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PROSPECTUS FEBRUARY 28, 1995
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KEYSTONE CUSTODIAN FUND, SERIES B-1
HIGH GRADE BOND FUND
200 BERKELEY STREET, BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-343-2898
Keystone Custodian Fund, Series B-1 (the "Fund") is a mutual fund whose goal
is the highest possible income consistent with preservation of principal.
The Fund invests primarily in high and investment grade corporate bonds, which
possess a high degree of dependability of interest payments.
Your purchase payment is fully invested. There is no sales charge when you buy
the Fund's shares. The Fund may, however, impose a deferred sales charge, which
declines from 4% to 1%, if you redeem your shares within four calendar years of
purchase.
The Fund has adopted a Distribution Plan (the "Distribution Plan") pursuant to
Rule 12b-1 under the Investment Company Act of 1940 (the "1940 Act") under which
it bears some of the costs of selling its shares to the public.
This prospectus sets forth concisely the information about the Fund that you
should know before investing. Please read it and retain it for future reference.
Additional information about the Fund is contained in a statement of
additional information dated February 28, 1995, which has been filed with the
Securities and Exchange Commission and is incorporated by reference into this
prospectus. For a free copy, or for other information about the Fund, write to
the address or call the telephone number listed above.
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY.
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TABLE OF CONTENTS
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<TABLE>
<CAPTION>
Page Page
<S> <C>
Fee Table .......................................... 2 How to Buy Shares .............................. 9
Financial Highlights ............................... 3 Distribution Plan .............................. 10
Fund Description ................................... 4 How to Redeem Shares ........................... 12
Fund Objective and Policies ........................ 4 Shareholder Services ........................... 14
Investment Restrictions ............................ 5 Performance Data ............................... 15
Pricing Shares ..................................... 6 Fund Shares .................................... 15
Dividends and Taxes ................................ 7 Additional Information ......................... 16
Fund Management and Expenses ....................... 7 Additional Investment Information .............. (i)
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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<PAGE>
FEE TABLE
KEYSTONE CUSTODIAN FUND, SERIES B-1
HIGH GRADE BOND FUND
The purpose of the fee table is to assist investors in understanding the
costs and expenses that an investor in the Fund will bear directly or
indirectly. For more complete descriptions of the various costs and expenses,
see the following sections of this prospectus: "Fund Management and Expenses";
"How to Buy Shares"; "Distribution Plan"; and "Shareholder Services."
SHAREHOLDER TRANSACTION EXPENSES
Contingent Deferred Sales Charge\1/ ..................... 4.00%
(as a percentage of the lesser of total
cost or net asset value of shares
redeemed)
Exchange Fee\2/ ......................................... $10.00
(per exchange)
ANNUAL FUND OPERATING EXPENSES\3/
(as a percentage of average net assets)
Management Fees ......................................... 0.56%
12b-1 Fees\4/ ........................................... 0.97%
Other Expenses .......................................... 0.33%
-----
Total Fund Operating Expenses ........................... 1.86%
-----
-----
EXAMPLE\5/ 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
You would pay the following expenses
on a $1,000 investment, assuming (1) 5%
annual return and (2) redemption at the
end of each period ..................... $59 $78 $101 $218
You would pay the following expenses on
the same investment, assuming no
redemption ............................. $19 $58 $101 $218
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES; ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
- ---------
\1/ The deferred sales charge declines from 4% to 1% of amounts redeemed within
four calendar years after purchase. No deferred sales charge is imposed
thereafter.
\2/ There is no exchange fee for exchange orders received by the Fund over the
Keystone Automated Response Line ("KARL") from an individual shareholder.
(For a description of KARL, see "Shareholder Services.")
\3/ Expense ratios are for the Fund's fiscal year ended October 31, 1994.
\4/ Long-term shareholders may pay more than the economic equivalent of the
maximum front end sales charge permitted by rules adopted by the National
Association of Securities Dealers, Inc. ("NASD").
\5/ The Securities and Exchange Commission requires use of a 5% annual return
figure for purposes of this example. Actual return for the Fund may be
greater or less than 5%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE CUSTODIAN FUND, SERIES B-1
HIGH GRADE BOND FUND
(For a share outstanding throughout the year)
The following table contains important financial information with respect to
the Fund and has been audited by KPMG Peat Marwick LLP, the Fund's independent
auditors. The table appears in the Fund's Annual Report and should be read in
conjunction with the Fund's financial statements and related notes, which also
appear, together with the auditors' report, in the Fund's Annual Report. The
Fund's financial statements, related notes, and auditors' report are included in
the statement of additional information. Additional information about the Fund's
performance is contained in its Annual Report, which will be made available upon
request and without charge.
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
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1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value:
Beginning of year .. $16.40 $15.92 $15.92 $15.11 $15.85 $15.71 $15.52 $17.30 $16.15 $15.45
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
INCOME FROM INVESTMENT
OPERATIONS
Investment income--
net ................ 0.76 0.96 1.04 1.08 1.11 1.21 1.19 1.20 1.50 1.63
Net gains (losses) on
investments and
foreign currency
related transactions (1.76) 0.66 0.15 0.99 (0.53) 0.25 0.32 (1.59) 1.56 0.94
Net commissions paid
on fund share
sales<F1>........... 0 0 0 0 0 0 0 0 (0.20) (0.19)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total from investment
operations ......... (1.00) 1.62 1.19 2.07 0.58 1.46 1.51 (0.39) 2.86 2.38
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
LESS DISTRIBUTIONS FROM:
Investment income--
net ................ (0.76) (0.96) (1.04) (1.08) (1.18) (1.32) (1.32) (1.39) (1.64) (1.68)
In excess of
investment income--
net<F2>............. (0.09) (0.18) (0.15) (0.18) (0.14) 0 0 0 0 0
Tax basis return of
capital ............ (0.11) 0 0 0 0 0 0 0 0 0
Realized gains on
investments and
foreign currency
related
transactions--net .. 0 0 0 0 0 0 0 0 (0.07) 0
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total distributions . (0.96) (1.14) (1.19) (1.26) (1.32) (1.32) (1.32) (1.39) (1.71) (1.68)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Net asset value: End
of year ............ $14.44 $16.40 $15.92 $15.92 $15.11 $15.85 $15.71 $15.52 $17.30 $16.15
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
TOTAL RETURN<F3>..... (6.27%) 10.50% 7.71% 14.09% 3.93% 9.82% 10.09% (2.44%) 18.13% 16.23%
RATIOS/SUPPLEMENTAL
DATA
Ratios to average net
assets:
Operating and
management expenses 1.86% 1.94% 2.01% 2.04% 1.95% 1.82% 1.64% 1.56% 1.00% 1.09%
Investment income--
net ............. 5.05% 5.85% 6.40% 6.95% 7.45% 7.61% 7.49% 7.32% 8.37% 10.14%
Portfolio turnover
rate ............... 169% 190% 102% 158% 117% 116% 153% 127% 97% 48%
Net assets, end of
year (thousands) ... $327,276 $458,925 $456,912 $453,528 $408,330 $462,425 $447,454 $440,836 $348,107 $105,351
<FN>
<F1>Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution Plan have been treated for both financial
statement and tax purposes as capital charges. On June 11, 1987, the
Securities and Exchange Commission adopted a rule that required for
financial statements for periods ended on or after June 30, 1987, that net
commissions paid under Rule 12b-1 be treated as operating expenses rather
than capital charges. Accordingly, beginning with the year ended October 31,
1987, the Fund's financial statements reflect 12b-1 Distribution Plan
expenses (i.e., shareholder services fees plus commissions paid net of
deferred sales charges received by the Fund) as a component of net
investment income.
<F2>Effective November 1, 1993, the Fund adopted Statement of Position 93-2:
"Determination, Disclosure, and Financial Statement Presentation of Income,
Capital Gain and Return of Capital Distributions by Investment Companies."
As a result, distribution amounts exceeding book basis net investment income
(or tax basis net income on a temporary basis) are presented as
"Distributions in excess of investment income--net." Similarly, capital gain
distributions in excess of book basis capital gains (or tax basis capital
gains on a temporary basis) are presented as "Distributions in excess of
realized capital gains." Prior to the date of adoption of the Statement of
Position, distribution amounts exceeding book basis investment income--net
were presented as "Distributions from paid-in capital."
<F3>Without contingent deferred sales charge (CDSC).
</FN>
</TABLE>
<PAGE>
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FUND DESCRIPTION
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The Fund is an open-end, diversified, management investment company,
commonly known as a mutual fund. The Fund was created under Pennsylvania law as
a common law trust and has been offering its shares continuously since September
11, 1935. The Fund is one of twenty funds managed by Keystone Management, Inc.
("Keystone Management"), the Fund's investment manager, and is one of
twenty-nine funds managed or advised by Keystone Custodian Funds, Inc.
("Keystone"), the Fund's investment adviser. Keystone and Keystone Management
are from time to time also collectively referred to as "Keystone."
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FUND OBJECTIVE AND POLICIES
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The Fund's investment objective is to provide shareholders with the highest
possible income consistent with preservation of principal. The Fund invests at
least 65% of its assets in high grade bonds (bonds rated A or better by Moody's
Investors Service, Inc. ("Moody's") or by Standard & Poor's Corporation ("S&P").
In addition the Fund invests in investment grade bonds and short-term money
market instruments at such times and in such proportions as seem appropriate to
best achieve this objective. Bonds will include obligations of the United States
("U.S.") government or its agencies (e.g., Government National Mortgage
Association ("GNMA") certificates, U.S. Treasury securities and such other
securities as are issued by or guaranteed as to principal and interest by the
full
The Fund has various pension and profit-sharing plans available to investors,
including: Individual Retirement Accounts ("IRAs"); Rollover IRAs; Simplified
Employee Pension Plans ("SEPs"); Tax Sheltered Annuity Plans ("TSAs"); 401(k)
Plans; Keogh Plans; Corporate Profit-Sharing Plans; Pension and Target Benefit
Plans; Money Purchase Pension Plans and Salary-Reduction Plans. For details,
including fees and application forms, call KDI toll free at 1-800-247-4075 or
write to KIRC.
AUTOMATIC INVESTMENT PLAN
Shareholders may take advantage of investing on an automatic basis by
establishing an automatic investment plan. Funds are drawn on a shareholder's
checking account monthly and used to purchase Fund shares.
AUTOMATIC WITHDRAWAL PLAN
Under an Automatic Withdrawal Plan, shareholders may arrange for regular
monthly or quarterly fixed withdrawal payments. Each payment must be at least
$100 and may be as much as 1% per month or 3% per quarter of the total net asset
value of the Fund shares in the shareholder's account when the Automatic
Withdrawal Plan is opened. Fixed withdrawal payments are not subject to a
deferred sales charge. Excessive withdrawals may decrease or deplete the value
of a shareholder's account.
OTHER SERVICES
Under certain circumstances, shareholders may, within 30 days after a
redemption, reinstate their accounts at current net asset value.
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PERFORMANCE DATA
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From time to time, the Fund may advertise "total return" and "current yield."
BOTH FIGURES ARE BASED ON HISTORICAL EARNINGS AND ARE NOT INTENDED TO INDICATE
FUTURE PERFORMANCE. Total return refers to the Fund's average annual compounded
rates of return over specified periods determined by comparing the initial
amount invested to the ending redeemable value of that amount. The resulting
equation assumes reinvestment of all dividends and distributions and deduction
of all recurring charges, if any, applicable to all shareholder accounts. The
deduction of the contingent deferred sales charge is reflected in the applicable
years. The exchange fee is not included in the calculation.
Current yield quotations represent the yield on an investment for a stated
30-day period computed by dividing net investment income earned per share during
the base period by the maximum offering price per share on the last day of the
base period.
The Fund may include comparative performance information in advertising or
marketing the Fund's shares, such as data from Lipper Analytical Services, Inc.,
Morningstar, Inc., CDS-Weisenberger and Value Line, or other industry
publications.
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FUND SHARES
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The Fund currently issues one class of shares, which participate equally in
dividends and distributions and have equal voting, liquidation and other rights.
When issued and paid for, the shares will be fully paid and nonassessable by the
Fund. Shares may be exchanged as explained under "Shareholder Services," but
will have no other preference, conversion, exchange or preemptive rights.
Shareholders are entitled to one vote for each full share owned and fractional
votes for fractional shares. Shares are redeemable, transferable and freely
assignable as collateral. There are no sinking fund provisions. The Fund may
establish additional classes or series of shares.
The Fund does not have annual meetings. The Fund will have special meetings
from time to time as required under its Restatement of Trust Agreement and under
the 1940 Act. As provided in the Fund's Restatement of Trust Agreement,
shareholders have the right to remove Trustees by an affirmative vote of two-
thirds of the outstanding shares. A special meeting of the shareholders will be
held when 10% of the outstanding shares request a meeting for the purpose of
removing a Trustee. The Fund is prepared to assist shareholders in
communications with one another for the purpose of convening such a meeting as
prescribed by Section 16(c) of the 1940 Act.
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ADDITIONAL INFORMATION
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KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519, is a
wholly-owned subsidiary of Keystone and serves as the Fund's transfer agent and
dividend disbursing agent.
When the Fund determines from its records that more than one account in the
Fund is registered in the name of a shareholder or shareholders having the same
address, upon written notice to those shareholders, the Fund intends, when an
annual report or semi-annual report of the Fund is required to be furnished, to
mail one copy of such report to that address.
Except as otherwise stated in this prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in this prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
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ADDITIONAL INVESTMENT INFORMATION
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DESCRIPTIONS OF CERTAIN TYPES OF INVESTMENTS AND
INVESTMENT TECHNIQUES AVAILABLE TO THE FUND
The Fund may engage in the following investment practices to the extent
described in the prospectus and the statement of additional information.
OBLIGATIONS OF FOREIGN BRANCHES OF UNITED STATES BANKS
The obligations of foreign branches of U.S. banks may be general obligations
of the parent bank in addition to the issuing branch or may be limited by the
terms of a specific obligation and by government regulation. Payment of interest
and principal upon these obligations may also be affected by governmental action
in the country of domicile of the branch (generally referred to as sovereign
risk). In addition, evidences of ownership of such securities may be held
outside the U.S., and the Fund may be subject to the risks associated with the
holding of such property overseas. Examples of governmental actions would be the
imposition of currency controls, interest limitations, withholding taxes,
seizure of assets or the declaration of a moratorium. Various provisions of
federal law governing domestic branches do not apply to foreign branches of
domestic banks.
OBLIGATIONS OF UNITED STATES BRANCHES OF FOREIGN BANKS
Obligations of U.S. branches of foreign banks may be general obligations of
the parent bank in addition to the issuing branch or may be limited by the terms
of a specific obligation and by federal and state regulation as well as by
governmental action in the country in which the foreign bank has its head
office. In addition, there may be less publicly available information about a
U.S. branch of a foreign bank than about a domestic bank.
MASTER DEMAND NOTES
Master demand notes are unsecured obligations that permit the investment of
fluctuating amounts by the Fund at varying rates of interest pursuant to direct
arrangements between the Fund as lender and the issuer as borrower. The Fund has
the right to increase the amount under the note at any time up to the full
amount provided by the note agreement or to decrease the amount. The borrower
may repay up to the full amount of the note without penalty. Notes acquired by
the Fund permit the Fund to demand payment of principal and accrued interest at
any time (on not more than seven days' notice). Notes acquired by the Fund may
have maturities of more than one year, provided that (1) the Fund is entitled to
payment of principal and accrued interest upon not more than seven days' notice,
and (2) the rate of interest on such notes is adjusted automatically at periodic
intervals which normally will not exceed 31 days, but may extend up to one year.
