIPPER, A REUTER'S COMPANY FIXED INCOME FUND PERFORMANCE ANALYSIS, a monthly
publication of industry-wide mutual fund performance averages by type of fund.
LOS ANGELES TIMES, a newspaper that 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 iMoneyNet, Inc. (formerly IBC
Financial Data, 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 "Taxable First Tier Fund Average."
MONEY MARKET INSIGHT, a monthly money market industry analysis prepared by
iMoneyNet, Inc. (formerly IBC Financial Data, Inc.)
MONEYLETTER, a biweekly newsletter that covers financial news and from time to
time rates specific mutual funds.
MORNINGSTAR 5 STAR INVESTOR, a monthly newsletter that covers financial news
and rates mutual funds produced by Morningstar, Inc. (a data service that
tracks open-end mutual funds).
MUNI BOND FUND REPORT, a monthly newsletter that covers news on the municipal
bond market and features performance data for municipal bond mutual funds.
MUNIWEEK, a weekly newspaper that 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 mutual fund
performance and rankings, 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.
that 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 that may cover financial news.
NO LOAD FUND INVESTOR, a newsletter covering companies in the mutual fund
industry.
ORLANDO SENTINEL, a newspaper that may cover financial news.
PERSONAL INVESTOR, a monthly magazine that 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 that may cover financial news.
SAN FRANCISCO CHRONICLE, a newspaper that may cover financial news.
SMART MONEY, a monthly magazine featuring news and articles on investing and
mutual funds.
USA TODAY, a newspaper that 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 that covers
financial news.
WASHINGTON POST, a newspaper that may cover financial news.
WORTH, a magazine that covers financial and investment subjects including
mutual funds.
20
<PAGE>
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, A Reuter Company and Morningstar, Inc. Each Fund will be
compared to Lipper's or Morningstar's appropriate fund category according to
its objective(s) and portfolio holdings. 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 Funds or by those publications listed previously are Schabaker
Investment Management and Investment Company Data, Inc. These are services that
collect and compile data on mutual fund companies.
21
<PAGE>
APPENDIX C - 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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06052-0800
<PAGE>
Part B
Statement of Additional Information for the
California Bond and
California Money Market Funds
<PAGE>
USAA USAA STATEMENT OF
EAGLE TAX EXEMPT ADDITIONAL INFORMATION
LOGO FUND, INC. AUGUST 1, 2000
-------------------------------------------------------------------------------
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 dated August 1, 2000, for the
California Funds by writing to USAA Tax Exempt Fund, Inc., 9800 Fredericksburg
Road, 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.
The financial statements of the Funds and the Independent Auditors' Report
thereon for the fiscal year ended March 31, 2000, are included in the
accompanying Annual Report to Shareholders of that date and are incorporated
herein by reference.
-------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
2 Valuation of Securities
2 Conditions of Purchase and Redemption
3 Additional Information Regarding Redemption of Shares
3 Investment Plans
4 Investment Policies
6 Investment Restrictions
7 Special Risk Considerations
11 Portfolio Transactions
12 Description of Shares
13 Certain Federal Income Tax Considerations
14 California Taxation
15 Directors and Officers of the Company
18 The Company's Manager
19 General Information
19 Calculation of Performance Data
21 Appendix A - Tax-Exempt Securities and Their Ratings
23 Appendix B - Comparison of Portfolio Performance
26 Appendix C - 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 that 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. There can be no assurance, however, that the
Fund will at all times be able to maintain a constant $1 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 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 an NAV per
share by using available market quotations.
CONDITIONS OF PURCHASE AND REDEMPTION
NONPAYMENT
If any order to purchase shares is canceled due to nonpayment or if the Company
does not receive good funds either by check or electronic funds transfer, USAA
Shareholder Account Services (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 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 $25 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.
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ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
The value of your 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 that 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 you.
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 your last known
address.
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 amounts 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. 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. You will continue
to earn dividends until the shares are redeemed by the presentation of a check.
When a check is presented to the Transfer Agent for payment, a sufficient
number of full and fractional shares from your account will be redeemed to
cover the amount of the check. If the account balance 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 checkwriting privilege is 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 you for the use
of the checks or for subsequent reorders of checks.
The Company reserves the right to assess a processing fee against your
account for any redemption check not honored by a clearing or paying agent.
Currently, this fee is $25 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.
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. The Transfer Agent
will charge you $20 for each stop payment you request.
INVESTMENT PLANS
The Company makes available the following investment plans 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.
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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 a non-governmental employer, an income-producing
investment, or an account with a participating financial institution.
DIRECT DEPOSIT PROGRAM - The monthly transfer of certain federal benefits to
directly purchase shares of a USAA mutual fund. Eligible federal benefits
include: Social Security, Supplemental Security Income, Veterans Compensation
and Pension, Civil Service Retirement Annuity, and Civil Service Survivor
Annuity.
GOVERNMENT ALLOTMENT - The transfer of military pay by the U.S. Government
Finance Center for the purchase of USAA mutual fund shares.
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. You may
initiate a "buy" or "sell" whenever you choose.
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.
Participation in these systematic purchase plans allows you to engage in
dollar-cost averaging. For additional information concerning the benefits of
dollar-cost averaging, see APPENDIX C.
SYSTEMATIC WITHDRAWAL PLAN
If you own shares having a net asset value of $5,000 or more in a single
investment account (accounts in different Funds cannot be aggregated for this
purpose), you 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,
you may choose to have withdrawals electronically deposited at your bank or
other financial institution. You may also elect to have checks mailed to a
designated address.
This 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. You may terminate
participation in the plan at any time. You are not charged 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 you select 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 your
investment and eventually exhaust the account. Reinvesting dividends and
distributions helps replenish the account. Because share values and net
investment income can fluctuate, you 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 your income tax return. Therefore, you should keep an accurate
record of any gain or loss on each withdrawal.
INVESTMENT POLICIES
The sections captioned WHAT ARE EACH FUND'S INVESTMENT OBJECTIVES AND MAIN
STRATEGIES? and FUND INVESTMENTS in the Prospectus describe the fundamental
investment objective(s) and the investment policies applicable to each Fund.
Each Fund's objective(s) cannot be changed without shareholder approval. 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 the results
of 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
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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 that, 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 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.
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.
TEMPORARY DEFENSIVE POLICY
Each Fund may on a temporary basis because of market, economic, political, or
other conditions invest up to 100% of its assets in short-term securities
whether or not they are exempt from federal and California state income taxes.
Such taxable
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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.
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 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;
(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;
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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, 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 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; or
(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, 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 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 previous 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 revenues 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
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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 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.
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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. Proposition 218 also
allows voters to use their initiative power to reduce or repeal
previously-authorized taxes, assessments, fees and charges.
The California economy and general financial condition affect the ability
of the State and local governments to raise and redistribute revenues to assist
issuers of municipal securities to make timely payments on their obligations.
California is the most populous state in the nation with a total population
estimated at 33.4 million. The State now comprises 12.4% of the nation's
population and 12.7% of its total personal income. California has a diverse
economy, with major employment in the agriculture, manufacturing, high
technology, services, trade, entertainment and construction sectors. After
experiencing strong growth throughout much of the 1980s, from 1990-1993 the
State suffered through a severe recession, the worst since the 1930s, heavily
influenced by large cutbacks in defense/aerospace industries, military base
closures and a major drop in real estate construction. California's economy has
been performing strongly since the start of 1994. The unemployment rate, while
still higher than the national average, fell to an estimated average of 5.2%
during 1999, compared to over 10% at the worst of the recession.
Certain of the State's significant industries, such as high technology,
are sensitive to economic disruptions in their export markets and the State's
rate of economic growth, therefore, could be adversely affected by any such
disruption. A significant downturn in U.S. stock market prices could adversely
affect California's economy by reducing household spending and business
investment, particularly in the important high technology sector. Moreover, a
large and increasing share of the State's General Fund revenue in the form of
income and capital gains taxes is directly related to, and would be adversely
affected by a significant downturn in the performance of, the stock markets.
In addition, it is impossible to predict the time, magnitude or location
of a major earthquake or its effect on the California economy. In January 1994,
a major earthquake struck the Los Angeles area, causing significant damage in a
four county area. The possibility exists that another such earthquake could
create a major dislocation of the California economy and significantly affect
state and local government budgets.
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The recession severely affected state revenues while the State's health
and welfare costs were increasing. Consequently, the State had a lengthy period
of budget imbalance; the State's accumulated budget deficit approached $2.8
billion at its peak at June 30, 1993. The large budget deficits depleted the
State's available cash resources and it had to use a series of external
borrowings to meet its cash needs. With the end of the recession, the State's
financial condition improved, with a combination of better than expected
revenues, slowdown in growth of social welfare programs, and continued spending
restraint. The accumulated budget deficit from the recession years was
eliminated. No deficit borrowing has occurred at the end of the last several
fiscal years.
STATE BUDGET. On June 29, 1999, the Governor of California signed the
1999-2000 Budget Act. The Budget Act estimated General Fund revenues and
transfers of $63.0 billion, and contained expenditures totaling $63.7 billion.
The Budget Act also contained expenditures of $16.1 billion from special funds
and $1.5 billion from bond funds. The Administration estimated a budget reserve
balance at June 30, 2000, of approximately $880 million. Not included in this
amount was an additional $300 million which (after the Governor's vetoes) was
"set aside" to provide funds for employee salary increases (to be negotiated in
bargaining with employee unions), and for litigation reserves. The Budget Act
anticipates normal cash flow borrowing during the fiscal year. Continued State
economic expansion and large revenue increases enabled the Governor and State
legislature to provide increases in spending programs in the 1999-2000 budget.
These included large increases in education and health and human services
funding.
On January 10, 2000, the Governor released his proposed budget for Fiscal
Year 2000-01. The 2000-01 Governor's Budget generally reflected an estimate
that General Fund revenues for Fiscal Year 1999-2000 would be higher than
projections made at the time of the 1999 Budget Act. Even these positive
estimates proved to be greatly understated as continuing economic growth and
stock market gains (at least through the first quarter of 2000) resulted in a
surge of revenues. The Administration estimated in the 2000 May Revision that
General Fund revenues would total $70.9 billion in 1999-2000, and $73.8 billion
in 2000-01, a two-year increase of $12.3 billion above the January Governor's
Budget revenue estimates. The 2000-01 revenue estimate assumes a $545 million
reduction in personal income tax revenue from the Governor's proposal to
provide an income tax exemption for all teachers in the State.
The 2000 May Revision proposes General Fund expenditures of $78.2 billion,
as compared to an original spending proposal of $68.8 billion in the January
Governor's Budget. Included in the revised Budget are set-asides of $500
million for legal contingencies and $200 million for various one-time
legislative initiatives. Based on the proposed revenues and expenditures, the
2000 May Revision projects the June 30, 2001 budget reserve balance to be
$1.769 billion, up from $1.238 billion proposed in the January Governor's
Budget. It contains a number of proposals for spending the additional revenues,
mostly in 2000-01, as well as permanent program enhancements. All of these
proposals are subject to review and action by the Legislature.
STATE INDEBTEDNESS. As of April 1, 2000, the State had over $20.6 billion
aggregate amount of its general obligation bonds outstanding and unused general
obligation bond authorizations in an aggregate amount of approximately $15.7
billion. The State also builds and acquires capital facilities through the use
of lease purchase borrowing. As of April 1, 2000, the State had approximately
$6.7 billion of outstanding Lease-Purchase Debt.
In addition to the general obligation bonds, State agencies and
authorities had approximately $26 billion aggregate principal amount of revenue
bonds and notes outstanding as of June 30, 1999. Revenue bonds represent both
obligations payable from State revenue-producing enterprises and projects,
which are not payable from the General Fund, and conduit obligations payable
only from revenues paid by private users of facilities financed by such revenue
bonds. Such enterprises and projects include transportation projects, various
public works and exposition projects, educational facilities (including the
California State University and University of California systems), housing,
health facilities and pollution control facilities.
LITIGATION. The State is a party to numerous legal proceedings, many of
which normally occur in governmental operations. In addition, the State is
involved in certain other legal proceedings that, if decided against the State,
might require the State to make significant future expenditures or impair
future revenue sources.
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. The State's improved economy and budget have resulted in
upgrades in its general obligation bond ratings. In October 1998, Moody's
raised its rating from A1 to Aa3 citing the State's continuing economic
recovery and a number of actions taken to improve the State's credit condition,
including the rebuilding of cash and budget reserves. In August 1999, Standard
& Poor's raised its rating from A+ to AA- citing the State's strong economic
performance and its return to structural fiscal balance. In February 2000,
Fitch raised its rating from AA- to AA, citing California's fundamental
strengths, sustained favorable economy and financial operations.
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Some local governments in California have experienced notable financial
difficulties. 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. 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%. In December, 1997, Moody's raised its ratings on $325 million of
Orange County pension obligation bonds to Baa3 from Ba. In February 1998, Fitch
assigned outstanding Orange County pension obligation bonds a BBB rating. In
September 1999, Moody's assigned the County an issuer (implied general
obligation) rating of Aa3 and, among other things, upgraded the ratings on the
County's pension obligation bonds to A1. In January 2000, Standard & Poor's
upgraded its rating on the County's pension obligation bonds from BB to A- and
in February 2000 Fitch upgraded its rating on the County's pension obligation
bonds from BBB to AA-.
Los Angeles County, the nation's largest county, has also experienced
financial difficulty. Between 1992 and 1995, the County's long term bonds were
downgraded three times. This occurred as a result of, among other things,
severe operating deficits for the County's health care system. In addition, the
County was affected by an ongoing loss of revenue caused by the State's
property tax shift initiatives in 1993 through 1995. The County's improving
financial condition has been reflected in improved general obligation bond
ratings. In June 1999, the Los Angeles County Board of Supervisors approved a
budget of approximately $15 billion for 1999-2000, up from the $13.6 billion
approved for the previous fiscal year. In April, 2000, the County's Chief
Administrative Officer proposed a County budget for 2000-2001 of just over $15
billion. The County's financial condition will continue to be affected by the
large number of County residents who are dependent on government services and
by a structural deficit in its health department.
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. These research
services may also include access to research on third party data bases, such as
historical data on companies, financial statements, earnings history and
estimates and corporate releases; real-time quotes and financial news; research
on specific fixed income securities; research on international market news and
securities; and rating services on companies and industries. 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.
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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 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:
1999. . . . . 7.20% 2000. . . . 48.46%
Portfolio turnover rates have been calculated excluding short-term
variable rate securities, which are those with put date intervals of less than
one year.
DESCRIPTION OF SHARES
The Funds are series of USAA Tax Exempt Fund, Inc. (the Company) and are
diversified. 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 series or funds. There are
ten mutual funds in the Company, 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.
