oFCF P-1
SUPPLEMENT DATED JANUARY 1, 2000
TO THE PROSPECTUS OF
FRANKLIN CUSTODIAN FUNDS, INC.
dated February 1, 1999, as amended August 30, 1999
The prospectus is amended as follows:
I. The following sentence is added after the minimum investments table on
page 58:
Please note that you may only buy shares of a fund eligible for sale in your
state or jurisdiction.
II. In the Selling Shares table on page 64 the section "By Wire" is replaced
with the following:
By Electronic Funds Transfer (ACH)
You can call or write to have redemption proceeds sent to a bank account. See
the policies above for selling shares by mail or phone.
Before requesting to have redemption proceeds sent to a bank account, please
make sure we have your bank account information on file. If we do not have
this information, you will need to send written instructions with your bank's
name and address, a voided check or savings account deposit slip, and a
signature guarantee if the ownership of the bank and fund accounts is
different.
If we receive your request in proper form by 1:00 p.m. Pacific time, proceeds
sent by ACH generally will be available within two to three business days.
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III. The sections "Waivers for investments from certain payments," "Waivers
for certain investors," "CDSC waivers" and "Retirement plans," on pages 56
and 57, are replaced with the following:
SALES CHARGE WAIVERS Class A shares may be purchased without an initial
sales charge or CDSC by various individuals, institutions and retirement
plans or by investors who reinvest certain distributions and proceeds within
365 days. Certain investors also may buy Class C shares without an initial
sales charge. The CDSC for each class may be waived for certain redemptions
and distributions. If you would like information about available sales
charge waivers, call your investment representative or call Shareholder
Services at 1-800/632-2301. For information about retirement plans, you may
call Retirement Plan Services at 1-800/527-2020. A list of available sales
charge waivers also may be found in the Statement of Additional Information
(SAI).
IV. The section "Dealer compensation" on page 67 is replaced with the
following:
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive
sales commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges, distribution and
service (12b-1) fees and its other resources.
DYNATECH (Class A and C only) AND GROWTH SERIES
Class A Class B Class C
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Commission (%) -- 4.00 2.00
Investment under $50,000 5.00 -- --
$50,000 but under $100,000 3.75 -- --
$100,000 but under $250,000 2.80 -- --
$250,000 but under $500,000 2.00 -- --
$500,000 but under $1 million 1.60 -- --
$1 million or more up to 1.00 1 -- --
12b-1 fee to dealer 0.25 0.25 2 1.00 3
INCOME, U.S. GOVERNMENT SECURITIES AND UTILITIES SERIES
Class A Class B Class C
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Commission (%) -- 3.00 2.00
Investment under $100,000 4.00 -- --
$100,000 but under $250,000 3.25 -- --
$250,000 but under $500,000 2.25 -- --
$500,000 but under $1 million 1.85 -- --
$1 million or more up to 0.75 1 -- --
12b-1 fee to dealer 0.15 0.15 2 0.65 3
A dealer commission of up to 1% may be paid on Class A NAV purchases by
certain retirement plans1 and on Class C NAV purchases. A dealer commission
of up to 0.25% may be paid on Class A NAV purchases by certain trust
companies and bank trust departments, eligible governmental authorities, and
broker-dealers or others on behalf of clients participating in comprehensive
fee programs.
1. During the first year after purchase, dealers may not be eligible to
receive the 12b-1 fee.
2. Dealers may be eligible to receive up to 0.25% for Growth Series and
0.15% for Income, U.S. Government Securities and Utilities Series from the
date of purchase. After 8 years, Class B shares convert to Class A shares
and dealers may then receive the 12b-1 fee applicable to Class A.
3. Dealers may be eligible to receive up to 0.25% for DynaTech and Growth
Series and 0.15% for Income, U.S. Government Securities and Utilities Series
during the first year after purchase and may be eligible to receive the full
12b-1 fee starting in the 13th month.
V. The section "Statements and reports" on page 65 is replaced with the
following:
STATEMENTS AND REPORTS You will receive quarterly account statements that
show all your account transactions during the quarter. You also will receive
written notification after each transaction affecting your account (except
for distributions and transactions made through automatic investment or
withdrawal programs, which will be reported on your quarterly statement).
You also will receive the fund's financial reports every six months. To
reduce fund expenses, we try to identify related shareholders in a household
and send only one copy of the financial reports. If you need additional
copies, please call 1-800/DIAL BEN.
If there is a dealer or other investment representative of record on your
account, he or she also will receive copies of all notifications and
statements and other information about your account directly from the fund.
Please keep this supplement for future reference.
FRANKLIN
CUSTODIAN
FUNDS, INC.
DYNATECH SERIES - CLASS A & C
GROWTH SERIES - CLASS A, B & C
INCOME SERIES - CLASS A, B & C
UTILITIES SERIES - CLASS A, B & C
U.S. GOVERNMENT SECURITIES SERIES - CLASS A, B & C
STATEMENT OF
ADDITIONAL INFORMATION
FEBRUARY 1, 1999, AS AMENDED JANUARY 1, 2000
[Insert Franklin Templeton Ben Head]
P.O. BOX 997151 SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R)
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This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the funds' prospectus. The funds'
prospectus, dated February 1, 1999, which we may amend from time to time,
contains the basic information you should know before investing in a fund. You
should read this SAI together with the funds' prospectus.
The audited financial statements and auditor's report in Franklin Custodian
Funds, Inc.'s (Custodian Funds) Annual Report to Shareholders, for the fiscal
year ended September 30, 1998, are incorporated by reference (are legally a part
of this SAI).
For a free copy of the current prospectus or annual report, contact your
investment representative or call 1-800/DIAL BEN (1-800/342-5236).
CONTENTS
Goals and Strategies 2
Risks 11
Officers and Directors 14
Management and Other Services 17
Portfolio Transactions 19
Distributions and Taxes 20
Organization, Voting Rights
and Principal Holders 22
Buying and Selling Shares 25
Pricing Shares 32
The Underwriter 33
Performance 36
Miscellaneous Information 40
Description of Bond Ratings 41
[Begin callout]
MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
O ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
O ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK;
O ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
[End callout]
GOALS AND STRATEGIES
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DYNATECH SERIES The fund's investment goal is capital appreciation. This goal is
fundamental, which means it may not be changed without shareholder approval.
The fund will normally invest primarily in the equity securities of companies
that emphasize technological development, in fast-growing industries, as well in
undervalued securities.
The fund's investments tend to be more speculative in nature, and there can be a
greater emphasis on short-term trading. Certain investments may be based on
market fluctuations caused by excessive optimism or pessimism of investors with
little or no basis in fundamental economic conditions.
The fund's assets may be invested in securities traded on any national
securities exchange or issued by a corporation, association or similar legal
entity with total assets of at least $1,000,000, according to its latest
published annual report, or held in cash or cash equivalents. It is thought that
most of the fund's assets will be invested in common stocks, including
securities convertible into common stocks. The fund, however, may also invest in
debt securities or preferred stocks that the manager believes will further the
fund's investment goal. From time to time, concentration of the fund's
investments in a few issues may develop due to market appreciation.
GROWTH SERIES The fund's investment goal is capital appreciation. This goal is
fundamental, which means it may not be changed without shareholder approval.
The fund will normally invest primarily in the equity securities of companies
that are leaders in their industries. The fund's manager looks for securities it
believes offer favorable possibilities for capital appreciation and these
securities may yield little or no current income. Current income is only a
secondary consideration when selecting portfolio investments.
The fund's assets may be invested in shares of common stock traded on any
national securities exchange or issued by a corporation, association or similar
legal entity with total assets of at least $1,000,000, according to its latest
published annual report. The fund's assets may also be invested in bonds or
preferred stock convertible into shares of common stock listed for trading on a
national securities exchange or held in cash or cash equivalents.
The fund may invest in smaller capitalization companies, which generally are
those with a market capitalization of less than $1.5 billion at the time of the
fund's investment.
INCOME SERIES The fund's investment goal is to maximize income while maintaining
prospects for capital appreciation. This goal is fundamental, which means it may
not be changed without shareholder approval.
The fund will normally invest in a diversified portfolio of equity securities,
debt securities and cash equivalents.
The fund's assets may be invested in securities traded on any national
securities exchange or issued by a corporation, association or similar legal
entity with total assets of at least $1,000,000, according to its latest
published annual report, or held in cash or cash equivalents. The fund may also
invest in preferred stocks. The fund may invest in debt securities regardless of
their rating or in securities that are unrated, including up to 5% of its assets
in securities that are in default at the time of purchase. The fund generally
invests in securities rated at least Caa by Moody's Investors Service, Inc.
(Moody's) or CCC by Standard & Poor's Corporation (S&P) or unrated securities
the fund's manager determines are comparable. Unrated debt securities are not
necessarily of lower quality than rated securities, but they may not be as
attractive to as many buyers.
If the rating on an issue held in the fund's portfolio is changed by the rating
service or the security goes into default, this event will be considered by the
fund in its evaluation of the overall investment merits of that security but
will not generally result in an automatic sale of the security. The fund may
also buy debt securities of issuers that are not currently paying interest, as
well as issuers who are in default, and may keep an issue that has defaulted.
The fund will buy defaulted debt securities if, in the opinion of the manager,
they may present an opportunity for later price recovery, the issuer may resume
interest payments, or other advantageous developments appear likely in the near
future. In general, securities that default lose much of their value before the
actual default so that the security, and thus the fund's net asset value, would
be impacted before the default. Defaulted debt securities may be illiquid and,
as such, will be part of the 10% limit discussed under "Illiquid securities."
There are no restrictions as to the proportion of investments that may be made
in a particular type of security and the determination is entirely within the
manager's discretion. As market conditions change, it is conceivable that all of
the assets of the fund could be invested in common stocks or, conversely, in
debt securities.
UTILITIES SERIES The fund's investment goals are capital appreciation and
current income. These goals are fundamental, which means they may not be changed
without shareholder approval.
The fund will normally invest substantially all of its assets in the securities
of public utilities companies. As a fundamental policy, the fund's assets may be
invested in securities of an issuer engaged in the public utilities industry, or
held in cash or cash equivalents. The public utilities industry includes the
manufacture, production, generation, transmission and sale of gas, water and
electricity and companies involved in providing services related to these
activities. The industry also includes issuers engaged in the communications
field, such as telephone, cellular, paging, telegraph, satellite, microwave and
other companies that provide communication facilities or services for the
public's benefit. At least 65% of the fund's investments will be in the
securities of issuers engaged in the public utilities industry. The manager
expects that more than 50% of the fund's assets will be invested in electric
utilities securities.
The fund invests primarily in common stocks, including, from time to time,
non-dividend paying common stocks if, in the opinion of the manager, these
securities appear to offer attractive opportunities for capital appreciation.
When buying fixed-income debt securities, the fund may invest in securities
regardless of their rating depending upon prevailing market and economic
conditions, including securities in the lowest rating categories and unrated
securities. Most of the fund's investments, however, are rated at least Baa by
Moody's or BBB by S&P. These ratings represent the opinions of the rating
services with respect to the securities and are not absolute standards of
quality. They will be considered in connection with the investment of the fund's
assets but will not be a determining or limiting factor. Please see the appendix
for a discussion of the ratings.
With respect to unrated securities, it is also the fund's intent to buy
securities that, in the view of the manager, would be comparable in quality to
the fund's rated securities and have been determined to be consistent with the
fund's objectives without exposing the fund to excessive risk. The fund will not
buy issues that are in default or that the manager believes involve excessive
risk.
U.S. GOVERNMENT SECURITIES SERIES The fund's investment goal is income. This
goal is fundamental, which means it may not be changed without shareholder
approval.
The fund invests in a portfolio limited to U.S. government securities. These
include U.S. Treasury bonds, notes and bills, U.S. Treasury STRIPS and
securities issued by U.S. government agencies. Other than investments in short
term government securities and cash, substantially all of the fund's investments
are currently held in Government National Mortgage Association obligations
(Ginnie Maes). Ginnie Maes have historically paid higher current yields than
other types of U.S. government securities with comparable maturities. These
higher yields compensate investors for the higher risks involved.
The fund will buy Ginnie Maes whose principal and interest are guaranteed. The
fund also buys adjustable rate Ginnie Maes and other types of securities that
may be issued with the guarantee of the Government National Mortgage
Association. Ginnie Maes differ from other bonds in that principal may be paid
back on an unscheduled basis rather than returned in a lump sum at maturity.
Payments to holders of Ginnie Maes consist of monthly distributions of interest
and principal less the Government National Mortgage Association's and issuers'
fees.
The Government National Mortgage Association's guarantee of payment of principal
and interest on Ginnie Maes is backed by the full faith and credit of the U.S.
government. The Government National Mortgage Association may borrow U.S.
Treasury funds to the extent needed to make payments under its guarantee. Of
course, this guarantee does not extend to the market value or yield of the
Ginnie Maes or the net asset value or performance of the fund, which will
fluctuate daily with market conditions. The fund's manager monitors the fund's
investments and changes are made as market conditions warrant. The fund does
not, however, engage in the trading of securities for the purpose of realizing
short-term profits.
Ginnie Maes and the other securities included in U.S. Government Securities
Series' portfolio have historically involved little risk to principal if held to
maturity. However, due to fluctuations in interest rates, the market value of
such securities may vary during the period of a shareholder's investment in the
fund. The U.S. government has never defaulted and never delayed payments of
interest or principal on its obligations, however, this does not guarantee the
value of a shareholder's investment in U.S. Government Securities Series. The
price per share you receive when you sell your shares may be more or less than
the price you paid for the shares. The dividends per share paid by the fund may
also vary.
The following is a description of the various types of securities the funds may
buy.
EQUITY SECURITIES generally entitle the holder to participate in a company's
general operating results. The purchaser of an equity security typically
receives an ownership interest in the company as well as certain voting rights.
The owner of an equity security may participate in a company's success through
the receipt of dividends, which are distributions of earnings by the company to
its owners. Equity security owners may also participate in a company's success
or lack of success through increases or decreases in the value of the company's
shares as traded in the public trading market for such shares. Equity securities
generally take the form of common stock or preferred stock, as well as
securities convertible into common stocks. Preferred stockholders typically
receive greater dividends but may receive less appreciation than common
stockholders and may have greater voting rights as well. Equity securities may
also include convertible securities, warrants, or rights. Warrants or rights
give the holder the right to buy a common stock at a given time for a specified
price.
DEBT SECURITIES A debt security typically has a fixed payment schedule that
obligates the issuer to pay interest to the lender and to return the lender's
money over a certain time period. A company typically meets its payment
obligations associated with its outstanding debt securities before it declares
and pays any dividend to holders of its equity securities. Bonds, notes,
debentures, and commercial paper differ in the length of the issuer's payment
schedule, with bonds carrying the longest repayment schedule and commercial
paper the shortest.
The market value of debt securities generally varies in response to changes in
interest rates and the financial condition of each issuer. During periods of
declining interest rates, the value of debt securities generally increases.
Conversely, during periods of rising interest rates, the value of such
securities generally declines. These changes in market value will be reflected
in the fund's net asset value per share.
RATINGS. Various investment services publish ratings of some of the debt
securities in which the funds may invest. Higher yields are ordinarily available
from securities in the lower rating categories, such as securities rated Ba or
lower by Moody's or BB or lower by S&P or from unrated securities deemed by a
fund's manager to be of comparable quality. These ratings represent the opinions
of the rating services with respect to the issuer's ability to pay interest and
repay principal. They do not purport to reflect the risk of fluctuations in
market value and are not absolute standards of quality. Please see the appendix
for a discussion of the ratings.
If the rating on an issue held in a fund's portfolio is changed by the rating
service or the security goes into default, this event will be considered by the
fund in its evaluation of the overall investment merits of that security but
will not generally result in an automatic sale of the security.
ZERO COUPON AND PAY-IN-KIND BONDS Income Series may buy certain bonds issued at
a discount that defer the payment of interest or pay no interest until maturity,
known as zero coupon bonds, or which pay interest through the issuance of
additional bonds, known as pay-in-kind bonds. For federal tax purposes, holders
of these bonds, such as the fund, are deemed to receive interest over the life
of the bonds and are taxed as if interest were paid on a current basis although
no cash interest payments are in fact received by the holder until the bonds
mature. See "Risks - High yield securities risk" for more information about
these bonds.
LOAN PARTICIPATIONS Income Series may invest up to 5% of its assets in loan
participations and other related direct or indirect bank obligations. These
instruments are interests in floating or variable rate senior loans to U.S.
corporations, partnerships and other entities. While loan participations
generally trade at par value, the fund will also be able to acquire loan
participations that sell at a discount because of the borrower's credit
problems. To the extent the borrower's credit problems are resolved, the loan
participation may appreciate in value. The manager may acquire loan
participations for the fund when it believes that over the long term
appreciation will occur. Most loan participations are illiquid and, to that
extent, will be included in the 10% limitation described under "Illiquid
securities."
Loan participations are interests in floating or variable rate senior loans
(Loans) to U.S. corporations, partnerships and other entities (Borrowers) which
operate in a variety of industries and geographical regions. An investment in
these securities, however, carries substantially the same risks as those for
defaulted debt securities. Interest payments on these securities may be reduced,
deferred, suspended or eliminated and principal payments may likewise be
reduced, deferred, suspended or canceled, causing the loss of the entire amount
of the investment. Loans will generally be acquired by Income Series from a
bank, finance company or other similar financial services entity (Lender).
Loans in which Income Series will purchase participation interests may pay
interest at rates which are periodically redetermined on the basis of a base
lending rate plus a premium. These base lending rates are generally the Prime
Rate offered by a major U.S. bank, the London Inter-Bank Offered Rate, the CD
rate or other base lending rates used by commercial lenders. The Loans typically
have the most senior position in a Borrower's capital structure, although some
Loans may hold an equal ranking with other senior securities of the Borrower.