The notes will be deemed to have a maturity equal to the longer of the period
remaining to the next interest rate adjustment or the demand notice period.
Because these types of notes are direct lending arrangements between the lender
and borrower, such instruments are not normally traded, and there is no
secondary market for these notes, although they are redeemable and thus
repayable by the borrower at face value plus accrued interest at any time.
Accordingly, the Fund's right to redeem is dependent on the ability of the
borrower to pay principal and interest on demand. In connection with master
demand notes arrangements, Keystone considers, under standards established by
the Board of Trustees, earning power, cash flow and other liquidity ratios of
the borrower and will monitor the ability of the borrower to pay principal and
interest on demand. These notes are not typically rated by credit rating
agencies. Unless rated, the Fund will invest in them only if at the time of an
investment the issuer meets the criteria established for commercial paper
discussed in the statement of additional information, which limit such
investments to commercial paper rated A-1 by S&P, Prime-1 by Moody's and F-1 by
Fitch Investors Service, Inc.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the Federal
Reserve System having at least $1 billion in assets, primary dealers in U.S.
government securities or other financial institutions believed by Keystone to be
credit-worthy. Such persons must be registered as U.S. government securities
dealers with an appropriate regulatory organization. Under such agreements, the
bank, primary dealer or other financial institution agrees, upon entering into
the contract, to repurchase the security at a mutually agreed upon date and
price, thereby determining the yield during the term of the agreement. This
results in a fixed rate of return insulated from market fluctuations during such
period. Under a repurchase agreement, the seller must maintain the value of the
securities subject to the agreement at not less than the repurchase price, such
value being determined on a daily basis by marking the underlying securities to
their market value. Although the securities subject to the repurchase agreement
might bear maturities exceeding a year, the Fund only intends to enter into
repurchase agreements that provide for settlement within a year and usually
within seven days. Securities subject to repurchase agreements will be held by
the Fund's custodian or in the Federal Reserve book entry system. The Fund does
not bear the risk of a decline in the value of the underlying security unless
the seller defaults under its repurchase obligation. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, the Fund
could experience both delays in liquidating the underlying securities and
losses, including (1) possible declines in the value of the underlying
securities during the period while the Fund seeks to enforce its rights thereto;
(2) possible subnormal levels of income and lack of access to income during this
period; and (3) expenses of enforcing its rights. The Board of Trustees of the
Fund has established procedures to evaluate the creditworthiness of each party
with whom the Fund enters into repurchase agreements by setting guidelines and
standards of review for Keystone and monitoring Keystone's actions with regard
to repurchase agreements.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, the Fund would sell securities and agree
to repurchase them at a mutually agreed upon date and price. The Fund intends to
enter into reverse repurchase agreements to avoid otherwise having to sell
securities during unfavorable market conditions in order to meet redemptions. At
the time the Fund enters into a reverse repurchase agreement, it will establish
a segregated account with the Fund's custodian containing liquid assets having a
value not less than the repurchase price (including accrued interest) and will
subsequently monitor the account to ensure such value is maintained. Reverse
repurchase agreements involve the risk that the market value of the securities
the Fund is obligated to repurchase may decline below the repurchase price.
Borrowing and reverse repurchase agreements magnify the potential for gain or
loss on the portfolio securities of the Fund and, therefore, increase the
possibility of fluctuation in the Fund's net asset value. Such practices may
constitute leveraging. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, such buyer or
its trustee or receiver may receive an extension of time to determine whether to
enforce the Fund's obligation to repurchase the securities, and the Fund's use
of the proceeds of the reverse repurchase agreement may effectively be
restricted pending such determination. The staff of the Securities and Exchange
Commission has taken the position that the 1940 Act treats reverse repurchase
agreements as being included in the percentage limit on borrowings imposed on a
fund.
"WHEN ISSUED" AND "FORWARD COMMITMENT" TRANSACTIONS
The Fund may also purchase securities and currencies on a when issued and
delayed delivery basis and may purchase or sell securities on a forward
commitment basis. When issued or delayed delivery transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future in order to secure what is considered to be an advantageous
price and yield to the Fund at the time of purchase. A forward commitment
transaction is an agreement by the Fund to purchase or sell securities at a
specified future date. The Fund may also enter into foreign currency forward
contracts which are described in more detail herein in the section entitled
"Foreign Currency Transactions." When the Fund engages in these transactions,
the Fund relies on the buyer or seller, as the case may be, to consummate the
sale. Failure to do so may result in the Fund missing the opportunity to obtain
a price or yield considered to be advantageous. When issued, delayed delivery
and forward commitment transactions may be expected to occur a month or more
before delivery is due. No payment or delivery is made by the Fund, however,
until it receives payment or delivery from the other party to the transaction.
The Securities and Exchange Commission has established certain requirements to
assure that the Fund is able to meet its obligations under these contracts; for
example, a separate account of liquid assets equal to the value of such purchase
commitments may be maintained until payment is made. When issued, delayed
delivery and forward commitment transactions are subject to risks from changes
in value based upon changes in the level of interest rates, currency rates and
other market factors, both before and after delivery. The Fund does not accrue
any income on such securities or currencies prior to their delivery. To the
extent the Fund engages in any of these transactions, it will do so consistent
with its investment objective and policies and not for the purpose of investment
leverage. The Fund currently does not intend to invest more than 5% of its
assets in when issued or delayed delivery transactions.
FOREIGN SECURITIES
The Fund may invest up to 25% of its assets in securities principally traded
in securities markets outside the U.S. While investment in foreign securities is
intended to reduce risk by providing further diversification, such investments
involve sovereign risk in addition to the credit and market risks normally
associated with domestic securities. Foreign investments may be affected
favorably or unfavorably by changes in currency rates and exchange control
regulations. There may be less publicly available information about a foreign
company, particularly emerging market countries companies, than about a U.S.
company, and foreign companies may not be subject to accounting, auditing and
financial reporting standards and requirements comparable to those applicable to
U.S. companies. Securities of some foreign companies are less liquid or more
volatile than securities of U.S. companies, and foreign brokerage commissions
and custodian fees are generally higher than in the United States. Investments
in foreign securities may also be subject to other risks different from those
affecting U.S. investments, including local political or economic developments,
expropriation or nationalization of assets, imposition of withholding taxes on
dividend or interest payments and currency blockage (which would prevent cash
from being brought back to the U.S.). These risks are carefully considered by
Keystone prior to the purchase of these securities.
LOANS OF SECURITIES TO BROKER-DEALERS
The Fund may lend securities to brokers and dealers pursuant to agreements
requiring that the loans be continuously secured by cash or securities of the
U.S. government, its agencies or instrumentalities, or any combination of cash
and such securities, as collateral equal at all times in value to at least the
market value of the securities loaned. Such securities loans will not be made
with respect to the Fund if as a result the aggregate of all outstanding
securities loans exceeds 15% of the value of the Fund's total assets taken at
their current value. The Fund continues to receive interest or dividends on the
securities loaned and simultaneously earns interest on the investment of the
cash loan collateral in U.S. Treasury notes, certificates of deposit, other
high-grade, short-term obligations or interest bearing cash equivalents.
Although voting rights attendant to securities loaned pass to the borrower, such
loans may be called at any time and will be called so that the securities may be
voted by the Fund if, in the opinion of the Fund, a material event affecting the
investment is to occur. There may be risks of delay in receiving additional
collateral or in recovering the securities loaned or even loss of rights in the
collateral should the borrower of the securities fail financially. Loans may be
made, however, to borrowers deemed to be of good standing, under standards
approved by the Board of Trustees, when the income to be earned from the loan
justifies the attendant risks.
DERIVATIVES
The Fund may only use derivatives in a manner consistent with its investment
objective. Derivatives are financial contracts whose value depends on, or is
derived from, the value of an underlying asset, reference rate or index. These
assets, rates, and indices may include bonds, stocks, mortgages, commodities,
interest rates, currency exchange rates, bond indices and stock indices.
Derivatives can be used to earn income or protect against risk, or both. For
example, one party with unwanted risk may agree to pass that risk to another
party who is willing to accept the risk, the second party being motivated, for
example, by the desire either to earn income in the form of a fee or premium
from the first party, or to reduce its own unwanted risk by attempting to pass
all or part of that risk to the first party.
Derivatives can be used by investors such as the Fund to earn income and
enhance returns, to hedge or adjust the risk profile of the portfolio, and
either in place of more traditional direct investments or to obtain exposure to
otherwise inaccessible markets. The use of derivatives for non-hedging purposes
entails greater risks than if derivatives were used solely for hedging purposes.
The Fund uses futures contracts and related options as well as forwards for
hedging purposes. Derivatives are a valuable tool, which, when used properly,
can provide significant benefit to Fund shareholders. With respect to the Fund,
Keystone does not currently intend to aggressively use derivatives. The Fund may
take positions in those derivatives that are within its investment policies if,
in Keystone's judgement, this represents an effective response to current or
anticipated market conditions. Keystone's use of derivatives is subject to
continuous risk assessment and control from the standpoint of the Fund's
investment objective and policies.
Derivatives may be (1) standardized, exchange-traded contracts or (2)
customized, privately negotiated contracts. Exchange-traded derivatives tend to
be more liquid and subject to less credit risk than those that are privately
negotiated.
There are four principal types of derivative instruments--options, futures,
forwards and swaps--from which virtually any type of derivative transaction can
be created. Further information regarding options, futures, forwards and swaps
is provided later in this section and is provided in the Fund's statement of
additional information.
Debt instruments that incorporate one or more of these building blocks for the
purpose of determining the principal amount of and/or rate of interest payable
on the debt instruments are often referred to as "structured securities." An
example of this type of structured security is indexed commercial paper. The
term is also used to describe certain securities issued in connection with the
restructuring of certain foreign obligations. See "Indexed Commercial Paper" and
"Structured Securities" below. The term "derivative" is also sometimes used to
describe securities involving rights to a portion of the cash flows from an
underlying pool of mortgages or other assets from which payments are passed
through to the owner of, or that collateralize, the securities. See "Mortgage
Related Securities," "Collateralized Mortgage Obligations," "Adjustable Rate
Mortgage Securities," "Stripped Mortgage Securities," "Mortgage Securities -
Special Considerations," and "Other Asset-Backed Securities" and the Fund's
statement of additional information.
While the judicious use of derivatives by experienced investment managers such
as Keystone can be beneficial, derivatives also involve risks different from,
and, in certain cases, greater than, the risks presented by more traditional
investments. Following is a general discussion of important risk factors and
issues concerning the use of derivatives that investors should understand before
investing in the Fund.
* Market Risk - This is the general risk attendant to all investments that the
value of a particular investment will decline or otherwise change in a way
detrimental to the Fund's interest.
* Management Risk - Derivative products are highly specialized instruments that
require investment techniques and risk analyses different from those
associated with stocks and bonds. The use of a derivative requires an
understanding not only of the underlying instrument, but also of the
derivative itself, without the benefit of observing the performance of the
derivative under all possible market conditions. In particular, the use and
complexity of derivatives require the maintenance of adequate controls to
monitor the transactions entered into, the ability to assess the risk that a
derivative adds to the Fund's portfolio and the ability to forecast price,
interest rate or currency exchange rate movements correctly.
* Credit Risk - This is the risk that a loss may be sustained by the Fund as a
result of the failure of another party to a derivative (usually referred to as
a "counterparty") to comply with the terms of the derivative contract. The
credit risk for exchange-traded derivatives is generally less than for
privately negotiated derivatives, since the clearing house, which is the
issuer or counterparty to each exchange-traded derivative, provides a
guarantee of performance. This guarantee is supported by a daily payment
system (i.e., margin requirements) operated by the clearing house in order to
reduce overall credit risk. For privately negotiated derivatives, there is no
similar clearing agency guarantee. Therefore, the Fund considers the
creditworthiness of each counterparty to a privately negotiated derivative in
evaluating potential credit risk.
* Liquidity Risk - Liquidity risk exists when a particular instrument is
difficult to purchase or sell. If a derivative transaction is particularly
large or if the relevant market is illiquid (as is the case with many
privately negotiated derivatives), it may not be possible to initiate a
transaction or liquidate a position at an advantageous price.
* Leverage Risk - Since many derivatives have a leverage component, adverse
changes in the value or level of the underlying asset, rate or index can
result in a loss substantially greater than the amount invested in the
derivative itself. In the case of swaps, the risk of loss generally is related
to a notional principal amount, even if the parties have not made any initial
investment. Certain derivatives have the potential for unlimited loss,
regardless of the size of the initial investment.
* Other Risks - Other risks in using derivatives include the risk of mispricing
or improper valuation and the inability of derivatives to correlate perfectly
with underlying assets, rates and indices. Many derivatives, in particular
privately negotiated derivatives, are complex and often valued subjectively.
Improper valuations can result in increased cash payment requirements to
counterparties or a loss of value to the Fund. Derivatives do not always
perfectly or even highly correlate or track the value of the assets, rates or
indices they are designed to closely track. Consequently, the Fund's use of
derivatives may not always be an effective means of, and sometimes could be
counterproductive to, furthering the Fund's investment objective.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS. The Fund may write (i.e., sell) covered call and put
options. By writing a call option, the Fund becomes obligated during the term of
the option to deliver the securities underlying the option upon payment of the
exercise price. By writing a put option, the Fund becomes obligated during the
term of the option to purchase the securities underlying the option at the
exercise price if the option is exercised. The Fund also may write straddles
(combinations of covered puts and calls on the same underlying security).
The Fund may only write "covered" options. This means that so long as the Fund
is obligated as the writer of a call option it will own the underlying
securities subject to the option or, in the case of call options on U.S.
Treasury bills, the Fund might own substantially similar U.S. Treasury bills. If
the Fund has written options against all of its securities that are available
for writing options, the Fund may be unable to write additional options unless
it sells a portion of its portfolio holdings to obtain new securities against
which it can write options. If this were to occur, higher portfolio turnover and
correspondingly greater brokerage commissions and other transaction costs may
result. The Fund does not expect, however, that this will occur.
The Fund will be considered "covered" with respect to a put option it writes
if, so long as it is obligated as the writer of the put option, it deposits and
maintains with its custodian in a segregated account liquid assets having a
value equal to or greater than the exercise price of the option.
The principal reason for writing call or put options is to obtain, through a
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. The Fund receives a premium from writing a call or
put option, which it retains whether or not the option is exercised. By writing
a call option, the Fund might lose the potential for gain on the underlying
security while the option is open, and, by writing a put option, the Fund might
become obligated to purchase the underlying security for more than its current
market price upon exercise.
PURCHASING OPTIONS. The Fund may purchase put or call options, including put
or call options for the purpose of offsetting previously written put or call
options of the same series.
If the Fund is unable to effect a closing purchase transaction with respect to
covered options it has written, the Fund will not be able to sell the underlying
securities or dispose of assets held in a segregated account until the options
expire or are exercised.
An option position may be closed out only in a secondary market for an option
of the same series. Although the Fund generally will write only those options
for which there appears to be an active secondary market, there is no assurance
that a liquid secondary market will exist for any particular option at any
particular time, and, for some options, no secondary market may exist. In such
event, it might not be possible to effect a closing transaction in a particular
option.