Under the provisions of the Bylaws of the Company, no annual meeting of
shareholders is required. Thus, there will ordinarily be no shareholder meeting
unless required by the 1940 Act. Under certain circumstances, however,
shareholders may apply to the Directors for shareholder information to obtain
signatures to request a special shareholder meeting. The Company may fill
vacancies on the Board or appoint new Directors if the result is that at least
two-thirds of the Directors have still been elected by shareholders. Moreover,
pursuant to the Bylaws of the Company, any Director may be removed by the
affirmative vote of a majority of the outstanding Company shares; and holders
of 10% or more of the outstanding shares of the Company can require Directors
to call a meeting of shareholders for the purpose of voting on the removal of
one or more Directors. The Company will assist in communicating to other
shareholders about the meeting. 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 that 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.
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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) and (2) 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
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 includable 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.
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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 or she 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.
CALIFORNIA TAXATION
The State of California has adopted legislation incorporating the federal
provisions relating to regulated investment companies as of January 1, 1998.
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
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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.
DIRECTORS AND OFFICERS OF THE COMPANY
The Board of Directors of the Company consists of eight Directors who supervise
the business affairs of the Company. 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 Road, San Antonio, TX 78288.
Robert G. Davis 1, 2
Director and Chairman of the Board of Directors
Age: 53
President and Chief Executive Officer of United Services Automobile Association
(USAA) (4/00-present); President and Chief Operating Officer of USAA
(6/99-3/00); Director of USAA (2/99-present); Deputy Chief Executive Officer
for Capital Management of USAA (6/98-5/99); 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);
President, Chief Executive Officer, Director, and Chairman of the Board of
Directors of USAA Financial Planning Network, Inc. (1/97-present); Executive
Vice President, Chief Operating Officer, Director, and Vice Chairman of the
Board of Directors of USAA Financial Planning Network, Inc. (6/96-12/96);
Special Assistant to Chairman, 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 serves as a
Director/Trustee and Chairman of the Boards of Directors/Trustees of each of
the remaining funds within the USAA Family of Funds; Director and Chairman of
the Boards of Directors of USAA Investment Management Company (IMCO), 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: 58
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, Director/Trustee, and Vice Chairman of the Boards of
Directors/Trustees of each of the remaining funds within the USAA Family of
Funds and USAA Shareholder Account Services; Director of USAA Life Insurance
Company; and Trustee and Vice Chairman of USAA Life Investment Trust.
David G. Peebles 1
Director and Vice President
Age: 60
Senior Vice President, Equity Investments, IMCO (11/98-present); Vice
President, Equity Investments IMCO (2/88-11/98); Mr. Peebles serves as
Director/Trustee and Vice President of each of the remaining Funds within the
USAA Family of Funds; Director of IMCO.
Barbara B. Dreeben 3, 4, 5
200 Patterson #1008
San Antonio, TX 78209
Director
Age: 55
President, Postal Addvantage (7/92-present); Consultant, Nancy Harkins
Stationer (8/91-12/95). Mrs. Dreeben serves as a Director/Trustee of each of
the remaining funds within the USAA Family of Funds.
15
<PAGE>
Robert L. Mason, Ph.D. 3, 4, 5
12823 Queens Forest
San Antonio, TX 78230
Director
Age: 54
Staff Analyst, Southwest Research Institute (9/98-present); Manager,
Statistical Analysis Section, Southwest Research Institute (2/79-9/98). Dr.
Mason serves as a Director/Trustee of the remaining funds within each of the
USAA Family of Funds.
Michael F. Reimherr 3, 4, 5
128 East Arrowhead
San Antonio, Texas 78216
Director
Age: 54
President of Reimherr Business Consulting (5/95-present). Mr. Reimherr serves
as a Director/Trustee for each of the remaining Funds within the USAA Family of
Funds.
Laura T. Starks, Ph.D. 3, 4, 5
5405 Ridge Pal Drive
Austin, TX 78731
Director
Age: 50
Charles E and Sarah M Seay Regents Chair Professor of Finance, University of
Texas at Austin (9/96-present); Sarah Meadows Seay Regents, Professor of
Finance, University of Texas at Austin (9/94-9/96). Dr. Starks serves as a
Director/Trustee of each of the remaining funds within the USAA Family of
Funds.
Richard A. Zucker 2, 3, 4, 5
407 Arch Bluff
San Antonio, TX 78216
Director
Age: 57
Vice President, Beldon Roofing and Remodeling (1985-present). Mr. Zucker serves
as a Director/Trustee of each of the remaining funds within the USAA Family of
Funds.
Kenneth E. Willmann 1
Vice President
Age: 53
Senior Vice President, Fixed Income Investments, IMCO (12/99-present); Vice
President, Mutual Fund Portfolios, IMCO (09/94-12/99). Mr. Willmann serves as a
Vice President of each of the remaining Funds within the USAA Family of Funds.
Michael D. Wagner 1
Secretary
Age: 52
Senior Vice President, USAA Capital Corporation (CAPCO) General Counsel
(01/99-present); Vice President, Corporate Counsel, USAA (1982-01/99). 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 of each of the remaining funds within the USAA
Family of Funds; Vice President, Corporate Counsel for various other USAA
subsidiaries and affiliates.
Mark S. Howard 1
Assistant Secretary
Age: 36
Vice President, Securities Counsel & Compliance, IMCO (7/00-present); Assistant
Vice President, Securities Counsel, USAA (2/98-7/00); Executive Director,
Securities Counsel, USAA (9/96-2/98); Senior Associate Counsel, Securities
16
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Counsel, USAA (5/95-8/96). Mr. Howard serves as Assistant Secretary for IMCO,
USAA Shareholder Account Services, USAA Financial Planning Network, Inc., each
of the remaining funds within the USAA Family of Funds, and for USAA Life
Investment Trust.
Sherron A. Kirk 1
Treasurer
Age: 55
Senior Vice President, Senior Financial Officer, IMCO (1/00-present); Vice
President, Senior Financial Officer, IMCO (8/98-1/00); Vice President,
Controller, IMCO (10/92-8/98). Ms. Kirk serves as Treasurer of each of the
remaining funds within the USAA Family of Funds; Vice President, Senior
Financial Officer of USAA Shareholder Account Services.
Roberto Galindo, Jr. 1
Assistant Treasurer
Age: 39
Executive Director, Mutual Fund Analysis & Support, IMCO (6/00-present);
Director, Mutual Fund Analysis, IMCO(9/99-6/00); Vice President, Portfolio
Administration, Founders Asset Management LLC (7/98-8/99); Assistant Vice
President, Director of Fund & Private Client Accounting, Founders Asset
Management LLC (7/93-7/98). Mr. Galindo serves as Assistant Treasurer for each
of the remaining funds within the USAA Family of Funds.
--------------------
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 individual is an executive officer of the Manager: Christopher W.
Claus, Senior Vice President, Investment Sales & Service. 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, 2000.
Name Aggregate Total Compensation
of Compensation from the USAA
Director From the company Family of Funds (b)
-------- ----------------- -------------------
Robert G. Davis None (a) None (a)
Barbara B. Dreeben $ 9,698 $ 35,000
Howard L. Freeman, Jr. (c $ 7,811 $ 28,500
Robert L. Mason $ 9,698 $ 35,000
David G. Peebles None (a) None (a)
Michael F. Reimherr $ 1,887 $ 6,500
Michael J.C. Roth None (a) None (a)
John W. Saunders, Jr. (c) None (a) None (a)
Richard A. Zucker $ 9,698 $ 35,000
-------------------------------------------------------------------------------
(a) Robert G. Davis, Michael J.C. Roth, John W. Saunders, Jr., and David G.
Peebles 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.
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(b) At March 31, 2000, the USAA Family of Funds consisted of four registered
investment companies offering 38 individual funds. Each Director
presently serves as a Director or Trustee 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 available
to the public only through the purchase of certain variable annuity
contracts and variable life insurance policies offered by USAA Life
Insurance Company. Mr. Roth receives no compensation as Trustee of USAA
Life Investment Trust.
(c) Effective December 31, 1999, John W. Saunders, Jr. and Howard L. Freeman,
Jr. retired from the Board of Directors.
All of the above Directors are also Directors/Trustees of the other funds
within the USAA Family of Funds. No compensation is paid by any fund to any
Director/Trustee 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, 2000, 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, 2000, 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. 6.6%
Market Fund 4660 La Jolla Village Drive Ste 850
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, a wholly owned indirect subsidiary of United Services
Automobile Association (USAA), a large, diversified financial services
institution, was organized in May 1970 and 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 $41 billion, of which
approximately $29 billion were in mutual fund portfolios.
While the officers and employees of the Manager, as well as those of the
Funds, may engage in personal securities transactions, they are restricted by
the procedures in a Joint Code of Ethics adopted by the Manager and the Funds.
The Joint Code of Ethics was designed to ensure that the shareholders'
interests come before those of the individuals who manage their Funds. It also
prohibits the portfolio managers and other investment personnel from buying
securities in an initial public offering or from profiting from the purchase or
sale of the same security within 60 calendar days. Additionally, the Joint Code
of Ethics requires the portfolio manager and other employees with access
information about the purchase or sale of securities by the Funds to obtain
approval before executing permitted personal trades. A copy of the Joint Code
of Ethics for the Manager has been filed with the SEC and is available for
public view.
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 FUND MANAGEMENT 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 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.
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<PAGE>
The Advisory Agreement will remain in effect until June 30, 2001, 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:
1998 1999 2000
---- ---- ----
California Bond Fund $1,547,374 $1,842,748 $1,910,612
California Money Market Fund $1,212,332 $1,250,763 $1,317,725
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 $28.50 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, each Fund pays 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 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.
CALCULATION OF PERFORMANCE DATA
Information regarding the total return and yield of each Fund is provided under
COULD THE VALUE OF YOUR INVESTMENT IN THESE FUNDS FLUCTUATE? 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:
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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, 2000 were:
1 year. . . . -2.91% 5 years . . . . 6.24% 10 year. . . . 6.95%
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[((a-b)/(cd)+1)^6 -1]
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, 2000 was 4.99%.
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 and income other than
investment income, 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 March 31, 2000, was 2.94%.
Effective Yield for 7-day Period Ended March 31, 2000, was 2.98%.
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.
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<PAGE>
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, 2000 were 8.60% and 5.06%, 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 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 (Moody's), Standard & Poor's
Ratings Group (S&P), Fitch Information, Inc. (Fitch), and Thompson BankWatch
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.
1. LONG-TERM DEBT RATINGS:
MOODY'S INVESTOR SERVICES
Aaa Bonds that 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 that 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.
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<PAGE>
A Bonds that 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 that suggest a susceptibility to impairment
some time in the future.
Baa Bonds that 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: MOODY'S APPLIES NUMERICAL MODIFIERS 1, 2, AND 3 IN EACH GENERIC RATING
CLASSIFICATION. THE MODIFIER 1 INDICATES THAT THE OBLIGATION RANKS IN THE
HIGHER END OF ITS GENERIC RATING CATEGORY, THE MODIFIER 2 INDICATES A MID-RANGE
RANKING, AND THE MODIFIER 3 INDICATES A RANKING IN THE LOWER END OF THAT
GENERIC RATING CATEGORY.
STANDARD & POOR'S RATINGS GROUP (S&P)
AAA An obligation rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is EXTREMELY STRONG.
AA An obligation rated AA differs from the highest rated issues only in
small degree. The obligor's capacity to meet its financial commitment
on the obligation is VERY STRONG.
A An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher rated categories. However, the obligor's
capacity to meet its financial commitment on the obligation is still
STRONG.
BBB An obligation rated BBB exhibits ADEQUATE capacity to pay interest and
repay principal. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
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.
FITCH INFORMATION, INC.
AAA Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong
capacity for timely payment of financial commitments. This capacity is
highly unlikely to be adversely affected by foreseeable events.
AA Very high credit quality. "AA" ratings denote a very low expectation
of credit risk. They indicate very strong capacity for timely payment
of financial commitments. This capacity is not significantly
vulnerable to foreseeable events.
A High credit quality. "A" ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is
considered strong. This capacity may, nevertheless, be more vulnerable
to changes in circumstances or in economic conditions than is the case
for higher ratings.
BBB Good credit quality. "BBB" ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of
financial commitments is considered adequate, but adverse changes in
circumstances and in economic conditions are more likely to impair
this capacity. This is the lowest investment-grade category.
2. SHORT-TERM DEBT RATINGS:
MOODY'S STATE AND TAX-EXEMPT NOTES
MIG-1/VMIG1 This designation denotes best quality. There is present
strong protection by established cash flows, superior
liquidity support, or demonstrated broad-based access to the
market for refinancing.
MIG-2/VMIG2 This designation denotes high quality. Margins of protection
are ample although not so large as in the preceding group.
MOODY'S COMMERCIAL PAPER
Prime-1 Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics:
* Leading market positions in well-established industries.
* High rates of return on funds employed.
* Conservative capitalization structures with moderate reliance on
debt and ample asset protection.
* Broad margins in earning coverage of fixed financial charges and
high internal cash generation.
* Well-established access to a range of financial markets and assured
sources of alternate liquidity.
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Prime-2 Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt 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, may be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
S&P 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.
S&P 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.
FITCH'S 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.
THOMPSON BANKWATCH
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.
APPENDIX B - COMPARISON OF PORTFOLIO PERFORMANCE
Occasionally, we may make comparisons in advertising and sales literature
between the Funds and other comparable funds in the industry. 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 but are not
restricted to the following:
AAII JOURNAL, a monthly association magazine for members of the American
Association of Individual Investors.
ARIZONA REPUBLIC, a newspaper that may cover financial and investment news.
AUSTIN AMERICAN-STATESMAN, a newspaper that 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 that covers bond market news.
BUSINESS WEEK, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds.
23
<PAGE>
CDA/WEISENBERGER MUTUAL FUNDS INVESTMENT REPORT, a monthly newsletter that
reports on both specific mutual fund companies and the mutual fund industry as
a whole.
CHICAGO TRIBUNE, a newspaper that may cover financial news.
CONSUMER REPORTS, a monthly magazine that from time to time reports on
companies in the mutual fund industry.
DALLAS MORNING NEWS, a newspaper that may cover financial news.
DENVER POST, a newspaper that may quote financial news.
FINANCIAL PLANNING, a monthly magazine that periodically features companies in
the mutual fund industry.
FINANCIAL SERVICES WEEK, a weekly newspaper that covers financial news.
FINANCIAL WORLD, a monthly magazine that periodically features companies in the
mutual fund industry.
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 that may cover financial news.
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, the national association of the American
Investment Company industry.
INVESTOR'S BUSINESS DAILY, a newspaper that covers financial news.
KIPLINGER'S PERSONAL FINANCE MAGAZINE, a monthly investment advisory
publication that periodically features the performance of a variety of
securities.
LIPPER, A REUTERS COMPANY EQUITY FUND PERFORMANCE ANALYSIS, a weekly and
monthly publication of industry-wide mutual fund performance averages by type
of fund.
LIPPER, A REUTERS COMPANY FIXED INCOME FUND PERFORMANCE ANALYSIS, a monthly
publication of industry-wide mutual fund performance averages by type of fund.
LOS ANGELES TIMES, a newspaper that 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 iMoneyNet, Inc. (formerly IBC
Financial Data, 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 "Taxable First Tier Fund Average."