Although the Loans generally are secured by specific collateral, Income Series
may invest in Loans which are not secured by any collateral. Uncollateralized
Loans pose a greater risk of nonpayment of interest or loss of principal than do
collateralized Loans. The collateral underlying a collateralized Loan may
consist of assets that may not be readily liquidated, and there is no assurance
that the liquidation of such assets would satisfy fully a Borrower's obligations
under a Loan. Income Series is not subject to any restrictions with respect to
the maturity of the Loans in which it purchases participation interests.
The Loans generally are not rated by nationally recognized statistical rating
organizations. Ratings of other securities issued by a Borrower do not
necessarily reflect adequately the relative quality of a Borrower's Loans.
Therefore, although the manager may consider such ratings in determining whether
to invest in a particular Loan, such ratings, will not be the determinative
factor in the manager's analysis.
The Loans are not readily marketable and may be subject to restrictions on
resale. Participation interests in the Loans generally are not listed on any
national securities exchange or automated quotation system and no regular market
has developed for such interests. Any secondary purchases and sales of loan
participations generally are conducted in private transactions between buyers
and sellers. Many of the Loans in which the Income Series expects to purchase
interests are of a relatively large principal amount and are held by a
relatively large number of owners which, in the manager's opinion, should
enhance the relative liquidity of such interests.
When acquiring a loan participation, Income Series will have a contractual
relationship only with the Lender (typically an entity in the banking, finance
or financial services industries), not with the Borrower. Income Series has the
right to receive payments of principal and interest to which it is entitled only
from the Lender selling the loan participation and only upon receipt by such
Lender of such payments from the Borrower. In connection with purchasing loan
participations, Income Series generally will have no right to enforce compliance
by the Borrower with the terms of the Loan Agreement, nor any rights with
respect to any funds acquired by other Lenders through set-off against the
Borrower, and the fund may not directly benefit from the collateral supporting
the Loan in which it has purchased the loan participation. As a result, Income
Series may assume the credit risk of both the Borrower and the Lender selling
the loan participation. In the event of the insolvency of the Lender selling a
loan participation, Income Series may be treated as a general creditor of such
Lender, and may not benefit from any set-off between such Lender and the
Borrower.
TRADE CLAIMS Income Series may invest a portion of its assets in trade claims.
Trade claims are purchased from creditors of companies in financial difficulty.
For buyers, such as the fund, trade claims offer the potential for profits since
they are often purchased at a significantly discounted value and, consequently,
may generate capital appreciation if the value of the claim increases as the
debtor's financial position improves. If the debtor is able to pay the full
obligation on the face of the claim as a result of a restructuring or an
improvement in the debtor's financial condition, trade claims offer the
potential for higher income due to the difference in the face value of the claim
as compared to the discounted purchase price.
An investment in trade claims is speculative and carries a high degree of risk.
There can be no guarantee that the debtor will ever be able to satisfy the
obligation on the trade claim. Trade claims are not regulated by federal
securities laws or the Securities and Exchange Commission. Currently, trade
claims are regulated primarily by bankruptcy laws. Because trade claims are
unsecured, holders of trade claims may have a lower priority in terms of payment
than most other creditors in a bankruptcy proceeding. In light of the nature and
risk of trade claims, the fund's investment in these instruments will not exceed
5% of its net assets at the time of acquisition.
FOREIGN SECURITIES U.S. Government Securities Series may not buy securities of
foreign issuers. Income Series may invest up to 25% of its assets in foreign
securities and Growth Series, DynaTech Series and Utilities Series may invest
without restriction in foreign securities, if the investments are consistent
with their objectives and comply with their concentration and diversification
policies. The funds will ordinarily buy foreign securities that are traded in
the U.S. or buy American Depositary Receipts, which are certificates issued by
U.S. banks representing the right to receive securities of a foreign issuer
deposited with that bank or a correspondent bank. The funds may also buy the
securities of foreign issuers directly in foreign markets. DynaTech Series and
Utilities Series presently have no intention of investing more than 10% of their
net assets in foreign securities not publicly traded in the U.S. Growth Series
presently has no intention of investing more than 25% of its net assets in
foreign securities not publicly traded in the U.S. Investments in foreign
securities where delivery takes place outside the U.S. will be made in
compliance with any applicable U.S. and foreign currency restrictions and tax
and other laws limiting the amount and types of foreign investments. Changes of
governmental administrations or economic or monetary policies in the U.S. or
abroad, changed circumstances in dealings between nations, or changes in
currency convertibility or exchange rates could result in investment losses for
a fund.
Investments may be in securities of foreign issuers, whether located in
developed or undeveloped countries, but investments will not be made in any
securities issued without stock certificates or comparable stock documents.
Securities that are acquired by a fund outside the U.S. and that are publicly
traded in the U.S. or on a foreign securities exchange or in a foreign
securities market are not considered by the fund to be illiquid assets so long
as the fund acquires and holds the securities with the intention of reselling
them in the foreign trading market, the fund reasonably believes it can readily
dispose of the securities for cash in the U.S. or a foreign market, and current
market quotations are readily available.
DEPOSITARY RECEIPTS American Depositary Receipts (ADRs) are typically issued by
a U.S. bank or trust company and evidence ownership of underlying securities
issued by a foreign corporation. European Depositary Receipts (EDRs) and Global
Depositary Receipts (GDRs) are typically issued by foreign banks or trust
companies, although they may be issued by U.S. banks or trust companies, and
evidence ownership of underlying securities issued by either a foreign or a U.S.
corporation. Generally, depositary receipts in registered form are designed for
use in the U.S. securities market and depositary receipts in bearer form are
designed for use in securities markets outside the U.S. Depositary receipts may
not necessarily be denominated in the same currency as the underlying securities
into which they may be converted.
Depositary receipts may be issued pursuant to sponsored or unsponsored programs.
In sponsored programs, an issuer has made arrangements to have its securities
traded in the form of depositary receipts. In unsponsored programs, the issuer
may not be directly involved in the creation of the program. Although regulatory
requirements with respect to sponsored and unsponsored programs are generally
similar, in some cases it may be easier to obtain financial information from an
issuer that has participated in the creation of a sponsored program.
Accordingly, there may be less information available regarding issuers of
securities underlying unsponsored programs, and there may not be a correlation
between such information and the market value of the depositary receipts.
Depositary receipts also involve the risks of other investments in foreign
securities, as discussed below. For purposes of the fund's investment policies,
the fund will consider its investments in depositary receipts to be investments
in the underlying securities.
CONVERTIBLE SECURITIES Each fund, except U.S. Government Securities Series, may
invest in convertible securities. A convertible security is generally a debt
obligation or preferred stock that may be converted within a specified period of
time into a certain amount of common stock of the same or a different issuer. A
convertible security provides a fixed-income stream and the opportunity, through
its conversion feature, to participate in the capital appreciation resulting
from a market price advance in its underlying common stock. As with a straight
fixed-income security, a convertible security tends to increase in market value
when interest rates decline and decrease in value when interest rates rise. Like
a common stock, the value of a convertible security also tends to increase as
the market value of the underlying stock rises, and it tends to decrease as the
market value of the underlying stock declines. Because its value can be
influenced by both interest rate and market movements, a convertible security is
not as sensitive to interest rates as a similar fixed-income security, nor is it
as sensitive to changes in share price as its underlying stock.
A convertible security is usually issued either by an operating company or by an
investment bank. When issued by an operating company, a convertible security
tends to be senior to common stock, but subordinate to other types of
fixed-income securities issued by that company. When a convertible security
issued by an operating company is "converted," the operating company often
issues new stock to the holder of the convertible security but, if the parity
price of the convertible security is less than the call price, the operating
company may pay out cash instead of common stock. If the convertible security is
issued by an investment bank, the security is an obligation of and is
convertible through the issuing investment bank.
The issuer of a convertible security may be important in determining the
security's true value. This is because the holder of a convertible security will
have recourse only to the issuer. In addition, a convertible security may be
subject to redemption by the issuer, but only after a specified date and under
circumstances established at the time the security is issued.
While the fund uses the same criteria to rate a convertible debt security that
it uses to rate a more conventional debt security, a convertible preferred stock
is treated like a preferred stock for the fund's financial reporting, credit
rating, and investment limitation purposes. A preferred stock is subordinated to
all debt obligations in the event of insolvency, and an issuer's failure to make
a dividend payment is generally not an event of default entitling the preferred
shareholder to take action. A preferred stock generally has no maturity date, so
that its market value is dependent on the issuer's business prospects for an
indefinite period of time. In addition, distributions from preferred stock are
dividends, rather than interest payments, and are usually treated as such for
corporate tax purposes.
ENHANCED CONVERTIBLE SECURITIES The funds, other than the U.S. Government
Securities Series, may invest in convertible preferred stocks that offer
enhanced yield features, such as Preferred Equity Redemption Cumulative Stocks
(PERCS), which provide an investor, such as the fund, with the opportunity to
earn higher dividend income than is available on a company's common stock. PERCS
are preferred stocks that generally feature a mandatory conversion date, as well
as a capital appreciation limit which is usually expressed in terms of a stated
price. Most PERCS expire three years from the date of issue, at which time they
are convertible into common stock of the issuer. PERCS are generally not
convertible into cash at maturity. Under a typical arrangement, after three
years PERCS convert into one share of the issuer's common stock if the issuer's
common stock is trading at a price below that set by the capital appreciation
limit, and into less than one full share if the issuer's common stock is trading
at a price above that set by the capital appreciation limit. The amount of that
fractional share of common stock is determined by dividing the price set by the
capital appreciation limit by the market price of the issuer's common stock.
PERCS can be called at any time prior to maturity, and hence do not provide call
protection. If called early, however, the issuer must pay a call premium over
the market price to the investor. This call premium declines at a preset rate
daily, up to the maturity date.
The funds (except U.S. Government Securities Series) may also invest in other
classes of enhanced convertible securities. These include but are not limited to
ACES (Automatically Convertible Equity Securities), PEPS (Participating Equity
Preferred Stock), PRIDES (Preferred Redeemable Increased Dividend Equity
Securities), SAILS (Stock Appreciation Income Linked Securities), TECONS (Term
Convertible Notes), QICS (Quarterly Income Cumulative Securities) and DECS
(Dividend Enhanced Convertible Securities). ACES, PEPS, PRIDES, SAILS, TECONS,
QICS and DECS all have the following features: they are issued by the company,
the common stock of which will be received in the event the convertible
preferred stock is converted; unlike PERCS, they do not have a capital
appreciation limit; they seek to provide the investor with high current income
with some prospect of future capital appreciation; they are typically issued
with three or four-year maturities; they typically have some built-in call
protection for the first two to three years; investors have the right to convert
them into shares of common stock at a preset conversion ratio or hold them until
maturity, and upon maturity they will necessarily convert into either cash or a
specified number of shares of common stock.
Similarly, there may be enhanced convertible debt obligations issued by the
operating company, whose common stock is to be acquired in the event the
security is converted or by a different issuer, such as an investment bank.
These securities may be identified by names such as ELKS (Equity Linked
Securities) or similar names. Typically they share most of the salient
characteristics of an enhanced convertible preferred stock but will be ranked as
senior or subordinated debt in the issuer's corporate structure according to the
terms of the debt indenture. There may be additional types of convertible
securities not specifically referred to herein which may be also similar to
those described in which a fund may invest, consistent with its objectives and
policies.
An investment in an enhanced convertible security or any other security may
involve additional risks to the fund. The fund may have difficulty disposing of
such securities because there may be a thin trading market for a particular
security at any given time. Reduced liquidity may have an adverse impact on
market price and the fund's ability to dispose of particular securities, when
necessary, to meet the fund's liquidity needs or in response to a specific
economic event, such as the deterioration in the creditworthiness of an issuer.
Reduced liquidity in the secondary market for certain securities may also make
it more difficult for the fund to obtain market quotations based on actual
trades for purposes of valuing the fund's portfolio. The fund, however, intends
to acquire liquid securities, though there can be no assurances that this will
be achieved. U.S. Government Securities Series does not invest in convertible
preferred stocks.
STRIPPED SECURITIES U.S. Government Securities Series may buy stripped
securities that are issued or guaranteed by the U.S. Treasury or by an agency or
instrumentality of the U.S. government. Stripped securities are the separate
income and principal components of a debt security. U.S. Treasury STRIPS
(Separate Trading of Registered Interest and Principal of Securities) are
considered U.S. Treasury securities for purposes of the fund's investment
policies. Once the securities have been stripped they are referred to as zero
coupon securities. Their risks are similar to those of other U.S. government
securities, although they may be more volatile. Stripped securities do not make
periodic payments of interest prior to maturity and the stripping of the
interest coupons causes them to be offered at a discount from their face amount.
This results in the security being subject to greater fluctuations in response
to changing interest rates than interest-paying securities of similar
maturities.
WHEN-ISSUED, DELAYED DELIVERY AND TO-BE-ANNOUNCED (TBA) TRANSACTIONS Income
Series may buy debt obligations and U.S. Government Securities Series may buy
and sell Ginnie Mae certificates on a "when-issued," "delayed delivery" or "TBA"
basis. These transactions are arrangements under which the fund may buy
securities with payment and delivery scheduled for a future time, generally
within 30 to 60 days. These transactions are subject to market fluctuation and
are subject to the risk that the value or yields at delivery may be more or less
than the purchase price or yields available when the transaction was entered
into. Although the funds will generally purchase these securities on a
when-issued or TBA basis with the intention of acquiring such securities, they
may sell such securities before the settlement date if it is deemed advisable.
When a fund is the buyer in such a transaction, it will maintain, in a
segregated account with its custodian bank, cash or high-grade marketable
securities having an aggregate value equal to the amount of such purchase
commitments until payment is made. To the extent the fund engages in
when-issued, delayed delivery or TBA transactions, it will do so only for the
purpose of acquiring portfolio securities consistent with the fund's investment
objectives and policies, and not for the purpose of investment leverage. In
when-issued, delayed delivery and TBA transactions, the fund relies on the
seller to complete the transaction. The other party's failure to do so may cause
the fund to miss a price or yield considered advantageous. Securities purchased
on a when-issued, delayed delivery or TBA basis do not generally earn interest
until their scheduled delivery date. Neither fund is subject to any percentage
limit on the amount of its assets which may be invested in when-issued, delayed
delivery or TBA purchase obligations.
ILLIQUID SECURITIES Each fund, other than U.S. Government Securities Series, may
invest in securities that cannot be offered to the public for sale without first
being registered under the Securities Act of 1933 (restricted securities), or in
other securities which, in the opinion of the board of directors, may be
otherwise illiquid. Illiquid equity securities will not be purchased if, upon
such purchase, such securities will constitute 5% of the value of the total net
assets of a fund.
It is also the policy of each fund that illiquid securities may not constitute,
at the time of purchase, more than 10% of the value of the total net assets of
the fund in which they are held. Illiquid securities are generally securities
that cannot be sold within seven days in the normal course of business at
approximately the amount at which the fund has valued them. Subject to this
limitation, Custodian Funds' board of directors has authorized each fund, except
U.S. Government Securities Series, to invest in restricted securities where such
investment is consistent with each fund's investment objective and has
authorized such securities to be considered liquid to the extent the investment
manager determines on a daily basis that there is a liquid institutional or
other market for such securities - for example, restricted securities which may
be freely transferred among qualified institutional buyers pursuant to Rule 144A
under the Securities Act of 1933, as amended, and for which a liquid
institutional market has developed. Notwithstanding the managers' determinations
in this regard, the board of directors will remain responsible for such
determinations and will consider appropriate action, consistent with the fund's
objectives and policies, if the security should become illiquid after purchase.
In determining whether a restricted security is properly considered a liquid
security, the investment manager and the board of directors will take into
account the following factors: (i) the frequency of trades and quotes for the
security; (ii) the number of dealers willing to purchase or sell the security
and the number of other potential purchasers; (iii) dealer undertakings to make
a market in the security; and (iv) the nature of the security and the nature of
the marketplace trades (e.g., the time needed to dispose of the security, the
method of soliciting offers, and the mechanics of transfer). To the extent a
fund invests in restricted securities that are deemed liquid, the general level
of illiquidity in the fund may be increased if qualified institutional buyers
become uninterested in purchasing these securities or the market for these
securities contracts.
REPURCHASE AGREEMENTS Each fund generally will have a portion of its assets in
cash or cash equivalents for a variety of reasons, including waiting for a
special investment opportunity or taking a defensive position. To earn income on
this portion of its assets, the fund may enter into repurchase agreements. Under
a repurchase agreement, the fund agrees to buy securities guaranteed as to
payment of principal and interest by the U.S. government or its agencies from a
qualified bank or broker-dealer and then to sell the securities back to the bank
or broker-dealer after a short period of time (generally, less than seven days)
at a higher price. The bank or broker-dealer must transfer to the fund's
custodian securities with an initial market value of at least 102% of the dollar
amount invested by the fund in each repurchase agreement. The manager will
monitor the value of such securities daily to determine that the value equals or
exceeds the repurchase price. U.S. Government Securities Series does not engage
in repurchase agreements.
Repurchase agreements may involve risks in the event of default or insolvency of
the bank or broker-dealer, including possible delays or restrictions upon the
fund's ability to sell the underlying securities. The fund will enter into
repurchase agreements only with parties who meet certain creditworthiness
standards, i.e., banks or broker-dealers that the manager has determined present
no serious risk of becoming involved in bankruptcy proceedings within the time
frame contemplated by the repurchase transaction.