Options on some securities are relatively new, and it is impossible to predict
the amount of trading interest that will exist in such options. There can be no
assurance that viable markets will develop or continue. The failure of such
markets to develop or continue could significantly impair the Fund's ability to
use such options to achieve its investment objective.
OPTIONS TRADING MARKETS. Options in which the Fund will trade are generally
listed on national securities exchanges. Exchanges on which such options
currently are traded include the Chicago Board Options Exchange and the New
York, American, Pacific and Philadelphia Stock Exchanges. Options on some
securities may not be listed on any exchange, but traded in the over-the-counter
market. Options traded in the over-the-counter market involve the additional
risk that securities dealers participating in such transactions could fail to
meet their obligations to the Fund. The use of options traded in the
over-the-counter market may be subject to limitations imposed by certain state
securities authorities. In addition to the limits on its use of options
discussed herein, the Fund is subject to the investment restrictions described
in this prospectus and in the statement of additional information.
The staff of the Securities and Exchange Commission is of the view that the
premiums that the Fund pays for the purchase of unlisted options and the value
of securities used to cover unlisted options written by the Fund are considered
to be invested in illiquid securities or assets for the purpose of calculating
whether the Fund is in compliance with its policies on illiquid securities.
FUTURES TRANSACTIONS
The Fund may enter into currency and other financial futures contracts and
write options on such contracts. The Fund intends to enter into such contracts
and related options for hedging purposes. The Fund will enter into securities,
currency or index-based futures contracts in order to hedge against changes in
interest or exchange rates or securities prices. A futures contract on
securities or currencies is an agreement to buy or sell securities or currencies
at a specified price during a designated month. A futures contract on a
securities index does not involve the actual delivery of securities, but merely
requires the payment of a cash settlement based on changes in the securities
index. The Fund does not make payment or deliver securities upon entering into a
futures contract. Instead, it puts down a margin deposit, which is adjusted to
reflect changes in the value of the contract and which continues until the
contract is terminated.
The Fund may sell or purchase futures contracts. When a futures contract is
sold by the Fund, the value of the contract will tend to rise when the value of
the underlying securities or currencies declines and to fall when the value of
such securities or currencies increases. Thus, the Fund sells futures contracts
in order to offset a possible decline in the value of its securities or
currencies. If a futures contract is purchased by the Fund, the value of the
contract will tend to rise when the value of the underlying securities or
currencies increases and to fall when the value of such securities or currencies
declines. The Fund intends to purchase futures contracts in order to fix what is
believed by Keystone to be a favorable price and rate of return for securities
or favorable exchange rate for currencies the Fund intends to purchase.
The Fund also intends to purchase put and call options on futures contracts
for hedging purposes. A put option purchased by the Fund would give it the right
to assume a position as the seller of a futures contract. A call option
purchased by the Fund would give it the right to assume a position as the
purchaser of a futures contract. The purchase of an option on a futures contract
requires the Fund to pay a premium. In exchange for the premium, the Fund
becomes entitled to exercise the benefits, if any, provided by the futures
contract, but is not required to take any action under the contract. If the
option cannot be exercised profitably before it expires, the Fund's loss will be
limited to the amount of the premium and any transaction costs.
The Fund may enter into closing purchase and sale transactions in order to
terminate a futures contract and may sell put and call options for the purpose
of closing out its options positions. The Fund's ability to enter into closing
transactions depends on the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. As a result, there can be no
assurance that the Fund will be able to enter into an offsetting transaction
with respect to a particular contract at a particular time. If the Fund is not
able to enter into an offsetting transaction, the Fund will continue to be
required to maintain the margin deposits on the contract and to complete the
contract according to its terms, in which case, it would continue to bear market
risk on the transaction.
Although futures and related options transactions are intended to enable the
Fund to manage market, interest rate or exchange rate risk, unanticipated
changes in interest rates, exchange rates or market prices could result in
poorer performance than if it had not entered into these transactions. Even if
Keystone correctly predicts interest or exchange rate movements, a hedge could
be unsuccessful if changes in the value of the Fund's futures position did not
correspond to changes in the value of its investments. This lack of correlation
between the Fund's futures and securities or currencies positions may be caused
by differences between the futures and securities or currencies markets or by
differences between the securities or currencies underlying the Fund's futures
position and the securities or currencies held by or to be purchased for the
Fund. Keystone will attempt to minimize these risks through careful selection
and monitoring of the Fund's futures and options positions.
The Fund does not intend to use futures transactions for speculation or
leverage. The Fund has the ability to write options on futures, but intends to
write such options only to close out options purchased by the Fund. The Fund
will not change these policies without supplementing the information in its
prospectus and statement of additional information.
FOREIGN CURRENCY TRANSACTIONS
As discussed above, the Fund may invest in securities of foreign issuers. When
the Fund invests in foreign securities, they usually will be denominated in
foreign currencies, and the Fund temporarily may hold funds in foreign
currencies. Thus, the value of Fund shares will be affected by changes in
exchange rates.
As one way of managing exchange rate risk, in addition to entering into
currency futures contracts, the Fund may enter into forward currency exchange
contracts (agreements to purchase or sell currencies at a specified price and
date). The exchange rate for the transaction (the amount of currency the Fund
will deliver or receive when the contract is completed) is fixed when the Fund
enters into the contract. The Fund usually will enter into these contracts to
stabilize the U.S. dollar value of a security it has agreed to buy or sell. The
Fund intends to use these contracts to hedge the U.S. dollar value of a security
it already owns, particularly if the Fund expects a decrease in the value of the
currency in which the foreign security is denominated. Although the Fund will
attempt to benefit from using forward contracts, the success of its hedging
strategy will depend on Keystone's ability to predict accurately the future
exchange rates between foreign currencies and the U.S. dollar. The value of the
Fund's investments denominated in foreign currencies will depend on the relative
strength of those currencies and the U.S. dollar, and the Fund may be affected
favorably or unfavorably by changes in the exchange rates or exchange control
regulations between foreign currencies and the dollar. Changes in foreign
currency exchange rates also may affect the value of dividends and interest
earned, gains and losses realized on the sale of securities and net investment
income and gains, if any, to be distributed to shareholders by the Fund.
Although the Fund does not currently intend to do so, the Fund may also purchase
and sell options related to foreign currencies. The Fund does not intend to
enter into foreign currency transactions for speculation or leverage.
INTEREST RATE TRANSACTIONS (SWAPS, CAPS AND FLOORS). If the Fund enters into
interest rate swap, cap or floor transactions, it expects to do so primarily for
hedging purposes, which may include preserving a return or spread on a
particular investment or portion of its portfolio or protecting against an
increase in the price of securities the Fund anticipates purchasing at a later
date. The Fund does not currently intend to use these transactions in a
speculative manner.
Interest rate swaps involve the exchange by the Fund with another party of
their respective commitments to pay or receive interest (e.g., an exchange of
floating rate payments for fixed rate payments). Interest rate caps and floors
are similar to options in that the purchase of an interest rate cap or floor
entitles the purchaser, to the extent that a specified index exceeds (in the
case of a cap) or falls below (in the case of a floor) a predetermined interest
rate, to receive payments of interest on a contractually-based principal
("notional") amount from the party selling the interest rate cap or floor. The
Fund may enter into interest rate swaps, caps and floors on either an
asset-based or liability-based basis, depending upon whether it is hedging its
assets or liabilities, and will usually enter into interest rate swaps on a net
basis (i.e., the two payment streams are netted out, with the Fund receiving or
paying, as the case may be, only the net amount of the two payments).
The swap market has grown substantially in recent years, with a large number
of banks and investment banking firms acting as principals and as agents
utilizing standardized swap documentation. As a result, the swap market has
become more established and relatively liquid. Caps and floors are less liquid
than swaps. These transactions also involve the delivery of securities or other
underlying assets and principal. Accordingly, the risk of loss to the Fund from
interest rate transactions is limited to the net amount of interest payments
that the Fund is contractually obligated to make.
INDEXED COMMERCIAL PAPER. Indexed commercial paper may have its principal
linked to changes in foreign currency exchange rates whereby its principal
amount is adjusted upwards or downwards (but not below zero) at maturity to
reflect changes in the referenced exchange rate. If permitted by its investment
policies, the Fund will purchase such commercial paper with the currency in
which it is denominated and, at maturity, will receive interest and principal
payments thereon in that currency, but the amount of principal payable by the
issuer at maturity will change in proportion to the change (if any) in the
exchange rate between the two specified currencies between the date the
instrument is issued and the date the instrument matures. While such commercial
paper entails the risk of loss of principal, the potential for realizing gains
as a result of changes in foreign currency exchange rates enables the Fund to
hedge (or cross-hedge) against a decline in the U.S. dollar value of investments
denominated in foreign currencies while providing an attractive money market
rate of return.
MORTGAGE-RELATED SECURITIES. The mortgage-related securities in which the Fund
may invest typically are securities representing interests in pools of mortgage
loans made to home owners. Mortgage-related securities bear interest at either a
fixed rate or an adjustable rate determined by reference to an index rate. The
mortgage loan pools may be assembled for sale to investors (such as the Fund) by
governmental or private organizations. Mortgage-related securities issued by the
Government National Mortgage Association ("GNMA") are backed by the full faith
and credit of the U.S. government; those issued by Federal National Mortgage
Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC") are
not so backed.
Securities representing interests in pools created by private issuers
generally offer a higher rate of interest than securities representing interests
in pools created by governmental issuers because there are no direct or indirect
governmental guarantees of the underlying mortgage payments. However, private
issuers sometimes obtain committed loan facilities, lines of credit, letters of
credit, surety bonds or other forms of liquidity and credit enhancement to
support the timely payment of interest and principal with respect to their
securities if the borrowers on the underlying mortgages fail to make their
mortgage payments. The ratings of such non-governmental securities are generally
dependent upon the ratings of the providers of such liquidity and credit support
and would be adversely affected if the rating of such an enhancer were
downgraded. The Fund may buy mortgage-related securities without credit
enhancement if the securities meet the Fund's investment standards. Although the
market for mortgage-related securities is becoming increasingly liquid, those of
certain private organizations may not be readily marketable.
One type of mortgage-related security is of the "pass-through" variety. The
holder of a pass-through security is considered to own an undivided beneficial
interest in the underlying pool of mortgage loans and receives a pro rata share
of the monthly payments made by the borrowers on their mortgage loans, net of
any fees paid to the issuer or guarantor of the securities. Prepayments of
mortgages resulting from the sale, refinancing or foreclosure of the underlying
properties are also paid to the holders of these securities. Some
mortgage-related securities, such as securities issued by GNMA, are referred to
as "modified pass-through" securities. The holders of these securities are
entitled to the full and timely payment of principal and interest, net of
certain fees, regardless of whether payments are actually made on the underlying
mortgages. Another form of mortgage-related security is a "pay- through"
security, which is a debt obligation of the issuer secured by a pool of mortgage
loans pledged as collateral that is legally required to be paid by the issuer
regardless of whether payments are actually made on the underlying mortgages.
COLLATERALIZED MORTGAGE OBLIGATIONS. ("CMOs") are the predominant type of
"pay-through" mortgage-related security. CMOs are designed to reduce the risk of
prepayment for investors by issuing multiple classes of securities, each having
different maturities, interest rates and payment schedules, and with the
principal and interest on the underlying mortgages allocated among the several
classes in various ways. The collateral securing the CMOs may consist of a pool
of mortgages, but may also consist of mortgage-backed bonds or pass-through
securities. CMOs may be issued by a U.S. government instrumentality or agency or
by a private issuer. Although payment of the principal of, and interest on, the
underlying collateral securing privately issued CMOs may be guaranteed by GNMA,
FNMA or FHLMC, these CMOs represent obligations solely of the private issuer and
are not insured or guaranteed by GNMA, FNMA, FHLMC, any other governmental
agency or any other person or entity.
INVERSE FLOATING RATE COLLATERALIZED MORTGAGE OBLIGATIONS. In addition to
investing in fixed rate and adjustable rate CMOs, if consistent with its
investment objective, the Fund may also invest in CMOs with rates that move
inversely to market rates ("inverse floaters").
An inverse floater bears an interest rate that resets in the opposite
direction of the change in a specified interest rate index. As market interest
rates rise, the interest rate on the inverse floater goes down, and vice versa.
Inverse floaters tend to exhibit greater price volatility than fixed-rate bonds
of similar maturity and credit quality. The interest rates on inverse floaters
may be significantly reduced, even to zero, if interest rates rise. Moreover,
the secondary market for inverse floaters may be limited in rising interest rate
environments.
ADJUSTABLE RATE MORTGAGE SECURITIES. Another type of mortgage-related security,
known as adjustable-rate mortgage securities ("ARMS"), bears interest at a rate
determined by reference to a predetermined interest rate or index. There are two
main categories of rates or indices: (1) rates based on the yield on U.S.
Treasury securities and (2) indices derived from a calculated measure such as a
cost of funds index or a moving average of mortgage rates. Some rates and
indices closely mirror changes in market interest rate levels, while others tend
to lag changes in market rate levels and tend to be somewhat less volatile.
ARMS may be secured by adjustable-rate mortgages or fixed-rate mortgages. ARMS
secured by fixed-rate mortgages generally have lifetime caps on the coupon rates
of the securities. To the extent that general interest rates increase faster
than the interest rates on the ARMS, these ARMS will decline in value. The
adjustable-rate mortgages that secure ARMS will frequently have caps that limit
the maximum amount by which the interest rate or the monthly principal and
interest payments on the mortgages may increase. These payment caps can result
in negative amortization (i.e., an increase in the balance of the mortgage
loan). Furthermore, since many adjustable-rate mortgages only reset on an annual
basis, the values of ARMS tend to fluctuate to the extent that changes in
prevailing interest rates are not immediately reflected in the interest rates
payable on the underlying adjustable-rate mortgages.
STRIPPED MORTGAGE SECURITIES. Stripped mortgage-related securities ("SMRS") are
mortgage-related securities that are usually structured with two classes of
securities collateralized by a pool of mortgages or a pool of mortgaged-backed
bonds or pass-through securities, with each class receiving different
proportions of the principal and interest payments from the underlying assets. A
common type of SMRS has one class of interest-only securities ("IOs") receiving
all of the interest payments from the underlying assets, while the other class
of securities, principal-only securities ("POs"), receives all of the principal
payments from the underlying assets. IOs and POs are extremely sensitive to
interest rate changes and are more volatile than mortgage-related securities
that are not stripped. IOs tend to decrease in value as interest rates decrease,
while POs generally increase in value as interest rates decrease. If prepayments
of the underlying mortgages are greater than anticipated, the amount of interest
earned on the overall pool will decrease due to the decreasing principal balance
of the assets. Changes in the values of IOs and POs can be substantial and occur
quickly, such as occurred in the first half of 1994 when the value of many POs
dropped precipitously due to increase in interest rates. For this reason the
Fund does not rely on IOs and POs as the principal means of furthering its
investment objective.
MORTGAGE-RELATED SECURITIES -- SPECIAL CONSIDERATIONS. The value of
mortgage-related securities is affected by a number of factors. Unlike
traditional debt securities, which have fixed maturity dates, mortgage-related
securities may be paid earlier than expected as a result of prepayment of the
underlying mortgages. If property owners make unscheduled prepayments of their
mortgage loans, these prepayments will result in the early payment of the
applicable mortgage-related securities. In that event the Fund may be unable to
invest the proceeds from the early payment of the mortgage-related securities in
an investment that provides as high a yield as the mortgage-related securities.