MONEY MARKET INSIGHT, a monthly money market industry analysis prepared by
iMoneyNet, Inc. (formerly IBC Financial Data, Inc.)
MONEYLETTER, a biweekly newsletter that covers financial news and from time to
time rates specific mutual funds.
MORNINGSTAR 5 STAR INVESTOR, a monthly newsletter that covers financial news
and rates mutual funds produced by Morningstar, Inc. (a data service that
tracks open-end mutual funds).
MUNI BOND FUND REPORT, a monthly newsletter that covers news on the municipal
bond market and features performance data for municipal bond mutual funds.
MUNIWEEK, a weekly newspaper that 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 mutual fund
performance and rankings, 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.
that describes and rates mutual funds.
MUTUAL FUND VALUES, a biweekly guidebook to mutual funds produced by
Morningstar, Inc.
24
<PAGE>
NEWSWEEK, a national business weekly.
NEW YORK TIMES, a newspaper that may cover financial news.
NO LOAD FUND INVESTOR, a newsletter covering companies in the mutual fund
industry.
ORLANDO SENTINEL, a newspaper that may cover financial news.
PERSONAL INVESTOR, a monthly magazine that 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 that may cover financial news.
SAN FRANCISCO CHRONICLE, a newspaper that may cover financial news.
SMART MONEY, a monthly magazine featuring news and articles on investing and
mutual funds.
USA TODAY, a newspaper that 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 that covers
financial news.
WASHINGTON POST, a newspaper that may cover financial news.
WORTH, a magazine that 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, A Reuter's Company and Morningstar, Inc. Each Fund will be
compared to Lipper's or Morningstar's appropriate fund category according to
its objective(s) and portfolio holdings. 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 Funds or by those publications listed previously are Schabaker
Investment Management and Investment Company Data, Inc. These are services that
collect and compile data on mutual fund companies.
25
<PAGE>
APPENDIX C -- 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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14356-0800
<PAGE>
Part B
Statement of Additional Information for the
New York Bond and
New York Money Market Funds
<PAGE>
USAA USAA STATEMENT OF
EAGLE TAX EXEMPT ADDITIONAL INFORMATION
LOGO FUND, INC. AUGUST 1, 2000
-------------------------------------------------------------------------------
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 dated August 1, 2000, for the New
York Funds by writing to USAA Tax Exempt Fund, Inc., 9800 Fredericksburg Road,
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.
The financial statements of the Funds and the Independent Auditors' Report
thereon for the fiscal year ended March 31, 2000, are included in the
accompanying Annual Report to Shareholders of that date and are incorporated
herein by reference.
-------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
2 Valuation of Securities
2 Conditions of Purchase and Redemption
3 Additional Information Regarding Redemption of Shares
3 Investment Plans
4 Investment Policies
6 Investment Restrictions
7 Special Risk Considerations
15 Portfolio Transactions
16 Description of Shares
17 Certain Federal Income Tax Considerations
19 Directors and Officers of the Company
22 The Company's Manager
23 General Information
23 Calculation of Performance Data
25 Appendix A - Tax-Exempt Securities and Their Ratings
27 Appendix B - Comparison of Portfolio Performance
30 Appendix C - 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 that 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. There can be no assurance, however, that the
Fund will at all times be able to maintain a constant $1 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 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 an NAV per
share by using available market quotations.
CONDITIONS OF PURCHASE AND REDEMPTION
NONPAYMENT
If any order to purchase shares is canceled due to nonpayment or if the Trust
does not receive good funds either by check or electronic funds transfer, USAA
Shareholder Account Services (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 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 $25 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.
2
<PAGE>
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
The value of your 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 that 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 you.
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 your last known
address.
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 amounts 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. 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. You will continue
to earn dividends until the shares are redeemed by the presentation of a check.
When a check is presented to the Transfer Agent for payment, a sufficient
number of full and fractional shares from your account will be redeemed to
cover the amount of the check. If the account balance 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 checkwriting privilege is 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 you for the use
of the checks or for subsequent reorders of checks.
The Company reserves the right to assess a processing fee against your
account for any redemption check not honored by a clearing or paying agent.
Currently, this fee is $25 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.
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. The Transfer Agent
will charge you $20 for each stop payment you request.
INVESTMENT PLANS
The Company makes available the following investment plans 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.
3
<PAGE>
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 a non-governmental employer, an income-producing
investment, or an account with a participating financial institution.
DIRECT DEPOSIT PROGRAM - The monthly transfer of certain federal benefits to
directly purchase shares of a USAA mutual fund. Eligible federal benefits
include: Social Security, Supplemental Security Income, Veterans Compensation
and Pension, Civil Service Retirement Annuity, and Civil Service Survivor
Annuity.
GOVERNMENT ALLOTMENT - The transfer of military pay by the U.S. Government
Finance Center for the purchase of USAA mutual fund shares.
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. You may
initiate a "buy" or "sell" whenever you choose.
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.
Participation in these systematic purchase plans allows you to engage in
dollar-cost averaging. For additional information concerning the benefits of
dollar-cost averaging, see APPENDIX C.
SYSTEMATIC WITHDRAWAL PLAN
If you own shares having a net asset value of $5,000 or more in a single
investment account (accounts in different Funds cannot be aggregated for this
purpose), you 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,
you may choose to have withdrawals electronically deposited at your bank or
other financial institution. You may also elect to have checks mailed to a
designated address.
This 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. You may terminate
participation in the plan at any time. You are not charged 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 you select 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 your
investment and eventually exhaust the account. Reinvesting dividends and
distributions helps replenish the account. Because share values and net
investment income can fluctuate, you 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 your income tax return. Therefore, you should keep an accurate
record of any gain or loss on each withdrawal.
INVESTMENT POLICIES
The sections captioned WHAT ARE EACH FUND'S INVESTMENT OBJECTIVES AND MAIN
STRATEGIES? and FUND INVESTMENTS in the Prospectus describe the fundamental
investment objective(s) and the investment policies applicable to each Fund.
Each Fund's objective(s) cannot be changed without shareholder approval. 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 the results
of 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
4
<PAGE>
maturity earlier than its stated maturity date if the instrument has technical
features such as puts or demand features that, 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 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.
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.
TEMPORARY DEFENSIVE POLICY
Each Fund may on a temporary basis because of market, economic, political, or
other conditions invest up to 100% of its assets in short-term securities
whether or not they are 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
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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.
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 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;
(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;
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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, 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 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; or
(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. Like the rest of the nation, the
State has a declining proportion of its workforce engaged in manufacturing, and
an increasing proportion engaged in service industries. The State is likely to
be less affected than the nation as a whole during an economic recession that
is concentrated in manufacturing and construction, but likely to be more
affected during a recession that is concentrated in the services sector. 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.
There can be no assurance that the State economy will not experience
worse-than-predicted results in the 2000-2001 fiscal year (April 1, 2000
through March 31, 2001) or subsequent fiscal years, 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.
In 1999, the State's per capita personal income exceeded the United States
average by approximately 19 percent according to preliminary data from the U.S.
Bureau of Economic Analysis. In the calendar years 1987 through 1998, the
State's rate of economic growth was somewhat slower than that of the nation.
According to the U.S. Bureau of Economic Analysis, total personal income in the
State has risen more slowly than the national average from 1988 through 1998.
The State Division of the Budget projects that personal income in the State
grew at 5.9% in 1999. This equals the comparable national figure according to
the U.S. Bureau of Economic Analysis. In 1999, for the first time in 13 years,
the employment growth rate of the State surpassed the national growth rate. The
State unemployment rates for 1997 and 1998 were 6.4% and 5.6%, respectively,
and the rate for 1999 has been projected by the State Division of Budget to be
5.1%.
STATE BUDGET. The State Constitution requires the Governor to submit to
the State 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.
On March 30, 2000, the State adopted the debt service portion of the State
Budget for the 2000-2001 fiscal year; the remainder of the budget was enacted
by the State Legislature on May 5, 2000, 35 days after the statutory deadline
of April 1. The Governor approved the budget as passed by the Legislature.
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The 2000-2001 State Financial Plan projects a balanced General Fund, on a
cash basis, with closing balances in the General Fund and other reserves of
approximately $3.2 billion, including $1.71 billion in the General Fund for the
2000-2001 fiscal year. The 2000-2001 State Financial Plan transfers
approximately $3.4 billion in net resources from the 1999-2000 fiscal year to
the 2000-2001 fiscal period as a tax reduction reserve. 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. Total General Fund receipts,
including transfers from other funds, are projected to be $39.72 billion, an
increase of $2.32 billion from total receipts estimated for the 1999-2000
fiscal year. Total General Fund disbursements and transfers to other funds are
projected to be $38.92 billion, an increase of $1.75 billion over the 1999-2000
fiscal year. All Governmental Funds spending (which includes the General Fund,
Special Revenue Funds, Debt Service Funds and Capital Project Funds) is
estimated to increase by 5.7 percent from the 1999-2000 fiscal year.
RECEIPTS. The forecast of General Fund receipts in fiscal year 2000-2001
reflects the School Tax Relief (STAR) property tax reduction program, as well
as the continuing impact of other earlier tax reductions. The State adopted an
additional tax relief package that will reduce tax receipts by $1.2 billion
when fully effective; this package includes the elimination or reduction of
gross receipts taxes on energy, the expansion of the "Power for Jobs" energy
tax credit program, a college tuition deduction or credit taken against
personal income taxes, and reduction of the marriage penalty for taxpayers who
file jointly.
Personal income tax collections for the 2000-2001 fiscal year are
projected to reach approximately $24.33 billion, an increase of nearly $4
billion over 1999-2000 reported collections. This increase is due in part to
refund reserve transactions which serve to increase reported 2000-2001 personal
income tax receipts. Growth in 2000-2001 personal income tax receipts is
partially offset by the diversion of $1.99 billion of such receipts into the
School Tax Relief Fund, which finances the STAR tax reduction program. Adjusted
for these transactions, the growth in net income tax receipts is roughly $1.3
billion, an increase of nearly 5 percent.
User tax and fees are projected at $7.02 billion in 2000-2001, a decrease
of $583 million below reported collections in the 1999-2000 fiscal year. The
sales tax and cigarette tax components of this category account for virtually
all of the 2000-2001 decline. Growth in base sales tax yield, after adjusting
for tax law changes and other factors, is projected at 4.5 percent. The
projected decrease in sales tax cash receipts of 3.4 percent reflects, in large
part, the impact of the permanent exemption for clothing and footwear items
costing under $110. Cigarette tax and tobacco products tax receipts are
projected to decline primarily due to reduced taxable consumption associated
with the increase in the cigarette tax of 55 cents per pack imposed on March 1,
2000. The decline in the motor fuel taxes and motor vehicle fees in the General
Fund largely reflect the increased dedication of these revenue sources to the
Dedicated Highway and Bridge Trust Fund and the Dedicated Mass Transportation
Trust Fund.
Business tax receipts are expected to total approximately $4.23 billion in
2000-2001, $332 million below 1999-2000 results. The year-over-year decline in
projected receipts is largely attributable to statutory changes. These include
the first year impact of a scheduled bank and insurance franchise tax rate
reduction, a reduction in the cap on tax liability for non-life insurers, and
the expansion of the Empire Zone and zone equivalent areas tax credits.
Receipts from other taxes, which are comprised primarily of receipts from
estate and gift taxes and pari-mutuel taxes on wagering, are expected to
decline $341 million to $766 million in 2000-2001. The primary factors
accounting for this decline are legislation enacted previously that repealed
both the real property gains tax and the gift tax and significantly reduced
estate taxes, and the incremental effects of tax reductions in the pari-mutuel
tax.
Miscellaneous receipts are expected to total approximately $1.34 billion
in the 2000-2001 fiscal year, a decline of $309 million from the 1999-2000
fiscal year. This reflects the absence in the 2000-2001 fiscal year of
non-recurring receipts received in the 1999-2000 fiscal year and the phase-out
of the medical provider assessments, completed in January 2000. Miscellaneous
receipts include license revenues, income from fees and fines, abandoned
property proceeds and investment income.
DISBURSEMENTS. Grants to Local Governments constitute approximately 68.9
percent of all General Fund spending, and include payments to local
governments, non-profit providers and entitlement benefits to individuals. It
is projected to be approximately $26.83 billion for the 2000-2001 fiscal year,
an increase of 4.7 percent from the level for the 1999-2000 fiscal year.
Welfare spending is projected at $1.20 billion, a decrease of $77 million from
the 1999-2000 fiscal year. This decrease results from a projected caseload
decline of approximately 65,000 recipients (or 7.4 percent) to an average
annual total of approximately 814,000 recipients in 2000-2001. Welfare spending
also reflects increased availability of federal Temporary Assistance for Needy
Families (TANF) Block Grant funds.
State Operations reflects the costs of running the Executive, Legislative
and Judicial branches of government. It is projected to be approximately $7.11
billion for the 2000-2001 fiscal year. This is approximately 18.3 percent of
General Fund disbursements. Spending in this category is projected to increase
7.7 percent above 1999-2000. The 2000-2001
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spending estimate, as of May 31, 2000, did not include costs of new labor
contracts that have not been approved by the State Legislature. These costs
will be funded through collective bargaining reserves of $675 million, which
are carried separately in the 2000-2001 Financial Plan. The State's overall
workforce is projected to be approximately 195,000 employees, up about 2,700
from the end of the 1999-2000 fiscal year.
General State Charges accounts primarily for the costs of providing fringe
benefits for State employees, including contributions to pension systems, the
employer's share of social security contributions, employer contributions
toward the cost of health insurance, and the costs of providing worker's
compensation and unemployment insurance benefits. This category also reflects
certain fixed costs such as payments in lieu of taxes and payments of judgments
against the State or its public officials. It is projected to be approximately
$2.19 billion for the 2000-2001 fiscal year, an increase of $104 million over
the level for the 1999-2000 fiscal year. This constitutes approximately 5.6
percent of General Fund disbursements.
Transfers to Other Funds from the General Fund are made primarily to
finance certain portions of State capital projects spending and debt service on
long-term bonds where these costs are not funded from other sources. State debt
service is projected to constitute approximately 5.8 percent of 2000-2001
fiscal year General Fund disbursements. Transfers for capital projects and all
other transfers are projected to constitute approximately 1.4 percent of all
such General Fund disbursements.
The Debt Reduction Reserve Fund (DRRF) is assumed by the State Division of
the Budget to be reclassified from the General Fund to the Capital Projects
fund type in the 2000-2001 fiscal year. The 2000-2001 Financial Plan reflects
the deposit of an additional $250 million in General Fund receipts to DRRF in
2000-2001, as well as $250 million in one-time resources from the State's share
of tobacco settlement proceeds.
NON-RECURRING RESOURCES. The Division of the Budget estimates that the
2000-2001 Financial Plan contains new actions in the enacted budget that
provide non-recurring resources totaling approximately $36 million, excluding
use of the 1999-2000 fiscal year surplus.