SECURITIES LENDING Each fund, except U.S. Government Securities Series, may lend
to broker-dealers portfolio securities with an aggregate market value of up to
10% of the fund's total assets.
Such loans must be secured by collateral (consisting of any combination of cash,
U.S. government securities or irrevocable letters of credit) in an amount equal
(on a daily marked-to-market basis) to the current market value of the
securities loaned. The funds retain all or a portion of the interest received on
the investment of the cash collateral or receive a fee from the borrower. The
funds will continue to receive any interest or dividends paid on any loaned
securities and will continue to have voting rights with respect to the
securities. However, as with other extensions of credit, there are risks of
delay in recovery or even loss of rights in the collateral should the borrower
fail.
OPTIONS Each fund, except U.S. Government Securities Series, may write covered
call options that trade on national securities exchanges. A call option gives
the purchaser of the option the right to buy the security from the writer of the
option at a set price during the term of the option. A call option is "covered"
if the option writer owns the underlying security which is subject to the call
or a call on the same security where the exercise price of the call held is
equal to or less than the exercise price of the call written.
The fund receives a premium when it writes a call option. A decline in the price
of the security during the option period would offset the amount of the premium.
If a call option the fund has written is exercised, the fund incurs a profit or
loss from the sale of the underlying security. The writer of a call option may
have no control over when the underlying securities must be sold since, with
regard to certain options, the writer may be assigned an exercise notice at any
time prior to the termination of the obligation. The risks associated with
covered call writing are that in the event of a price increase on the underlying
security, which would likely trigger the exercise of the call option, the fund
will not participate in the increase in price beyond the exercise price of the
option.
A fund generally may terminate its obligation under an option by entering into a
closing purchase transaction. This is accomplished by buying an option identical
to the option previously written. However, a writer may not effect a closing
purchase transaction after being notified of the exercise of an option. There is
no guarantee that a closing purchase will be available to be effected at the
time desired by the fund. If the fund desires to sell a particular security from
its portfolio on which it has written a call option, it will effect a closing
transaction prior to or concurrent with the sale of the security.
When a fund has written an option, the fund will realize a profit from a closing
transaction if the price of the transaction is less than the premium and will
realize a loss if the price is more than the premium. Because increases in the
market price of a call option will generally reflect increases in the market
price of the underlying security, any loss resulting from the repurchase of a
call option is likely to be offset in whole or in part by appreciation of the
underlying security owned by the fund until the time of repurchase. Thereafter,
the fund bears the risk of the security's rise or fall in market value unless it
sells the security.
The managers of the funds do not currently intend to write options which would
cause the market value of any fund's open options to exceed 5% of the fund's
total net assets. There is no specific limitation on a fund's ability to write
covered call options. However, as a practical matter, the fund's option writing
activities may be limited by federal regulations. As of the fiscal year ended
September 30, 1998, there were no open options transactions in any fund. U.S.
Government Securities Series does not presently engage in option transactions,
as discussed in investment restriction 10, below.
Transactions in options are generally considered "derivative securities."
TEMPORARY INVESTMENTS When the manager believes that the securities trading
markets or the economy are experiencing excessive volatility or a prolonged
general decline, or other adverse conditions exist, it may invest each fund's
portfolio in a temporary defensive manner. Under such circumstances, each fund
may invest up to 100% of its assets in U.S. government securities, bank CDs,
bankers' acceptances and high-grade commercial paper issued by domestic
corporations, and commercial deposits or other cash equivalents, provided such
investments are otherwise permissible investments for the fund.
INVESTMENT RESTRICTIONS Custodian Funds has adopted the following restrictions
as fundamental policies. This means they may only be changed if the change is
approved by (i) more than 50% of Custodian Funds' outstanding shares or (ii) 67%
or more of Custodian Funds' shares present at a shareholder meeting if more than
50% of Custodian Funds' outstanding shares are represented at the meeting in
person or by proxy, whichever is less.
Custodian Funds may not:
1. Borrow money or mortgage or pledge any of the assets of the fund, except
that borrowings for temporary or emergency purposes may be made in an amount up
to 5% of total asset value.
2. Buy any securities on "margin" or sell any securities "short."
3. Lend any funds or other assets, except by the purchase of publicly
distributed bonds, debentures, notes, to-be-announced securities or other debt
securities and except that securities of any fund, other than the U.S.
Government Securities Series, may be loaned to broker-dealers or other
institutional investors as discussed under "Securities lending." For additional
information relating to this policy see discussions under "Loan participations"
and "Illiquid securities."
4. Act as underwriter of securities issued by other persons except insofar as
the fund may be technically deemed an underwriter under the federal securities
laws in connection with the disposition of portfolio securities.
5. Invest more than 5% of the value of the gross assets of a fund in the
securities of any one issuer, but this limitation does not apply to investments
in securities issued or guaranteed by the U.S. government or its
instrumentalities. (Growth, DynaTech, Income and Utilities Series also have
policies that concentration of investments in a single industry may not exceed
25% of their assets, except that Utilities Series will concentrate its
investments in the utilities industry.)
6. Purchase the securities of any issuer which would result in any fund owning
more than 10% of the outstanding voting securities of an issuer.
7. Purchase from or sell to its officers and directors, or any firm of which
any officer or director is a member, as principal, any securities, but may deal
with such persons or firms as brokers and pay a customary brokerage commission;
retain securities of any issuer if, to the knowledge of the fund, one or more of
its officers, directors or investment advisor own beneficially more than
one-half of 1% of the securities of such issuer and all such officers and
directors together own beneficially more than 5% of such securities.
8. Purchase any securities issued by a corporation which has not been in
continuous operation for three years, but such period may include the operation
of a predecessor.
9. Acquire, lease or hold real estate except such as may be necessary or
advisable for the maintenance of its offices.
10. Invest in commodities and commodity contracts, puts, calls, straddles,
spreads or any combination thereof, or interests in oil, gas or other mineral
exploration or development programs. The fund may, however, write covered call
options listed for trading on a national securities exchange and purchase call
options to the extent necessary to cancel call options previously written. At
the present, there are no options listed for trading on a national securities
exchange covering the types of securities which are appropriate for investment
by the U.S. Government Securities Series and, therefore, there are no option
transactions available for that fund.
11. Invest in companies for the purpose of exercising control or management.
12. Purchase securities of other investment companies; except to the extent each
fund invests its uninvested daily cash balances in shares of the Franklin Money
Fund and other money market funds in the Franklin Templeton Group of Funds
provided (i) its purchases and redemptions of such money market fund shares may
not be subject to any purchase or redemption fees, (ii) its investments may not
be subject to duplication of management fees, nor to any charge related to the
expense of distributing each fund's shares (as determined under Rule 12b-1, as
amended, under the federal securities laws) and (iii) provided aggregate
investments by a fund in any such money market fund do not exceed (A) the
greater of (i) 5% of each fund's total net assets or (ii) $2.5 million, or (B)
more than 3% of the outstanding shares of any such money market fund.
DynaTech, Growth and Utilities Series may also be subject to investment
limitations imposed by foreign jurisdictions in which the funds sell their
shares.
If a bankruptcy or other extraordinary event occurs concerning a particular
security a fund owns, the fund may receive stock, real estate, or other
investments that the fund would not, or could not, buy. If this happens, the
fund intends to sell such investments as soon as practicable while maximizing
the return to shareholders.
If a percentage restriction is met at the time of investment, a later increase
or decrease in the percentage due to a change in the value or liquidity of
portfolio securities or the amount of assets will not be considered a violation
of any of the foregoing restrictions.
RISKS
- -------------------------------------------------------------------------------
The value of your shares will increase as the value of the securities owned by
the fund increases and will decrease as the value of the fund's investments
decrease. In this way, you participate in any change in the value of the
securities owned by the fund. In addition to the factors that affect the value
of any particular security that the fund owns, the value of fund shares may also
change with movements in the stock and bond markets as a whole.
INTEREST RATE RISK To the extent a fund invests in debt securities, changes in
interest rates in any country where the fund is invested will affect the value
of the fund's portfolio and its share price. Rising interest rates, which often
occur during times of inflation or a growing economy, are likely to have a
negative effect on the value of the fund's shares. Of course, interest rates
throughout the world have increased and decreased, sometimes very dramatically,
in the past. These changes are likely to occur again in the future at
unpredictable times.
HIGH YIELD SECURITIES RISK Income Series may invest up to 100% of its net assets
in non-investment grade securities. Because the fund may invest in securities
below investment grade, an investment in the fund is subject to a higher degree
of risk than an investment in a fund that invests primarily in higher-quality
securities. You should consider the increased risk of loss to principal that is
present with an investment in higher risk securities, such as those in which the
fund invests. Accordingly, an investment in the fund should not be considered a
complete investment program and should be carefully evaluated for its
appropriateness in light of your overall investment needs and goals.
Utilities Series may also invest a portion of its assets in non-investment grade
securities.
The market value of high yield, lower-quality fixed-income securities, commonly
known as junk bonds, tends to reflect individual developments affecting the
issuer to a greater degree than the market value of higher-quality securities,
which react primarily to fluctuations in the general level of interest rates.
Lower-quality securities also tend to be more sensitive to economic conditions
than higher-quality securities.
Issuers of high yield, fixed-income securities are often highly leveraged and
may not have more traditional methods of financing available to them. Therefore,
the risk associated with buying the securities of these issuers is generally
greater than the risk associated with higher-quality securities. For example,
during an economic downturn or a sustained period of rising interest rates,
issuers of lower-quality securities may experience financial stress and may not
have sufficient cash flow to make interest payments. The issuer's ability to
make timely interest and principal payments may also be adversely affected by
specific developments affecting the issuer, including the issuer's inability to
meet specific projected business forecasts or the unavailability of additional
financing.
The risk of loss due to default may also be considerably greater with
lower-quality securities because they are generally unsecured and are often
subordinated to other creditors of the issuer. If the issuer of a security in
the fund's portfolio defaults, the fund may have unrealized losses on the
security, which may lower the fund's net asset value. Defaulted securities tend
to lose much of their value before they default. Thus, the fund's net asset
value may be adversely affected before an issuer defaults. In addition, the fund
may incur additional expenses if it must try to recover principal or interest
payments on a defaulted security.
High yield, fixed-income securities frequently have call or buy-back features
that allow an issuer to redeem the securities from the fund. Although these
securities are typically not callable for a period of time, usually for three to
five years from the date of issue, if an issuer calls its securities during
periods of declining interest rates, the manager may find it necessary to
replace the securities with lower-yielding securities, which could result in
less net investment income for the fund. The premature disposition of a high
yield security due to a call or buy-back feature, the deterioration of an
issuer's creditworthiness, or a default by an issuer may make it more difficult
for the fund to manage the timing of its income. Under the Internal Revenue Code
and U.S. Treasury regulations, the fund may have to accrue income on defaulted
securities and distribute the income to shareholders for tax purposes, even
though the fund is not currently receiving interest or principal payments on the
defaulted securities. To generate cash to satisfy these distribution
requirements, the fund may have to sell portfolio securities that it otherwise
may have continued to hold or use cash flows from other sources, such as the
sale of fund shares.
Lower-quality, fixed-income securities may not be as liquid as higher-quality
securities. Reduced liquidity in the secondary market may have an adverse impact
on market price of a security and on the fund's ability to sell a security in
response to a specific economic event, such as a deterioration in the
creditworthiness of the issuer, or if necessary to meet the fund's liquidity
needs. Reduced liquidity may also make it more difficult to obtain market
quotations based on actual trades for purposes of valuing the fund's portfolio.
The fund may buy high yield, fixed-income securities that are sold without
registration under the federal securities laws and therefore carry restrictions
on resale. While many high yielding securities have been sold with registration
rights, covenants and penalty provisions for delayed registration, if the fund
is required to sell restricted securities before the securities have been
registered, it may be deemed an underwriter of the securities under the
Securities Act of 1933, which entails special responsibilities and liabilities.
The fund may also incur special costs in disposing of restricted securities,
although the fund will generally not incur any costs when the issuer is
responsible for registering the securities.
The fund may buy high yield, fixed-income securities during an initial
underwriting. These securities involve special risks because they are new
issues. The manager will carefully review their credit and other
characteristics. The fund has no arrangement with its underwriter or any other
person concerning the acquisition of these securities.
The high yield securities market is relatively new and much of its growth before
1990 paralleled a long economic expansion. The recession that began in 1990
disrupted the market for high yield securities and adversely affected the value
of outstanding securities, as well as the ability of issuers of high yield
securities to make timely principal and interest payments. Although the economy
has improved and high yield securities have performed more consistently since
that time, the adverse effects previously experienced may reoccur. For example,
the highly publicized defaults on some high yield securities during 1989 and
1990 and concerns about a sluggish economy that continued into 1993 depressed
the prices of many of these securities. While market prices may be temporarily
depressed due to these factors, the ultimate price of any security generally
reflects the true operating results of the issuer. Factors adversely impacting
the market value of high yield securities may lower the fund's net asset value.
The fund relies on the manager's judgment, analysis and experience in evaluating
the creditworthiness of an issuer. In this evaluation, the manager takes into
consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters.
The credit risk factors above also apply to lower-quality zero coupon, deferred
interest and pay-in-kind securities. These securities have an additional risk,
however, because unlike securities that pay interest throughout the time until
maturity, the fund will not receive any cash until the cash payment date. If the
issuer defaults, the fund may not obtain any return on its investment.
Zero coupon or deferred interest securities are debt obligations that make no
periodic interest payments before maturity or a specified date when the
securities begin paying current interest (the cash payment date), and therefore
are generally issued and traded at a discount from their face amount or par
value. The discount varies depending on the time remaining until maturity or the
cash payment date, as well as prevailing interest rates, liquidity of the
security, and the perceived credit quality of the issuer. The discount, in the
absence of financial difficulties of the issuer, typically decreases as the
final maturity or cash payment date approaches.
The value of zero coupon securities is generally more volatile than the value of
other fixed-income securities that pay interest periodically. Zero coupon
securities are also likely to respond to changes in interest rates to a greater
degree than other fixed-income securities having similar maturities and credit
quality. The fund is not limited in the amount of its assets that may be
invested in these types of securities.
Certain of the high yielding, fixed-income securities in which the funds may
invest may be purchased at a discount. When held to maturity or retired, these
securities may include an element of capital gain. Capital losses may be
realized when securities purchased at a premium, that is, in excess of their
stated or par value, are held to maturity or are called or redeemed at a price
lower than their purchase price. Capital gains or losses also may be realized
upon the sale of securities.
The table below shows the percentage of Income Series' assets invested in
securities rated in each of the rating categories shown. A credit rating by a
rating agency evaluates the safety of principal and interest based on an
evaluation of the security's credit quality, but does not consider the market
risk or the risk of fluctuation in the price of the security. The information
shown is based on a dollar-weighted average of the fund's portfolio composition
based on month-end assets for each of the 12 months in the fiscal year ended
September 30, 1998. The appendix includes a description of each rating category.
AVERAGE
WEIGHTED
PERCENTAGE
MOODY'S RATING OF ASSETS
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Aaa 13.84%
Aa 0.00%
A 0.08%
Baa 3.93%
Ba 7.05%
B 23.16%
Caa 2.77%*
Ca 0.07%
C 0.00%
*2.20% of these securities, which are unrated by Moody's, have been included in
the Caa rating category.
GINNIE MAE RISK Ginnie Mae yields (interest income as a percentage of price)
have historically exceeded the current yields on other types of U.S. government
securities with comparable maturities. The effects of interest rate fluctuations
and unpredictable prepayments of principal, however, can greatly change realized
yields. As with most bonds, in a period of rising interest rates, the value of a
Ginnie Mae will generally decline. In a period of declining interest rates, it
is more likely that mortgages contained in Ginnie Mae pools will be prepaid,
thus reducing the effective yield. This potential for prepayment during periods
of declining interest rates may reduce the general upward price increases of
Ginnie Maes as compared to the increases experienced by noncallable debt
securities over the same periods. In addition, any premium paid on the purchase
of a Ginnie Mae will be lost if the obligation is prepaid. Of course, price
changes of Ginnie Maes and other securities held by U.S. Government Securities
Series will have a direct impact on the net asset value per share of the fund.
FOREIGN SECURITIES RISK The value of foreign (and U.S.) securities is affected
by general economic conditions and individual company and industry earnings
prospects. While foreign securities may offer significant opportunities for
gain, they also involve additional risks that can increase the potential for
losses in the fund. These risks can be significantly greater for investments in
emerging markets. Many of the risks described below also apply to investments in
depositary receipts.
The political, economic and social structures of some countries in which a fund
invests may be less stable and more volatile than those in the U.S. The risks of
investing in these countries include the possibility of the imposition of
exchange controls, expropriation, restrictions on removal of currency or other
assets, nationalization of assets, and punitive taxes.
There may be less publicly available information about a foreign company or
government than about a U.S. company or public entity. Certain countries'
financial markets and services are less developed than those in the U.S. or
other major economies. As a result, they may not have uniform accounting,
auditing and financial reporting standards and may have less government
supervision of financial markets. Foreign securities markets may have
substantially lower trading volumes than U.S. markets, resulting in less
liquidity and more volatility than experienced in the U.S. Transaction costs on
foreign securities markets are generally higher than in the U.S. The settlement
practices may be cumbersome and result in delays that may affect portfolio
liquidity. The fund may have greater difficulty voting proxies, exercising
shareholder rights, pursuing legal remedies and obtaining judgments with respect
to foreign investments in foreign courts than with respect to domestic issuers
in U.S. courts.
Some of the countries in which the funds invest are considered developing or
emerging markets. Investments in these markets are subject to all of the risks
of foreign investing generally, and have additional and heightened risks due to
a lack of legal, business and social frameworks to support securities markets.