Consequently, early payment associated with mortgage-related securities causes
these securities to experience significantly greater price and yield volatility
than experienced by traditional fixed-income securities. The occurrence of
mortgage prepayments is affected by the level of general interest rates, general
economic conditions and other social and demographic factors. During periods of
falling interest rates, the rate of mortgage prepayments tends to increase,
thereby tending to decrease the life of mortgage-related securities. During
periods of rising interest rates, the rate of mortgage prepayments usually
decreases, thereby tending to increase the life of mortgage-related securities.
If the life of a mortgage-related security is inaccurately predicted, the Fund
may not be able to realize the rate of return it expected.
As with fixed-income securities generally, the value of mortgage-related
securities can also be adversely affected by increases in general interest rates
relative to the yield provided by such securities. Such adverse effect is
especially possible with fixed-rate mortgage securities. If the yield available
on other investments rises above the yield of the fixed-rate mortgage securities
as a result of general increases in interest rate levels, the value of the
mortgage-related securities will decline. Although the negative effect could be
lessened if the mortgage-related securities were to be paid earlier (thus
permitting the Fund to reinvest the prepayment proceeds in investments yielding
the higher current interest rate), as described above the rate of mortgage
prepayments and earlier payment of mortgage-related securities generally tends
to decline during a period of rising interest rates.
Although the value of ARMS may not be affected by rising interest rates as
much as the value of fixed-rate mortgage securities is affected by rising
interest rates, ARMS may still decline in value as a result of rising interest
rates. Although, as described above, the yield on ARMS varies with changes in
the applicable interest rate or index, there is often a lag between increases in
general interest rates and increases in the yield on ARMS as a result of
relatively infrequent interest rate reset dates. In addition, adjustable-rate
mortgages and ARMS often have interest rate or payment caps that limit the
ability of the adjustable-rate mortgages or ARMS to fully reflect increases in
the general level of interest rates.
OTHER ASSET-BACKED SECURITIES. The securitization techniques used to develop
mortgage-related securities are being applied to a broad range of financial
assets. Through the use of trusts and special purpose corporations, various
types of assets, including automobile loans and leases, credit card receivables,
home equity loans, equipment leases and trade receivables, are being securitized
in structures similar to the structures used in mortgage securitizations. These
asset-backed securities are subject to risks associated with changes in interest
rates and prepayment of underlying obligations similar to the risks of
investment in mortgage-related securities discussed above.
Each type of asset-backed security also entails unique risks depending on the
type of assets involved and the legal structure used. For example, credit card
receivables are generally unsecured obligations of the credit card holder and
the debtors are entitled to the protection of a number of state and federal
consumer credit laws, many of which give such debtors the right to set off
certain amounts owed on the credit cards, thereby reducing the balance due.
There have also been proposals to cap the interest rate that a credit card
issuer may charge. In some transactions, the value of the asset-backed security
is dependent on the performance of a third party acting as credit enhancer or
servicer. Furthermore, in some transactions (such as those involving the
securitization of vehicle loans or leases) it may be administratively burdensome
to perfect the interest of the security issuer in the underlying collateral and
the underlying collateral may become damaged or stolen.
VARIABLE, FLOATING AND LEVERAGED INVERSE FLOATING RATE INSTRUMENTS. Fixed-
income securities may have fixed, variable or floating rates of interest.
Variable and floating rate securities pay interest at rates that are adjusted
periodically, according to a specified formula. A "variable" interest rate
adjusts at predetermined intervals (e.g., daily, weekly or monthly), while a
"floating" interest rate adjusts whenever a specified benchmark rate (such as
the bank prime lending rate) changes.
If permitted by its investment policies, the Fund may invest in fixed-income
securities that pay interest at a coupon rate equal to a base rate, plus
additional interest for a certain period of time if short-term interest rates
rise above a predetermined level or "cap." The amount of such an additional
interest payment typically is calculated under a formula based on a short-term
interest rate index multiplied by a designated factor.
An inverse floater may be considered to be leveraged to the extent that its
interest rate varies by a magnitude that exceeds the magnitude of the change in
the index rate of interest. The higher degree of leverage inherent in inverse
floaters is associated with greater volatility in market value.
STRUCTURED SECURITIES. Structured securities represent interests in entities
organized and operated solely for the purpose of restructuring the investment
characteristics of sovereign debt obligations or foreign government securities.
This type of restructuring involves the deposit with or purchase by an entity,
such as a corporation or trust, of specified instruments (such as commercial
bank loans or Brady Bonds) and the issuance by that entity of one or more
classes of structured securities backed by, or representing interests in, the
underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued structured securities to create securities
with different investment characteristics such as varying maturities, payment
priorities and interest rate provisions, and the extent of the payments made
with respect to structured securities is dependent on the extent of the cash
flow on the underlying instruments. Because structured securities typically
involve no credit enhancement, their credit risk generally will be equivalent to
that of the underlying instruments. Structured securities of a given class may
be either subordinated or unsubordinated to the right of payment of another
class. Subordinated structured securities typically have higher yields and
present greater risks than unsubordinated structured securities.
<PAGE>
READ CAREFULLY BEFORE FILLING OUT APPLICATION.
APPLICATION INFORMATION
Keystone offers a wide variety of options to help you manage your investments
quickly and effortlessly. Please be sure to indicate only the services you
desire.
Automatic investments and redemptions are normally processed through Electronic
Funds Transfer if your bank participates in the Automated Clearing House. If
your bank does not have Electronic Funds Transfer, your investments or
redemptions can be handled by check. Electronic Funds Transfer is generally
faster than issuing checks which may result in delays. For you own protection,
you may wish to inquire about your bank's standard procedures.
For the protection of shareholders, regardless of the number of shares or
amounts of money involved in a redemption or repurchase, signatures on
certificates, stock powers and all written orders or authorizations must be
guaranteed by a U.S. stock exchange member, a bank or other persons eligible to
guarantee signatures under the Securities Exchange Act of 1934 and KIRCOs
policies. KIRC may waive this requirement but may also require additional
documents in certain cases.
APPLICATION Keystone Custodian Funds
_______________________________________________________________________________
Mail application and check(s) to Keystone Investor Resource Center, Inc.
P.O. Box 2121, Boston, MA 02106-9970
_______________________________________________________________________________
INTERNAL USE ONLY
_______________________________________________________________________________
Account Number
_______________________ _______________________ _______________________
DN AT SC
A. FUND SELECTION
Initial Minimum $1,000 Except: Keystone Tax Exempt Trust $10,000.
Make checks payable to fund(s) selected.
(44) Series B-1 $______________ (49) Series S-1 $______________
(45) Series B-2 $______________ (50) Series S-3 $______________
(46) Series B-4 $______________ (51) Series S-4 $______________
(47) Series K-1 $______________ (52) Keystone
(48) Series K-2 $______________ International $______________
(54) Keystone (30) Keystone Tax
Precious Metals Exempt Trust $______________
Holdings $______________ Other $______________
_______________________________________________________________________________
B. YOUR INVESTMENT DEALER
_______________________________________________________________________________
Broker/Dealer Firm Name
_______________________________________________________________________________
Branch Location and Number
_______________________________________________________________________________
Last Name First Name Rep #
(____________)_________________________________________________________________
Area Code Telephone
_______________________________________________________________________________
Investor's account # (if any) with dealer's firm
<PAGE>
_______________________________________________________________________________
C. SHAREHOLDER REGISTRATION (please print)
Individual_____________________________________________________________________
First Name Middle Initial Last Name Social Security #
Joint Tenant___________________________________________________________________
First Name Middle Initial Last Name Social Security #
Other__________________________________________________________________________
Name of Corporation, Organization, Fiduciary Taxpayer I.D. #
If trust give date of trust agreement:____________________
Uniform Gifts to Minors Act____________________________________________________
Custodian's Name
Uniform Transfers to Minors Act________________________________________________
Custodian's Name
As Custodian for__________________________________ Under the_______________ Act
Minor's Name Social Security # State
_______________________________________________________________________________
Street Address City State 9-digit Zip Code
Daytime Telephone ( )_________________________________________________
Area Code
NOTE: See reverse side for important tax information.
( ) Check here if any owner is a citizen or resident of the U.S.
( ) Check here if any owner is a foreign person not subject to U.S. tax
reporting requirements. _____________________________
Indicate Country
_______________________________________________________________________________
D. DISTRIBUTIONS
Check appropriate box. If no choice indicated, all distributions will be
reinvested.
( ) Reinvest all income dividends and capital gains distributions in
additional shares.
( ) Pay all income dividends in cash; reinvest capital gains distributions.
( ) Pay all income dividends and capital gains distributions in cash.
( ) Invest all distributions in another Keystone Fund.
_______________________________________________________________________________
Designate Fund Name
_______________________________________________________________________________
E. OPTIONAL SERVICES
Check appropriate box(es). Please read "Application Information" on front.
1. TELEPHONE EXCHANGES 1-800-343-2898
( ) Subject to Prospectus provisions, I authorize Keystone to accept my
telephone instructions to exchange my shares in any fund in the Keystone
Custodian Family of Funds for shares of another fund in the Keystone
Custodian Family of Funds. There is a $10.00 fee for each exchange;
however, if the exchange is made through KARL by an individual investor
there is no fee.
( ) Subject to Prospectus provisions, I authorize Keystone to accept
telephone instructions from my financial adviser of record to exchange my
shares in any fund in the Keystone Custodian Family of Funds for shares
of another fund in the Keystone Custodian Family of Funds. There is a
$10.00 fee for each exchange.
Please refer to the Prospectus for a more complete description of
telephone privileges.
2. ( ) TELEPHONE REDEMPTIONS 1-800-343-2898
Subject to Prospectus provisions, I authorize Keystone to accept my
telephone instructions to redeem up to $50,000 (minimum $1,000) from my
account. Only shares on deposit with Keystone can be redeemed by
telephone. Redemptions by telephone are allowed only if the address and
bank account of record have been the same for a minimum period of 30
days. Please provide bank information in Section F at left.
Please refer to the Prospectus for a more complete description of
telephone privileges.
<PAGE>
3. ( ) AUTOMATIC INVESTMENT PLAN I authorize $_____________ ($100 minimum)
amount
to be automatically invested in_______________________ on the ( ) 5th or
name of fund
( )20th day of each month.
Please allow up to 30 days after application is received to begin this
service. Provide bank information in Section F at left.
4. ( ) AUTOMATIC WITHDRAWAL PLAN ( ) MONTHLY OR ( ) QUARTERLY I authorize
Keystone to withdraw $_____________________ (min. $100 to max. 1% per
month or 3% per quarter of account assets) from my account on the first
day of each period, beginning ___________________________ 1st, 19___, and
month
and to send the amount as follows:
(check one)
( ) Deposit directly to my bank account shown in Section F at left.
( ) Mail a check to the registered shareholder's address.
( ) Mail check to other payee:__________________________________________
Payee Name
________________________________________________________________________
Street Address City State 9-Digit Zip Code
Please allow up to 30 days after application is received to begin this service.
Please provide bank information in Section F, at left.
________________________________________________________________________________
F. BANK INFORMATION
For Optional Services 2, 3 and 4.
If you elected to have funds deposited to or withdrawn from your bank, please
attach a voided check or preprinted deposit slip for your bank account. Your
Keystone account and your bank account must have one name in common.
________________________________________________________________________________
Name of Bank
________________________________________________________________________________
Bank Address
________________________________________________________________________________
Name on Bank Account
________________________________________________________________________________
Bank Account Number
IMPORTANT: KEYSTONE PRESENTLY DOES NOT CHARGE FOR ELECTRONIC BANKING TRANSFERS.
SOME BANKS, HOWEVER, MAY CHARGE FOR THESE SERVICES.
________________________________________________________________________________
G. SIGNATURES AND AUTHORIZATIONS
Under penalties of perjury, you, the undersigned, certify that the number shown
above is your correct taxpayer identification number and that you are not
subject to backup withholding unless you have checked a box below.
( ) Check here if you are subject to backup withholding under the provisions
of the Internal Revenue Code Section 3406(a)(1)(C).
( ) Check here if you do not have a Social Security or Taxpayer I.D. number
but have applied for one. Your signature on this application serves to
certify this, and that you understand that if you do not provide a number
within 60 days, Keystone is required by law to withhold 31% of all your
dividends, capital gains, redemptions, exchanges, and certain other
payments. If by setting up your account without a properly certified Social
Security or Taxpayer Identification Number Keystone incurs a penalty fine,
we reserve the right to deduct such an amount from your account.
<PAGE>
APPLICANT(S) SIGNATURE
I (we) am (are) of legal age and have read the prospectus(es) and agree to the
terms. I/we authorize Keystone to provide information over the telephone to any
person identifying him/herself as the registered shareholder or the
shareholder's representative and understand that all telephone conversations may
be recorded. IMPORTANT: If I (we) have elected any of the optional exchange,
redemption, automatic investment or automatic withdrawal services described
above: (i) I (we) hereby ratify any instructions received by Keystone in writing
and I (we) agree that neither the Fund, KIRC nor KDI will be held responsible
for the authenticity of such instructions; (ii) I (we) agree that neither the
Fund, KIRC nor KDI will be held liable when following instructions received over
KARL or by telephone which are reasonably believed to be genuine; and (iii) I
(we) understand, that if such reasonable procedures are not followed, the Fund,
KIRC or KDI may be liable for any losses due to unauthorized or fraudulent
instructions.
________________________________________________________________________________
Signature Date
________________________________________________________________________________
Signature Date
IMPORTANT TAX NOTICE
BACKUP WITHHOLDING INFORMATION
________________________________________________________________________________
Federal tax law requires us to obtain your certification that:
1. The taxpayer identification number you provide is correct, and
2. That you are not subject to backup withholding. (For most individuals, the
taxpayer identification number is the Social Security Number.)
Nonresident aliens must certify that they qualify as foreign persons, exempt
from U.S. tax reporting requirements. On joint accounts where an owner is a U.S.
citizen or resident, that owner must certify that the taxpayer identification
number provided is correct and is not subject to backup withholding.
Certification of foreign status must be filed every three years.
If you do not provide us with the above information on the application, we are
required by law to withhold 31% of all your dividends, capital gains,
redemptions, exchanges and certain other payments.
The following are the other conditions under which you will be subject to backup
withholding:
1. If you have received a notice from the Internal Revenue Service that you
provided an incorrect taxpayer identification number.
2. If you have received a notice from the Internal Revenue Service that you
underreported interest or dividend payments or did not file a return
reporting such payments.
DO NOT CHECK THE BOX INDICATING THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING
UNLESS YOU HAVE RECEIVED A NOTICE FROM THE INTERNAL REVENUE SERVICE.
If you fall within one of the following categories, you are exempt from backup
withholding on ALL payments and should NOT check the box:
* CORPORATION * FINANCIAL INSTITUTION * REGISTERED SECURITIES DEALER * COMMON
TRUST FUND * COLLEGE, CHURCH OR CHARITABLE ORGANIZATION * RETIREMENT PLAN *
OTHER ENTITY LISTED IN INTERNAL REVENUE CODE SEC. 3452.
For further details, refer to Internal Revenue Service Form W-9.
KEYSTONE CUSTODIAN
FAMILY OF FUNDS
B-1 High Grade Bond Fund
B-2 Diversified Bond Fund
B-4 High Income Bond Fund
K-1 Balanced Income Fund
K-2 Strategic Growth Fund
S-1 Blue Chip Stock Fund
S-3 Capital Growth Fund
S-4 Small Company Growth Fund
International Fund
Precious Metals Holdings
Tax Free Fund
Tax Exempt Trust
Liquid Trust
KEYSTONE
Distributors, Inc.