OUTYEAR PROJECTIONS OF RECEIPTS AND DISBURSEMENTS. State law requires the
Governor to propose a balanced budget each year. Preliminary analysis by the
State Division of Budget indicates that the State will have a 2001-2002 budget
gap of approximately $2 billion, which is comparable with gaps projected
following enactment of recent budgets. This estimate includes the projected
costs of new collective bargaining agreements, no assumed operating
efficiencies, and the planned application of approximately $1.2 billion in STAR
tax reduction reserves.
In a report released on June 7, 2000, the State Comptroller estimated
future State budget gaps of approximately $3.0 billion in the 2001-2002 fiscal
year and $4.9 billion in the 2002-2003 fiscal year, assuming certain one-time
legislative additions to the State budget would be recurring.
Sustained growth in the State's economy could contribute to closing
potential budget imbalances over the next several years, both in terms of
higher-than-projected tax receipts and in lower-than-expected entitlement
spending. Savings from initiatives by State agencies to deliver services more
efficiently, workforce management efforts, and maximization of federal and
non-General Fund spending offsets could also help bring projected disbursements
and receipts into balance.
SPECIAL CONSIDERATION. Despite recent budgetary surpluses recorded by the
State, actions affecting the level of receipts and disbursements, the relative
strength of the State and regional economy, and actions by the Federal
government could impact projected budget gaps for the State. These gaps would
result from a disparity between recurring revenues and the costs of increasing
the level of support for State programs. To address a potential imbalance in
any given fiscal year, the State would be required to take actions to increase
receipts and/or reduce disbursements as it enacts the budget for that year, and
under the State Constitution, the Governor is required to propose a balanced
budget each year. There can be no assurance, however, that the State
Legislature will enact the Governor's proposals or that the State's actions
will be sufficient to preserve budgetary balance in a given fiscal year or to
align recurring receipts and disbursements in future fiscal years.
Many complex political, social and economic forces influence the State's
economy and finances, which may in turn affect the State Financial Plan. These
forces may affect the State unpredictably from fiscal year to fiscal year and
are influenced by governments, institutions, and events that are not subject to
the State's control. The State Financial Plan is based upon forecasts of
national and State economic activity. Many uncertainties exist in forecasts of
both the national and the State economies, including consumer attitudes toward
spending, the extent of corporate and governmental restructuring, the condition
of the financial sector, federal fiscal and monetary policies, the level of
interest rates, and the condition of the world economy, which could have an
adverse effect on the State. There can be no assurance that the State economy
will not experience results in the current or any future fiscal year that are
worse than predicted, with corresponding material and adverse effects on the
State's projections of receipts and disbursements.
Projections of total State receipts in the State Financial Plan are based
on the State tax structure in effect during the fiscal year and on assumptions
relating to basic economic factors and their historical relationships to State
tax receipts. In preparing projections of State receipts, economic forecasts
relating to personal income, wages, consumption, profits and
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employment have been particularly important. The projection of receipts from
most tax or revenue sources is generally made by estimating the change in yield
of such tax or revenue source caused by economic and other factors, rather than
by estimating the total yield of such tax or revenue source from its estimated
tax base. The forecasting methodology, however, ensures that State fiscal year
collection estimates for taxes that are based on a computation of annual
liability, such as the business and personal income taxes, are consistent with
estimates of total liability under such taxes.
Projections of total State disbursements are based on assumptions relating
to economic and demographic factors, potential collective bargaining
agreements, levels of disbursements for various services provided by local
governments (where the cost is partially reimbursed by the State), and the
results of various administrative and statutory mechanisms in controlling
disbursements for State operations. Factors that may affect the level of
disbursements in the fiscal year include uncertainties relating to the economy
of the nation and the State, the policies of the Federal government, collective
bargaining negotiations and changes in the demand for and use of State
services.
Over the long-term, uncertainties with regard to the economy present the
largest potential risk to future budget balance in New York State. For example,
a downturn in the financial markets or the wider economy is possible, a risk
that is heightened by the lengthy expansion currently underway. The securities
industry is more important to the New York economy than the national economy as
a whole, potentially amplifying the impact of an economic downturn. A large
change in stock market performance during the forecast horizon could result in
wage, bonus, and unemployment levels that are significantly different from
those embodied in the State's 2000-2001 Financial Plan forecast. Merging and
downsizing by firms, as a consequence of deregulation or continued foreign
competition, may also have more significant adverse effects on employment than
expected.
An ongoing risk to the State Financial Plan arises from the potential
impact of certain litigation and of federal disallowances now pending against
the State, which could adversely affect the State's projections of receipts and
disbursements. The State's 2000-2001 Financial Plan contains projected reserves
of $150 million in the 2000-2001 fiscal year for such events, but assumes no
significant federal disallowances or other federal actions that could affect
State finances (see "LITIGATION" within).
Additional risks to the 2000-2001 Financial Plan may arise from the
enactment of legislation by the U.S. Congress. The Personal Responsibility and
Work Opportunity Reconciliation Act of 1996 created a new Temporary Assistance
to Needy Families program (TANF) partially funded with a fixed federal block
grant to states. Congress has recently debated proposals under which the
Federal government would take a portion of state reserves from the TANF block
grant for use in funding other federal programs. It has also considered
proposals that would lower the State's share of mass transit operating
assistance. Finally, several proposals to alter federal tax law that have
surfaced in recent years could adversely affect State revenues, since many
State taxes depend on federal definitions of income. While Congress has not
enacted these proposals, it may do so in the future, or it may take other
actions that could have an adverse effect on State finances.
The State's 2000-2001 Financial Plan assumes the availability of certain
resources to finance portions of General Fund spending for fringe benefits,
health and welfare programs. These resources could become unavailable or
decrease, placing additional pressures on budget balance.
TOBACCO SETTLEMENT PROCEEDS AND USES/HCRA 2000. On November 23, 1998, the
attorneys general for forty-six states (including New York) entered into a
master settlement agreement (MSA) with the nation's largest tobacco
manufacturers. Under the terms of the MSA, the states agreed to release the
manufacturers from all smoking-related claims in exchange for specified
payments and the imposition of restrictions on tobacco advertising and
marketing. New York is projected to receive $25 billion over 25 years under the
MSA, with payments apportioned among the State (51 percent), counties (22
percent), and New York City (27 percent).
The 2000-2001 Financial Plan utilizes certain resources from HCRA 2000,
the successor legislation to the Health Care Reform Act of 1996. HCRA continues
the negotiated reimbursement system for non-governmental payors, and provides
funding for, among other things, graduate medical education, indigent care, and
the expansion of health insurance coverage for uninsured adults and children.
HCRA 2000 will help finance several health-related programs, including
prescription drug assistance for the elderly, supplemental Medicare insurance,
and other public health services that were previously funded from the General
Fund. Programs under HCRA 2000 will be financed with revenues generated from
the financing mechanisms continued from HCRA 1996, a share of the State's
tobacco settlement and revenues from an increased excise tax on cigarettes. The
State plans to use $1.29 billion in tobacco settlement money over the next
three years to finance health programs under HCRA 2000 ($1.01 billion) and
projected increased costs in Medicaid ($274 million).
RECENT STATE FISCAL YEARS. The State ended its 1999-2000 fiscal year on
March 31, 2000 in balance on a cash basis, with a General Fund cash-basis
surplus of $1.51 billion as reported by the State Division of the Budget. As in
recent years, strong growth in receipts above forecasted amounts produced most
of the year-end surplus. Spending was also modestly below projections, further
adding to the surplus.
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The state reported a closing balance of $1.17 billion in the General Fund,
an increase of $275 million over the closing balance from the prior year. The
closing fund balance excludes $3.97 billion that the State deposited into the
tax refund reserve account at the close of the 1999-2000 fiscal year to pay for
tax refunds in the 2000-2001 fiscal year.
The State ended its 1998-1999 fiscal year in balance on a cash basis, with
a reported cash surplus of approximately $1.82 billion. Prior to adoption of
the State's 1998-1999 fiscal year budget, the State had projected a potential
budget gap of under $1 billion.
The State ended its 1997-1998 fiscal year in balance on a cash basis, with
a reported 1997-1998 cash surplus of approximately $2.04 billion. Prior to
adoption of the State's 1997-1998 fiscal year budget, the State had projected a
potential budget gap of approximately $2.3 billion.
DEBT LIMITS, RATINGS 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 constitutional
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. As of June 1995, LGAC had
issued bonds to provide net proceeds of $4.7 billion, completing the program.
The impact of LGAC's borrowing is that the State is able to meet its cash flow
needs without relying on short-term seasonal borrowings.
As of May 31, 2000, Moody's rated New York State general obligations bonds
A2, and Standard & Poor's rated such bonds A+. Standard & Poor's revised its
rating upwards from A- to A on August 28, 1997. Standard & Poor's again revised
its ratings upward from A to A+ in November 1999. Moody's revised its outlook
for the State's general obligation and appropriation-backed indebtedness to
positive from stable on June 12, 2000. Ratings reflect only the respective
views of such organizations, and an explanation of the significance of such
ratings may be obtained from the rating agency furnishing the same. There is no
assurance that a particular rating will continue for any given period of time
or that any such rating will not be revised downward or withdrawn entirely, if
in the judgment of the agency originally establishing the rating, circumstances
so warrant.
As of March 31, 2000, the State had approximately $4.6 billion outstanding
in general obligation debt, including $45 million in bond anticipation notes
outstanding. The total amount of moral obligation debt was approximately $594
million, and approximately $27.4 billion of bonds issued primarily in
connection with lease-purchase and contractual-obligation financing of State
capital programs were outstanding.
For purposes of analyzing the financial condition of the State, debt of
the State and of certain public authorities may be classified as
State-supported debt, which includes general obligations debt of the State and
lease-purchase and contractual obligations of public authorities (and
municipalities) where debt service is paid from State appropriations (including
dedicated tax sources, and other revenues such as patient charges and dormitory
facilities rentals). In addition, a broader classification, referred to as
State-related debt, includes State-supported debt, as well as certain types of
contingent obligations, including moral-obligation financing, certain
contingent contractual-obligation financing arrangements, and State-guaranteed
debt, where debt service is expected to be paid from other sources and State
appropriations are contingent in that they may be made and used only under
certain circumstances.
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The total amount of State-supported debt outstanding grew from 4.13
percent of personal income in the State in the 1990-1991 fiscal year to 5.96
percent for the 1999-2000 fiscal year while State-related debt outstanding
declined from 6.75 percent to 6.25 percent of personal income for the same
period. Thus, State-supported debt grew at a faster rate than personal income
while State-related obligations grew at a slower rate. At the end of the
1999-2000 fiscal year, there was $38.58 billion of outstanding State-related
debt and $36.80 billion of outstanding State-supported debt. State
lease-purchase and contractual-obligation payments (including State installment
payments relating to certificates of participation (COPS)) were $2.63 billion
in fiscal year 1999-2000, and are estimated to be $2.97 billion for 2000-2001.
Principal and interest payments on general obligation bonds and interest
payments on bond anticipation notes were $724 million for the 1999-2000 fiscal
year and are estimated to be $687.4 million for the 2000-2001 fiscal year.
The State Legislature has enacted the Debt Reform Act of 2000 ("Debt
Reform Act"). The Debt Reform Act, which applies to new State-supported debt
issued on or after April 1, 2000, imposes caps on new debt outstanding and new
debt service costs, restricts the use of debt to capital purposes only, and
restricts the maximum term of State debt issuances to no more than 30 years.
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 taxes. 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, 1999, the State reported its estimated
liability for awarded and anticipated unfavorable judgments to be $895 million.
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
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 is
State-supported or State-related. As of December 31, 1999, there were 17
Authorities that had outstanding debt of $100 million or more. The aggregate
outstanding debt, including refunding bonds, of all State Authorities was $95
billion, up from $75.4 billion as of September 30, 1996.
Public authority operating expenses and debt service costs are generally
paid by revenues generated by the projects financed or operated, such as user
fees on bridges or tunnels, highway tolls and rentals for dormitory rooms and
housing units and charges for occupancy at medical care facilities. 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 in any given fiscal year
will be adopted by the April 1 statutory deadline, or interim appropriations
enacted, or that any such reductions or delays will not have adverse effects on
the City's cash flow or expenditures.
For each of the 1981 through 1999 fiscal years, the City had an operating
surplus, before discretionary and other transfers, and achieved balanced
operating results as reported in accordance with generally accepted accounting
principles ("GAAP"), after discretionary and other transfers. The City has been
required to close substantial budget gaps in recent years in order to maintain
balanced operating results. A pattern of current year surplus operating results
and projected subsequent year budget gaps has been consistent through the
entire period since 1982, during which the City has achieved surplus operating
results, before discretionary transfers for each fiscal year. There can be no
assurance that the City will continue to maintain a balanced budget as required
by State law, or that it can maintain a balanced budget without tax or other
revenue increases or 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.
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As of June 28, 2000, Moody's rated the City's outstanding general
obligation bonds A3, Standard & Poor's rated such bonds A- and Fitch rated such
bonds A. In July 1995, Standard & Poor's revised downwards its ratings on
outstanding general obligation bonds of the City from A- to BBB+. In July 1998,
Standard & Poor's revised its rating of City bonds upward to A-. Moody's rating
of City bonds was revised in February 1998 to A3 from Baal. On March 8, 1999,
Fitch revised its rating of City bonds upward to A. Such ratings reflect only
the view of Moody's, Standard & Poor's and Fitch, from which an explanation of
the significance of such ratings may be obtained. There is no assurance that
such ratings will continue for any given period of time or that they will not
be revised downward or withdrawn entirely. Any such downward revision or
withdrawal could have an adverse effect on the market prices of City bonds.
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 balance
its budgets. 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 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, 2000, MAC had outstanding an aggregate of
approximately $2.9 billion of net long-term debt. MAC is authorized to issue
bonds and notes to refund its outstanding bonds and notes and to fund certain
reserves.
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 Control Board continues to
have oversight responsibilities.
The Mayor is responsible for preparing the City's financial plan,
including the City's current financial plan for the 2000 through 2004 fiscal
years (the "2000-2004 Financial Plan", "Financial Plan" or "City Plan"). On
June 15, 2000, the City released the Financial Plan for the 2000 through 2004
fiscal years, which relates to the City and certain entities which receive
funds from the City. The Financial Plan reflects changes as a result of the
City's expense and capital budgets for fiscal year 2001 (which began July 1,
2000), which were adopted on June 6, 2000. The Financial Plan projects revenues
and expenditures for the 2000 and 2001 fiscal years balanced in accordance with
GAAP, and project gaps of $2.6 billion, $2.7 billion and $2.7 billion for the
2002 through 2004 fiscal years, respectively, after implementation of a gap
closing program.
The 2000-2004 Financial Plan includes a proposed discretionary transfer
from fiscal year 2000 to fiscal year 2001 primarily to pay debt service due in
fiscal year 2001 totaling $3.2 billion, a proposed discretionary transfer from
fiscal year 2001 to fiscal year 2002 to pay debt service due in fiscal year
2002 totaling $904 million and a proposed discretionary transfer from fiscal
year 2002 to fiscal year 2003 to pay debt service in fiscal year 2003 totaling
$345 million.