Emerging markets involve additional significant risks, including:
o political and social uncertainty (for example, regional conflicts and risk
of war)
o currency exchange rate volatility
o pervasiveness of corruption and crime
o delays in settling portfolio transactions
o risk of loss arising out of the system of share registration and custody
o comparatively smaller and less liquid than developed markets
o dependency upon foreign economic assistance and international trade
o less government supervision and regulation of business and industry practices,
stock exchanges, brokers and listed companies than in the U.S.
All of these factors make developing market equity and fixed-income securities'
prices generally more volatile than securities issued in developed countries.
CURRENCY RISK Some of the funds' investments may be denominated in foreign
currencies. Changes in foreign currency exchange rates will affect the value of
what a fund owns and a fund's share price. Generally, when the U.S. dollar rises
in value against a foreign currency, an investment in that country loses value
because that currency is worth fewer U.S. dollars.
EURO RISK On January 1, 1999, the European Monetary Union (EMU) introduced a new
single currency, the euro, which will replace the national currency for
participating member countries. The transition and the elimination of currency
risk among EMU countries may change the economic environment and behavior of
investors, particularly in European markets.
Franklin Resources, Inc. has created an interdepartmental team to handle all
euro-related changes to enable the Franklin Templeton Funds to process
transactions accurately and completely with minimal disruption to business
activities. While the implementation of the euro could have a negative effect on
the fund, the fund's manager and its affiliated services providers are taking
steps they believe are reasonably designed to address the euro issue.
UTILITIES RISK Historically, electric utility companies were required by state
regulators to build and maintain generation plants, transmission and
distribution lines, and other equipment. State regulators set the rates that the
companies could charge customers to pay for these costs, spread over as much as
30 years. As the various states move away from the traditional regulatory model
toward greater competitiveness among electric utilities, customers will be able
to choose different electricity suppliers and will no longer pay for the
equipment and facilities that were mandated by regulators, thus creating
"stranded costs" for their former electricity suppliers. If states fail to enact
legislation that permits electricity suppliers to recover their stranded costs,
the financial position of these suppliers could be adversely affected, which
could cause the value of the fund's holdings in such companies and its net asset
value to fall.
OFFICERS AND DIRECTORS
- -------------------------------------------------------------------------------
Custodian Funds has a board of directors. The board is responsible for the
overall management of the funds, including general supervision and review of
each fund's investment activities. The board, in turn, elects the officers of
Custodian Funds who are responsible for administering each fund's day-to-day
operations. The board also monitors each fund to ensure no material conflicts
exist among share classes. While none is expected, the board will act
appropriately to resolve any material conflict that may arise.
The affiliations of the officers and board members and their principal
occupations for the past five years are shown below.
POSITIONS AND OFFICES PRINCIPAL OCCUPATION
NAME, AGE AND ADDRESS WITH THE FUND DURING THE PAST FIVE YEARS
- -------------------------------------------------------------------------------
Harris J. Ashton (66)
191 Clapboard Ridge Road
Greenwich, CT 06830
DIRECTOR
Director, RBC Holdings, Inc. (a bank holding company) and Bar-S Foods (a meat
packing company); director or trustee, as the case may be, of 49 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers).
S. Joseph Fortunato (66)
Park Avenue at Morris County
P.O. Box 1945
Morristown, NJ 07962-1945
DIRECTOR
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee, as
the case may be, of 51 of the investment companies in the Franklin Templeton
Group of Funds.
Edith E. Holiday (46)
3239 38th Street, N.W.
Washington, DC 20016
DIRECTOR
Director, Amerada Hess Corporation (exploration and refining of natural gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present) and H.J.
Heinz Company (processed foods and allied products) (1994-present); director or
trustee, as the case may be, of 25 of the investment companies in the Franklin
Templeton Group of Funds; and FORMERLY, Chairman (1995-1997) and Trustee
(1993-1997), National Child Research Center, Assistant to the President of the
United States and Secretary of the Cabinet (1990-1993), General Counsel to the
United States Treasury Department (1989-1990), and Counselor to the Secretary
and Assistant Secretary for Public Affairs and Public Liaison-United States
Treasury Department (1988-1989).
*Charles B. Johnson (66)
777 Mariners Island Blvd.
San Mateo, CA 94404
PRESIDENT
AND DIRECTOR
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin Advisory
Services, Inc., Franklin Investment Advisory Services, Inc. and Franklin
Templeton Distributors, Inc.; Director, Franklin/Templeton Investor Services,
Inc. and Franklin Templeton Services, Inc.; officer and/or director or trustee,
as the case may be, of most of the other subsidiaries of Franklin Resources,
Inc. and of 50 of the investment companies in the Franklin Templeton Group of
Funds.
*Rupert H. Johnson, Jr. (58)
777 Mariners Island Blvd.
San Mateo, CA 94404
VICE PRESIDENT
AND DIRECTOR
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.;
Senior Vice President and Director, Franklin Advisory Services, Inc. and
Franklin Investment Advisory Services, Inc.; Director, Franklin/Templeton
Investor Services, Inc.; and officer and/or director or trustee, as the case may
be, of most of the other subsidiaries of Franklin Resources, Inc. and of 53 of
the investment companies in the Franklin Templeton Group of Funds.
Gordon S. Macklin (70)
8212 Burning Tree Road
Bethesda, MD 20817
DIRECTOR
Director, Fund American Enterprises Holdings, Inc., Martek Biosciences
Corporation, MCI WorldCom, MedImmune, Inc. (biotechnology), Spacehab, Inc.
(aerospace services) and Real 3D (software); director or trustee, as the case
may be, of 49 of the investment companies in the Franklin Templeton Group of
Funds; and FORMERLY, Chairman, White River Corporation (financial services) and
Hambrecht and Quist Group (investment banking), and President, National
Association of Securities Dealers, Inc.
Harmon E. Burns (53)
777 Mariners Island Blvd.
San Mateo, CA 94404
VICE PRESIDENT
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin/Templeton Investor
Services, Inc.; and officer and/or director or trustee, as the case may be, of
most of the other subsidiaries of Franklin Resources, Inc. and of 53 of the
investment companies in the Franklin Templeton Group of Funds.
Martin L. Flanagan (38)
777 Mariners Island Blvd.
San Mateo, CA 94404
VICE PRESIDENT
AND CHIEF
FINANCIAL OFFICER
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.;
Executive Vice President and Director, Templeton Worldwide, Inc.; Executive Vice
President, Chief Operating Officer and Director, Templeton Investment Counsel,
Inc.; Executive Vice President and Chief Financial Officer, Franklin Advisers,
Inc.; Chief Financial Officer, Franklin Advisory Services, Inc. and Franklin
Investment Advisory Services, Inc.; President and Director, Franklin Templeton
Services, Inc.; Senior Vice President and Chief Financial Officer,
Franklin/Templeton Investor Services, Inc.; officer and/or director of some of
the other subsidiaries of Franklin Resources, Inc.; and officer and/or director
or trustee, as the case may be, of 53 of the investment companies in the
Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd.
San Mateo, CA 94404
VICE PRESIDENT
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, Inc.; Vice President, Chief Legal Officer
and Chief Operating Officer, Franklin Investment Advisory Services, Inc.; and
officer of 53 of the investment companies in the Franklin Templeton Group of
Funds.
Diomedes Loo-Tam (59)
777 Mariners Island Blvd.
San Mateo, CA 94404
TREASURER AND
PRINCIPAL
ACCOUNTING OFFICER
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32 of
the investment companies in the Franklin Templeton Group of Funds.
Brian E. Lorenz (59)
One North Lexington Avenue
White Plains, NY 10001-1700
SECRETARY
Attorney, member of the law firm of Bleakley Platt & Schmidt; and officer of
three of the investment companies in the Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal
securities laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers.
Custodian Funds pays noninterested board members $1,550 per month plus $1,500
per meeting attended. Noninterested board members may also serve as directors or
trustees of other funds in the Franklin Templeton Group of Funds and may receive
fees from these funds for their services. The fees payable to noninterested
board members by Custodian Funds are subject to reductions resulting from fee
caps limiting the amount of fees payable to board members who serve on other
boards within the Franklin Templeton Group of Funds. The following table
provides the total fees paid to noninterested board members by Custodian Funds
and by other funds in the Franklin Templeton Group of Funds.
NUMBER OF
TOTAL FEES TOTAL FEES BOARDS
RECEIVED RECEIVED FROM IN THE FRANKLIN
FROM THE FRANKLIN TEMPLETON GROUP
CUSTODIAN TEMPLETON OF FUNDS ON WHICH
NAME FUNDS(1) GROUP OF FUNDS(2) EACH SERVES(3)
- ----------------------------------------------------------------------
Harris J. Ashton $29,476 $361,157 49
S. Joseph Fortunato 28,844 367,835 51
Edith Holiday 20,704 211,400 25
Gordon S. Macklin 30,072 361,157 49
(1)For the fiscal year ended September 30, 1998. During the period from October
1, 1997, through May 31, 1998, fees at the rate of $1,350 per month plus $1,300
per board meeting attended were in effect.
(2)For the calendar year ended December 31, 1998.
(3)We base the number of boards on the number of registered investment companies
in the Franklin Templeton Group of Funds. This number does not include the total
number of series or funds within each investment company for which the board
members are responsible. The Franklin Templeton Group of Funds currently
includes 54 registered investment companies, with approximately 166 U.S. based
funds or series.
Noninterested board members are reimbursed for expenses incurred in connection
with attending board meetings, paid pro rata by each fund in the Franklin
Templeton Group of Funds for which they serve as director or trustee. No officer
or board member received any other compensation, including pension or retirement
benefits, directly or indirectly from the funds or other funds in the Franklin
Templeton Group of Funds. Certain officers or board members who are shareholders
of Franklin Resources, Inc. may be deemed to receive indirect remuneration by
virtue of their participation, if any, in the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February 1998,
this policy was formalized through adoption of a requirement that each board
member invest one-third of fees received for serving as a director or trustee of
a Templeton fund in shares of one or more Templeton funds and one-third of fees
received for serving as a director or trustee of a Franklin fund in shares of
one or more Franklin funds until the value of such investments equals or exceeds
five times the annual fees paid such board member. Investments in the name of
family members or entities controlled by a board member constitute fund holdings
of such board member for purposes of this policy, and a three year phase-in
period applies to such investment requirements for newly elected board members.
In implementing such policy, a board member's fund holdings existing on February
27, 1998, are valued as of such date with subsequent investments valued at cost.
MANAGEMENT AND OTHER SERVICES
- -------------------------------------------------------------------------------
MANAGER AND SERVICES PROVIDED Franklin Advisers, Inc. is the manager of the
funds, except for Growth Series. Growth Series' manager is Franklin
Investment Advisory, Inc. Each manager is wholly owned by Franklin Resources,
Inc. (Resources), a publicly owned company engaged in the financial services
industry through its subsidiaries. Charles B. Johnson and Rupert H. Johnson,
Jr. are the principal shareholders of Resources.
The managers provide investment research and portfolio management services, and
selects the securities for the funds to buy, hold or sell. The managers also
select the brokers who execute the funds' portfolio transactions. The managers
provide periodic reports to the board, which reviews and supervises the
managers' investment activities. To protect the funds, the managers and their
officers, directors and employees are covered by fidelity insurance.
The managers and their affiliates manage numerous other investment companies and
accounts. Each manager may give advice and take action with respect to any of
the other funds it manages, or for its own account, that may differ from action
taken by the manager on behalf of the funds. Similarly, with respect to the
funds, the managers are not obligated to recommend, buy or sell, or to refrain
from recommending, buying or selling any security that the managers and access
persons, as defined by applicable federal securities laws, may buy or sell for
their own account or for the accounts of any other fund. The managers are not
obligated to refrain from investing in securities held by the funds or other
funds they manage. Of course, any transactions for the accounts of the managers
and other access persons will be made in compliance with the funds' code of
ethics.
Under the funds' code of ethics, employees of the Franklin Templeton Group who
are access persons may engage in personal securities transactions subject to the
following general restrictions and procedures: (i) the trade must receive
advance clearance from a compliance officer and must be completed by the close
of the business day following the day clearance is granted; (ii) copies of all
brokerage confirmations and statements must be sent to a compliance officer;
(iii) all brokerage accounts must be disclosed on an annual basis; and (iv)
access persons involved in preparing and making investment decisions must, in
addition to (i), (ii) and (iii) above, file annual reports of their securities
holdings each January and inform the compliance officer (or other designated
personnel) if they own a security that is being considered for a fund or other
client transaction or if they are recommending a security in which they have an
ownership interest for purchase or sale by a fund or other client.
MANAGEMENT FEES Each fund pays the manager a fee equal to a monthly rate of:
o 5/96 of 1% of the value of net assets up to and including $100 million;
o 1/24 of 1% of the value of net assets over $100 million and not over $250
million;
o 9/240 of 1% of the value of net assets over $250 million and not over $10
billion;
o 11/300 of 1% of the value of net assets over $10 billion and not over
$12.50 billion;
o 7/200 of 1% of the value of net assets over $12.5 billion and not over $15
billion;
o 1/30 of 1% of the value of net assets over $15 billion and not over $17.5
billion;
o 19/600 of 1% of the value of net assets over $17.5 billion and not over $20
billion; and
o 3/100 of 1% of the value of net assets in excess of $20 billion.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of the
funds' shares pays its proportionate share of the fee.
For the last three fiscal years ended September 30, the funds paid the following
management fees:
MANAGEMENT FEES PAID ($)
--------------------------------------
1998 1997 1996
--------------------------------------
DynaTech Series 1,166,790 840,480 601,568
Growth Series 8,291,109 6,295,304 4,329,460
Income Series 40,167,205 35,364,027 30,075,761
Utilities Series 9,617,382 9,987,693 12,335,820
U.S. Government Securities 42,190,481 44,411,776 48,138,799
Series
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with each manager to provide certain administrative
services and facilities for the funds. FT Services is wholly owned by Resources
and is an affiliate of the funds' manager and principal underwriter.
The administrative services FT Services provides include preparing and
maintaining books, records, and tax and financial reports, and monitoring
compliance with regulatory requirements.
ADMINISTRATION FEES The manager pays FT Services a monthly fee equal to an
annual rate of:
o 0.15% of a fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion; and
o 0.075% of average daily net assets over $1.2 billion.
During the last two fiscal years ended September 30, the manager paid FT
Services the following administration fees:
ADMINISTRATION
FEES PAID ($)
--------------------------------
1998 1997
--------------------------------
DynaTech Series 309,337 210,734
Growth Series 1,913,636 1,567,377
Income Series 7,226,547 6,381,600
Utilities Series 2,127,219 2,210,121
U.S. Government
Securities Series 7,561,475 7,950,675
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/ Templeton Investor Services,
Inc. (Investor Services) is the funds' shareholder servicing agent and acts as
the funds' transfer agent and dividend-paying agent. Investor Services is
located at 777 Mariners Island Blvd., San Mateo, CA 94404. Please send all
correspondence to Investor Services to P.O. Box 997151, Sacramento, CA
95899-9983.
For its services, Investor Services receives a fixed fee per account. The funds
may also reimburse Investor Services for certain out-of-pocket expenses, which
may include payments by Investor Services to entities, including affiliated
entities, that provide sub-shareholder services, recordkeeping and/or transfer
agency services to beneficial owners of the funds. The amount of reimbursements
for these services per benefit plan participant fund account per year may not
exceed the per account fee payable by the funds to Investor Services in
connection with maintaining shareholder accounts.
CUSTODIAN Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of the funds' securities and other assets.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105,
is the Custodian Funds' independent auditor. The auditor gives an opinion on the
financial statements included in Custodian Funds' Annual Report to Shareholders
and reviews Custodian Funds' registration statement filed with the U.S.
Securities and Exchange Commission (SEC).
PORTFOLIO TRANSACTIONS
- -------------------------------------------------------------------------------
The manager selects brokers and dealers to execute the funds' portfolio
transactions in accordance with criteria set forth in the management agreement
and any directions that the board may give.
When placing a portfolio transaction, the manager seeks to obtain prompt
execution of orders at the most favorable net price. For portfolio transactions
on a securities exchange, the amount of commission paid is negotiated between
the manager and the broker executing the transaction. The determination and
evaluation of the reasonableness of the brokerage commissions paid are based to
a large degree on the professional opinions of the persons responsible for
placement and review of the transactions. These opinions are based on the
experience of these individuals in the securities industry and information
available to them about the level of commissions being paid by other
institutional investors of comparable size. The manager will ordinarily place
orders to buy and sell over-the-counter securities on a principal rather than
agency basis with a principal market maker unless, in the opinion of the
manager, a better price and execution can otherwise be obtained. Purchases of
portfolio securities from underwriters will include a commission or concession
paid by the issuer to the underwriter, and purchases from dealers will include a
spread between the bid and ask price.
The manager may pay certain brokers commissions that are higher than those
another broker may charge, if the manager determines in good faith that the
amount paid is reasonable in relation to the value of the brokerage and research
services it receives. This may be viewed in terms of either the particular
transaction or the manager's overall responsibilities to client accounts over
which it exercises investment discretion. The services that brokers may provide
to the manager include, among others, supplying information about particular
companies, markets, countries, or local, regional, national or transnational
economies, statistical data, quotations and other securities pricing
information, and other information that provides lawful and appropriate
assistance to the manager in carrying out its investment advisory
responsibilities. These services may not always directly benefit the funds. They
must, however, be of value to the manager in carrying out its overall
responsibilities to its clients.