200 Berkeley Street
Boston, Massachusetts 02116-5034
KEYSTONE
B-1 HIGH GRADE
BOND FUND
PROSPECTUS AND
APPLICATION
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE CUSTODIAN FUND, SERIES B-1
High Grade Bond Fund
February 28, 1995
This statement of additional information is not a prospectus but
relates to, and should be read in conjunction with, the prospectus of
Keystone Custodian Fund, Series B-1 (the "Fund") dated February 28,
1995. A copy of the prospectus may be obtained from Keystone
Distributors, Inc.("KDI"), the Fund's principal underwriter
("Principal Underwriter"), 200 Berkeley Street, Boston, Massachusetts
02116-5034 or your broker-dealer.
TABLE OF CONTENTS
Page
The Fund's Objective and Policies 2
Investment Restrictions 2
Valuation of Securities 4
Distributions and Taxes 5
Sales Charges 6
Distribution Plan 8
Redemptions in Kind 10
The Trust Agreement 10
Investment Manager 12
Investment Adviser 15
Trustees and Officers 16
Principal Underwriter 20
Brokerage 21
Standardized Total Return
and Yield Quotations 23
Additional Information 24
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-12
<PAGE>
THE FUND'S OBJECTIVE AND POLICIES
The Fund is an open-end, diversified management investment
company. The Fund's investment objective is to provide
shareholders with the highest possible income consistent with
preservation of principal. The Fund invests primarily in high and
good grade bonds and short-term money market instruments at such
times and in such proportions as seem appropriate to best achieve
this objective. Bonds will include obligations of the United
States ("U.S.") government or its agencies and other bond issues of
high or good grade including high grade municipal bonds. Such
bonds possess a high degree of dependability of interest payments
with price action affected almost exclusively by the trend and
level of money rates.
The Fund invests primarily in the securities of domestic
companies, but on October 31, 1994 it also owned foreign securities
equal to approximately 5% of its net assets.
INVESTMENT RESTRICTIONS
None of the restrictions enumerated in this paragraph may be
changed without a vote of the holders of a majority, as defined in
the Investment Company Act of 1940 (the "1940 Act"), of the Fund's
outstanding shares. The Fund shall not do any of the following:
(1) invest more than 5% of its total assets, computed at
market value, in the securities of any one issuer, other than
securities issued or guaranteed by the U.S. government, its
agencies or instrumentalities;
(2) invest in more than 10% of any class of securities of any
one issuer, other than securities issued or guaranteed by the U.S.
government, its agencies or instrumentalities;
(3) invest more than 5% of the value of its total assets in
companies which have been in operation for less than three years;
(4) borrow money, except that the Fund may (a) borrow money
from banks for temporary or emergency purposes in aggregate amounts
up to 10% of the value of the Fund's net assets (computed at cost),
or (b) enter into reverse repurchase agreements, provided that bank
borrowings and reverse repurchase agreements, in aggregate, shall
not exceed 10% of the value of the Fund's net assets;
(5) underwrite securities, except that the Fund may purchase
securities from issuers thereof or others and dispose of such
securities in a manner consistent with its other investment
policies; in the disposition of restricted securities the Fund may
be deemed to be an underwriter, as defined in the Securities Act of
1933 (the "1933 Act");
(6) purchase or sell real estate or interests in real estate,
except that it may purchase and sell securities secured by real
estate and securities of companies which invest in real estate, and
will not purchase or sell commodities or commodity contracts,
except that the Fund may engage in currency or other financial
futures contracts and related options transactions;
(7) invest for the primary purpose of exercising control over
or management of any one issuer;
(8) make margin purchases or short sales of securities;
(9) make loans, except that the Fund may purchase money
market securities, enter into repurchase agreements, buy publicly
and privately distributed debt securities and lend limited amounts
of its portfolio securities to broker-dealers; all such investments
must be consistent with the Fund's investment objective and
policies;
(10) invest more than 25% of its assets in the securities of
issuers in any single industry other than securities issued by
banks and savings and loan associations or securities issued or
guaranteed by the U.S. government, its agencies or
instrumentalities; and
(11) purchase the securities of any other investment company
except in the open market and at customary brokerage rates and in
no event more than 3% of the voting securities of any investment
company.
If a percentage limit is satisfied at the time of investment
or borrowing, a later increase or decrease resulting from a change
in the value of a security or a decrease in Fund assets is not a
violation of the limit.
Although not fundamental restrictions or policies requiring a
shareholders' vote to change, the Fund has undertaken to a state
securities authority that, so long as the state authority requires
and shares of the Fund are registered for sale in that state, the
Fund will (1) limit its purchase of warrants to 5% of net assets,
of which 2% may be warrants not listed on the New York or American
Stock Exchange; (2) not invest in real estate limited partnership
interests; and (3) not invest in oil, gas or other mineral leases.
Additional restrictions adopted by the Fund, which may be
changed by the Board of Trustees, provide that the Fund may not
purchase or retain securities of an issuer if, to the knowledge of
the Fund, any officer, Trustee or Director of the Fund, Keystone
Management, Inc. ("Keystone Management") or Keystone Custodian
Funds, Inc. ("Keystone"), each owning beneficially more than 1/2 of
1% of the securities of such issuer, own in the aggregate more than
5% of the securities of such issuer, or such persons or management
personnel of the Fund, Keystone Management or Keystone have a
substantial beneficial interest in the securities of such issuer.
Portfolio securities of the Fund may not be purchased from or sold
or loaned to Keystone Management, Keystone or any affiliate thereof
or any of their Directors, officers or employees.
The Fund has no current intention of attempting to increase
its net income by borrowing and intends to repay any borrowings
made in accordance with the fourth investment restriction
enumerated above before it makes any additional investments.
In order to permit the sale of Fund shares in certain states,
the Fund may make commitments more restrictive than the investment
restrictions described above. Should the Fund determine that any
such commitment is no longer in the best interests of the Fund, it
will revoke the commitment by terminating sales of its shares in
the state involved.
The Fund intends to follow policies of the Securities and
Exchange Commission as they are adopted from time to time with
respect to illiquid securities, including, at this time (1)
treating as illiquid, securities which may not be sold or disposed
of in the ordinary course of business within seven days at
approximately the value at which the Fund has valued the investment
on its books; and (2) limiting its holdings of such securities to
15% of net assets.
VALUATION OF SECURITIES
Current value for the Fund's portfolio securities is
determined in the following manner:
Securities traded on the established exchanges are valued on
the basis of the last sales price on the exchange where the
securities are primarily traded prior to the time of the valuation.
Securities traded in the over-the-counter market, for which
complete quotations are readily available, are valued at the mean
of the bid and asked prices at the time of valuation. Money market
instruments that are purchased with maturities of sixty days or
less are valued at amortized cost (original purchase cost as
adjusted for amortization of premium or accretion of discount),
which, when combined with accrued interest, approximates market;
money market instruments maturing in more than sixty days for which
market quotations are readily available are valued at market value;
and money market instruments maturing in more than sixty days when
purchased that are held on the sixtieth day prior to maturity are
valued at amortized cost (market value on the sixtieth day adjusted
for amortization of premium or accretion of discount), which, when
combined with accrued interest, approximates market and in any case
reflects fair value as determined by the Fund's Board of Trustees.
The Board of Trustees values the following at prices it deems
in good faith to be fair: (1) securities, including restricted
securities, for which complete quotations are not readily
available, (2) listed securities if in the Fund's opinion the last
sales price does not reflect a current market value or if no sale
occurred, and (3) other assets.
The Fund believes that reliable market quotations are
generally not readily available for purposes of valuing fixed
income securities. As a result, depending on the particular
securities owned by the Fund, it is likely that most of the
valuations for such securities will be based upon their fair value
determined under procedures that have been approved by the Fund's
Board of Trustees. The Fund's Board of Trustees has authorized the
use of a pricing service to determine the fair value of the Fund's
fixed income securities and certain other securities. Securities
for which market quotations are readily available are valued on a
consistent basis at that price quoted that, in the opinion of the
Board of Trustees or the person designated by the Board of Trustees
to make the determination, most nearly represents the market value
of the particular security. Any securities for which market
quotations are not readily available or other assets are valued on
a consistent basis at fair value as determined in good faith using
methods prescribed by the Board of Trustees.
DISTRIBUTIONS AND TAXES
The Fund ordinarily distributes its net capital gains in
shares of the Fund or, at the option of the shareholder, in cash.
All shareholders may reinvest dividends without being subject to a
deferred sales charge when shares so purchased are redeemed.
Shareholders who have opted prior to the record date to receive
shares with regard to capital gains and/or income distributions
will have the number of such shares determined on the basis of the
share value computed at the end of the day on the record date after
adjustment for the distribution. Net asset value is used in
computing the appropriate number of shares in both a capital gains
distribution and an income distribution reinvestment. Account
statements and/or checks as appropriate will be mailed to
shareholders by the 15th of the appropriate month. Unless the Fund
receives instructions to the contrary from a shareholder before the
record date, it will assume that the shareholder wishes to receive
both capital gains distributions and income distributions in
shares. Instructions continue in effect until changed in writing.
The Fund's income distributions are largely derived from
interest on bonds and thus are not to any significant degree
eligible in whole or in part for the corporate 70% dividends
received deduction. Distributed long-term capital gains are
taxable as such to the shareholder whether received in cash or in
additional Fund shares and regardless of the period of time Fund
shares have been held by the shareholder. Distributions designated
by the Fund as capital gains dividends are not eligible for the 70%
corporate dividends received deduction. If the net asset value of
shares was reduced below a shareholder's cost by distribution of
capital gains realized on sales of securities, such distribution to
the extent of the reduction would be a return of investment though
taxable as stated above. Since distributions of capital gains
depend upon securities profits actually realized, they may or may
not occur. The foregoing comments relating to the taxation of
dividends and distributions paid on the Fund's shares relate solely
to federal income taxation and such dividends and distributions may
also be subject to state and local taxes.
When the Fund makes a distribution on behalf of the Fund, it
intends to distribute only the Fund's net capital gains and such
income as has been predetermined to the best of the Fund's ability
to be taxable as ordinary income. Therefore, net investment income
distributions will not be made on the basis of distributable income
as computed on the books of the Fund, but will be made on a federal
income tax basis. Shareholders of the Fund will be advised
annually of the federal tax status of distributions.
SALES CHARGES
In order to reimburse the Fund for certain expenses relating
to the sale of its shares (see "Distribution Plan"), a deferred
sales charge may be imposed at the time of redemption of certain
Fund shares within four calendar years after their purchase. If
imposed, the deferred sales charge is deducted from the redemption
proceeds otherwise payable to the shareholder. Since July 8, 1992,
the deferred sales charge attributable to shares purchased prior to
January 1, 1992 has been retained by the Fund, and the deferred
sales charge attributable to shares purchased after January 1, 1992
is, to the extent permitted by the National Association of
Securities Dealers, Inc. ("NASD"), paid to KDI. For the fiscal
year ended October 31, 1994 the Fund recovered $98,756 in deferred
sales charges.
The contingent deferred sales charge is a declining percentage
of the lesser of (1) the net asset value of the shares redeemed or
(2) the total cost of such shares. No deferred sales charge is
imposed when the shareholder redeems amounts derived from (1)
increases in the value of his account above the total cost of such
shares due to increases in the net asset value per share of the
Fund; or (2) certain shares with respect to which the Fund did not
pay a commission on issuance, including shares acquired through
reinvestment of dividend income and capital gains distributions; or
(3) shares held in all or part of more than four consecutive
calendar years.
Subject to the limitations stated above, the Fund imposes the
deferred sales charge according to the following schedule: 4% of
amounts redeemed during the calendar year of purchase; 3% of
amounts redeemed during the calendar year after the year of
purchase; 2% of amounts redeemed during the second calendar year
after the year of purchase; and 1% of amounts redeemed during the
third calendar year after the year of purchase. No deferred sales
charge is imposed on amounts redeemed thereafter.
The following example illustrates the operation of the
contingent deferred sales charge. Assume that an investor makes a
purchase payment of $10,000 during the calendar year 1994 and on a
given date in 1995 the value of the investor's account has grown
through investment performance and reinvestment of distributions to
$12,000. On such date in 1995, the investor could redeem up to
$2,000 ($12,000 minus $10,000) without incurring a deferred sales
charge. If, on such date, the investor should redeem $3,000, a
deferred sales charge would be imposed on $1,000 of the redemption
(the amount by which the investor's account was reduced by the
redemption below the amount of the initial purchase payment). The
charge would be imposed at the rate of 3% (because the redemption
is made during the calendar year after the calendar year of
purchase) and would total $30.
In determining whether a contingent deferred sales charge is
payable and, if so, the percentage charge applicable, it is assumed
that shares held the longest are the first to be redeemed. There
is no deferred sales charge on permitted exchanges of shares
between Keystone funds that have adopted Distribution Plans
pursuant to Rule 12b-1 under the 1940 Act. Moreover, when shares
of one such fund have been exchanged for shares of another such
fund, for purposes of any future contingent deferred sales charge,
the calendar year of the purchase of the shares of the fund
exchanged into is assumed to be the year shares tendered for
exchange were originally purchased.
Shares also may be sold, to the extent permitted by applicable
law, regulations, interpretations or exemptions, at net asset value
without the imposition of a deferred sales charge upon redemption
of shares by (1) officers, Directors, Trustees, full-time employees
and sales representatives of Keystone Management, Keystone,
Keystone Group, Inc. ("Keystone Group"), Harbor Capital Management
Company, Inc., their subsidiaries and KDI who have been such for
not less than ninety days; and (2) the pension and profit-sharing
plans established by said companies, their subsidiaries and
affiliates, for the benefit of their officers, Directors, Trustees,
full-time employees and sales representatives, provided all such
sales are made upon the written assurance of the purchaser that the
purchase is made for investment purposes and that the securities
will not be resold except through redemption by the Fund.
In addition, no deferred sales charge is imposed on a
redemption of shares of the Fund purchased by a bank or trust
company in a single account in the name of such bank or trust
company as trustee if the initial investment in shares of the Fund,
any other Keystone Custodian Fund, Keystone Precious Metals
Holdings, Inc., Keystone International Fund Inc., Keystone Tax
Exempt Trust, Keystone Tax Free Fund, Keystone Liquid Trust and/or
any Keystone America Fund is at least $500,000 and any commission
paid by the Fund and such other funds at the time of such purchase
is not more than 1% of the amount invested.
DISTRIBUTION PLAN
Rule 12b-1 under the 1940 Act permits investment companies,
such as the Fund, to use their assets to bear expenses of
distributing their shares if they comply with various conditions,
including adoption of a distribution plan containing certain
provisions set forth in Rule 12b-1. The Fund bears some of the
costs of selling its shares under a Distribution Plan adopted on
June 1, 1983 pursuant to Rule 12b-1.
The Fund's Distribution Plan provides that the Fund may expend
up to 0.3125% quarterly (approximately 1.25% annually) of average
daily net asset value of its shares to pay distribution costs for
sales of its shares and to pay shareholder service fees. The NASD
limits such annual expenditures to 1%, of which 0.75% may be used
to pay such distribution costs and 0.25% may be used to pay
shareholder service fees. The aggregate amount that the Fund may
pay for such distribution costs is limited to 6.25% of gross share
sales since the inception of the Fund's Distribution Plan plus
interest at the prime rate plus 1% on unpaid amounts thereof (less
any contingent deferred sales charge paid by shareholders to KDI).