In addition, the Financial Plan sets forth gap-closing actions to
eliminate previously projected gaps for the 2000 and 2001 fiscal years and to
reduce projected gaps for fiscal years 2002 through 2004. The gap-closing
actions for the 2000 through 2004 fiscal years include: (i) additional agency
actions totaling $337 million, $400 million, $210 million, $210 million and
$210 million for fiscal years 2000 through 2004, respectively; (ii) assumed
additional federal and State actions of $75 million in each of fiscal years
2001 through 2004, which are subject to federal and State approval; and (iii)
proposed productivity savings and reducing fringe benefits costs totaling $250
million, $265 million, $280 million and $300 million in fiscal years 2001
through 2004, respectively to partly offset the costs of a proposed merit pay
program to partly offset the costs of a proposed merit pay program which is
subject to collective bargaining negotiations. The Financial Plan also reflects
a proposed tax reduction program totaling $418 million, $735 million, $877
million and $1.1 billion in fiscal years 2001 through 2004, respectively,
including the elimination of the commercial rent tax over four years commencing
June 1, 2000 at a cost of $16 million in fiscal year 2001increasing to $430
million in fiscal year 2004; a reduction and restructing of the 14% personal
income tax surcharge on July 1, 2000 at a cost of $329 million in fiscal year
2001, increasing to $403 million in fiscal year 2004; the extension of current
tax reductions for owners of cooperative and condominium apartments
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at an annual cost of approximately $200 million starting in fiscal year 2002;
repeal of the $2 flat fee hotel occupancy tax effective December 1, 2000 and
other tax reduction proposals including elimination of the borough commerical
revitalization tax. Wage increases for City employees are provided for in the
Financial Plan through a merit pay plan for two years after their collective
bargaining agreements expire in fiscal years 2000 and 2001, contingent upon
productivity savings. The Financial Plan does not make any provision for wage
increases thereafter.
The 2000-2004 Financial Plan is based on numerous assumptions, including
the condition of the City's and the region's economies and modest employment
growth and the concomitant receipt of economically sensitive tax revenues in
the amounts projected. The 2000-2004 Financial Plan is subject to various other
uncertainties and contingencies relating to, among other factors, the extent,
if any, to which wage increases for City employees exceed the annual wage costs
assumed for the 2000 through 2004 fiscal years; continuation of projected
interest earnings assumptions for pension fund assets and current assumptions
with respect to wages for City employees affecting the City's required pension
fund contributions; the willingness and ability of the State to provide the aid
contemplated by the Financial Plan and to take various other actions to assist
the City; the ability of Health and Hospitals Corporation (the "HHC"), the
Board of Education (the "BOE") and other such agencies to maintain balanced
budgets; the willingness of the Federal government to provide the amount of
federal aid contemplated in the Financial Plan; the impact on City revenues and
expenditures of federal and State welfare reform and any future legislation
affecting Medicare or other entitlement programs; adoption of the City's
budgets by the City Council in substantially the forms submitted by the Mayor;
the ability of the City to implement cost reduction initiatives, and the
success with which the City controls expenditures; the impact of conditions in
the real estate market on real estate tax revenues; and unanticipated
expenditures that may be incurred as a result of the need to maintain the
City's infrastructure. Certain of these assumptions have been questioned by the
City Comptroller and other public officials. In addition, the economic and
financial condition of the City may be affected by various financial, social,
economic and political factors which could have a material effect on the City.
Implementation of the City Financial Plan is dependent upon the City's
ability to market its securities successfully. The City's program for financing
capital projects for fiscal years 2000 through 2004 contemplates the issuance
of $7.21 billion of general obligation bonds and $7.33 billion of bonds to be
issued by the New York City Transitional Finance Authority (the "Transitional
Finance Authority"). In addition, the Financial Plan anticipates access to
approximately $2.4 billion in financing capacity of TSASC, Inc. ("TSASC"),
which issues debt secured by revenues derived from the settlement of litigation
with tobacco companies selling cigarettes in the United States. The
Transitional Finance Authority and TSASC were created to assist the City in
financing its capital program while keeping City indebtedness within the
forecast level of the constitutional restrictions on the amount of debt the
City is authorized to incur.
In addition, the City issues revenue notes and tax anticipation notes to
finance its seasonal working capital requirements. The success of projected
public sales of City, New York City Municipal Water Finance Authority (the
"Water Authority"), Transitional Finance Authority, TSASC and other bonds and
notes will be subject to prevailing market conditions. The City's planned
capital and operating expenditures are dependent upon the sale of its general
obligation debt, as well as debt of the Water Authority, Transitional Finance
Authority and TSASC.
From time to time, the Control Board staff, the staff of the Office of the
State Deputy Comptroller of New York, the City Comptroller, the City's
Independent Budget Office and others issue reports and make public statements
regarding the City's financial condition, commenting on, among other matters,
the City's financial plans, projected revenues and expenditures and actions by
the City to eliminate projected operating deficits. Some of these reports and
statements have warned that the City may have underestimated certain
expenditures and overestimated certain revenues and have suggested that the
City may not have adequately provided for future contingencies. Certain of
these reports have analyzed the City's future economic and social conditions
and have questioned whether the City has the capacity to generate sufficient
revenues in the future to meet the costs of its expenditure increases and to
provide necessary services. It is reasonable to expect that reports and
statements will continue to be issued and to engender public comment.
On August 25, 1998, the City Comptroller issued a report reviewing the
current condition of the City's major physical assets and the capital
expenditures required to bring them to a state of good repair. The report's
findings relate only to current infrastructure and do not address future
capacity or technology needs. The report estimated that the expenditure of
approximately $91.83 billion would be required over the next decade to bring
the City's infrastructure to a systematic state of good repair and address new
capital needs already identified. The report stated that the City's current
Ten-Year Capital Strategy, together with funding received from other sources,
is projected to provide approximately $52.08 billion. The report noted that the
City's ability to meet all capital obligations is limited by law, as well as
funding capacity, and that the issue for the City is how best to set priorities
and manage limited resources.
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 issued $750 million of short-term obligations
in the 2000 fiscal year to finance the City's cash flow needs for the 2000
fiscal year. The City issued $500 million of short-term obligations in the 1999
fiscal year for financing cash flow needs for the 1999 fiscal year. The City
issued $1.075 billion of
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short-term obligations in fiscal year 1998 to finance the City's current
estimate of its seasonal cash flow needs for the 1998 fiscal year. The City
issued $2.4 billion of short-term obligations in fiscal year 1997. 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.
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.
The State as of May 31, 2000 was considering various measures to help
resolve persistent fiscal difficulties in Nassau County. The Governor has
proposed actions which would, if legislation is enacted, establish a Nassau
County Interim Finance Authority. The Authority would be empowered to issue
bonds, backed solely by diverted Nassau County sales tax revenues, to achieve
short-term budget relief and ensure credit market access for the County. Such
Authority would also impose financial plan requirements on Nassau County. The
Governor has also proposed that transitional State assistance be appropriated
in State fiscal year 2000-01, and in four subsequent State fiscal years.
Allocation of such assistance would be subject to the Authority's approval of
Nassau County's financial plan. There is no assurance that such proposals will
be enacted, or that future actions will not be required by the State to assist
Nassau County, resulting in increased State expenditures for extraordinary
local assistance.
The State has provided extraordinary financial assistance to select
municipalities, primarily cities, since the 1996-97 fiscal year. Funding has
essentially been continued or increased in each subsequent fiscal year, and in
2000-01 totals $200.4 million. The 2000-01 enacted budget also increased
general purpose State aid for local governments by $11 million to $562 million.
Counties, cities, towns, villages, school districts and fire districts
have engaged in substantial short-term and long-term borrowings. In 1998, the
total indebtedness of all localities in New York State other than New York City
was approximately $20.3 billion. A small portion (approximately $80 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. Twenty-three localities had outstanding indebtedness for deficit
financing at the close of their fiscal year ending in 1998.
Like the State, local governments must respond to changing political,
economic and financial influences over which they have little or no control.
Such changes may adversely affect the financial condition of certain local
governments. For example, the Federal government may reduce (or in some cases
eliminate) federal funding of some local programs which, in turn, may require
local governments to fund these expenditures from their own resources. It is
also possible that the State, New York City, Nassau County, or any of their
respective public authorities may suffer serious financial difficulties that
could jeopardize local access to the public credit markets, which may adversely
affect the marketability of notes and bonds issued by localities within the
State. Localities may also face unanticipated problems resulting from certain
pending litigation, judicial decisions and long-range economic trends. Other
large-scale potential problems, such as declining urban populations, increasing
expenditures, and the loss of skilled manufacturing jobs, may also adversely
affect localities and necessitate State assistance.
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
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settlement. These research services may also include access to research on
third party data bases, such as historical data on companies, financial
statements, earnings history and estimates and corporate releases; real-time
quotes and financial news; research on specific fixed income securities;
research on international market news and securities; and rating services on
companies and industries. 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 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:
1999. . . . . 27.64% 2000. . . . . 31.77%
Portfolio turnover rates have been calculated excluding short-term
variable rate securities, which are those with put date intervals of less than
one year.
DESCRIPTION OF SHARES
The Funds are series of USAA Tax Exempt Fund, Inc. (the Company) and are
diversified. 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 series or funds. There are
ten mutual funds in the Company, 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.
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Under the provisions of the Bylaws of the Company, no annual meeting of
shareholders is required. Thus, there will ordinarily be no shareholder meeting
unless required by the 1940 Act. Under certain circumstances, however,
shareholders may apply to the Directors for shareholder information to obtain
signatures to request a special shareholder meeting. The Company may fill
vacancies on the Board or appoint new Directors if the result is that at least
two-thirds of the Directors have still been elected by shareholders. Moreover,
pursuant to the Bylaws of the Company, any Director may be removed by the
affirmative vote of a majority of the outstanding Company shares; and holders
of 10% or more of the outstanding shares of the Company can require Directors
to call a meeting of shareholders for the purpose of voting on the removal of
one or more Directors. The Company will assist in communicating to other
shareholders about the meeting. 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 that 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) and (2) 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
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.
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<PAGE>
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 includable 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 or she 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.
DIRECTORS AND OFFICERS OF THE COMPANY
The Board of Directors of the Company consists of eight Directors who supervise
the business affairs of the Company. 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 Road, San Antonio, TX 78288.
Robert G. Davis 1, 2
Director and Chairman of the Board of Directors
Age: 53
President and Chief Executive Officer of United Services Automobile Association
(USAA) (4/00-present); President and Chief Operating Officer of USAA
(6/99-3/00); Director of USAA (2/99-present); Deputy Chief Executive Officer
for Capital Management of USAA (6/98-5/99); 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);
President, Chief
18
<PAGE>
Executive Officer, Director, and Chairman of the Board of Directors of USAA
Financial Planning Network, Inc. (1/97-present); Executive Vice President,
Chief Operating Officer, Director, and Vice Chairman of the Board of Directors
of USAA Financial Planning Network, Inc. (6/96-12/96); Special Assistant to
Chairman, 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 serves as a Director/Trustee and
Chairman of the Boards of Directors/Trustees of each of the remaining funds
within the USAA Family of Funds; Director and Chairman of the Boards of
Directors of USAA Investment Management Company (IMCO), USAA Federal Savings
Bank, and USAA Real Estate Company.
Michael J. C. Roth 1, 2, 4
Director, President, and Vice Chairman of the Board of Directors
Age: 58
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, Director/Trustee, and Vice Chairman of the Boards of
Directors/Trustees of each of the remaining funds within the USAA Family of
Funds and USAA Shareholder Account Services; Director of USAA Life Insurance
Company; and Trustee and Vice Chairman of USAA Life Investment Trust.
David G. Peebles 1
Director and Vice President
Age: 60
Senior Vice President, Equity Investments, IMCO (11/98-present); Vice
President, Equity Investments, IMCO (2/88-11/98). Mr. Peebles serves as
Director/Trustee and Vice President of each of the remaining Funds within the
USAA Family of Funds; Director of IMCO; Senior Vice President of USAA
Shareholder Account Services; and Vice President of USAA Life Investment Trust.
Barbara B. Dreeben 3, 4, 5
200 Patterson #1008
San Antonio, TX 78209
Director
Age: 55
President, Postal Addvantage (7/92-present); Consultant, Nancy Harkins
Stationer (8/91-12/95). Mrs. Dreeben serves as a Director/Trustee of each of
the remaining funds within the USAA Family of Funds.
Robert L. Mason, Ph.D. 3, 4, 5
12823 Queens Forest
San Antonio, TX 78230
Director
Age: 54
Staff Analyst, Southwest Research Institute (9/98-present); Manager,
Statistical Analysis Section, Southwest Research Institute (2/79-9/98). Dr.
Mason serves as a Director/Trustee of the remaining funds within each of the
USAA Family of Funds.
Michael F. Reimherr 3, 4, 5
128 East Arrowhead
San Antonio, Texas 78228
Director
Age: 54
President of Reimherr Business Consulting (5/95-present). Mr. Reimherr serves
as a Director/Trustee of each of the remaining Funds within the USAA Family of
Funds.
Laura T. Starks, Ph.D. 3, 4, 5
5405 Ridge Pal Drive
Austin, TX 78731
Director
Age: 50
Charles E and Sarah M Seay Regents Chair Professor of Finance, University of
Texas at Austin (9/96-present); Sarah Meadows Seay Regents, Professor of
Finance, University of Texas at Austin (9/94-9/96). Dr. Starks serves as a
Director/Trustee of each of the remaining funds within the USAA Family of
Funds.
19
<PAGE>
Richard A. Zucker 2, 3, 4, 5
407 Arch Bluff
San Antonio, TX 78216
Director
Age: 57
Vice President, Beldon Roofing and Remodeling (1985-present). Mr. Zucker serves
as a Director/Trustee of each of the remaining funds within the USAA Family of
Funds.
Kenneth E. Willmann 1
Vice President
Age: 53
Senior Vice President, Fixed Income Investments, IMCO (12/99-present); Vice
President, Mutual Fund Portfolios, IMCO (09/94-12/99). Mr. Willmann serves as
Vice President of each of the remaining Funds within the USAA Family of Funds,
Director of IMCO, Senior Vice President of USAA Shareholder Account Services,
and Vice President of USAA Life Investment Trust.
Michael D. Wagner 1
Secretary
Age: 52
Senior Vice President, USAA Capital Corporation (CAPCO) General Counsel
(01/99-present); Vice President, Corporate Counsel, USAA (1982-01/99). 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 of each of the remaining funds within the USAA
Family of Funds; Vice President, Corporate Counsel for various other USAA
subsidiaries and affiliates.