Since most purchases by U.S. Government Securities Series are principal
transactions at net prices, U.S. Government Securities Series incurs little or
no brokerage costs. The fund deals directly with the selling or buying principal
or market maker without incurring charges for the services of a broker on its
behalf, unless it is determined that a better price or execution may be obtained
by using the services of a broker. Purchases of portfolio securities from
underwriters will include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers will include a spread between the bid
and ask prices. The fund seeks to obtain prompt execution of orders at the most
favorable net price. Transactions may be directed to dealers in return for
research and statistical information, as well as for special services provided
by the dealers in the execution of orders.
It is not possible to place a dollar value on the special executions or on the
research services the manager receives from dealers effecting transactions in
portfolio securities. The allocation of transactions in order to obtain
additional research services allows the manager to supplement its own research
and analysis activities and to receive the views and information of individuals
and research staffs of other securities firms. As long as it is lawful and
appropriate to do so, the manager and its affiliates may use this research and
data in their investment advisory capacities with other clients. If the funds'
officers are satisfied that the best execution is obtained, the sale of fund
shares, as well as shares of other funds in the Franklin Templeton Group of
Funds, may also be considered a factor in the selection of broker-dealers to
execute the funds' portfolio transactions.
Because Franklin Templeton Distributors, Inc. (Distributors) is a member of the
National Association of Securities Dealers, Inc., it may sometimes receive
certain fees when a fund tenders portfolio securities pursuant to a tender-offer
solicitation. To recapture brokerage for the benefit of a fund, any portfolio
securities tendered by the fund will be tendered through Distributors if it is
legally permissible to do so. In turn, the next management fee payable to the
manager will be reduced by the amount of any fees received by Distributors in
cash, less any costs and expenses incurred in connection with the tender.
If purchases or sales of securities of the funds and one or more other
investment companies or clients supervised by the manager are considered at or
about the same time, transactions in these securities will be allocated among
the several investment companies and clients in a manner deemed equitable to all
by the manager, taking into account the respective sizes of the funds and the
amount of securities to be purchased or sold. In some cases this procedure could
have a detrimental effect on the price or volume of the security so far as the
funds are concerned. In other cases it is possible that the ability to
participate in volume transactions may improve execution and reduce transaction
costs to the funds.
During the last three fiscal years ended September 30, the funds paid the
following brokerage commissions:
BROKERAGE COMMISSIONS ($)
------------------------------------
1998 1997 1996
------------------------------------
DynaTech Series 27,869 11,855 18,930
Growth Series 187,647 78,178 105,528
Income Series 549,013 848,922 1,220,342
Utilities Series 811,152 1,146,668 1,525,621
U.S. Government Securities Series -0- -0- -0-
As of September 30, 1998, the funds did not own securities of their regular
broker-dealers.
DISTRIBUTIONS AND TAXES
- -------------------------------------------------------------------------------
The funds calculate dividends and capital gains the same way for each class. The
amount of any income dividends per share will differ, however, generally due to
the difference in the distribution and service (Rule 12b-1) fees of each class.
The funds do not pay "interest" or guarantee any fixed rate of return on an
investment in its shares.
DISTRIBUTIONS OF NET INVESTMENT INCOME The funds receive income generally in the
form of dividends and interest on their investments. This income, less expenses
incurred in the operation of a fund, constitute the fund's net investment income
from which dividends may be paid to you. Any distributions by a fund from such
income will be taxable to you as ordinary income, whether you take them in cash
or in additional shares.
DISTRIBUTIONS OF CAPITAL GAINS The funds may derive capital gains and losses in
connection with sales or other dispositions of their portfolio securities.
Distributions from net short-term capital gains will be taxable to you as
ordinary income. Distributions from net long-term capital gains will be taxable
to you as long-term capital gain, regardless of how long you have held your
shares in a fund. Any net capital gains realized by a fund generally will be
distributed once each year, and may be distributed more frequently, if
necessary, in order to reduce or eliminate excise or income taxes on the fund.
EFFECT OF FOREIGN INVESTMENTS ON DISTRIBUTIONS The funds, other than the U.S.
Government Securities Series, are authorized to invest in foreign currency
denominated securities. Most foreign exchange gains realized on the sale of debt
securities are treated as ordinary income by a fund. Similarly, foreign exchange
losses realized by a fund on the sale of debt securities are generally treated
as ordinary losses by the fund. These gains when distributed will be taxable to
you as ordinary dividends, and any losses will reduce a fund's ordinary income
otherwise available for distribution to you. This treatment could increase or
reduce a fund's ordinary income distributions to you, and may cause some or all
of a fund's previously distributed income to be classified as a return of
capital.
A fund may be subject to foreign withholding taxes on income from certain of its
foreign securities. If more than 50% of a fund's total assets at the end of the
fiscal year are invested in securities of foreign corporations, a fund may elect
to pass-through to you your pro rata share of foreign taxes paid by the fund. If
this election is made, the year-end statement you receive from a fund will show
more taxable income than was actually distributed to you. However, you will be
entitled to either deduct your share of such taxes in computing your taxable
income or (subject to limitations) claim a foreign tax credit for such taxes
against your U.S. federal income tax. A fund will provide you with the
information necessary to complete your individual income tax return if it makes
this election.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS. The funds will inform you of
the amount of your ordinary income dividends and capital gains distributions at
the time they are paid, and will advise you of their tax status for federal
income tax purposes shortly after the close of each calendar year. If you have
not held fund shares for a full year, the fund may designate and distribute to
you, as ordinary income or capital gain, a percentage of income that is not
equal to the actual amount of such income earned during the period of your
investment in a fund.
ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY Each fund has elected to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code, has qualified as such for its most recent fiscal year, and intends
to so qualify during the current fiscal year. As regulated investment companies,
the funds generally pay no federal income tax on the income and gains they
distribute to you. The board reserves the right not to maintain the
qualification of a fund as a regulated investment company if it determines such
course of action to be beneficial to shareholders. In such case, a fund will be
subject to federal, and possibly state, corporate taxes on its taxable income
and gains, and distributions to you will be taxed as ordinary dividend income to
the extent of the fund's earnings and profits.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Internal
Revenue Code requires each fund to distribute to you by December 31 of each
year, at a minimum, the following amounts:
o 98% of its taxable ordinary income earned during the calendar year;
o 98% of its capital gain net income earned during the twelve month period
ending October 31; and
o 100% of any undistributed amounts from the prior year.
Each fund intends to declare and pay these amounts in December (or in January
that are treated by you as received in December) to avoid these excise taxes,
but can give no assurances that its distributions will be sufficient to
eliminate all such taxes.
REDEMPTION OF FUND SHARES Redemptions and exchanges of fund shares are taxable
transactions for federal and state income tax purposes. If you redeem your fund
shares, or exchange your fund shares for shares of a different Franklin
Templeton fund, the IRS will require that you report a gain or loss on your
redemption or exchange. If you hold your shares as a capital asset, the gain or
loss that you realize will be capital gain or loss and will be long-term or
short-term, generally depending on how long you hold your shares. Any loss
incurred on the redemption or exchange of shares held for six months or less
will be treated as a long-term capital loss to the extent of any long-term
capital gains distributed to you by the fund on those shares.
All or a portion of any loss that you realize upon the redemption of your fund
shares will be disallowed to the extent that you buy other shares in the fund
(through reinvestment of dividends or other-wise) within 30 days before or after
your share redemption. Any loss disallowed under these rules will be added to
your tax basis in the new shares you buy.
DEFERRAL OF BASIS If you redeem some or all of your shares in a fund, and then
reinvest the sales proceeds in the fund or in another Franklin Templeton Fund
within 90 days of buying the original shares, the sales charge that would
otherwise apply to your reinvestment may be reduced or eliminated. The IRS will
require you to report gain or loss on the redemption of your original shares in
a fund. In doing so, all or a portion of the sales charge that you paid for your
original shares in a fund will be excluded from your tax basis in the shares
sold (for the purpose of determining gain or loss upon the sale of such shares).
The portion of the sales charge excluded will equal the amount that the sales
charge is reduced on your reinvestment. Any portion of the sales charge excluded
from your tax basis in the shares sold will be added to the tax basis of the
shares you acquire from your reinvestment.
U.S. GOVERNMENT OBLIGATIONS Many states grant tax-free status to dividends paid
to you from interest earned on direct obligations of the U.S. government,
subject in some states to minimum investment requirements that must be met by
the fund. Investments in Government National Mortgage Association or Federal
National Mortgage Association securities, bankers' acceptances, commercial paper
and repurchase agreements collateralized by U.S. government securities do not
generally qualify for tax-free treatment. The rules on exclusion of this income
are different for corporations.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS If you are a corporate
shareholder, you should note that 23.34% of the dividends paid by the DynaTech
Series, 46.92% of the dividends paid by the Growth Series, 25.92% of the
dividends paid by the Income Series and 88.24% of the dividends paid by the
Utilities Series for the most recent fiscal year qualified for the
dividends-received deduction. In some circumstances, you will be allowed to
deduct these qualified dividends, thereby reducing the tax that you would
otherwise be required to pay on these dividends. The dividends-received
deduction will be available only with respect to dividends designated by a fund
as eligible for such treatment. All dividends (including the deducted portion)
must be included in your alternative minimum taxable income calculation.
Because U.S. Government Securities Series' income consists of interest rather
than dividends, no portion of its distributions will generally be eligible for
the intercorporate dividends-received deduction. None of the dividends paid by
U.S. Government Securities Series for the most recent calendar year qualified
for such deduction, and it is anticipated that none of the current year's
dividends will so qualify.
INVESTMENT IN COMPLEX SECURITIES The funds may invest in complex securities.
These investments may be subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by a fund are
treated as ordinary income or capital gain, accelerate the recognition of income
to a fund and/or defer a fund's ability to recognize losses and, in limited
cases, subject a fund to U.S. federal income tax on income from certain of its
foreign securities. In turn, these rules may affect the amount, timing or
character of the income distributed to you by a fund.
ORGANIZATION, VOTING RIGHTS
AND PRINCIPAL HOLDERS
- -------------------------------------------------------------------------------
Each fund is a diversified series of Custodian Funds, an open-end management
investment company, commonly called a mutual fund. Custodian Funds was organized
as a Delaware corporation in 1947, reincorporated as a Maryland corporation in
1979, and is registered with the SEC.
The funds currently offer four classes of shares, Class A, Class B, Class C and
Advisor Class, except DynaTech Series which offers two classes of shares, Class
A and Class C. Before January 1, 1999, Class A shares were designated Class I
and Class C shares were designated Class II. Growth, Income, Utilities and U.S.
Government Securities Series began offering Class B shares on January 1, 1999.
The funds may offer additional classes of shares in the future. The full title
of each class is:
o DynaTech Series - Class A
o DynaTech Series - Class C
o Growth Series - Class A
o Growth Series - Class B
o Growth Series - Class C
o Growth Series - Advisor Class
o Income Series - Class A
o Income Series - Class B
o Income Series - Class C
o Income Series - Advisor Class
o Utilities Series - Class A
o Utilities Series - Class B
o Utilities Series - Class C
o Utilities Series - Advisor Class
o U.S. Government Securities Series - Class A
o U.S. Government Securities Series - Class B
o U.S. Government Securities Series - Class C
o U.S. Government Securities Series - Advisor Class
Shares of each class represent proportionate interests in each fund's assets. On
matters that affect the fund as a whole, each class has the same voting and
other rights and preferences as any other class. On matters that affect only one
class, only shareholders of that class may vote. Each class votes separately on
matters affecting only that class, or expressly required to be voted on
separately by state or federal law. Shares of each class of a series have the
same voting and other rights and preferences as the other classes and series of
Custodian Funds for matters that affect Custodian Funds as a whole. Additional
series may be offered in the future.
Custodian Funds has noncumulative voting rights. For board member elections,
this gives holders of more than 50% of the shares voting the ability to elect
all of the members of the board. If this happens, holders of the remaining
shares voting will not be able to elect anyone to the board.
Custodian Funds does not intend to hold annual shareholder meetings. Custodian
Funds or a series of Custodian Funds may hold special meetings, however, for
matters requiring shareholder approval. A meeting may be called by the board to
consider the removal of a board member if requested in writing by shareholders
holding at least 10% of the outstanding shares. In certain circumstances, we are
required to help you communicate with other shareholders about the removal of a
board member. A special meeting may also be called by the board in its
discretion.
As of December 7, 1998, the principal shareholders of the funds, beneficial or
of record, were:
NAME AND ADDRESS SHARE AMOUNT PERCENTAGE
- -------------------------------------------------------------------------------
GROWTH SERIES - ADVISOR CLASS
Franklin Templeton Trust Company 122,585.721 6.03%
Trust Services FBO
Vivian J. Palmieri
P.O. Box 7519
San Mateo, CA 94403-7519
Franklin Templeton Trust Company 175,541.806 8.64%
Trust Services FBO
FBO Rupert Johnson IRA
P.O. Box 7519
San Mateo, CA 94403-7519
Franklin Templeton Trust Company 218,578.728 10.76%
Trustee for ValuSelect
Franklin Templeton 401K
Attn: Trading
P.O. Box 2438
Rancho Cordova, CA 95741-2438
Franklin Templeton Trust Company 179,227.249 8.82%
Trustee for ValuSelect
Franklin Resources PSP
Attn: Trading
P.O. Box 2438
Rancho Cordova, CA 95741-2438
FT Fund Allocator Conservative
Target Fund 211,042.852 10.38%
C/O Fund Accounting Department
Kimberley Monasterio
1810 Gateway 3rd Floor
San Mateo, CA 94404-2470
FT Fund Allocator Moderate
Target Fund 401,843.289 19.77%
C/O Fund Accounting Department
Kimberley Monasterio
1810 Gateway 3rd Floor
San Mateo, CA 94404-2470
FT Fund Allocator Growth
Target Fund 459,996.056 22.63%
C/O Fund Accounting Department
Kimberley Monasterio
1810 Gateway 3rd Floor
San Mateo, CA 94404-2470
UTILITIES SERIES - ADVISOR CLASS
FIRST MAR & CO 2 144,115.414 11.66%
101 W. Washington St.
P.O. Box 580
Marquette, MI 49855
The Washington Trust Company 132,668.980 10.73%
Attn. Trust Dept.
23 Broad St.
Westerly, RI 02891
Franklin Templeton Trust Company 1 413,265.371 33.44%
Trustee for ValuSelect
Franklin Resources PSP
Attn Trading
P.O. Box 2438
Rancho Cordova, CA 95741-2438
FT Fund Allocator Moderate
Target Fund 151,231.272 12.24%
C/O Fund Accounting Department
Kimberley Monasterio
1810 Gateway 3rd Floor
San Mateo, CA 94404-2470
FT Fund Allocator Growth
Target Fund 214,320.948 17.34%
C/O Fund Accounting Department
Kimberley Monasterio
1810 Gateway 3rd Floor
San Mateo, CA 94404-2470
INCOME SERIES - ADVISOR CLASS
Franklin Templeton Trust Company 2,068,787.793 21.55%
Trustee for ValuSelect
Franklin Templeton 401K
Attn Trading
P.O. Box 2438
Rancho Cordova, CA 95741-2438
Franklin Templeton Trust Company 1 2,544,072.391 26.50%
Trustee for ValuSelect
Franklin Resources PSP
Attn Trading
P.O. Box 2438
Rancho Cordova, CA 95741-2438
U.S. GOVERNMENT SECURITIES SERIES - ADVISOR CLASS
FT Fund Allocator Conservative
Target Fund 256,043.898 9.25%
C/O Fund Accounting Department
Kimberley Monasterio
1810 Gateway 3rd Floor
San Mateo, CA 94404-2470
FT Fund Allocator Moderate
Target Fund 694,247.527 25.07%
C/O Fund Accounting Department
Kimberley Monasterio
1810 Gateway 3rd Floor
San Mateo, CA 94404-2470
Franklin Templeton Trust Company 272,434.960 9.84%
Trustee for ValuSelect
Franklin Templeton 401K
Attn Trading
P.O. Box 2438
Rancho Cordova, CA 95741-2438
Franklin Templeton Trust Company 1 766,352.471 27.67%
Trustee for ValuSelect
Franklin Resources PSP
Attn Trading
P.O. Box 2438
Rancho Cordova, CA 95741-2438
1. Franklin Templeton Trust Company is a California corporation and is wholly
owned by Franklin Resources, Inc.
From time to time, the number of fund shares held in the "street name" accounts
of various securities dealers for the benefit of their clients or in centralized
securities depositories may exceed 5% of the total shares outstanding.
As of December 7, 1998, the officers and board members, as a group, owned of
record and beneficially the following shares of Custodian Funds: approximately
4,636 shares of Growth Series - Class A, 10,858 shares of Growth Series -
Advisor Class, 111 shares of Utilities Series - Class A, 9,986 shares of
Utilities Series - Advisor Class, 50,197 shares of DynaTech Series - Class A,
81,951 shares of Income Series - Class A, 17,949 shares of Income Series -
Advisor Class, 51,634 shares of U.S. Government Securities Series - Class A, or
less than 1% of the total outstanding Class A shares of each fund and Advisor
Class shares of Growth, Income, and Utilities Series, and 124,499 shares of U.S.
Government Securities Series - Advisor Class or 4.50% of U.S. Government
Securities Series' Advisor Class shares. The board members may own shares in
other funds in the Franklin Templeton Group of Funds.
During the fiscal year ended September 30, 1998, legal fees and expenses of
$111,457 were paid to the law firm of which Mr. Lorenz, an officer of Custodian
Funds, is a partner, and which acts as counsel to Custodian Funds.
BUYING AND SELLING SHARES
- -------------------------------------------------------------------------------
The funds continuously offer their shares through securities dealers who have an
agreement with Franklin Templeton Distributors, Inc. (Distributors). A
securities dealer includes any financial institution that, either directly or
through affiliates, has an agreement with Distributors to handle customer orders
and accounts with the funds. This reference is for convenience only and does not
indicate a legal conclusion of capacity. Banks and financial institutions that
sell shares of the funds may be required by state law to register as securities
dealers.