Amounts paid under the Distribution Plan are paid to the Fund's
Principal Underwriter, currently KDI, (1) as commissions for Fund
shares sold under the Distribution Plan, all or any part of which
commissions may be reallowed by KDI to others for selling the Fund
shares, and (2) to enable KDI to pay such others shareholder service
fees in respect of shares maintained by such recipients outstanding on
the Fund's books for specified periods. Amounts paid or accrued to KDI
under (1) and (2) in the aggregate may not exceed the annual
limitation referred to above. From the amounts received by KDI in
connection with the Distribution Plan, and subject to the limitations
discussed above, KDI generally pays brokers or others a commission
equal to 4% of the price paid to the Fund for each sale of Fund shares
as well as a shareholder service fee at a rate of 0.25% per annum of
the net asset value of shares maintained by such brokers or others
outstanding on the books of the Fund for specified periods.
If the Fund is unable to pay KDI a commission on a new sale
because the annual maximum (0.75% of average daily net assets) has
been reached, KDI intends, but is not obligated, to continue to accept
new orders for the purchase of Fund shares and to pay commissions and
service fees to dealers in excess of the amount it currently receives
from the Fund. While the Fund is under no contractual obligation to
pay KDI such amounts that exceed the Distribution Plan limitation, KDI
intends to seek full payment of such amounts from the Fund (together
with interest at the rate of prime plus one percent) at such time in
the future as, and to the extent that, payment thereof by the Fund
would be within permitted limits. KDI currently intends to seek
payment of interest only on such charges paid or accrued by KDI
subsequent to July 7, 1992. If the Fund's Independent Trustees
("Independent Trustees") authorize such payments, the effect will be
to extend the period of time during which the Fund incurs the maximum
amount of costs allowed by the Distribution Plan. If the Distribution
Plan is terminated, KDI will ask the Independent Trustees to take
whatever action they deem appropriate under the circumstances with
respect to payment of such amounts.
The total amounts paid by the Fund under the foregoing
arrangements may not exceed the maximum Distribution Plan limit
specified above, and the amounts and purposes of expenditures under
the Distribution Plan must be reported to the Fund's Rule 12b-1
Trustees ("Rule 12b-1 Trustees") quarterly. The Fund's Rule 12b-1
Trustees may require or approve changes in the implementation or
operation of the Distribution Plan and may require that total
expenditures by the Fund under the Distribution Plan be kept within
limits lower than the maximum amount permitted by the Distribution
Plan as stated above. If such costs are not limited by the
Independent Trustees, such costs could, for some period of time, be
higher than such costs permitted by most other plans presently
adopted by other investment companies.
The Distribution Plan may be terminated at any time by vote of
the Rule 12b-1 Trustees, or by vote of a majority of the
outstanding voting securities of the Fund. Any change in the
Distribution Plan that would materially increase the distribution
expenses of the Fund provided for in the Distribution Plan requires
shareholder approval. Otherwise the Distribution Plan may be
amended by the Trustees, including the Rule 12b-1 Trustees.
While the Distribution Plan is in effect, the Fund is required
to commit the selection and nomination of candidates for
Independent Trustees to the discretion of the Independent Trustees.
For the fiscal year ended October 31, 1994, the Fund paid KDI
$3,868,521 under the Distribution Plan. During said year, KDI
received $1,856,670 after payments of commissions on new sales and
service fees to dealers and others of $2,011,851.
Whether any expenditure under the Plan is subject to a state
expense limit will depend upon the nature of the expenditure and
the terms of the state law, regulation or order imposing the limit.
A portion of the Fund's Distribution Plan expenses may be
includable in the Fund's total operating expenses for purposes of
determining compliance with state expense limits.
The Independent Trustees of the Fund have determined that the
sales of the Fund's shares resulting from payments under the
Distribution Plan have benefited the Fund.
REDEMPTIONS IN KIND
If conditions arise that would make it undesirable for the
Fund to pay for all redemptions in cash, the Fund's Board of
Trustees may authorize payment to be made in portfolio securities
or other Fund property. The Fund has obligated itself, however,
under the 1940 Act to redeem for cash all shares presented for
redemption by any one shareholder in any 90-day period up to the
lesser of $250,000 or 1% of the Fund's net assets. Securities
delivered in payment of redemptions would be valued at the same
value assigned to them in computing the net asset value per share.
Shareholders receiving such securities would incur brokerage costs
when these securities are sold.
THE TRUST AGREEMENT
Trust Agreement
The Fund is a Pennsylvania common law trust established under
a Trust Agreement dated July 15, 1935, as amended and restated on
December 19, 1989 (the "Restatement"). The Restatement
restructured the Fund so that its operation would be substantially
similar to that of most other mutual funds. The Restatement
provides for a Board of Trustees and enables the Fund to enter into
an agreement with an investment manager and/or adviser to provide
the Fund with investment advisory, management and administrative
services. A copy of the Restatement is filed as an exhibit to the
Fund's Registration Statement, of which this statement of
additional information is a part. This summary is qualified in its
entirety by reference to the Restatement.
Description of Shares
The Restatement authorizes the issuance of an unlimited number
of shares of beneficial interest and the creation of additional
series and/or classes of series of Fund shares. Each share
represents an equal proportionate interest in the Fund with each
other share of that class. Upon liquidation, shares are entitled
to a pro rata share in the net assets of their class of Fund
shares. Shareholders shall have no preemptive or conversion
rights. Shares are transferable. The Fund currently intends to
issue only one class of shares.
Shareholder Liability
Pursuant to court decisions or other theories of law,
shareholders of the Fund, a Pennsylvania common law trust, could
possibly be personally liable for the obligations of the Fund. The
possibility of Fund shareholders incurring financial loss under
such circumstances appears to be remote, however, because the
Restatement (1) contains an express disclaimer of shareholder
liability for obligations of the Fund; (2) requires that notice of
such disclaimer be given in each agreement, obligation or
instrument entered into or executed by the Fund or the Trustees;
and (3) provides for indemnification out of Fund property for any
shareholder held personally liable for the obligations of the Fund.
Voting Rights
Under the terms of the Restatement, the Fund does not hold
annual meetings. However, at meetings called for the initial
election of Trustees or to consider other matters, shares are
entitled to one vote per share. Shares generally vote together as
one class on all matters. No amendment may be made to the
Restatement, however, that adversely affects any class of shares
without the approval of a majority of the shares of that class.
There shall be no cumulative voting in the election of Trustees.
After a meeting as described above, no further meetings of
shareholders for the purpose of electing Trustees will be held,
unless required by law until such time as less than a majority of
the Trustees holding office have been elected by shareholders, at
which time the Trustees then in office will call a shareholders'
meeting for the election of Trustees.
Except as set forth above, the Trustees shall continue to hold
office indefinitely unless otherwise required by law and may
appoint successor Trustees. A Trustee may cease to hold office or
may be removed from office (as the case may be) (1) at any time by
a two-thirds vote of the remaining Trustees; (2) when such Trustee
becomes mentally or physically incapacitated; or (3) at a special
meeting of shareholders by a two-thirds vote of the outstanding
shares. Any Trustee may voluntarily resign from office.
Limitation of Trustees' Liability
The Restatement provides that a Trustee shall be liable only
for his own willful defaults and, if reasonable care has been
exercised in the selection of officers, agents, employees or
investment advisers, shall not be liable for any neglect or
wrongdoing of any such person; provided, however, that nothing in
the Restatement shall protect a Trustee against any liability for
his willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties.
The Trustees have absolute and exclusive control over the
management and disposition of all assets of the Fund and may
perform such acts as in their sole judgment and discretion are
necessary and proper for conducting the business and affairs of the
Fund or promoting the interests of the Fund and the shareholders.
INVESTMENT MANAGER
Subject to the general supervision of the Fund's Board of
Trustees, Keystone Management, located at 200 Berkeley Street,
Boston, Massachusetts 02116-5034, serves as investment manager to
the Fund and is responsible for the overall management of the
Fund's business and affairs. Keystone Management, organized in
1989, is a wholly-owned subsidiary of Keystone and its directors
and principal executive officers have been affiliated with
Keystone, a seasoned investment adviser, for a number of years.
Keystone Management also serves as investment manager to each of
the other Keystone Custodian Funds and to certain other
funds in the Keystone Group of Mutual Funds.
Except as otherwise noted below, pursuant to an Investment
Management Agreement with the Fund ("Management Agreement") and
subject to the supervision of the Fund's Board of Trustees,
Keystone Management manages and administers the operation of the
Fund and manages the investment and reinvestment of the Fund's
assets in conformity with the Fund's investment objectives and
restrictions. The Management Agreement stipulates that Keystone
Management shall provide office space, all necessary office
facilities, equipment and personnel in connection with its services
and pay or reimburse the Fund for the compensation of Fund officers
and Trustees who are affiliated with the investment manager as well
as pay all expenses of Keystone Management incurred in connection
with the provisions of its services. All charges and expenses
other than those specifically referred to as being borne by
Keystone Management will be paid by the Fund, including, but not
limited to, custodian charges and expenses, bookkeeping and
auditors' charges and expenses; transfer agent charges and
expenses; fees of Independent Trustees; brokerage commissions,
brokers' fees and expenses; issue and transfer taxes; costs and
expenses under the Distribution Plan; taxes and trust fees payable
to governmental agencies; the cost of share certificates; fees and
expenses of the registration and qualification of the Fund and its
shares with the Securities and Exchange Commission (sometimes
referred to herein as the "SEC" or the "Commission") or under state
or other securities laws; expenses of preparing, printing and
mailing prospectuses, statements of additional information,
notices, reports and proxy materials to shareholders of the Fund;
expenses of shareholders' and Trustees' meetings; charges and
expenses of legal counsel for the Fund and for the Trustees of the
Fund on matters relating to the Fund; charges and expenses of
filing annual and other reports with the SEC and other authorities;
and all extraordinary charges and expenses of the Fund.
The Management Agreement permits Keystone Management to enter
into an agreement with Keystone or another investment adviser,
under which Keystone or such other investment adviser, as
investment adviser, will provide substantially all the services to
be provided by Keystone Management under the Management Agreement.
The Management Agreement also permits Keystone Management to
delegate to Keystone or another investment adviser substantially
all of the investment manager's rights, duties and obligations
under the Management Agreement. Services performed by Keystone
Management include (1) performing research and planning with
respect to (a) the Fund's qualification as a regulated investment
company under Subchapter M of the Internal Revenue Code, (b) tax
treatment of the Fund's portfolio investments, (c) tax treatment of
special corporate actions (such as reorganizations), (d) state tax
matters affecting the Fund, and (e) the Fund's distributions of
income and capital gains; (2) preparing the Fund's federal and
state tax returns; (3) providing services to the Fund's
shareholders in connection with federal and state taxation and
distributions of income and capital gains; and (4) storing
documents relating to the Fund's activities.
The Fund pays Keystone Management a fee for its services at
the annual rate of:
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Annual Aggregate Net Asset
Management Value of the Shares
Fee Income of the Fund
2% of
Gross Dividend and Interest
Income Plus
0.50% of the first $ 100,000,000 plus
0.45% of the next $ 100,000,000 plus
0.40% of the next $ 100,000,000 plus
0.35% of the next $ 100,000,000 plus
0.30% of the next $ 100,000,000 plus
0.25% of amounts over $ 500,000,000;
computed as of the close of business each business day and paid
daily.
The Fund is subject to certain state annual expense
limitations, the most restrictive of which is as follows:
2.5% of the first $30 million of Fund average net assets;
2.0% of the next $70 million of Fund average net assets; and
1.5% of Fund average net assets over $100 million.
Capital charges and certain expenses, including a portion of
the Fund's Distribution Plan expenses, are not included in the
calculation of the state expense limitation. This limitation may
be modified or eliminated in the future.
As a continuing condition of registration of shares in a
state, Keystone Management has agreed to reimburse the Fund
annually for certain operating expenses incurred by the Fund in
excess of certain percentages of the Fund's average daily net
assets. Keystone Management is not required, however, to make such
reimbursements to the extent it would result in the Fund's
inability to qualify as a regulated investment company under
provisions of the Internal Revenue Code. This condition may be
modified or eliminated in the future.
The Management Agreement will continue in effect from year to
year only if approved at least annually by the Fund's Board of
Trustees or by a vote of a majority of the outstanding shares, and
such renewal has been approved by the vote of a majority of the
Independent Trustees cast in person at a meeting called for the
purpose of voting on such approval. The Management Agreement may
be terminated, without penalty, on 60 days' written notice by the
Fund's Board of Trustees or by a vote of a majority of outstanding
shares. The Management Agreement will terminate automatically upon
its "assignment" as that term is defined in the 1940 Act.
For additional discussion of fees paid to Keystone Management,
see "Investment Adviser" below.
INVESTMENT ADVISER
Pursuant to its Management Agreement with the Fund, Keystone
Management has delegated its investment management functions,
except for certain administrative and management services, to
Keystone and has entered into an Investment Advisory Agreement
("Advisory Agreement") with Keystone under which Keystone
provides investment advisory and management services to the Fund.
Keystone, located at 200 Berkeley Street, Boston,
Massachusetts 02116-5034, has provided investment advisory and
management services to investment companies and private accounts
since it was organized in 1932. Keystone is a wholly-owned
subsidiary of Keystone Group, located at 200 Berkeley Street,
Boston, Massachusetts 02116-5034.
Keystone Group is a corporation predominately owned by current
and former members of management and employees of Keystone and its
affiliates. The shares of Keystone Group common stock beneficially
owned by management are held in a number of voting trusts, the
trustees of which are George S. Bissell, Albert H. Elfner, III,
Roger T. Wickers, Edward F. Godfrey and Ralph J. Spuehler, Jr.
Keystone Group provides accounting, bookkeeping, legal, personnel
and general corporate services to Keystone Management, Keystone,
their affiliates and the Keystone Group of Mutual Funds.
Pursuant to the Advisory Agreement, Keystone receives for its
services an annual fee representing 85% of the management fee
received by Keystone Management under its Management Agreement with
the Fund.
Pursuant to its Advisory Agreement with Keystone Management, and
subject to the supervision of the Fund's Board of Trustees, Keystone
manages and administers the Fund's operation, and manages the
investment and reinvestment of the Fund's assets in conformity with
the Fund's investment objectives and restrictions. The Advisory
Agreement stipulates that Keystone shall provide office space, all
necessary office facilities, equipment and personnel in connection
with its services and pay or reimburse the Fund for the compensation
of Fund officers and Trustees who are affiliated with the investment
adviser as well as pay all expenses of Keystone incurred in connection
with the provision of its services. All charges and expenses other
than those specifically referred to as being borne by Keystone will be
paid by the Fund, including, but not limited to, custodian charges and
expenses; bookkeeping and auditors' charges and expenses; transfer
agent charges and expenses; fees of Independent Trustees; brokerage
commissions, brokers' fees and expenses; issue and transfer taxes;
costs and expenses under the Distribution Plan; taxes and trust fees
payable to governmental agencies; the cost of share certificates; fees
and expenses of the registration and qualification of the Fund and its
shares with the SEC or under state or other securities laws; expenses
of preparing, printing and mailing prospectuses, statements of
additional information, notices, reports and proxy materials to
shareholders of the Fund; expenses of shareholders' and Trustees'
meetings; charges and expenses of legal counsel for the Fund and for
the Trustees of the Fund on matters relating to the Fund; charges and
expenses of filing annual and other reports with the SEC and other
authorities; and all extraordinary charges and expenses of the Fund.