Mark S. Howard 1
Assistant Secretary
Age: 36
Vice President, Securities Counsel & Compliance, IMCO (7/00-present); Assistant
Vice President, Securities Counsel, USAA (2/98-7/00); Executive Director,
Securities Counsel, USAA (9/96-2/98); Senior Associate Counsel, Securities
Counsel, USAA (5/95-8/96). Mr. Howard serves as Assistant Secretary for IMCO,
USAA Shareholder Account Services, USAA Financial Planning Network, Inc., each
of the remaining funds within the USAA Family of Funds, and for USAA Life
Investment Trust.
Sherron A. Kirk 1
Treasurer
Age: 55
Senior Vice President, Senior Financial Officer, IMCO (1/00-present); Vice
President, Senior Financial Officer, IMCO (8/98-1/00); Vice President,
Controller, IMCO (10/92-8/98). Ms. Kirk serves as Treasurer of each of the
remaining funds within the USAA Family of Funds; Vice President, Senior
Financial Officer of USAA Shareholder Account Services.
Roberto Galindo, Jr. 1
Assistant Treasurer
Age: 39
Executive Director, Mutual Fund Analysis & Support, IMCO (6/00-present);
Director, Mutual Fund Analysis, IMCO (9/99-6/00); Vice President, Portfolio
Administration, Founders Asset Management LLC (7/98-8/99); Assistant Vice
President, Director of Fund & Private Client Accounting, Founders Asset
Management LLC (7/93-7/98). Mr. Galindo serves as Assistant Treasurer for each
of the remaining funds within the USAA Family of Funds.
---------------------
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
20
<PAGE>
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 individual is an executive officer of the Manager: Christopher W.
Claus, Senior Vice President, Investment Sales & Service. 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, 2000.
Name Aggregate Total Compensation
of Compensation from the USAA
Director from the Company Family of Funds (b)
-------- ----------------- -------------------
Robert G. Davis None (a) None (a)
Barbara B. Dreeben $ 9,698 $ 35,000
Howard L. Freeman, Jr. (c) $ 7,811 $ 28,500
Robert L. Mason $ 9,698 $ 35,000
David G. Peebles None (a) None (a)
Michael F. Reimherr $ 1,887 $ 6,500
Michael J. C. Roth None (a) None (a)
John W. Saunders, Jr. (c) None (a) None (a)
Richard A. Zucker $ 9,698 $ 35,000
-------------------------------------------------------------------------------
(a) Robert G. Davis, Michael J.C. Roth, John W. Saunders, Jr., and David G.
Peebles 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, 2000, the USAA Family of Funds consisted of four registered
investment companies offering 38 individual funds. Each Director
presently serves as a Director or Trustee 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 available to the
public only through the purchase of certain variable annuity contracts
and variable life insurance policies offered by USAA Life Insurance
Company. Mr. Roth receives no compensation as Trustee of USAA Life
Investment Trust.
(c) Effective December 31, 1999, John W. Saunders, Jr. and Howard L. Freeman,
Jr. retired from the Board of Directors.
All of the above Directors are also Directors/Trustees of the other funds
within the USAA Family of Funds. No compensation is paid by any fund to any
Director/Trustee 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, 2000, 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, 2000, 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
-------------- ------------------- ----------------
New York Money Frederick M. Weissman 6.4%
Market Fund 3333 Henry Hudson Pkwy
Apt 17M
Riverdale, NY 10463-3277
21
<PAGE>
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, a wholly owned indirect subsidiary of United Services
Automobile Association (USAA), a large, diversified financial services
institution, was organized in May 1970 and 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 $41 billion, of which
approximately $29 billion were in mutual fund portfolios.
While the officers and employees of the Manager, as well as those of the
Funds, may engage in personal securities transactions, they are restricted by
the procedures in a Joint Code of Ethics adopted by the Manager and the Funds.
The Joint Code of Ethics was designed to ensure that the shareholders'
interests come before those of the individuals who manage their Funds. It also
prohibits the portfolio managers and other investment personnel from buying
securities in an initial public offering or from profiting from the purchase or
sale of the same security within 60 calendar days. Additionally, the Joint Code
of Ethics requires the portfolio manager and other employees with access
information about the purchase or sale of securities by the Funds to obtain
approval before executing permitted personal trades. A copy of the Joint Code
of Ethics for the Manager has been filed with the SEC and is available for
public view.
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 FUND MANAGEMENT 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 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, 2001, 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, 2001,
and will reimburse the Funds for all expenses in excess of the limitations.
For the last three fiscal years, management fees were as follows:
1998 1999 2000
---- ---- -----
New York Bond Fund $272,778 $317,866 $ 345,611
New York Money Market Fund $217,662 $255,130 $ 284,887
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:
1998 1999 2000
---- ---- ----
New York Bond Fund $ 71,681 $ 59,045 $ 59,702
New York Money Market Fund $ 71,994 $ 62,576 $ 60,420
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<PAGE>
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 $28.50 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, each Fund pays 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 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.
CALCULATION OF PERFORMANCE DATA
Information regarding the total return and yield of each Fund is provided under
COULD THE VALUE OF YOUR INVESTMENT IN THESE FUNDS FLUCTUATE? 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.
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, 2000 were:
1 year........-2.20% 5 years.......5.76% Since inception..........7.10%
23
<PAGE>
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[((a-b)/(cd)+1)^6 -1]
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, 2000 was 5.33%.
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 and income other than
investment income, 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 March 31, 2000, was 3.29%.
Effective Yield For 7-day Period Ended March 31, 2000, was 3.34%.
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 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 42.80% is 57.20%, that is (1.00-0.4280 = 0.5720)
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 10.63%, resulting in an EMTR of 42.80%, the tax-equivalent yields for
the New York Bond and New York Money Market Funds for the period ended March
31, 2000, were 9.32% and 5.75%, respectively.
24
<PAGE>
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 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 (Moody's), Standard & Poor's
Ratings Group (S&P), Fitch Information, Inc. (Fitch), and Thompson BankWatch
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.
1. LONG-TERM DEBT RATINGS:
MOODY'S INVESTOR SERVICES
Aaa Bonds that 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 that 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 that 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 that suggest a susceptibility to impairment
sometime in the future.
Baa Bonds that 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: MOODY'S APPLIES NUMERICAL MODIFIERS 1, 2, AND 3 IN EACH GENERIC RATING
CLASSIFICATION. THE MODIFIER 1 INDICATES THAT THE OBLIGATION RANKS IN THE
HIGHER END OF ITS GENERIC RATING CATEGORY, THE MODIFIER 2 INDICATES A MID-RANGE
RANKING, AND THE MODIFIER 3 INDICATES A RANKING IN THE LOWER END OF THAT
GENERIC RATING CATEGORY.
STANDARD & POOR'S RATINGS GROUP
AAA An obligation rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA An obligation rated AA differs from the highest rated issues only in
small degree. The obligor's capacity to meet its financial commitment
on the obligation is VERY STRONG.
25
<PAGE>
A An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher rated categories. However, the obligor's
capacity to meet its financial commitment on the obligation is still
STRONG.
BBB An obligation rated BBB exhibits adequate capacity to pay interest and
repay principal. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
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.
FITCH INFORMATION, INC.
AAA Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong
capacity for timely payment of financial commitments. This capacity is
highly unlikely to be adversely affected by foreseeable events.
AA Very high credit quality. "AA" ratings denote a very low expectation
of credit risk. They indicate very strong capacity for timely payment
of financial commitments. This capacity is not significantly
vulnerable to foreseeable events.
A High credit quality. "A" ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is
considered strong. This capacity may, nevertheless, be more vulnerable
to changes in circumstances or in economic conditions than is the case
for higher ratings.
BBB Good credit quality. "BBB" ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of
financial commitments is considered adequate, but adverse changes in
circumstances and in economic conditions are more likely to impair
this capacity. This is the lowest investment-grade category.
2. SHORT-TERM DEBT RATINGS:
MOODY'S STATE AND TAX-EXEMPT NOTES
MIG-1/VMIG1 This designation denotes best quality. There is present
strong protection by established cash flows, superior
liquidity support, or demonstrated broad-based access to the
market for refinancing.
MIG-2/VMIG2 This designation denotes high quality. Margins of protection
are ample although not so large as in the preceding group.
MOODY'S COMMERCIAL PAPER
Prime-1 Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the
following characteristics:
* Leading market positions in well-established industries.
* High rates of return on funds employed.
* Conservative capitalization structures with moderate reliance on
debt and ample asset protection.
* Broad margins in earning coverage of fixed financial charges and
high internal cash generation.
* Well-established access to a range of financial markets and assured
sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior 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, may be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
S&P 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.
S&P 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.
26
<PAGE>
FITCH'S COMMERCIAL PAPER, CERTIFICATES OF DEPOSIT, AND TAX-EXEMPT NOTES
F1 Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit features.
F2 Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in
the case of the higher ratings.
F3 Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could
result in a reduction to non-investment grade.
THOMPSON BANKWATCH
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.
APPENDIX B - COMPARISON OF PORTFOLIO PERFORMANCE
Occasionally, we may make comparisons in advertising and sales literature
between the Funds and other comparable funds in the industry. 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 but are not
restricted to the following:
AAII JOURNAL, a monthly association magazine for members of the American
Association of Individual Investors.
ARIZONA REPUBLIC, a newspaper that may cover financial and investment news.
AUSTIN AMERICAN-STATESMAN, a newspaper that 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 that covers bond market news.
BUSINESS WEEK, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds.
CDA/WEISENBERGER MUTUAL FUNDS INVESTMENT REPORT, a monthly newsletter that
reports on both specific mutual fund companies and the mutual fund industry as
a whole.
CHICAGO TRIBUNE, a newspaper that may cover financial news.
CONSUMER REPORTS, a monthly magazine that from time to time reports on
companies in the mutual fund industry.
DALLAS MORNING NEWS, a newspaper that may cover financial news.
DENVER POST, a newspaper that may quote financial news.
FINANCIAL PLANNING, a monthly magazine that periodically features companies in
the mutual fund industry.
FINANCIAL SERVICES WEEK, a weekly newspaper that covers financial news.
FINANCIAL WORLD, a monthly magazine that periodically features companies in the
mutual fund industry.
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.
27
<PAGE>
HOUSTON CHRONICLE, a newspaper that may cover financial news.
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, the national association of the American
Investment Company industry.
INVESTOR'S BUSINESS DAILY, a newspaper that covers financial news.
KIPLINGER'S PERSONAL FINANCE MAGAZINE, a monthly investment advisory
publication that periodically features the performance of a variety of
securities.
LIPPER, A REUTER'S COMPANY EQUITY FUND PERFORMANCE ANALYSIS, a weekly and
monthly publication of industry-wide mutual fund performance averages by type
of fund.
LIPPER, A REUTER'S COMPANY FIXED INCOME FUND PERFORMANCE ANALYSIS, a monthly
publication of industry-wide mutual fund performance averages by type of fund.
LOS ANGELES TIMES, a newspaper that 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 iMoneyNet, Inc. (formerly IBC
Financial Data, 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 "Taxable First Tier Fund Average."
MONEY MARKET INSIGHT, a monthly money market industry analysis prepared by
iMoneyNet, Inc. (formerly IBC Financial Data, Inc.)
MONEYLETTER, a biweekly newsletter that covers financial news and from time to
time rates specific mutual funds.
MORNINGSTAR 5 STAR INVESTOR, a monthly newsletter that covers financial news
and rates mutual funds produced by Morningstar, Inc. (a data service that
tracks open-end mutual funds).
MUNI BOND FUND REPORT, a monthly newsletter that covers news on the municipal
bond market and features performance data for municipal bond mutual funds.
MUNIWEEK, a weekly newspaper that 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 mutual fund
performance and rankings, 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.
that 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 that may cover financial news.
NO LOAD FUND INVESTOR, a newsletter covering companies in the mutual fund
industry.
ORLANDO SENTINEL, a newspaper that may cover financial news.
PERSONAL INVESTOR, a monthly magazine that 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.
28
<PAGE>
SAN ANTONIO EXPRESS-NEWS, a newspaper that may cover financial news.
SAN FRANCISCO CHRONICLE, a newspaper that may cover financial news.
SMART MONEY, a monthly magazine featuring news and articles on investing and
mutual funds.
USA TODAY, a newspaper that 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 that covers
financial news.
WASHINGTON POST, a newspaper that may cover financial news.
WORTH, a magazine that 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, A Reuter's Company and Morningstar, Inc. Each Fund will be
compared to Lipper's or Morningstar's appropriate fund category according to
its objective(s) and portfolio holdings. 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 Funds or by those publications listed previously are Schabaker
Investment Management and Investment Company Data, Inc. These are services that
collect and compile data on mutual fund companies.
29
<PAGE>
APPENDIX C - 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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17005-0800
<PAGE>
Part B
Statement of Additional Information for the
Virginia Bond and
Virginia Money Market Funds
<PAGE>
USAA USAA STATEMENT OF
EAGLE TAX EXEMPT ADDITIONAL INFORMATION
LOGO FUND, INC. AUGUST 1, 2000
-------------------------------------------------------------------------------
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 dated August 1, 2000, for the
Virginia Funds by writing to USAA Tax Exempt Fund, Inc., 9800 Fredericksburg
Road, 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.
The financial statements of the Funds and the Independent Auditors' Report
thereon for the fiscal year ended March 31, 2000, are included in the
accompanying Annual Report to Shareholders of that date and are incorporated
herein by reference.
-------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
2 Valuation of Securities
2 Conditions of Purchase and Redemption
3 Additional Information Regarding Redemption of Shares
3 Investment Plans
4 Investment Policies
6 Investment Restrictions
7 Special Risk Considerations
9 Portfolio Transactions
10 Description of Shares
10 Certain Federal Income Tax Considerations
12 Virginia Taxation
12 Directors and Officers of the Company
15 The Company's Manager
17 General Information
17 Calculation of Performance Data
18 Appendix A - Tax-Exempt Securities and Their Ratings
21 Appendix B - Comparison of Portfolio Performance
24 Appendix C - 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 that 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. There can be no assurance, however, that the
Fund will at all times be able to maintain a constant $1 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 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 an NAV per share by using
available market quotations.
CONDITIONS OF PURCHASE AND REDEMPTION
NONPAYMENT
If any order to purchase shares is canceled due to nonpayment or if the Company
does not receive good funds either by check or electronic funds transfer, USAA
Shareholder Account Services (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 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 $25 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.
2
<PAGE>
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
The value of your 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 that 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 you.
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 your last known
address.
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 amounts 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. 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. You will continue
to earn dividends until the shares are redeemed by the presentation of a check.
When a check is presented to the Transfer Agent for payment, a sufficient
number of full and fractional shares from your account will be redeemed to
cover the amount of the check. If the account balance 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 checkwriting privilege is 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 you for the use
of the checks or for subsequent reorders of checks.
The Company reserves the right to assess a processing fee against your
account for any redemption check not honored by a clearing or paying agent.
Currently, this fee is $25 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.
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. The Transfer Agent
will charge you $20 for each stop payment you request.
INVESTMENT PLANS
The Company makes available the following investment plans 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.
3
<PAGE>
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 a non-governmental employer, an income-producing
investment, or an account with a participating financial institution.