For investors outside the U.S., the offering of fund shares may be limited in
many jurisdictions. An investor who wishes to buy shares of the funds should
determine, or have a broker-dealer determine, the applicable laws and
regulations of the relevant jurisdiction. Investors are responsible for
compliance with tax, currency exchange or other regulations applicable to
redemption and purchase transactions in any jurisdiction to which they may be
subject. Investors should consult appropriate tax and legal advisors to obtain
information on the rules applicable to these transactions.
All checks, drafts, wires and other payment mediums used to buy or sell shares
of the funds must be denominated in U.S. dollars. We may, in our sole
discretion, either (a) reject any order to buy or sell shares denominated in any
other currency or (b) honor the transaction or make adjustments to your account
for the transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
When you buy shares, if you submit a check or a draft that is returned unpaid to
a fund we may impose a $10 charge against your account for each returned item.
If you buy shares through the reinvestment of dividends, the shares will be
purchased at the net asset value determined on the business day following the
dividend record date (sometimes known as the "ex-dividend date"). The processing
date for the reinvestment of dividends may vary and does not affect the amount
or value of the shares acquired.
INITIAL SALES CHARGES For DynaTech and Growth Series, the maximum initial sales
charge is 5.75% for Class A and 1% for Class C. For Income, Utilities and U.S.
Government Securities Series, the maximum initial sales charge is 4.25% for
Class A and 1% for Class C. There is no initial sales charge for Class B. The
initial sales charge for Class A shares may be reduced for certain large
purchases, as described in the prospectus. We offer several ways for you to
combine your purchases in the Franklin Templeton Funds to take advantage of the
lower sales charges for large purchases. The Franklin Templeton Funds include
the U.S. registered mutual funds in the Franklin Group of Funds(R) and the
Templeton Group of Funds except Franklin Valuemark Funds, Templeton Capital
Accumulator Fund, Inc., and Templeton Variable Products Series Fund.
CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on
Class A shares, you may combine the amount of your current purchase with the
cost or current value, whichever is higher, of your existing shares in the
Franklin Templeton Funds. You may also combine the shares of your spouse,
children under the age of 21 or grandchildren under the age of 21. If you are
the sole owner of a company, you may also add any company accounts, including
retirement plan accounts. Companies with one or more retirement plans may add
together the total plan assets invested in the Franklin Templeton Funds to
determine the sales charge that applies.
LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge by
completing the letter of intent section of your account application. A letter of
intent is a commitment by you to invest a specified dollar amount during a 13
month period. The amount you agree to invest determines the sales charge you
pay. By completing the letter of intent section of the application, you
acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase in
Class A shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares you
own, and we will pay or reinvest dividend and capital gain distributions on
the reserved shares according to the distribution option you have chosen.
o You give Distributors a security interest in the reserved shares and appoint
Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares until
you complete the LOI or pay the higher sales charge.
After you file your LOI with the fund, you may buy Class A shares at the sales
charge applicable to the amount specified in your LOI. Sales charge reductions
based on purchases in more than one Franklin Templeton Fund will be effective
only after notification to Distributors that the investment qualifies for a
discount. Any Class A purchases you made within 90 days before you filed your
LOI may also qualify for a retroactive reduction in the sales charge. If you
file your LOI with the fund before a change in the fund's sales charge, you may
complete the LOI at the lower of the new sales charge or the sales charge in
effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days before
you filed your LOI will be counted towards the completion of the LOI, but they
will not be entitled to a retroactive reduction in the sales charge. Any
redemptions you make during the 13 month period, except in the case of certain
retirement plans, will be subtracted from the amount of the purchases for
purposes of determining whether the terms of the LOI have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of your
total purchases, less redemptions, is more than the amount specified in your LOI
and is an amount that would qualify for a further sales charge reduction, a
retroactive price adjustment will be made by Distributors and the securities
dealer through whom purchases were made. The price adjustment will be made on
purchases made within 90 days before and on those made after you filed your LOI
and will be applied towards the purchase of additional shares at the offering
price applicable to a single purchase or the dollar amount of the total
purchases.
If the amount of your total purchases, less redemptions, is less than the amount
specified in your LOI, the sales charge will be adjusted upward, depending on
the actual amount purchased (less redemptions) during the period. You will need
to send Distributors an amount equal to the difference in the actual dollar
amount of sales charge paid and the amount of sales charge that would have
applied to the total purchases if the total of the purchases had been made at
one time. Upon payment of this amount, the reserved shares held for your account
will be deposited to an account in your name or delivered to you or as you
direct. If within 20 days after written request the difference in sales charge
is not paid, we will redeem an appropriate number of reserved shares to realize
the difference. If you redeem the total amount in your account before you
fulfill your LOI, we will deduct the additional sales charge due from the sale
proceeds and forward the balance to you.
For LOIs filed on behalf of certain retirement plans, the level and any
reduction in sales charge for these plans will be based on actual plan
participation and the projected investments in the Franklin Templeton Funds
under the LOI. These plans are not subject to the requirement to reserve 5% of
the total intended purchase or to the policy on upward adjustments in sales
charges described above, or to any penalty as a result of the early termination
of a plan, nor are these plans entitled to receive retroactive adjustments in
price for investments made before executing the LOI.
GROUP PURCHASES. If you are a member of a qualified group, you may buy Class A
shares at a reduced sales charge that applies to the group as a whole. The sales
charge is based on the combined dollar value of the group members' existing
investments, plus the amount of the current purchase.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
o Has more than 10 members,
o Can arrange for meetings between our representatives and group members,
o Agrees to include Franklin Templeton Fund sales and other materials in
publications and mailings to its members at reduced or no cost to
Distributors,
o Agrees to arrange for payroll deduction or other bulk transmission of
investments to the funds, and
o Meets other uniform criteria that allow Distributors to achieve cost savings
in distributing shares.
A qualified group does not include a 403(b) plan that only allows salary
deferral contributions, although any such plan that purchased a fund's Class A
shares at a reduced sales charge under the group purchase privilege before
February 1, 1998, may continue to do so.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be purchased
without an initial sales charge or contingent deferred sales charge (CDSC) by
investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton Fund. The
distributions generally must be reinvested in the same share class. Certain
exceptions apply, however, to Class C shareholders who chose to reinvest their
distributions in Class A shares of a fund before November 17, 1997, and to
Advisor Class or Class Z shareholders of a Franklin Templeton Fund who may
reinvest their distributions in a fund's Class A shares. This waiver category
also applies to Class B and C shares.
o Dividend or capital gain distributions from a real estate investment trust
(REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death benefit
proceeds, if the annuity contract offers as an investment option the Franklin
Valuemark Funds or the Templeton Variable Products Series Fund. You should
contact your tax advisor for information on any tax consequences that may
apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating Rate
Trust, if the shares were continuously held for at least 12 months.
If you immediately placed your redemption proceeds in a Franklin Bank CD or a
Franklin Templeton money fund, you may reinvest them as described above. The
proceeds must be reinvested within 365 days from the date the CD matures,
including any rollover, or the date you redeem your money fund shares.
o Redemption proceeds from the sale of Class A shares of any of the Templeton
Global Strategy Funds if you are a qualified investor.
If you paid a CDSC when you redeemed your Class A shares from a Templeton Global
Strategy Fund, a new CDSC will apply to your purchase of fund shares and the
CDSC holding period will begin again. We will, however, credit your fund account
with additional shares based on the CDSC you previously paid and the amount of
the redemption proceeds that you reinvest.
If you immediately placed your redemption proceeds in a Franklin Templeton money
fund, you may reinvest them as described above. The proceeds must be reinvested
within 365 days from the date they are redeemed from the money fund.
o Distributions from an existing retirement plan invested in the Franklin
Templeton Funds
WAIVERS FOR CERTAIN INVESTORS. Class A shares may also be purchased without an
initial sales charge or CDSC by various individuals and institutions due to
anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in Franklin
Templeton Funds over a 13 month period at least $1 million of assets held in a
fiduciary, agency, advisory, custodial or similar capacity and over which the
trust companies and bank trust departments or other plan fiduciaries or
participants, in the case of certain retirement plans, have full or shared
investment discretion. We will accept orders for these accounts by mail
accompanied by a check or by telephone or other means of electronic data
transfer directly from the bank or trust company, with payment by federal
funds received by the close of business on the next business day following the
order.
o Any state or local government or any instrumentality, department, authority or
agency thereof that has determined a fund is a legally permissible investment
and that can only buy fund shares without paying sales charges. Please consult
your legal and investment advisors to determine if an investment in a fund is
permissible and suitable for you and the effect, if any, of payments by the
fund on arbitrage rebate calculations.
o Broker-dealers, registered investment advisors or certified financial planners
who have entered into an agreement with Distributors for clients participating
in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer or
service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their investment
accounts only
o Current employees of securities dealers and their affiliates and their family
members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family members,
consistent with our then-current policies
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting distributions
from the trusts
o Group annuity separate accounts offered to retirement plans
o Chilean retirement plans that meet the requirements described under
"Retirement plans" below
o Any investor who is currently a Class Z shareholder of Franklin Mutual Series
Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z
shareholder who had an account in any Mutual Series fund on October 31, 1996,
or who sold his or her shares of Mutual Series Class Z within the past 365
days
In addition, Class C shares may be purchased without an initial sales charge by
any investor who buys Class C shares through an omnibus account with Merrill
Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the shares are
sold within 18 months of purchase.
RETIREMENT PLANS. Retirement plans sponsored by an employer (i) with at least
100 employees, or (ii) with retirement plan assets of $1 million or more, or
(iii) that agrees to invest at least $500,000 in the Franklin Templeton Funds
over a 13 month period may buy Class A shares without an initial sales charge.
Retirement plans that are not qualified retirement plans (employer sponsored
pension or profit-sharing plans that qualify under section 401 of the Internal
Revenue Code, including 401(k), money purchase pension, profit sharing and
defined benefit plans), SIMPLEs (savings incentive match plans for employees) or
SEPs (employer sponsored simplified employee pension plans established under
section 408(k) of the Internal Revenue Code) must also meet the group purchase
requirements described above to be able to buy Class A shares without an initial
sales charge. We may enter into a special arrangement with a securities dealer,
based on criteria established by the funds, to add together certain small
qualified retirement plan accounts for the purpose of meeting these
requirements.
For retirement plan accounts opened on or after May 1, 1997, a CDSC may apply if
the retirement plan is transferred out of the Franklin Templeton Funds or
terminated within 365 days of the retirement plan account's initial purchase in
the Franklin Templeton Funds.
SALES IN TAIWAN. Under agreements with certain banks in Taiwan, Republic of
China, the funds' shares are available to these banks' trust accounts without a
sales charge. The banks may charge service fees to their customers who
participate in the trusts. A portion of these service fees may be paid to
Distributors or one of its affiliates to help defray expenses of maintaining a
service office in Taiwan, including expenses related to local literature
fulfillment and communication facilities.
The funds' Class A shares may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class A
shares may be offered with the following schedule of sales charges:
For DynaTech and Growth Series Series:
SALES
SIZE OF PURCHASE - U.S. DOLLARS CHARGE (%)
- -------------------------------------------------------------------------------
Under $30,000 3.0
$30,000 but less than $50,000 2.5
$50,000 but less than $100,000 2.0
$100,000 but less than $200,000 1.5
$200,000 but less than $400,000 1.0
$400,000 or more 0
For Income Series, Utilities Series and U.S. Government Securities Series:
SALES
SIZE OF PURCHASE - U.S. DOLLARS CHARGE (%)
- -------------------------------------------------------------------------------
Under $30,000 3.0
$30,000 but less than $100,000 2.0
$100,000 but less than $400,000 1.0
$400,000 or more 0
DEALER COMPENSATION Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may be
deemed an underwriter under the Securities Act of 1933, as amended. Financial
institutions or their affiliated brokers may receive an agency transaction fee
in the percentages indicated in the dealer compensation table in the funds'
prospectus.
For DynaTech and Growth Series, Distributors may pay the following commissions,
out of its own resources, to securities dealers who initiate and are responsible
for purchases of Class A shares of $1 million or more: 1% on sales of $1 million
to $2 million, plus 0.80% on sales over $2 million to $3 million, plus 0.50% on
sales over $3 million to $50 million, plus 0.25% on sales over $50 million to
$100 million, plus 0.15% on sales over $100 million.
For Income, Utilities and U.S. Government Securities Series, Distributors may
pay the following commissions, out of its own resources, to securities dealers
who initiate and are responsible for purchases of Class A shares of $1 million
or more: 0.75% on sales of $1 million to $2 million, plus 0.60% on sales over $2
million to $3 million, plus 0.50% on sales over $3 million to $50 million, plus
0.25% on sales over $50 million to $100 million, plus 0.15% on sales over $100
million.
Either Distributors or one of its affiliates may pay the following amounts, out
of its own resources, to securities dealers who initiate and are responsible for
purchases of Class A shares by certain retirement plans without an initial sales
charge: 1% on sales of $500,000 to $2 million, plus 0.80% on sales over $2
million to $3 million, plus 0.50% on sales over $3 million to $50 million, plus
0.25% on sales over $50 million to $100 million, plus 0.15% on sales over $100
million. Distributors may make these payments in the form of contingent advance
payments, which may be recovered from the securities dealer or set off against
other payments due to the dealer if shares are sold within 12 months of the
calendar month of purchase. Other conditions may apply. All terms and conditions
may be imposed by an agreement between Distributors, or one of its affiliates,
and the securities dealer.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors and/or its affiliates provide financial support to various
securities dealers that sell shares of the Franklin Templeton Group of Funds.
This support is based primarily on the amount of sales of fund shares. The
amount of support may be affected by: total sales; net sales; levels of
redemptions; the proportion of a securities dealer's sales and marketing efforts
in the Franklin Templeton Group of Funds; a securities dealer's support of, and
participation in, Distributors' marketing programs; a securities dealer's
compensation programs for its registered representatives; and the extent of a
securities dealer's marketing programs relating to the Franklin Templeton Group
of Funds. Financial support to securities dealers may be made by payments from
Distributors' resources, from Distributors' retention of underwriting
concessions and, in the case of funds that have Rule 12b-1 plans, from payments
to Distributors under such plans. In addition, certain securities dealers may
receive brokerage commissions generated by fund portfolio transactions in
accordance with the rules of the National Association of Securities Dealers,
Inc.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin Templeton
Funds and are afforded the opportunity to speak with portfolio managers.
Invitation to these meetings is not conditioned on selling a specific number of
shares. Those who have shown an interest in the Franklin Templeton Funds,
however, are more likely to be considered. To the extent permitted by their
firm's policies and procedures, registered representatives' expenses in
attending these meetings may be covered by Distributors.
CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in
Class A shares, either as a lump sum or through our cumulative quantity discount
or letter of intent programs, a CDSC may apply on any shares you sell within 12
months of purchase. For Class C shares, a CDSC may apply if you sell your shares
within 18 months of purchase. The CDSC is 1% of the value of the shares sold or
the net asset value at the time of purchase, whichever is less.
Certain retirement plan accounts opened on or after May 1, 1997, and that
qualify to buy Class A shares without an initial sales charge may also be
subject to a CDSC if the retirement plan is transferred out of the Franklin
Templeton Funds or terminated within 365 days of the account's initial purchase
in the Franklin Templeton Funds.
For Class B shares, there is a CDSC if you sell your shares within six years, as
described in the table below. The charge is based on the value of the shares
sold or the net asset value at the time of purchase, whichever is less.
IF YOU SELL YOUR CLASS B THIS % IS DEDUCTED
SHARES WITHIN THIS MANY FROM YOUR PROCEEDS
YEARS AFTER BUYING THEM AS A CDSC
- ----------------------------------------------------------------------
1 Year 4
2 Years 4
3 Years 3
4 Years 3
5 Years 2
6 Years 1
7 Years 0
CDSC WAIVERS. The CDSC for any share class will generally be waived for:
o Account fees
o Sales of Class A shares purchased without an initial sales charge by certain
retirement plan accounts if (i) the account was opened before May 1, 1997, or
(ii) the securities dealer of record received a payment from Distributors of
0.25% or less, or (iii) Distributors did not make any payment in connection
with the purchase, or (iv) the securities dealer of record has entered into a
supplemental agreement with Distributors
o Redemptions by the funds when an account falls below the minimum required
account size
o Redemptions following the death of the shareholder or beneficial owner
o Redemptions through a systematic withdrawal plan set up before February 1,
1995
o Redemptions through a systematic withdrawal plan set up on or after February
1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12% annually of
your account's net asset value depending on the frequency of your plan
o Redemptions by Franklin Templeton Trust Company employee benefit plans or
employee benefit plans serviced by ValuSelect(R) (not applicable to Class B)
o Distributions from individual retirement accounts (IRAs) due to death or
disability or upon periodic distributions based on life expectancy (for Class
B, this applies to all retirement plan accounts, not only IRAs)
o Returns of excess contributions (and earnings, if applicable) from
retirement plan accounts
o Participant initiated distributions from employee benefit plans or participant
initiated exchanges among investment choices in employee benefit plans (not
applicable to Class B)
o Redemptions of Class A shares by investors who purchased $1 million or more
without an initial sales charge if the securities dealer of record waived its
commission in connection with the purchase
EXCHANGE PRIVILEGE If you request the exchange of the total value of your
account, declared but unpaid income dividends and capital gain distributions
will be reinvested in the fund and exchanged into the new fund at net asset
value when paid. Backup withholding and information reporting may apply.