During the fiscal year ended October 31, 1992, the Fund paid
or accrued to Keystone Management investment management and
administrative services fees of $2,651,959, which represented 0.58%
of the Fund's average net assets on an annualized basis. Of such
amount paid to Keystone Management, $2,254,165 was paid to Keystone
for its services to the Fund.
During the fiscal year ended October 31, 1993, the Fund paid
or accrued to Keystone Management investment administrative
services fees of $2,584,363, which represented 0.56% of the Fund's
average net assets on an annualized basis. Of such amount paid to
Keystone Management, $2,196,709 was paid to Keystone for its
services to the Fund.
For the fiscal year ended October 31, 1994, the Fund paid or
accrued to Keystone Management investment management and
administrative services fees of $2,193,546, which represented 0.56%
of the Fund's average net assets on an annualized basis. Of such
amount, $1,864,514 was paid to Keystone for its services to the
Fund.
TRUSTEES AND OFFICERS
Trustees and officers of the Fund, their principal occupations
and some of their affiliations over the last five years are as
follows:
*ALBERT H. ELFNER, III: President, Trustee and Chief Executive
Officer of the Fund; Chairman of the Board, President,
Director and Chief Executive Officer of Keystone Group,
President and Trustee or Director of Keystone America Capital
Preservation and Income Fund, Keystone America Intermediate
Term Bond Fund, Keystone America Strategic Income Fund,
Keystone America World Bond Fund, Keystone Tax Free Income
Fund, Keystone America State Tax Free Fund, Keystone America
State Tax Free Fund - Series II, Keystone America Fund for
Total Return, Keystone America Global Opportunities Fund,
Keystone America Hartwell Emerging Growth Fund, Inc., Keystone
America Hartwell Growth Fund, Inc., Keystone America Omega
Fund, Inc., Keystone Fund of the Americas-Luxembourg and
Keystone Fund of the Americas - U.S., Keystone Strategic
Development Fund (collectively, "Keystone America Funds");
Keystone Custodian Funds, Series B-2, B-4, K-1, K-2, S-1, S-3,
and S-4; Keystone International Fund, Keystone Precious Metals
Holdings, Inc., Keystone Tax Free Fund, Keystone Tax Exempt
Trust, Keystone Liquid Trust (together with the Fund,
collectively, "Keystone Custodian Funds"); Keystone
Institutional Adjustable Rate Fund and Master Reserves Trust
(all such funds, collectively, "Keystone Group Funds");
Director and Chairman of the Board, Chief Executive Officer
and Vice Chairman of Keystone; Chairman of the Board and
Director of Keystone Investment Management Corporation
("KIMCO") and Keystone Fixed Income Advisors ("KFIA");
Director, Chairman of the Board, Chief Executive Officer and
President of Keystone Management, Keystone Software Inc.
("Keystone Software"); Director and President of Hartwell
Keystone Advisers, Inc. ("Hartwell Keystone"), Keystone Asset
Corporation, Keystone Capital Corporation, and Keystone Trust
Company; Director of KDI, Keystone Investor Resource Center,
Inc. ("KIRC"), and Fiduciary Investment Company, Inc.
("FICO"); Director and Vice President of Robert Van Partners,
Inc.; Director of Boston Children's Services Association;
Trustee of Anatolia College, Middlesex School, and Middlebury
College; Member, Board of Governors, New England Medical
Center and former Trustee of Neworld Bank.
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all
other Keystone Group Funds; Professor, Finance Department,
George Washington University; President, Amling & Company
(investment advice); Member, Board of Advisers, Credito
Emilano (banking); and former Economics and Financial
Consultant, Riggs National Bank.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of
all other Keystone Group Funds; Investment Counselor to
Appleton Partners, Inc.; former Managing Director, Seaward
Management Corporation (investment advice) and former
Director, Executive Vice President and Treasurer, State Street
Research & Management Company (investment advice).
*GEORGE S. BISSELL: Chairman of the Board and Trustee of the Fund;
Director of Keystone Group; Chairman of the Board and Trustee
or Director of all other Keystone Group Funds,; Director and
Chairman of the Board of Hartwell Keystone; Chairman of the
Board and Trustee of Anatolia College; Trustee of University
Hospital (and Chairman of its Investment Committee); former
Chairman of the Board and Chief Executive Officer of Keystone
Group; and former Chief Executive Officer of the Fund.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all
other Keystone Group Funds; Executive Director, Coalition of
Essential Schools, Brown University; Director and former
Executive Vice President, National Alliance of Business;
former Vice President, Educational Testing Services; and
former Dean, School of Business, Adelphi University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all
other Keystone Group Funds; former Group Vice President,
Textron Corp.; and former Director, Peoples Bank (Charlotte,
N.C).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all
other Keystone Group Funds; Director of Phoenix Total Return
Fund and Equifax, Inc.; Trustee of Phoenix Series Fund,
Phoenix Multi-Portfolio Fund and The Phoenix Big Edge Series
Fund; and former President, Morehouse College.
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all
other Keystone Group Funds; Chairman of the Board, Director
and Executive Vice President, The London Harness Company;
Managing Partner, Roscommon Capital Corp.; Trustee, Cambridge
College; Chairman Emeritus and Director, American Institute of
Food and Wine; Chief Executive Officer, Gifford Gifts of Fine
Foods; Chairman, Gifford, Drescher & Associates (environmental
consulting); President, Oldways Preservation and Exchange
Trust (education); and former Director, Keystone Group and
Keystone.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all
other Keystone Group Funds; Of Counsel, Keyser, Crowley &
Meub, P.C.; Member, Governor's (VT) Council of Economic
Advisers; Chairman of the Board and Director, Central Vermont
Public Service Corporation and Hitchcock Clinic; Director,
Vermont Yankee Nuclear Power Corporation, Vermont Electric
Power Company, Inc., Grand Trunk Corporation, Central Vermont
Railway, Inc., S.K.I. Ltd., Sherburne Corporation, Union
Mutual Fire Insurance Company, New England Guaranty Insurance
Company, Inc. and the Investment Company Institute; former
Governor of Vermont; former Director and President, Associated
Industries of Vermont; former Chairman and President, Vermont
Marble Company; former Director of Keystone; and former
Director and Chairman of the Board, Green Mountain Bank.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of
all other Keystone Group Funds; Executive Vice President, DHR
International, Inc. (executive recruitment); former Senior
Vice President, Boyden International Inc. (executive
recruitment); and Director, Commerce and Industry Association
of New Jersey, 411 International, Inc. and J & M Cumming Paper
Co.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all
other Keystone Group Funds; Chairman, Environmental Warranty,
Inc., and Consultant, Drake Beam Morin, Inc. (executive
outplacement); Director of Connecticut Natural Gas
Corporation, Trust Company of Connecticut, Hartford Hospital,
Old State House Association and Enhanced Financial Services,
Inc.; Member, Georgetown College Board of Advisors; Chairman,
Board of Trustees, Hartford Graduate Center; Trustee,
Kingswood-Oxford School and Greater Hartford YMCA; former
Director, Executive Vice President and Vice Chairman of The
Travelers Corporation; and former Managing Director of Russell
Miller, Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all
other Keystone Group Funds; Partner, Farrell, Fritz,
Caemmerer, Cleary, Barnosky & Armentano, P.C.; President,
Nassau County Bar Association; former Associate Dean and
Professor of Law, St. John's University School of Law.
EDWARD F. GODFREY: Senior Vice President of the Fund; Senior Vice
President of all other Keystone Group Funds; Director, Senior
Vice President, Chief Financial Officer and Treasurer of
Keystone Group, KDI, Keystone Asset Corporation, Keystone
Capital Corporation, Keystone Trust Company; Treasurer of
KIMCO, Robert Van Partners, Inc., and FICO; Treasurer and
Director of Keystone Management, Keystone Software, Inc., and
Hartwell Keystone; Vice President and Treasurer of KFIA; and
Director of KIRC.
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice
President of all other Keystone Group Funds; and President of
Keystone.
CHRISTOPHER P. CONKEY: Vice President of the Fund and Vice President
of Keystone.
BARBARA McCUE: Vice President of the Fund and Vice President of Keystone.
KEVIN J. MORRISSEY: Treasurer of the Fund; Treasurer of all other
Keystone Group Funds; Vice President of Keystone Group;
Assistant Treasurer of FICO and Keystone; and former Vice
President and Treasurer of KIRC.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of
the Fund; Senior Vice President and Secretary of all other
Keystone Group Funds; Senior Vice President, General Counsel
and Secretary of Keystone; Senior Vice President, General
Counsel, Secretary and Director of KDI, Keystone Management
and Keystone Software, Senior Vice President and General
Counsel of KIMCO; Senior Vice President, General Counsel and
Director of FICO and KIRC; Senior Vice President and Secretary
of Hartwell Keystone and Robert Van Partners, Inc.; Vice
President and Secretary of KFIA; Senior Vice President,
General Counsel and Secretary of Keystone Group, Keystone
Asset Corporation, Keystone Capital Corporation and Keystone
Trust Company.
* This Trustee may be considered an "interested person" within the
meaning of the 1940 Act.
Mr. Elfner and Mr. Bissell are "interested persons" by virtue
of their positions as officers and/or Directors of Keystone Group
and several of its affiliates including Hartwell Keystone, KDI and
KIRC. Mr. Elfner and Mr. Bissell own shares of Keystone Group.
Mr. Elfner is Chairman of the Board, Chief Executive Officer and
Director of Keystone Group. Mr. Bissell is a Director of Keystone
Group.
For the fiscal year ended October 31, 1994, the Directors and
officers of Keystone received in aggregate $41,769 in direct
remuneration from the Fund. On January 31, 1995, the Fund's Trustees
and officers beneficially owned less than 1% of the Fund's then
outstanding shares. For the fiscal year ended October 31, 1994, fees
paid to Independent Trustees on a fund complex wide basis were
approximately $585,960.
The address of all the Fund's Trustees and officers is 200
Berkeley Street, Boston, Massachusetts 02116-5034.
PRINCIPAL UNDERWRITER
Keystone Distributors, Inc., 200 Berkeley Street, Boston,
Massachusetts 02116-5034, a Delaware corporation wholly owned by
Keystone, acts as Principal Underwriter of the shares of the Fund
under a Principal Underwriting Agreement ("Underwriting
Agreement"). KDI, as agent, has agreed to use its best efforts to
find purchasers for the Fund's shares. KDI may retain and employ
representatives to promote distribution of the shares and may
obtain orders from brokers, dealers and others, acting as
principals, for sales of shares to them. The Underwriting
Agreement provides that KDI will bear the expense of preparing,
printing and distributing advertising and sales literature and
prospectuses used by it. In its capacity as principal underwriter,
KDI may receive payments from the Fund pursuant to the Fund's
Distribution Plan.
The Underwriting Agreement provides that it will remain in
effect as long as its terms and continuance are approved by a
majority of the Fund's Independent Trustees at least annually at a
meeting called for that purpose, and if its continuance is approved
annually by vote of a majority of Trustees, or by vote of a
majority of the outstanding shares.
The Underwriting Agreement may be terminated, without penalty,
on 60 days' written notice by the Fund's Board of Trustees or by a
vote of a majority of outstanding shares. The Underwriting
Agreement will terminate automatically upon its "assignment" as
that term is defined in the 1940 Act.
From time to time, if in KDI's judgment it could benefit the
sales of Fund shares, KDI may use its discretion in providing to
selected dealers promotional materials and selling aids, including,
but not limited to, personal computers, related software and Fund
data files.
During the fiscal years ended October 31, 1992 and 1993, KDI
earned commissions of $709,505 and $719,609, respectively, after
allowing commissions on new sales and service fees to dealers and
others of $4,663,763 and $4,021,392, respectively.
During the fiscal year ended October 31, 1994, KDI received
$1,856,670 after payments of commissions on new sales and service
fees to dealers and others of $2,011,851.
BROKERAGE
It is the policy of the Fund, in effecting transactions in
portfolio securities, to seek best execution of orders at the most
favorable prices. The determination of what may constitute best
execution and price in the execution of a securities transaction by
a broker involves a number of considerations including, without
limitation, the overall direct net economic result to the Fund,
involving both price paid or received and any commissions and other
costs paid, the efficiency with which the transaction is effected,
the ability to effect the transaction at all where a large block is
involved, the availability of the broker to stand ready to execute
potentially difficult transactions in the future and the financial
strength and stability of the broker. Management weighs such
considerations in determining the overall reasonableness of
brokerage commissions paid.
Subject to the foregoing, a factor in the selection of brokers is
the receipt of research services, such as analyses and reports
concerning issuers, industries, securities, economic factors and
trends and other statistical and factual information. Any such
research and other statistical and factual information provided by
brokers to the Fund, Keystone Management or Keystone is considered to
be in addition to and not in lieu of services required to be performed
by Keystone Management under the Management Agreement or Keystone under
the Advisory Agreement. The cost, value and specific application of
such information are indeterminable and cannot be practically
allocated among the Fund and other clients of Keystone Management or
Keystone who may indirectly benefit from the availability of such
information. Similarly, the Fund may indirectly benefit from
information made available as a result of transactions effected for
such other clients. Under the Management Agreement and the Advisory
Agreement, Keystone Management and Keystone are permitted to pay
higher brokerage commissions for brokerage and research services in
accordance with Section 28(e) of the Securities Exchange Act of 1934.
In the event Keystone Management and Keystone do follow such a
practice, they will do so on a basis that is fair and equitable to the
Fund.
The Fund may participate, if and when practicable, in group
bidding for the purchase directly from an issuer of certain
securities for the Fund's portfolio in order to take advantage of
the lower purchase price available to members of such a group.
Neither Keystone Management, Keystone, nor the Fund intend to
place securities transactions with any particular broker-dealer or
group thereof. The Fund's Board of Trustees, however, has
determined that the Fund may follow a policy of considering sales
of shares as a factor in the selection of broker-dealers to execute
portfolio transactions, subject to the requirements of best
execution, including best price, described above.
The Fund expects that purchases and sales of bonds and money
market instruments usually will be principal transactions. Bonds
and money market instruments are normally purchased directly from
the issuer or from an underwriter or market maker for the
securities. There usually will be no brokerage commissions paid by
the Fund for such purchases. Purchases from underwriters will
include the underwriting commission or concession and purchases
from dealers serving as market makers will include the spread
between the bid and asked prices. Where transactions are made in
the over-the-counter market, the Fund will deal with primary market
makers unless more favorable prices are otherwise obtainable.
The policy of the Fund with respect to brokerage is and will
be reviewed by the Fund's Board of Trustees from time to time.
Because of the possibility of further regulatory developments
affecting the securities exchanges and brokerage practices
generally, the foregoing practices may be changed, modified or
eliminated.
Investment decisions for the Fund are made independently by
Keystone Management or Keystone from those of the other funds and
investment accounts managed by Keystone Management or Keystone. It
may frequently develop that the same investment decision is made
for more than one fund. Simultaneous transactions are inevitable
when the same security is suitable for the investment objective of
more than one account. When two or more funds or accounts are
engaged in the purchase or sale of the same security, the
transactions are allocated as to amount in accordance with a
formula which is equitable to each fund or account. It is
recognized that in some cases this system could have a detrimental
effect on the price or volume of the security as far as the Fund is
concerned. In other cases, however, it is believed that the
ability of the Fund to participate in volume transactions will
produce better executions for the Fund.