DIRECT DEPOSIT PROGRAM - The monthly transfer of certain federal benefits to
directly purchase shares of a USAA mutual fund. Eligible federal benefits
include: Social Security, Supplemental Security Income, Veterans Compensation
and Pension, Civil Service Retirement Annuity, and Civil Service Survivor
Annuity.
GOVERNMENT ALLOTMENT - The transfer of military pay by the U.S. Government
Finance Center for the purchase of USAA mutual fund shares.
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. You may
initiate a "buy" or "sell" whenever you choose.
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.
Participation in these systematic purchase plans allows you to engage in
dollar-cost averaging. For additional information concerning the benefits of
dollar-cost averaging, see APPENDIX C.
SYSTEMATIC WITHDRAWAL PLAN
If you own shares having a net asset value of $5,000 or more in a single
investment account (accounts in different Funds cannot be aggregated for this
purpose), you 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,
you may choose to have withdrawals electronically deposited at your bank or
other financial institution. You may also elect to have checks mailed to a
designated address.
This 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. You may terminate
participation in the plan at any time. You are not charged 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 you select 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 your
investment and eventually exhaust the account. Reinvesting dividends and
distributions helps replenish the account. Because share values and net
investment income can fluctuate, you 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 your income tax return. Therefore, you should keep an accurate
record of any gain or loss on each withdrawal.
INVESTMENT POLICIES
The sections captioned WHAT ARE EACH FUND'S INVESTMENT OBJECTIVES AND MAIN
STRATEGIES? and FUND INVESTMENTS in the Prospectus describe the fundamental
investment objective(s) and the investment policies applicable to each Fund.
Each Fund's objective(s) cannot be changed without shareholder approval. 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 the results
of 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
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maturity earlier than its stated maturity date if the instrument has technical
features such as puts or demand features that, 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 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.
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.
TEMPORARY DEFENSIVE POLICY
Each Fund may on a temporary basis because of market, economic, political, or
other conditions invest up to 100% of its assets in short-term securities
whether or not they are exempt from federal and Virginia state income taxes.
Such taxable
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securities may consist of obligations of the U.S. Government, its agencies or
instrumentalities, and repurchase agreements secured by such instruments.
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 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;
(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;
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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, 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 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; or
(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
Commonwealth 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. For the fiscal year ended June 30, 1999,
general fund revenues exceeded budget projections by $179 million. The economy
of the Commonwealth is based primarily on manufacturing, the government sector
(including defense), agriculture, mining and tourism. Defense spending is a
major component. Defense installations are concentrated in Northern Virginia,
the location of the Pentagon, and the Hampton Roads area, including the Cities
of Newport News, Hampton, Norfolk, and Virginia Beach, the locations of, among
other installations, the Army Transportation Center (Ft. Eustis), the Langley
Air Force Base, Norfolk Naval Base, and the Oceana Naval Air Station,
respectively. Any substantial reductions in defense spending generally or in
particular areas, including base closings, could adversely affect the state and
local economies.
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
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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.
(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.
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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.
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. These research
services may also include access to research on third party data bases, such as
historical data on companies, financial statements, earnings history and
estimates and corporate releases; real-time quotes and financial news; research
on specific fixed income securities; research on international market news and
securities; and rating services on companies and industries. 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:
1999. . . . . 10.55% 2000. . . . . 24.60%
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Portfolio turnover rates have been calculated excluding short-term
variable rate securities, which are those with put date intervals of less than
one year.
DESCRIPTION OF SHARES
The Funds are series of USAA Tax Exempt Fund, Inc. (the Company) and are
diversified. 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 series or funds. There are
ten mutual funds in the Company, 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.
Under the provisions of the Bylaws of the Company, no annual meeting of
shareholders is required. Thus, there will ordinarily be no shareholder meeting
unless required by the 1940 Act. Under certain circumstances, however,
shareholders may apply to the Directors for shareholder information to obtain
signatures to request a special shareholder meeting. The Company may fill
vacancies on the Board or appoint new Directors if the result is that at least
two-thirds of the Directors have still been elected by shareholders. Moreover,
pursuant to the Bylaws of the Company, any Director may be removed by the
affirmative vote of a majority of the outstanding Company shares; and holders
of 10% or more of the outstanding shares of the Company can require Directors
to call a meeting of shareholders for the purpose of voting on the removal of
one or more Directors. The Company will assist in communicating to other
shareholders about the meeting. 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 that 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) and (2) 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
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 includable 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 or she 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.
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VIRGINIA TAXATION
As a regulated investment company, each Fund may distribute dividends (Virginia
exempt-interest dividends) and capital gains (Virginia exempt-capital gains)
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 and Virginia is exempt-capital gains. If a Fund fails to so qualify
or report, no part of its dividends or capital gains 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.
The portion of distributions constituting Virginia exempt-capital gains is
that portion derived from long-term capital gains on the sale or exchange by
the Funds of obligations of the Commonwealth of Virginia, any political
subdivision or instrumentality of the Commonwealth, or the United States.
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. Distributions of long-term capital gains,
other than exempt-capital gains, realized and distributed by the Funds
generally will be taxable 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. 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 other distributions and as to
their own Virginia tax situation.
DIRECTORS AND OFFICERS OF THE COMPANY
The Board of Directors of the Company consists of eight Directors who supervise
the business affairs of the Company. 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 Road, San Antonio, TX 78288.
Robert G. Davis 1, 2
Director and Chairman of the Board of Directors
Age: 53
President and Chief Executive Officer of United Services Automobile Association
(USAA) (4/00-present); President and Chief Operating Officer of USAA
(6/99-3/00); Director of USAA (2/99-present); Deputy Chief Executive Officer
for Capital Management of USAA (6/98-5/99); 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);
President, Chief Executive Officer, Director, and Chairman of the Board of
Directors of USAA Financial Planning Network, Inc. (1/97-present); Executive
Vice President, Chief Operating Officer, Director, and Vice Chairman of the
Board of Directors of USAA Financial Planning Network, Inc. (6/96-12/96);
Special Assistant to Chairman, 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 serves as a
Director/Trustee and Chairman of the Boards of Directors/Trustees of each of
the remaining funds within the USAA Family of Funds; Director and Chairman of
the Boards of Directors of USAA Investment Management Company (IMCO), USAA
Federal Savings Bank, and USAA Real Estate Company.
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Michael J.C. Roth 1, 2
Director, President, and Vice Chairman of the Board of Directors
Age: 58
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, Director/Trustee, and Vice Chairman of the Boards of
Directors/Trustees of each of the remaining funds within the USAA Family of
Funds and USAA Shareholder Account Services; Director of USAA Life Insurance
Company; and Trustee and Vice Chairman of USAA Life Investment Trust.
David G. Peebles 1
Director and Vice President
Age: 60
Senior Vice President, Equity Investments, IMCO (11/98-present); Vice
President, Equity Investments, IMCO (2/88-1198). Mr. Peebles serves as
Director/Trustee and Vice President of each of the remaining Funds within the
USAA Family of Funds; Director of IMCO; Senior Vice President of USAA
Shareholder Account Services; and Vice President of USAA Life Investment Trust.
Barbara B. Dreeben 3, 4, 5
200 Patterson #1008
San Antonio, TX 78209
Director
Age: 55
President, Postal Addvantage (7/92-present); Consultant, Nancy Harkins
Stationer (8/91-12/95). Mrs. Dreeben serves as a Director/Trustee of each of
the remaining funds within the USAA Family of Funds.
Robert L. Mason, Ph.D. 3, 4, 5
12823 Queens Forest
San Antonio, TX 78230
Director
Age: 54
Staff Analyst, Southwest Research Institute (9/98-present); Manager,
Statistical Analysis Section, Southwest Research Institute (2/79-9/98). Dr.
Mason serves as a Director/Trustee of the remaining funds within each of the
USAA Family of Funds.
Michael F. Reimherr 3, 4, 5
128 East Arrowhead
San Antonio, Texas 78228
Director
Age: 54
President of Reimherr Business Consulting (5/95-present). Mr. Reimherr serves
as a Director/Trustee of each of the remaining Funds within the USAA Family of
Funds.
Laura T. Starks, Ph.D. 3, 4, 5
5405 Ridge Pal Drive
Austin, TX 78731
Age: 50
Charles E and Sarah M Seay Regents Chair Professor of Finance, University of
Texas at Austin (9/96-present); Sarah Meadows Seay Regents, Professor of
Finance, University of Texas at Austin (9/94-9/96). Dr. Starks serves as a
Director/Trustee of each of the remaining funds within the USAA Family of
Funds.
Richard A. Zucker 2, 3, 4, 5
407 Arch Bluff
San Antonio, TX 78216
Director
Age: 57
Vice President, Beldon Roofing and Remodeling (1985-present). Mr. Zucker serves
as a Director/Trustee of each of the remaining funds within the USAA Family of
Funds.
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Kenneth E. Willmann 1
Vice President
Age: 53
Senior Vice President, Fixed Income Investments, IMCO (12/99-present); Vice
President, Mutual Fund Portfolios, IMCO (09/94-12/99). Mr. Willmann serves as
Vice President of each of the remaining Funds within the USAA Family of Funds,
Director of IMCO, Senior Vice President of USAA Shareholder Account Services,
and Vice President of USAA Life Investment Trust.
Michael D. Wagner 1
Secretary
Age: 52
Senior Vice President, USAA Capital Corporation (CAPCO) General Counsel
(01/99-present); Vice President, Corporate Counsel, USAA (1982-01/99). 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 of each of the remaining funds within the USAA
Family of Funds; Vice President, Corporate Counsel for various other USAA
subsidiaries and affiliates.
Mark S. Howard 1
Assistant Secretary
Age: 36
Vice President, Securities Counsel & Compliance, IMCO (7/00-present); Assistant
Vice President, Securities Counsel, USAA (2/98-7/00); Executive Director,
Securities Counsel, USAA (9/96-2/98); Senior Associate Counsel, Securities
Counsel, USAA (5/95-8/96). Mr. Howard serves as Assistant Secretary for IMCO,
USAA Shareholder Account Services, USAA Financial Planning Network, Inc., each
of the remaining funds within the USAA Family of Funds, and for USAA Life
Investment Trust.
Sherron A. Kirk 1
Treasurer
Age: 55
Senior Vice President, Senior Financial Officer, IMCO (1/00-present); Vice
President, Senior Financial Officer (8/98-1/00); Vice President, Controller,
IMCO (10/92-8/98). Ms. Kirk serves as Treasurer of each of the remaining funds
within the USAA Family of Funds; Vice President, Senior Financial Officer of
USAA Shareholder Account Services.
Roberto Galindo, Jr. 1
Assistant Treasurer
Age: 39
Executive Director, Mutual Fund Analysis & Support, IMCO (6/00-present);
Director, Mutual Fund Analysis, IMCO(9/99-6/00); Vice President, Portfolio
Administration, Founders Asset Management LLC (7/98-8/99); Assistant Vice
President, Director of Fund & Private Client Accounting, Founders Asset
Management LLC (7/93-7/98). Mr. Galindo serves as Assistant Treasurer for each
of the remaining funds within the USAA Family of Funds.
------------------------
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.
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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 individual is an executive officer of the Manager: Christopher W.
Claus, Senior Vice President, Investment Sales & Service. 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, 2000.
Name Aggregate Total Compensation
of Compensation from the USAA
Director from the Company Family of Funds (b)
-------- ----------------- -------------------
Robert G. Davis None (a) None (a)
Barbara B. Dreeben $ 9,698 $ 35,000
Howard L. Freeman, Jr. (c) $ 7,811 $ 28,500
Robert L. Mason $ 9,698 $ 35,000
David G. Peebles None (a) None (a)
Michael F. Reimherr $ 1,887 $ 6,500
Michael J.C. Roth None (a) None (a)
John W. Saunders, Jr. (c) None (a) None (a)
Richard A. Zucker $ 9,698 $ 35,000
-------------------------------------------------------------------------------
(a) Robert G. Davis, Michael J.C. Roth, John W. Saunders, Jr., and David G.
Peebles 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, 2000, the USAA Family of Funds consisted of four registered
investment companies offering 38 individual funds. Each Director
presently serves as a Director or Trustee 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 available to the
public only through the purchase of certain variable annuity contracts
and variable life insurance policies offered by USAA Life Insurance
Company. Mr. Roth receives no compensation as Trustee of USAA Life
Investment Trust.
(c) Effective December 31, 1999, John W. Saunders, Jr., and Howard L. Freeman,
Jr. retired from the Board of Directors.
All of the above Directors are also Directors/Trustees of the other funds
within the USAA Family of Funds. No compensation is paid by any fund to any
Director/Trustee 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, 2000, 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, 2000, 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, a wholly owned indirect subsidiary of United Services
Automobile Association (USAA), a large, diversified financial services
institution, was organized in May 1970 and 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 $41 billion, of which
approximately $29 billion were in mutual fund portfolios.
While the officers and employees of the Manager, as well as those of the
Funds, may engage in personal securities transactions, they are restricted by
the procedures in a Joint Code of Ethics adopted by the Manager and the Funds.
The Joint Code of Ethics was designed to ensure that the shareholders'
interests come before those of the individuals who manage their Funds. It also
prohibits the portfolio managers and other investment personnel from buying
securities in an initial public offering or from profiting from the purchase or
sale of the same security within 60 calendar days. Additionally,
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the Joint Code of Ethics requires the portfolio manager and other employees
with access information about the purchase or sale of securities by the Funds
to obtain approval before executing permitted personal trades. A copy of the
Joint Code of Ethics for the Manager has been filed with the SEC and is
available for public view.
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 FUND MANAGEMENT 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 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, 2001, 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, 2001,
and will reimburse the Funds for all expenses in excess of the limitations.
For the last three fiscal years, management fees were as follows:
1998 1999 2000
---- ---- ----
Virginia Bond Fund $ 1,063,438 $ 1,227,753 $ 1,270,143
Virginia Money Market Fund $ 388,424 $ 434,276 $ 472,606
Because the expenses of the Virginia Money Market Fund exceeded the
Manager's voluntary expense limitation, in 1998 and 1999 the Manager did not
receive management fees of $13,712 and $3,706, 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 $28.50 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, each Fund pays all out-of-pocket expenses of
the Transfer Agent and other expenses which are incurred at the specific
direction of the Company.
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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 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.
CALCULATION OF PERFORMANCE DATA
Information regarding the total return and yield of each Fund is provided under
COULD THE VALUE OF YOUR INVESTMENT IN THESE FUNDS FLUCTUATE? 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, 2000, were:
1 year. . . . -2.00% 5 years . . . 5.54% Since inception . . . 6.84%
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[((a-b)/(cd)+1)^6 -1]
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, 2000, was 5.30%.
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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 and income other than
investment income, 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 March 31, 2000, was 3.36%.
Effective Yield For 7-day Period Ended March 31, 2000, was 3.42%.