If a substantial number of shareholders should, within a short period, sell
their fund shares under the exchange privilege, a fund might have to sell
portfolio securities it might otherwise hold and incur the additional costs
related to such transactions. On the other hand, increased use of the exchange
privilege may result in periodic large inflows of money. If this occurs, it is
each fund's general policy to initially invest this money in short-term,
interest-bearing money market instruments, unless it is believed that attractive
investment opportunities consistent with the fund's investment goals exist
immediately. This money will then be withdrawn from the short-term,
interest-bearing money market instruments and invested in portfolio securities
in as orderly a manner as is possible when attractive investment opportunities
arise.
The proceeds from the sale of shares of an investment company are generally not
available until the seventh day following the sale. The funds you are seeking to
exchange into may delay issuing shares pursuant to an exchange until that
seventh day. The sale of fund shares to complete an exchange will be effected at
net asset value at the close of business on the day the request for exchange is
received in proper form.
SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at least
$50. For retirement plans subject to mandatory distribution requirements, the
$50 minimum will not apply. There are no service charges for establishing or
maintaining a systematic withdrawal plan. Once your plan is established, any
distributions paid by the fund will be automatically reinvested in your account.
Payments under the plan will be made from the redemption of an equivalent amount
of shares in your account, generally on the 25th day of the month in which a
payment is scheduled. If the 25th falls on a weekend or holiday, we will process
the redemption on the next business day. When you sell your shares under a
systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if you
plan to buy shares on a regular basis. Shares sold under the plan may also be
subject to a CDSC.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust the
shares in your account if payments exceed distributions received from the fund.
This is especially likely to occur if there is a market decline. If a withdrawal
amount exceeds the value of your account, your account will be closed and the
remaining balance in your account will be sent to you. Because the amount
withdrawn under the plan may be more than your actual yield or income, part of
the payment may be a return of your investment.
You may discontinue a systematic withdrawal plan, change the amount and schedule
of withdrawal payments, or suspend one payment by notifying us by mail or by
phone at least seven business days before the end of the month preceding a
scheduled payment. The funds may discontinue a systematic withdrawal plan by
notifying you in writing and will automatically discontinue a systematic
withdrawal plan if all shares in your account are withdrawn or if the fund
receives notification of the shareholder's death or incapacity.
REDEMPTIONS IN KIND Each fund has committed itself to pay in cash (by check) all
requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1% of the value
of the fund's net assets at the beginning of the 90-day period. This commitment
is irrevocable without the prior approval of the U.S. Securities and Exchange
Commission (SEC). In the case of redemption requests in excess of these amounts,
the board reserves the right to make payments in whole or in part in securities
or other assets of the fund, in case of an emergency, or if the payment of such
a redemption in cash would be detrimental to the existing shareholders of the
fund. In these circumstances, the securities distributed would be valued at the
price used to compute the fund's net assets and you may incur brokerage fees in
converting the securities to cash. The funds do not intend to redeem illiquid
securities in kind. If this happens, however, you may not be able to recover
your investment in a timely manner.
SHARE CERTIFICATES We will credit your shares to your fund account. We do not
issue share certificates unless you specifically request them. This eliminates
the costly problem of replacing lost, stolen or destroyed certificates. If a
certificate is lost, stolen or destroyed, you may have to pay an insurance
premium of up to 2% of the value of the certificate to replace it.
Any outstanding share certificates must be returned to the fund if you want to
sell or exchange those shares or if you would like to start a systematic
withdrawal plan. The certificates should be properly endorsed. You can do this
either by signing the back of the certificate or by completing a share
assignment form. For your protection, you may prefer to complete a share
assignment form and to send the certificate and assignment form in separate
envelopes.
GENERAL INFORMATION If dividend checks are returned to a fund marked "unable to
forward" by the postal service, we will consider this a request by you to change
your dividend option to reinvest all distributions. The proceeds will be
reinvested in additional shares at net asset value until we receive new
instructions.
Distribution or redemption checks sent to you do not earn interest or any other
income during the time the checks remain uncashed. Neither the funds nor their
affiliates will be liable for any loss caused by your failure to cash such
checks. The funds are not responsible for tracking down uncashed checks, unless
a check is returned as undeliverable.
In most cases, if mail is returned as undeliverable we are required to take
certain steps to try to find you free of charge. If these attempts are
unsuccessful, however, we may deduct the costs of any additional efforts to find
you from your account. These costs may include a percentage of the account when
a search company charges a percentage fee in exchange for its location services.
The wiring of redemption proceeds is a special service that we make available
whenever possible. By offering this service to you, the funds are not bound to
meet any redemption request in less than the seven day period prescribed by law.
Neither the funds nor their agents shall be liable to you or any other person
if, for any reason, a redemption request by wire is not processed as described
in the prospectus.
Franklin Templeton Investor Services, Inc. (Investor Services) may pay certain
financial institutions that maintain omnibus accounts with the funds on behalf
of numerous beneficial owners for recordkeeping operations performed with
respect to such owners. For each beneficial owner in the omnibus account, a fund
may reimburse Investor Services an amount not to exceed the per account fee that
the fund normally pays Investor Services. These financial institutions may also
charge a fee for their services directly to their clients.
If you buy or sell shares through your securities dealer, we use the net asset
value next calculated after your securities dealer receives your request, which
is promptly transmitted to the fund. If you sell shares through your securities
dealer, it is your dealer's responsibility to transmit the order to the fund in
a timely fashion. Your redemption proceeds will not earn interest between the
time we receive the order from your dealer and the time we receive any required
documents. Any loss to you resulting from your dealer's failure to transmit your
redemption order to the fund in a timely fashion must be settled between you and
your securities dealer.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
For institutional accounts, there may be additional methods of buying or selling
fund shares than those described in this SAI or in the prospectus.
In the event of disputes involving multiple claims of ownership or authority to
control your account, each fund has the right (but has no obligation) to: (a)
freeze the account and require the written agreement of all persons deemed by
the fund to have a potential property interest in the account, before executing
instructions regarding the account; (b) interplead disputed funds or accounts
with a court of competent jurisdiction; or (c) surrender ownership of all or a
portion of the account to the IRS in response to a notice of levy.
PRICING SHARES
- -------------------------------------------------------------------------------
When you buy shares, you pay the offering price. The offering price is the net
asset value (NAV) per share plus any applicable sales charge, calculated to two
decimal places using standard rounding criteria. When you sell shares, you
receive the NAV minus any applicable CDSC.
The value of a mutual fund is determined by deducting the fund's liabilities
from the total assets of the portfolio. The net asset value per share is
determined by dividing the net asset value of the fund by the number of shares
outstanding.
The funds calculate the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (normally 1:00 p.m. pacific
time). The funds do not calculate the NAV on days the New York Stock Exchange
(NYSE) is closed for trading, which include New Year's Day, Martin Luther King
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
When determining its NAV, each fund values cash and receivables at their
realizable amounts, and records interest as accrued and dividends on the
ex-dividend date. If market quotations are readily available for portfolio
securities listed on a securities exchange or on the NASDAQ National Market
System, each fund values those securities at the last quoted sale price of the
day or, if there is no reported sale, within the range of the most recent quoted
bid and ask prices. Each fund values over-the-counter portfolio securities
within the range of the most recent quoted bid and ask prices. If portfolio
securities trade both in the over-the-counter market and on a stock exchange,
each fund values them according to the broadest and most representative market
as determined by the manager.
Each fund values portfolio securities underlying actively traded call options at
their market price as determined above. The current market value of any option a
fund holds is its last sale price on the relevant exchange before the fund
values its assets. If there are no sales that day or if the last sale price is
outside the bid and ask prices, the fund values options within the range of the
current closing bid and ask prices if the fund believes the valuation fairly
reflects the contract's market value.
Each fund determines the value of a foreign security as of the close of trading
on the foreign exchange on which the security is traded or as of the close of
trading on the NYSE, if that is earlier. The value is then converted into its
U.S. dollar equivalent at the foreign exchange rate in effect at noon, New York
time, on the day the value of the foreign security is determined. If no sale is
reported at that time, the foreign security is valued within the range of the
most recent quoted bid and ask prices. Occasionally events that affect the
values of foreign securities and foreign exchange rates may occur between the
times at which they are determined and the close of the exchange and will,
therefore, not be reflected in the computation of the NAV. If events materially
affecting the values of these foreign securities occur during this period, the
securities will be valued in accordance with procedures established by the
board.
Generally, trading in corporate bonds, U.S. government securities and money
market instruments is substantially completed each day at various times before
the close of the NYSE. The value of these securities used in computing the NAV
is determined as of such times. Occasionally, events affecting the values of
these securities may occur between the times at which they are determined and
the close of the NYSE that will not be reflected in the computation of the NAV.
If events materially affecting the values of these securities occur during this
period, the securities will be valued at their fair value as determined in good
faith by the board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following procedures approved by the board. With the approval of the board, the
funds may use a pricing service, bank or securities dealer to perform any of the
above described functions.
THE UNDERWRITER
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Franklin Templeton Distributors, Inc. (Distributors) acts as the principal
underwriter in the continuous public offering of the funds' shares. Distributors
is located at 777 Mariners Island Blvd., San Mateo, CA 94404.
Distributors pays the expenses of the distribution of fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. Each fund pays the expenses of preparing and
printing amendments to its registration statements and prospectuses (other than
those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the funds' shares, the net
underwriting discounts and commissions Distributors retained after allowances to
dealers, and the amounts Distributors received in connection with redemptions or
repurchases of shares for the last three fiscal years ended September 30:
AMOUNT RECEIVED
TOTAL AMOUNT IN CONNECTION
COMMISSIONS RETAINED BY WITH REDEMPTIONS
RECEIVED ($) DISTRIBUTORS ($) AND REPURCHASES ($)
- ------------------------------------------------------------------------------
1998
DynaTech Series 726,687 71,933 6,857
Growth Series 6,106,577 627,929 83,796
Income Series 38,432,701 2,191,540 403,597
Utilities Series 1,800,127 100,078 12,642
U.S. Government Securities
Series 12,066,960 756,299 111,036
AMOUNT RECEIVED
TOTAL AMOUNT IN CONNECTION
COMMISSIONS RETAINED BY WITH REDEMPTIONS
RECEIVED ($) DISTRIBUTORS ($) AND REPURCHASES ($)
- -------------------------------------------------------------------------------
1997
DynaTech Series 682,911 67,617 1,344
Growth Series 7,068,758 708,574 47,529
Income Series 39,253,724 1,822,592 293,033
Utilities Series 1,698,314 99,703 19,661
U.S. Government Securities
Series 10,252,511 620,114 56,854
1996
DynaTech Series 285,074 32,125 -0-
Growth Series 4,835,570 505,111 7,930
Income Series 46,806,723 1,739,086 136,828
Utilities Series 3,913,659 228,611 11,242
U.S. Government Securities
Series 13,160,355 834,565 23,231
Distributors may be entitled to reimbursement under the Rule 12b-1 plans, as
discussed below. Except as noted, Distributors received no other compensation
from the funds for acting as underwriter.
DISTRIBUTION AND SERVICE (12B-1) FEES Each class has a separate distribution or
"Rule 12b-1" plan. Under each plan, each fund shall pay or may reimburse
Distributors or others for the expenses of activities that are primarily
intended to sell shares of the class. These expenses may include, among others,
distribution or service fees paid to securities dealers or others who have
executed a servicing agreement with the fund, Distributors or its affiliates; a
prorated portion of Distributors' overhead expenses; and the expenses of
printing prospectuses and reports used for sales purposes, and preparing and
distributing sales literature and advertisements.
The distribution and service (12b-1) fees charged to each class are based only
on the fees attributable to that particular class.
THE CLASS A PLAN. Payments by DynaTech Series and Growth Series under the Class
A plans may not exceed 0.25% per year of Class A's average daily net assets, and
payments by Income Series, Utilities Series and U.S. Government Securities
Series under the Class A plan may not exceed 0.15% per year of Class A's average
daily net assets, payable quarterly. All distribution expenses over this amount
will be borne by those who have incurred them.
In implementing the Class A plan, the board has determined that the annual fees
payable under Growth Series' and DynaTech Series' Class A plans will be equal to
the sum of: (i) the amount obtained by multiplying 0.25% by the average daily
net assets represented by the fund's Class A shares that were acquired by
investors on or after May 1, 1994, the effective date of the plan (new assets),
and (ii) the amount obtained by multiplying 0.15% by the average daily net
assets represented by the fund's Class A shares that were acquired before May 1,
1994 (old assets). These fees will be paid to the current securities dealer of
record on the account. In addition, until such time as the maximum payment of
0.25% is reached on a yearly basis, up to an additional 0.05% will be paid to
Distributors under DynaTech Series' and Growth Series' Class A plans. With
respect to Income and Utilities Series, the annual fees payable under their
respective Class A plans will be equal to the sum of: (i) the amount obtained by
multiplying 0.15% by the average daily net assets represented by the new assets
of such fund's Class A shares and (ii) the amount obtained by multiplying 0.10%
by the average daily net assets represented by the old assets of such fund's
Class A shares. With respect to U.S. Government Securities Series, the annual
fees payable under its Class A plan will be equal to the sum of: (i) the amount
obtained by multiplying 0.15% by the average daily net assets represented by the
new assets of such fund's Class A shares and (ii) the amount obtained by
multiplying 0.05% by the average daily net assets represented by the old assets
of the fund's Class A shares. These fees will be paid to the current securities
dealer of record on the account. In addition, until such time as the maximum
payment of 0.15% with respect to Income, Utilities and U.S. Government
Securities Series is reached on a yearly basis, up to an additional 0.02% will
be paid to Distributors under their respective Class A plan. The payments made
to Distributors will be used by Distributors to defray other marketing expenses
that have been incurred in accordance with each plan, such as advertising.
The fee is a Class A expense. This means that all Class A shareholders,
regardless of when they purchased their shares, will bear Rule 12b-1 expenses at
the same rate. The initial rate will be at least 0.20% (0.15% plus 0.05%) for
DynaTech and Growth Series; 0.12% (0.10% plus 0.02%) for Income and Utilities
Series; and 0.07% (0.05% plus 0.02%) for U.S. Government Securities Series of
the average daily net assets of Class A and, as Class A shares are sold on or
after May 1, 1994, will increase over time. Thus, as the proportion of Class A
shares purchased on or after May 1, 1994, increases in relation to outstanding
Class A shares, the expenses attributable to payments under the plan will also
increase (but will not exceed the maximum allowable under each Class A plan).
While this is the currently anticipated calculation for fees payable under the
Class A plan, the plan permits the board to allow DynaTech and Growth Series to
pay a full 0.25% and Income, Utilities, and U.S. Government Securities Series to
pay a full 0.15% on all assets at any time. The approval of the board would be
required to change the calculation of the payments to be made under the Class A
plan.
The Class A plan does not permit unreimbursed expenses incurred in a particular
year to be carried over to or reimbursed in later years.
THE CLASS B AND C PLANS. Under the Class B and C plans, DynaTech and Growth
Series pays Distributors up to 0.75% per year of the class's average daily net
assets, and Income Series, Utilities Series and U.S. Government Securities
Series pays Distributors up to 0.50% per year of the class's average daily net
assets, payable quarterly, to pay Distributors or others for providing
distribution and related services and bearing certain expenses. All distribution
expenses over this amount will be borne by those who have incurred them.
DynaTech and Growth Series may also pay a servicing fee of up to 0.25% per year
of the class's average daily net assets and Income Series, Utilities Series and
U.S. Government Securities Series also pay a servicing fee of up to 0.15% per
year of the class's average daily net assets, payable quarterly. This fee may be
used to pay securities dealers or others for, among other things, helping to
establish and maintain customer accounts and records, helping with requests to
buy and sell shares, receiving and answering correspondence, monitoring dividend
payments from the fund on behalf of customers, and similar servicing and account
maintenance activities.
The expenses relating to each of the Class B and C plans are also used to pay
Distributors for advancing the commission costs to securities dealers with
respect to the initial sale of Class B and C shares. Further, the expenses
relating to the Class B plan may be used by Distributors to pay third party
financing entities that have provided financing to Distributors in connection
with advancing commission costs to securities dealers.
THE CLASS A, B AND C PLANS. In addition to the payments that Distributors or
others are entitled to under each plan, each plan also provides that to the
extent the fund, the manager or Distributors or other parties on behalf of the
fund, the manager or Distributors make payments that are deemed to be for the
financing of any activity primarily intended to result in the sale of fund
shares within the context of Rule 12b-1 under the Investment Company Act of
1940, as amended, then such payments shall be deemed to have been made pursuant
to the plan. The terms and provisions of each plan relating to required reports,
term, and approval are consistent with Rule 12b-1.
In no event shall the aggregate asset-based sales charges, which include
payments made under each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
To the extent fees are for distribution or marketing functions, as distinguished
from administrative servicing or agency transactions, certain banks will not be
entitled to participate in the plans as a result of applicable federal law
prohibiting certain banks from engaging in the distribution of mutual fund
shares. These banking institutions, however, are permitted to receive fees under
the plans for administrative servicing or for agency transactions. If you are a
customer of a bank that is prohibited from providing these services, you would
be permitted to remain a shareholder of the fund, and alternate means for
continuing the servicing would be sought. In this event, changes in the services
provided might occur and you might no longer be able to avail yourself of any
automatic investment or other services then being provided by the bank. It is
not expected that you would suffer any adverse financial consequences as a
result of any of these changes.