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,
2000 were 8.79% and 5.57%, 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
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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
the states, cities, municipalities or municipal agencies, include Tax
Anticipation Notes, Revenue Anticipation Notes, Bond Anticipation Notes,
Construction Loan Notes, and Short-Term 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 (Moody's), Standard & Poor's
Ratings Group (S&P), Fitch Information, Inc. (Fitch), and Thompson BankWatch
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.
1. LONG-TERM DEBT RATINGS:
MOODY'S INVESTOR SERVICES
Aaa Bonds that 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 that 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 that 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 that suggest a susceptibility to impairment
sometime in the future.
Baa Bonds that 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: MOODY'S APPLIES NUMERICAL MODIFIERS 1, 2, AND 3 IN EACH GENERIC RATING
CLASSIFICATION. THE MODIFIER 1 INDICATES THAT THE OBLIGATION RANKS IN THE
HIGHER END OF ITS GENERIC RATING CATEGORY, THE MODIFIER 2 INDICATES A MID-RANGE
RANKING, AND THE MODIFIER 3 INDICATES A RANKING IN THE LOWER END OF THAT
GENERIC RATING CATEGORY.
STANDARD & POOR'S RATINGS GROUP
AAA An obligation rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA An obligation rated AA differs from the highest rated issues only in
small degree. The obligor's capacity to meet its financial commitment
on the obligation is VERY STRONG.
A An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher rated categories. However, the obligor's
capacity to meet its financial commitment on the obligation is still
STRONG.
BBB An obligation rated BBB exhibits adequate capacity to pay interest and
repay principal. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
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.
FITCH INFORMATION, INC.
AAA Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong
capacity for timely payment of financial commitments. This capacity is
highly unlikely to be adversely affected by foreseeable events.
AA Very high credit quality. "AA" ratings denote a very low expectation
of credit risk. They indicate very strong capacity for timely payment
of financial commitments. This capacity is not significantly
vulnerable to foreseeable events.
19
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A High credit quality. "A" ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is
considered strong. This capacity may, nevertheless, be more vulnerable
to changes in circumstances or in economic conditions than is the case
for higher ratings.
BBB Good credit quality. "BBB" ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of
financial commitments is considered adequate, but adverse changes in
circumstances and in economic conditions are more likely to impair
this capacity. This is the lowest investment-grade category.
2. SHORT-TERM DEBT RATINGS:
MOODY'S STATE AND TAX-EXEMPT NOTES
MIG-1/VMIG1 This designation denotes best quality. There is present
strong protection by established cash flows, superior
liquidity support, or demonstrated broad-based access to
the market for refinancing.
MIG-2/VMIG2 This designation denotes high quality. Margins of
protection are ample although not so large as in the
preceding group.
MOODY'S COMMERCIAL PAPER
Prime-1 Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the
following characteristics:
* Leading market positions in well-established industries.
* High rates of return on funds employed
* Conservative capitalization structures with moderate reliance on
debt and ample asset protection.
* Broad margins in earning coverage of fixed financial charges and
high internal cash generation.
* Well-established access to a range of financial markets and
assured sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior 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, may be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
S&P 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.
S&P 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.
FITCH'S COMMERCIAL PAPER, CERTIFICATES OF DEPOSIT, AND TAX-EXEMPT NOTES
F1 Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit features.
F2 Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in
the case of the higher ratings.
F3 Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could
result in a reduction to non-investment grade.
THOMPSON BANKWATCH
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.
20
<PAGE>
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.
APPENDIX B -- COMPARISON OF PORTFOLIO PERFORMANCE
Occasionally, we may make comparisons in advertising and sales literature
between the Funds and other comparable funds in the industry. 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 but are not
restricted to the following:
AAII JOURNAL, a monthly association magazine for members of the American
Association of Individual Investors.
ARIZONA REPUBLIC, a newspaper that may cover financial and investment news.
AUSTIN AMERICAN-STATESMAN, a newspaper that 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 that covers bond market news.
BUSINESS WEEK, a national business weekly that periodically reports the
performance rankings and ratings of a variety of mutual funds.
CDA/WEISENBERGER MUTUAL FUNDS INVESTMENT REPORT, a monthly newsletter that
reports on both specific mutual fund companies and the mutual fund industry as
a whole.
CHICAGO TRIBUNE, a newspaper that may cover financial news.
CONSUMER REPORTS, a monthly magazine that from time to time reports on
companies in the mutual fund industry.
DALLAS MORNING NEWS, a newspaper that may cover financial news.
DENVER POST, a newspaper that may quote financial news.
FINANCIAL PLANNING, a monthly magazine that periodically features companies in
the mutual fund industry.
FINANCIAL SERVICES WEEK, a weekly newspaper that covers financial news.
FINANCIAL WORLD, a monthly magazine that periodically features companies in the
mutual fund industry.
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 that may cover financial news.
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, the national association of the American
Investment Company industry.
INVESTOR'S BUSINESS DAILY, a newspaper that covers financial news.
KIPLINGER'S PERSONAL FINANCE MAGAZINE, a monthly investment advisory
publication that periodically features the performance of a variety of
securities.
21
<PAGE>
LIPPER, A REUTER'S COMPANY EQUITY FUND PERFORMANCE ANALYSIS, a weekly and
monthly publication of industry-wide mutual fund performance averages by type
of fund.
LIPPER, A REUTER'S COMPANY FIXED INCOME FUND PERFORMANCE ANALYSIS, a monthly
publication of industry-wide mutual fund performance averages by type of fund.
LOS ANGELES TIMES, a newspaper that 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 iMoneyNet, Inc. (formerly IBC
Financial Data, 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 "Taxable First Tier Fund Average."
MONEY MARKET INSIGHT, a monthly money market industry analysis prepared by
iMoneyNet, Inc. (formerly IBC Financial Data, Inc.)
MONEYLETTER, a biweekly newsletter that covers financial news and from time to
time rates specific mutual funds.
MORNINGSTAR 5 STAR INVESTOR, a monthly newsletter that covers financial news
and rates mutual funds produced by Morningstar, Inc. (a data service that
tracks open-end mutual funds).
MUNI BOND FUND REPORT, a monthly newsletter that covers news on the municipal
bond market and features performance data for municipal bond mutual funds.
MUNIWEEK, a weekly newspaper that 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 mutual fund
performance and rankings, 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.
that 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 that may cover financial news.
NO LOAD FUND INVESTOR, a newsletter covering companies in the mutual fund
industry.
ORLANDO SENTINEL, a newspaper that may cover financial news.
PERSONAL INVESTOR, a monthly magazine that 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 that may cover financial news.
SAN FRANCISCO CHRONICLE, a newspaper that may cover financial news.
SMART MONEY, a monthly magazine featuring news and articles on investing and
mutual funds.
USA TODAY, a newspaper that 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 that covers
financial news.
WASHINGTON POST, a newspaper that may cover financial news.
22
<PAGE>
WORTH, a magazine that 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, A Reuter's Company and Morningstar, Inc. Each Fund will be
compared to Lipper's or Morningstar's appropriate fund category according to
its objective(s) and portfolio holdings. 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 Funds or by those publications listed previously are Schabaker
Investment Management and Investment Company Data, Inc. These are services that
collect and compile data on mutual fund companies.
23
<PAGE>
APPENDIX C -- 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.
===============================================================================
17004-0800
<PAGE>
C-6
USAA TAX EXEMPT FUND, INC.
PART C. OTHER INFORMATION
Item 23. 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 (4)
(y) Articles Supplementary dated March 4, 1998 (5)
(z) Articles Supplementary dated April 3, 1998 (5)
2 Bylaws as amended July 19, 2000 (filed herewith)
3 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)
4 (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)
5 (a) Underwriting Agreement dated July 25, 1990 (1)
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EXHIBIT NO. DESCRIPTION OF EXHIBITS
(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 Not Applicable
7 (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)
8 (a) Transfer Agency Agreement dated January 23, 1992 (1)
(b) Amendments dated January 1, 1999 to Transfer Agency
Agreement Fee Schedules for 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
(6)
(c) Master Revolving Credit Facility Agreement with USAA
Capital Corporation dated January 11, 2000
($500,000,000) (filed herewith)
(d) Master Revolving Credit Facility Agreement with
NationsBank of Texas dated January 12, 2000
(filed herewith)
(e) Master Revolving Credit Facility Agreement with USAA
Capital Corporation dated January 11, 2000
($250,000,000) (filed herewith)
9 (a) Opinion of Counsel (5)
(b) Consent of Counsel (filed herewith)
10 Consent of Independent Accountants (filed herewith)
11 Omitted Financial statements - Not Applicable
12 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)
13 12b-1 Plans - Not Applicable
14 18f-3 Plans - Not Applicable
15 Plan Adopting Multiple Class of Shares - Not Applicable
16 CODE OF ETHICS (filed herewith)
17 POWERS OF ATTORNEY
(a) Powers of Attorney for Robert G. Davis, Michael J. C. Roth
Sherron A. Kirk, David G. Peebles, Michael Reimherr,
Richard A. Zucker, Barbara B. Dreeben, Laura T. Starks, and
Robert L. Mason, dated July 19, 2000. (filed herewith)
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(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.
(4) Previously filed with Post-Effective Amendment No. 26 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
July 30, 1997.
(5) Previously filed with Post-Effective Amendment No. 27 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
May 29, 1998.
(6) Previously filed with Post-Effective Amendment No. 28 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
June 1, 1999.
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Item 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH THE FUND
-----------------------------------------------------------
Information pertaining to persons controlled by or under common
control with Registrant is hereby incorporated by reference to the
section captioned "Directors and Officers of the Company" in the
Statement of Additional Information.
Item 25. 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
his 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 authorized 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 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
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<PAGE>
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 26. BUSINESS AND OTHER CONNECTIONS OF THE 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 "Fund
Management" and to the section of the Statement of Additional
Information captioned "Directors and Officers of the Company."
Item 27. 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 Chairman
9800 Fredericksburg Road of the Board of of the Board of
San Antonio, TX 78288 Directors Directors
Michael J.C. Roth Chief Executive Officer, President, Director
9800 Fredericksburg Road President, Director, and Vice Chairman
San Antonio, TX 78288 and Vice Chairman of of the Board of
the Board of Directors Directors
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David G. Peebles Senior Vice President, Vice President and
9800 Fredericksburg Road Equity Investments Director
San Antonio, TX 78288 and Director
Kenneth E. Willmann Senior Vice President, Vice President
9800 Fredericksburg Road Fixed Income Investments
San Antonio, TX 78288 and Director
Michael D. Wagner Vice President, Secretary
9800 Fredericksburg Road Secretary and Counsel
San Antonio, TX 78288
Sherron A. Kirk Senior Vice President, Treasurer
9800 Fredericksburg Road Senior Financial Officer,
San Antonio, TX 78288 and Treasurer
Mark S. Howard Vice President, Assistant Secretary
9800 Fredericksburg Road Compliance and Assistant
San Antonio, TX 78288 Secretary
(c) Not Applicable.
Item 28. 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 Road
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 29. MANAGEMENT SERVICES
Not Applicable.
Item 30. UNDERTAKINGS
None
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SIGNATURES
Pursuant to the requirements of the Securities Act and the Investment
Company Act, the Registrant certifies that it meets all requirements for
effectiveness of this registration statement pursuant to Rule 485(b) under the
Securities Act and it has duly caused this amendment to its registration
statement to be signed on its behalf by the undersigned, duly authorized, in
the city of San Antonio and state of Texas on the 19th day of July 2000.
USAA TAX EXEMPT FUND, INC.
/s/ MICHAEL J.C. ROTH
----------------------------------
Michael J.C. Roth
President
Pursuant to the requirements of the Securities Act, this amendment to the
registration statement has been signed below by the following persons in the
capacities and on the date(s) indicated.
(Signature) (Title) (Date)
Chairman of the
/S/ ROBERT G. DAVIS Board of Directors July 19, 2000
---------------------------
Robert G. Davis
Vice Chairman of the Board
of Directors and President
/S/ MICHAEL J. C. ROTH (Principal Executive Officer) July 19, 2000
---------------------------
Michael J.C. Roth
Treasurer (Principal
Financial and
/S/ SHERRRON A. KIRK Accounting Officer) July 19, 2000
---------------------------
Sherron A. Kirk
Director
/S/ DAVID G. PEEBLES July 19, 2000
---------------------------
David G. Peebles
Director
/S/ ROBERT L. MASON July 19, 2000
---------------------------
Robert L. Mason
Director
/S/ MICHAEL F. REIMHERR July 19, 2000
---------------------------
Michael F. Reimherr
Director
/S/ RICHARD A. ZUCKER July 19, 2000
---------------------------
Richard A. Zucker
Director
/S/ BARBARA B. DREEBEN July 19, 2000
---------------------------
Barbara B. Dreeben
Director
/S/ LAURA T. STARKS July 19, 2000
--------------------------
Laura T. Starks
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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 (4)
(y) Articles Supplementary dated March 4, 1998 (5)
(z) Articles Supplementary dated April 3, 1998 (5)
2 Bylaws as amended July 19, 2000 (filed herewith) 289
3 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)
4 (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)
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<PAGE>
Exhibit Index, cont.
EXHIBIT ITEM PAGE NO. *
5 (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)
6 Not Applicable
7 (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)
8 (a) Transfer Agency Agreement dated January 23, 1992 (1)
(b) Amendments dated January 1, 1999 to Transfer Agency
Agreement Fee Schedules for 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 (6)
(c) Master Revolving Credit Facility Agreement with USAA
Capital Corporation dated January 11, 2000
($500,000,000)(filed herewith) 300
(d) Master Revolving Credit Facility Agreement with
NationsBank of Texas dated January 12, 2000
(filed herewith) 324
(e) Master Revolving Credit Facility Agreement with USAA
Capital Corporation dated January 11, 2000
($250,000,000) (filed herewith) 354
9 (a) Opinion of Counsel (5)
(b) Consent of Counsel (filed herewith) 378
10 Consent of Independent Accountants (filed herewith) 380
11 Omitted Financial statements - Not Applicable
12 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)
13 12b-1 Plans - Not Applicable
14 18f-3 Plans - Not Applicable
15 Plan Adopting Multiple Class of Shares - Not Applicable
16 CODE OF ETHICS - (filed herewith) 382
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Exhibit Index, cont.
EXHIBIT ITEM PAGE NO. *
17 POWERS OF ATTORNEY
(a) Powers of Attorney for Robert G. Davis, Michael J.C. Roth,
Sherron A. Kirk, David G. Peebles, Michael F. Reimherr,
Robert L. Mason, Barbara B. Dreeben, Laura T. Starks,
and Richard A. Zucker dated July 19, 2000
(file herewith) 402
------------------------
(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.
(4) Previously filed with Post-Effective Amendment No. 26 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
July 30, 1997.
(5) Previously filed with Post-Effective Amendment No. 27 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
May 29, 1998.
(6) Previously filed with Post-Effective Amendment No. 28 of the Registrant
(No. 2-75093) filed with the Securities and Exchange Commission on
June 1, 1999.
--------------------------------------------------------
* Refers to sequentially numbered pages
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