Each plan has been approved in accordance with the provisions of Rule 12b-1. The
plans are renewable annually by a vote of the board, including a majority vote
of the board members who are not interested persons of the fund and who have no
direct or indirect financial interest in the operation of the plans, cast in
person at a meeting called for that purpose. It is also required that the
selection and nomination of such board members be done by the noninterested
members of the fund's board. The plans and any related agreement may be
terminated at any time, without penalty, by vote of a majority of the
noninterested board members on not more than 60 days' written notice, by
Distributors on not more than 60 days' written notice, by any act that
constitutes an assignment of the management agreement with the manager or by
vote of a majority of the outstanding shares of the class. Distributors or any
dealer or other firm may also terminate their respective distribution or service
agreement at any time upon written notice.
The plans and any related agreements may not be amended to increase materially
the amount to be spent for distribution expenses without approval by a majority
of the outstanding shares of the class, and all material amendments to the plans
or any related agreements shall be approved by a vote of the noninterested board
members, cast in person at a meeting called for the purpose of voting on any
such amendment.
Distributors is required to report in writing to the board at least quarterly on
the amounts and purpose of any payment made under the plans and any related
agreements, as well as to furnish the board with such other information as may
reasonably be requested in order to enable the board to make an informed
determination of whether the plans should be continued.
For the fiscal year ended September 30, 1998, Distributors eligible expenditures
for advertising, printing, and payments to underwriters and broker-dealers
pursuant to the plans and the amounts the fund paid Distributors under the plans
were:
DISTRIBUTORS' AMOUNT
ELIGIBLE PAID BY
EXPENSES ($) THE FUND ($)
- ----------------------------------------------------------
DynaTech Series -
Class C 106,273 62,288
Growth Series -
Class C 1,736,604 1,449,870
Income Series -
Class A 13,604,237 11,793,854
Income Series -
Class C 8,779,825 5,455,896
Utilities Series -
Class C 280,336 178,180
U.S. Government
Securities Series -
Class A 8,687,657 8,494,991
U.S. Government
Securities Series -
Class C 1,937,329 999,690
For the fiscal year ended September 30, 1998, the amounts paid by the funds
pursuant to the following plans were:
DYNATECH SERIES - CLASS A $
- ----------------------------------------------------------------------
Advertising 10,273
Printing and mailing prospectuses 55,878
other than to current shareholders
Payments to underwriters 9,104
Payments to broker-dealers 358,659
Total 433,914
GROWTH SERIES - CLASS A
- ----------------------------------------------------------------------
Advertising 189,714
Printing and mailing prospectuses 277,801
other than to current shareholders
Payments to underwriters 92,335
Payments to broker-dealers 2,944,839
Total 3,504,689
UTILITIES SERIES - CLASS A
- ----------------------------------------------------------------------
Advertising 51,255
Printing and mailing prospectuses 307,576
other than to current shareholders
Payments to underwriters 18,922
Payments to broker-dealers 2,292,177
Total 2,669,930
PERFORMANCE
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Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by a fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by the funds are
based on the standardized methods of computing performance mandated by the SEC.
If a Rule 12b-1 plan is adopted, performance figures reflect fees from the date
of the plan's implementation. An explanation of these and other methods used by
the funds to compute or express performance follows. Regardless of the method
used, past performance does not guarantee future results, and is an indication
of the return to shareholders only for the limited historical period used.
AVERAGE ANNUAL TOTAL RETURN Average annual total return is determined by finding
the average annual rates of return over the periods indicated below that would
equate an initial hypothetical $1,000 investment to its ending redeemable value.
The calculation assumes the maximum initial sales charge is deducted from the
initial $1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. The quotation assumes the account was completely
redeemed at the end of each period and the deduction of all applicable charges
and fees. If a change is made to the sales charge structure, historical
performance information will be restated to reflect the maximum initial sales
charge currently in effect.
When considering the average annual total return quotations, you should keep in
mind that the maximum initial sales charge reflected in each quotation is a one
time fee charged on all direct purchases, which will have its greatest impact
during the early stages of your investment. This charge will affect actual
performance less the longer you retain your investment in the fund. The average
annual total returns for the indicated periods ended September 30, 1998, were:
CLASS A 1 YEAR 5 YEARS 10 YEARS
- ----------------------------------------------------------------------
DynaTech Series -2.87% 15.11% 15.28%
Growth Series 2.01% 15.79% 13.45%
Income Series -2.10% 7.15% 10.89%
Utilities Series 16.49% 7.45% 11.20%
U.S. Government
Securities Series 3.75% 5.86% 8.03%
SINCE INCEPTION
CLASS C 1 YEAR INCEPTION DATE
- ----------------------------------------------------------------------
DynaTech Series 0.09% 17.64% 9/16/96
Growth Series 5.32% 17.53% 5/1/95
Income Series -0.44% 10.16% 5/1/95
Utilities Series 19.05% 15.09% 5/1/95
U.S. Government
Securities Series 5.77% 7.75% 5/1/95
These figures were calculated according to the SEC formula:
n
P(1+T) = 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 each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. Cumulative total return, however, is based on the
actual return for a specified period rather than on the average return over the
periods indicated above. The cumulative total returns for the indicated periods
ended September 30, 1998, were:
CLASS A 1 YEAR 5 YEARS 10 YEARS
- ----------------------------------------------------------------------
DynaTech Series -2.87% 102.12% 314.59%
Growth Series 2.01% 108.16% 253.37%
Income Series -2.10% 41.27% 181.15%
Utilities Series 16.49% 43.22% 189.16%
U.S. Government
Securities Series 3.75% 32.92% 116.58%
SINCE INCEPTION
CLASS C 1 YEAR INCEPTION DATE
- ----------------------------------------------------------------------
DynaTech Series 0.09% 39.23% 9/16/96
Growth Series 5.32% 73.63% 5/1/95
Income Series -0.44% 39.19% 5/1/95
Utilities Series 19.05% 61.63% 5/1/95
U.S. Government
Securities Series 5.77% 29.05% 5/1/95
CURRENT YIELD Current yield shows the income per share earned by a fund. It is
calculated by dividing the net investment income per share earned during a
30-day base period by the applicable maximum offering price per share on the
last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders of the class during the base
period. The yields for the 30-day period ended September 30, 1998, were:
CLASS A YIELD
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Income Series 7.31%
Utilities Series 4.34%
U.S. Government Securities Series 5.98%
CLASS C YIELD
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Income Series 7.10%
Utilities Series 3.98%
U.S. Government Securities Series 5.64%
These figures were obtained using the following SEC formula:
6
Yield = 2 [(a-b + 1) - 1]
---
cd
where:
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
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
CURRENT DISTRIBUTION RATE Current yield, which is calculated according to a
formula prescribed by the SEC, is not indicative of the amounts which were or
will be paid to shareholders. Amounts paid to shareholders are reflected in the
quoted current distribution rate. The current distribution rate is usually
computed by annualizing the dividends paid per share by a class during a certain
period and dividing that amount by the current maximum offering price. The
current distribution rate differs from the current yield computation because it
may include distributions to shareholders from sources other than dividends and
interest, such as premium income from option writing and short-term capital
gains, and is calculated over a different period of time. The current
distribution rates for the 30-day period ended September 30, 1998, were:
DISTRIBUTION
CLASS A RATE
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Income Series 7.38%
Utilities Series 4.42%
U.S. Government Securities Series 6.08%
DISTRIBUTION
CLASS C RATE
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Income Series 7.08%
Utilities Series 4.42%
U.S. Government Securities Series 5.76%
VOLATILITY Occasionally statistics may be used to show a fund's volatility or
risk. Measures of volatility or risk are generally used to compare a fund's net
asset value or performance to a market index. One measure of volatility is beta.
Beta is the volatility of a fund relative to the total market, as represented by
an index considered representative of the types of securities in which the fund
invests. A beta of more than 1.00 indicates volatility greater than the market
and a beta of less than 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard deviation is used
to measure variability of net asset value or total return around an average over
a specified period of time. The idea is that greater volatility means greater
risk undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS The fund may also quote the performance of shares
without a sales charge. Sales literature and advertising may quote a cumulative
total return, average annual total return and other measures of performance with
the substitution of net asset value for the public offering price.
Sales literature referring to the use of the funds as a potential investment for
IRAs, business retirement plans, and other tax-advantaged retirement plans may
quote a total return based upon compounding of dividends on which it is presumed
no federal income tax applies.
The funds may include in their advertising or sales material information
relating to investment goals and performance results of funds belonging to the
Franklin Templeton Group of Funds. Franklin Resources, Inc. is the parent
company of the advisors and underwriter of the Franklin Templeton Group of
Funds.
COMPARISONS To help you better evaluate how an investment in the funds may
satisfy your investment goal, advertisements and other materials about the funds
may discuss certain measures of fund performance as reported by various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
These comparisons may include, but are not limited to, the following examples:
o Dow Jones(R) Composite Average and its component averages - a price-weighted
average of 65 stocks that trade on the New York Stock Exchange. The average is
a combination of the Dow Jones Industrial Average (30 blue-chip stocks that
are generally leaders in their industry), the Dow Jones Transportation Average
(20 transportation stocks), and the Dow Jones Utilities Average (15 utility
stocks involved in the production of electrical energy).
o Standard & Poor's(R) 500 Stock Index or its component indices - a
capitalization-weighted index designed to measure performance of the broad
domestic economy through changes in the aggregate market value of 500 stocks
representing all major industries.
o The New York Stock Exchange composite or component indices - an unmanaged
index of all industrial, utilities, transportation, and finance stocks listed
on the NYSE.
o Wilshire 5000 Equity Index - represents the return on the market value of all
common equity securities for which daily pricing is available. Comparisons of
performance assume reinvestment of dividends.
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions, exclusive
of any applicable sales charges.
o CDA Mutual Fund Report, published by CDA Investment Technologies, Inc.
analyzes price, current yield, risk, total return, and average rate of return
(average annual compounded growth rate) over specified time periods for the
mutual fund industry.
o Mutual Fund Source Book, published by Morningstar, Inc. - analyzes price,
yield, risk, and total return for mutual funds.
o Financial publications: THE WALL STREET JOURNAL, and BUSINESS WEEK, CHANGING
TIMES, FINANCIAL WORLD, FORBES, FORTUNE, and MONEY magazines provide
performance statistics over specified time periods.
o Consumer Price Index (or Cost of Living Index), published by the U.S. Bureau
of Labor Statistics - a statistical measure of change, over time, in the price
of goods and services in major expenditure groups.
o Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, Treasury bills, and inflation.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect Morningstar's
assessment of the historical risk-adjusted performance of a fund over
specified time periods relative to other funds within its category.
In addition to the indices listed above, the following specific comparisons may
be appropriate:
Utilities Series may be compared to Moody's Utilities Stock Index, an unmanaged
index of utility stock performance.
DynaTech Series may be compared to:
o Hambrecht & Quist Technology Index - an unmanaged index of technology-based
companies published by Hambrecht & Quist.
o Pacific Stock Exchange Technology Index - an unmanaged index representing a
wide variety of technology-based companies ranging from established companies
to emerging growth companies.
o Over-the-Counter (OTC) Composite Stock Index - an unmanaged index of stock
performance of all stocks listed in the OTC market.
Income Series and U.S. Government Securities Series may be compared to:
o Salomon Brothers Broad Bond Index or its component indices - measures yield,
price and total return for Treasury, agency, corporate and mortgage bonds.
o Lehman Brothers Aggregate Bond Index or its component indices - measures
yield, price and total return for Treasury, agency, corporate, mortgage and
Yankee bonds.
o Standard & Poor's(R) Bond Indices - measures yield and price of corporate,
municipal and government bonds.
o Other taxable investments including certificates of deposit (CDs), money
market deposit accounts (MMDAs), checking accounts, savings accounts, money
market mutual funds and repurchase agreements.
From time to time, advertisements or information for the funds may include a
discussion of certain attributes or benefits to be derived from an investment in
the funds. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
1. Franklin pioneered the concept of Ginnie Mae funds, and U.S. Government
Securities Series, with over $9.3 billion in assets and more than 424,000
shareholders as of September 30, 1998, is one of the largest Ginnie Mae funds in
the U.S. and the world. Shareholders in this fund, which has a history of solid
performance, range from individual investors with a few thousand dollars to
institutions that have invested millions of dollars.
U.S. Government Securities Series offers investors the opportunity to invest
in Ginnie Maes, which are among the highest yielding U.S. government
securities on the market.
2. Advertisements or information may also compare the funds' performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in a fund involves the risk of fluctuation of
principal value, a risk generally not present in an investment in a CD issued by
a bank. For example, as the general level of interest rates rise, the value of
the fund's fixed-income investments, if any, as well as the value of its shares
that are based upon the value of such portfolio investments, can be expected to
decrease. Conversely, when interest rates decrease, the value of the fund's
shares can be expected to increase. CDs are frequently insured by an agency of
the U.S. government. An investment in a fund is not insured by any federal,
state or private entity.
3. Utilities Series has paid uninterrupted dividends for the past 49 years. Over
the life of Utilities Series, dividends have increased in 28 of the last 49
years. Historically, equity securities of utility companies have paid a higher
level of dividends than that paid by the general stock market. Utilities Series,
well established for over 40 years, is the oldest mutual fund in the U.S.
investing in securities issued by public utility companies, primarily in the
country's fast growing regions, and the fund has been continuously managed by
the same portfolio manager since 1990.
4. Income Series has paid uninterrupted dividends for the past 49 years.
5. Growth Series offers investors a convenient way to invest in a diversified
portfolio focusing on companies with long-term growth prospects.
6. Growth Series made the 1990, 1991 and 1996 Forbes Mutual Fund Honor Roll for
its performance in both up and down markets.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the funds' portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by the funds to calculate its figures. In
addition, there can be no assurance that the funds will continue their
performance as compared to these other averages.
MISCELLANEOUS INFORMATION
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The funds may help you achieve various investment goals such as accumulating
money for retirement, saving for a down payment on a home, college costs and
other long-term goals. The Franklin College Costs Planner may help you in
determining how much money must be invested on a monthly basis in order to have
a projected amount available in the future to fund a child's college education.
(Projected college cost estimates are based upon current costs published by the
College Board.) The Franklin Retirement Planning Guide leads you through the
steps to start a retirement savings program. Of course, an investment in a fund
cannot guarantee that these goals will be met.
Each fund is a member of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin is one of the
oldest mutual fund organizations and now services more than 3 million
shareholder accounts. In 1992, Franklin, a leader in managing fixed-income
mutual funds and an innovator in creating domestic equity funds, joined forces
with Templeton, a pioneer in international investing. The Mutual Series team,
known for its value-driven approach to domestic equity investing, became part of
the organization four years later. Together, the Franklin Templeton Group has
over $222 billion in assets under management for approximately 7 million U.S.
based mutual fund shareholder and other accounts. The Franklin Templeton Group
of Funds offers 115 U.S. based open-end investment companies to the public. Each
fund may identify itself by its NASDAQ symbol or CUSIP number.
Currently, there are more mutual funds than there are stocks listed on the New
York Stock Exchange. While many of them have similar investment goals, no two
are exactly alike. Shares of the funds are generally sold through securities
dealers, whose investment representatives are experienced professionals who can
offer advice on the type of investments suitable to your unique goals and needs,
as well as the risks associated with such investments.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has already
begun making necessary software changes to help the computer systems that
service the fund and its shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues to
seek reasonable assurances from all major hardware, software or data-services
suppliers that they will be Year 2000 compliant on a timely basis. Resources is
also beginning to develop a contingency plan, including identification of those
mission critical systems for which it is practical to develop a contingency
plan. However, in an operation as complex and geographically distributed as
Resources' business, the alternatives to use of normal systems, especially
mission critical systems, or supplies of electricity or long distance voice and
data lines are limited.
DESCRIPTION OF BOND RATINGS
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CORPORATE BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
Aaa - Bonds 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 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 rated Aa are judged to be 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, fluctuation of protective elements may be of greater amplitude, or
there may be other elements present that make the long-term risks appear
somewhat larger.
A - Bonds rated A possess many favorable investment attributes and are
considered 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 rated Baa are considered medium-grade obligations. 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. These
bonds lack outstanding investment characteristics and, in fact, have speculative
characteristics as well.
Ba - Bonds rated Ba are judged to have predominantly speculative elements and
their future cannot be considered well assured. Often the protection of interest
and principal payments is very moderate and, thereby, not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B - Bonds rated B generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other terms of
the contract over any long period of time may be small.
Caa - Bonds rated Caa are of poor standing. These issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca - Bonds rated Ca represent obligations that are speculative to a high degree.
These issues are often in default or have other marked shortcomings.
C - Bonds rated C are the lowest rated class of bonds and can be regarded as
having extremely poor prospects of ever attaining any real investment standing.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond ratings. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
STANDARD & POOR'S CORPORATION (S&P)
AAA - This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay principal and interest.
AA - Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong and, in the majority of instances,
differ from AAA issues only in a small degree.
A - Bonds rated A have a strong capacity to pay principal and interest, although
they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay principal and interest for bonds in this category
than for bonds in the A category.
BB, B, CCC, CC - Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligations. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While these bonds will likely have some quality and protective
characteristics, they are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C - Bonds rated C are typically subordinated debt to senior debt that is
assigned an actual or implied CCC- rating. The C rating may also reflect the
filing of a bankruptcy petition under circumstances where debt service payments
are continuing. The C1 rating is reserved for income bonds on which no interest
is being paid.
D - Debt rated D is in default and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
COMMERCIAL PAPER RATINGS
MOODY'S
Moody's commercial paper ratings are opinions of the ability of issuers to repay
punctually their promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following designations, all judged to
be investment grade, to indicate the relative repayment capacity of rated
issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment is
very strong. A "plus" (+) designation indicates an even stronger likelihood of
timely payment.
A-2: Capacity for timely payment on issues with this designation is strong. The
relative degree of safety, however, is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