For the fiscal years ended October 31, 1992 and 1993, the Fund
did not pay any brokerage commissions. For the fiscal year ended
October 31, 1994, the Fund paid brokerage commissions of $8,000.
In no instance are portfolio securities purchased from or sold
to Keystone Management, Keystone, KDI or any of their affiliated
persons, as defined in the 1940 Act and rules and regulations
issued thereunder.
The Fund does not intend to engage in short-term trading, but
reserves the right to do so if circumstances warrant. Securities
will be disposed of without regard to the length of time held in
situations where the Fund believes that such securities are no
longer appropriate investments. Since the Fund may in some
instances sell securities without regard to the length of time they
may have been held, the Fund may have substantial portfolio
turnover.
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
Total return quotations for the Fund as they may appear from
time to time in advertisements are calculated by finding the
average annual compounded rates of return over the one, five and
ten year periods on a hypothetical $1,000 investment which would
equate the initial amount invested to the ending redeemable value.
To the initial investment all dividends and distributions are
added, and all recurring fees charged to all shareholder accounts
are deducted. The ending redeemable value assumes a complete
redemption at the end of the one, five or ten year periods.
The cumulative total returns of the Fund for the one, five and
ten year periods ended October 31, 1994 were (8.91%), 32.29% and
114.23%, respectively. The compounded average rates of return for
the five and ten year periods ended October 31, 1994 were 5.76% and
7.92%, respectively.
Current yield quotations as they may appear from time to time
in advertisements will consist of a quotation based on a 30-day
period ended on the date of the most recent balance sheet of the
Fund, computed by dividing the net investment income per share
earned during the period by the maximum offering price per share on
the last day of the base period. The Fund's current yield for the
30-day period ended October 31, 1994 was 5.93%.
ADDITIONAL INFORMATION
To the best of the Fund's knowledge, as of January 31, 1995,
the following was the only shareholder of record who owned 5% or
more the Fund's outstanding shares:
% of Fund
Merrill Lynch Pierce Fenner & Smith 12.63%
Attn: Book Entry
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
State Street Bank and Trust Company, 225 Franklin Street,
Boston, Massachusetts 02110, is the Custodian of all securities and
cash of the Fund (the "Custodian"). The Custodian may hold
securities of some foreign issuers outside the United States. The
Custodian performs no investment management functions for the Fund,
but, in addition to its custodial services, is responsible for
accounting and related recordkeeping on behalf of the Fund.
KPMG Peat Marwick LLP, One Boston Place, Boston, Massachusetts
02108, Certified Public Accountants, are the Fund's independent
auditors.
KIRC, located at 101 Main Street, Cambridge, Massachusetts,
02142-1519, is a wholly-owned subsidiary of Keystone and serves as
the Fund's transfer agent and dividend disbursing agent.
Except as otherwise stated in its prospectus or required by
law, the Fund reserves the right to change the terms of the offer
stated in its prospectus without shareholder approval, including
the right to impose or change fees for services provided.
No dealer, salesman or other person is authorized to give any
information or to make any representation not contained in the
Fund's prospectus, this statement of additional information or in
supplemental sales literature issued by the Fund or the Principal
Underwriter, and no person is entitled to rely on any information
or representation not contained therein.
The Fund's prospectus and this statement of additional
information omit certain information contained in the registration
statement filed with the SEC which may be obtained from the SEC's
principal office in Washington, D.C. upon payment of the fee
prescribed by the rules and regulations promulgated by the SEC.
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APPENDIX
CORPORATE BOND RATINGS
S&P Corporate Bond Ratings
An S&P corporate bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the United States,
with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
a. Likelihood of default - capacity and willingness of the
obligor as to the timely payment of interest and repayment of
principal in accordance with the terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from AA to BBB may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by
S&P. Capacity to pay interest and repay principal is extremely
strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in a small degree.
3. A - Debt rated A has a strong capacity to pay interest
and repay principal although it is somewhat more susceptible to the
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adverse effects of changes in circumstances and economic conditions than debt in
higher rated categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
5. BB, B, CCC, CC and C - Debt rated BB, B, CCC, CC and C is regarded,
on balance, as predominantly speculative with respect to capacity to pay
interest and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and C the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
Moody's Corporate Bond Ratings
Moody's ratings are as follows:
1. Aaa - Bonds that are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. Aa - Bonds that are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present that
make the long term risks appear somewhat larger than in Aaa securities.
3. A - Bonds that are rated A possess many favorable investment
attributes and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present that suggest a susceptibility to impairment sometime in the
future.
4. Baa - Bonds that are rated Baa are considered as medium
grade obligations, i.e., they are neither highly protected nor
poorly secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be
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A-3
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
5. Ba - Bonds that are rated Ba are judged to have speculative
elements. Their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
6. B - Bonds that are 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.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
COMMON AND PREFERRED STOCK RATINGS
S&P's Earnings and Dividend Rankings for Common Stocks
Because the investment process involves assessment of various factors,
such as product and industry position, corporate resources and financial policy,
with results that make some common stocks more highly esteemed than others, S&P
believes that earnings and dividend performance is the end result of the
interplay of these factors and that, over the long run, the record of this
performance has a considerable bearing on relative quality. S&P rankings,
however, do not reflect all of the factors, tangible or intangible, that bear on
stock quality.
Growth and stability of earnings and dividends are deemed key elements
in establishing S&P earnings and dividend rankings for common stocks, which
capsulize the nature of this record in a single symbol.
S&P has established a computerized scoring system based on per-share
earnings and dividend records of the most recent ten years, a period deemed long
enough to measure a company's performance under varying economic conditions. S&P
measures growth, stability within the trend line and cyclicity. The ranking
system also makes allowances for company size, since large companies have
certain inherent advantages over small ones. From these scores for earnings and
dividends are determined.
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The final score for each stock is measured against a scoring matrix
determined by analysis of the scores of a large and representative sample which
is reviewed and sometimes modified with the following ladder of rankings:
A+ Highest B+ Average C Lowest
A High B Below Average D In Reorganization
A- Above Average B- Lower
S&P believes its rankings are not a forecast of future market price
performance but are basically an appraisal of past performance of earnings and
dividends and relative current standing.
Moody's Common Stock Rankings
Moody's presents a concise statement of the important characteristics
of a company and an evaluation of the grade (quality) of its common stock. Data
presented includes: (a) capsule stock information which reveals short and long
term growth and yield afforded by the indicated dividend, based on a recent
price; (b) a long term price chart which shows patterns of monthly stock price
movements and monthly trading volumes; (c) a breakdown of a company's capital
account which aids in determining the degree of conservatism or financial
leverage in a company's balance sheet; (d) interim earnings for the current year
to date, plus three previous years; (e) dividend information; (f) company
background; (g) recent corporate developments; (h) prospects for a company in
the immediate future and the next few years; and (i) a ten year comparative
statistical analysis.
This information provides investors with information on what a company
does, how it has performed in the past, how it is performing currently and what
its future performance prospects appear to be.
These characteristics are then evaluated and result in a grading, or
indication of quality. The grade is based on an analysis of each company's
financial strength, stability of earnings and record of dividend payments. Other
considerations include conservativeness of capitalization, depth and caliber of
management, accounting practices, technological capabilities and industry
position. Evaluation is represented by the following grades:
(1) High Grade
(2) Investment Grade
(3) Medium Grade
(4) Speculative Grade
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A-5
Moody's Preferred Stock Ratings
Preferred stock ratings and their definitions are as follows:
1. aaa: An issue that is rated aaa is considered to be a
top-quality preferred stock. This rating indicates good asset
protection and the least risk of dividend impairment within the
universe of preferred stocks.
2. aa: An issue that is rated aa is considered a high-grade
preferred stock. This rating indicates that there is a reasonable
assurance that earnings and asset protection will remain relatively
well maintained in the foreseeable future.
3. a: An issue that is rated a is considered to be an upper-
medium grade preferred stock. While risks are judged to be
somewhat greater then in the aaa and aa classification, earnings
and asset protection are, nevertheless, expected to be maintained
at adequate levels.
4. baa: An issue that is rated baa is considered to be a
medium-grade preferred stock,neither highly protected nor poorly
secured. Earnings and asset protection appear adequate at present
but may be questionable over any great length of time.
5. ba: An issue that is rated ba is considered to have
speculative elements and its future cannot be considered well
assured. Earnings and asset protection may be very moderate and
not well-safeguarded during adverse periods. Uncertainty of
position characterizes preferred stocks in this class.
6. b: An issue that is rated b generally lacks the
characteristics of a desirable investment. Assurance of dividend
payments and maintenance of other terms of the issue over any long
period of time may be small.
7. caa: An issue that is rated caa is likely to be in
arrears on dividend payments. This rating designation does not
purport to indicate the future status of payments.
8. ca: An issue that is rated ca is speculative in a high
degree and is likely to be in arrears on dividends with little
likelihood of eventual payments.
9. c: This is the lowest rated class of preferred or
preference stock. Issues so rated can be regarded as having
extremely poor prospects of ever attaining any real investment
standing.
Moody's applies numerical modifiers 1, 2 and 3 in each rating
classification: the modifier 1 indicates that the security ranks in the higher
end of its generic rating category, the
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A-6
modifier 2 indicates a mid-range ranking and the modifier 3 indicates that the
issue ranks in the lower end of its generic rating category.
LIMITED PARTNERSHIPS
The Fund may invest in limited and master limited partnerships. A
limited partnership is a partnership consisting of one or more general partners,
jointly and severally responsible as ordinary partners, and by whom the business
is conducted, and one or more limited partners who contribute cash as capital to
the partnership and who generally are not liable for the debts of the
partnership beyond the amounts contributed. Limited partners are not involved in
the day-to-day management of the partnership. They receive income, capital gains
and other tax benefits associated with the partnership project in accordance
with terms established in the partnership agreement. Typical limited
partnerships are in real estate, oil and gas and equipment leasing, but they
also finance movies, research and development and other projects.
For an organization classified as a partnership under the Internal
Revenue Code, each item of income, gain, loss, deduction and credit is not taxed
at the partnership level but flows through to the holder of the partnership
unit. This allows the partnership to avoid taxation and to pass through income
to the holder of the partnership unit at lower individual rates.
A master limited partnership is a publicly traded limited partnership.
The partnership units are registered with the Securities and Exchange Commission
and are freely exchanged on a securities exchange or in the over-the-counter
market.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated
A-1 by Standard & Poor's Corporation, Prime-1 by Moody's Investors Service, Inc.
or F-1 by Fitch Investors Service, Inc. These ratings and other money market
instruments are described as follows:
Commercial Paper Ratings
Commercial paper rated A-1 by Standard & Poor's has the following
characteristics: Liquidity ratios are adequate to meet cash requirements. The
issuer's long-term senior debt is rated A or better, although in some cases BBB
credits may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an upward trend with
allowance made for unusual circumstances. Typically, the issuer's industry is
well established and the issuer has a strong position within the industry.
<PAGE>
A-7
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships that exist with the issuer; and (8) recognition by the management
of obligations which may be present or may arise as a result of public
preparations to meet such obligations. Relative strength or weakness of the
above factors determines how the issuer's commercial paper is rated within
various categories.
The rating F-1 is the highest rating assigned by Fitch. Among the
factors considered by Fitch in assigning this rating are: (1) the issuer's
liquidity; (2) its standing in the industry; (3) the size of its debt; (4) its
ability to service its debt; (5) its profitability; (6) its return on equity;
(7) its alternative sources of financing; and (8) its ability to access the
capital markets. Analysis of the relative strength or weakness of these factors
and others determines whether an issuer's commercial paper is rated F-1.
United States Government Securities
Securities issued or guaranteed by the United States Government include
a variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance. Treasury bills have maturities of one year or
less. Treasury notes have maturities of one to ten years and Treasury bonds
generally have maturities of greater than ten years at the date of issuance.
Securities issued or guaranteed by the United States ("U.S.")
Government or its agencies or instrumentalities include direct obligations of
the United States Treasury and securities issued or guaranteed by the Federal
Housing Administration, Farmers Home Administration, Export-Import Bank of the
United States, Small Business Administration, Government National Mortgage
Association, General Services Administration, Central Bank for Cooperatives,
Federal Home Loan Banks, Federal Loan Mortgage Corporation, Federal Intermediate
Credit Banks, Federal Land Banks, Maritime Administration, The Tennessee Valley
Authority, District of Columbia Armory Board and Federal National Mortgage
Association.
Some obligations of United States Government agencies and
instrumentalities, such as Treasury bills and Government National Mortgage
Association pass-through certificates, are supported by the full faith and
credit of the United States; others, such as securities of Federal Home Loan
Banks, by the right of the issuer
<PAGE>
A-8
to borrow from the Treasury; still others, such as bonds issued by the Federal
National Mortgage Association, a private corporation, are supported only by the
credit of the instrumentality. Because the United States Government is not
obligated by law to provide support to an instrumentality it sponsors, the Fund
will invest in the securities issued by such an instrumentality only when
Keystone determines that the credit risk with respect to the instrumentality
does not make its securities unsuitable investments. United States Government
securities will not include international agencies or instrumentalities in which
the United States Government, its agencies or instrumentalities participate,
such as the World Bank, the Asian Development Bank or the InterAmerican
Development Bank, or issues insured by the Federal Deposit Insurance
Corporation.
Certificates of Deposit
Certificates of deposit are receipts issued by a bank in exchange for
the deposit of funds. The issuer agrees to pay the amount deposited plus
interest to the bearer of the receipt on the date specified on the certificate.
The certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar-denominated
certificates of United States banks, including their branches abroad, and of
U.S. branches of foreign banks that are members of the Federal Reserve System or
the Federal Deposit Insurance Corporation and have at least $1 billion in
deposits as of the date of their most recently published financial statements.
Bankers' Acceptances
Bankers' acceptances typically arise from short term credit
arrangements designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by the Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total deposits at the time of purchase in excess of $1 billion and must be
payable in U.S. dollars.
OPTIONS TRANSACTIONS
The Fund is authorized to write (i.e., sell) covered call options and
to purchase call options to close out covered call
<PAGE>
A-9
options previously written. A call option obligates a writer to sell, and gives
a purchaser the right to buy, the underlying security at the stated exercise
price at any time until the stated expiration date.
The Fund will only write call options that are covered, which means
that the Fund will own the underlying security (or other securities, such as
convertible securities, that are acceptable for escrow) when it writes the call
option and until the Fund's obligation to sell the underlying security is
extinguished by exercise or expiration of the call option or the purchase of a
call option covering the same underlying security and having the same exercise
price and expiration date. The Fund will receive a premium for writing a call
option, but will give up, until the expiration date, the opportunity to profit
from an increase in the underlying security's price above the exercise price.
The Fund will retain the risk of loss from a decrease in the price of the
underlying security. The writing of covered call options is a conservative
investment technique believed to involve relatively little risk (in contrast to
the writing of naked options which the Fund will not do) but capable of
enhancing the Fund's total return.
The premium received by the Fund for writing a covered call option will
be recorded as a liability in the Fund's statement of assets and liabilities.
This liability will be adjusted daily to the option's current market value,
which will be the latest sale price at the time as of which the net asset value
per share of the Fund is computed (the close of the New York Stock Exchange),
or, in the absence of such sale, at the latest bid quotation. The liability will
be extinguished upon expiration of the option, the purchase of an identical
option in a closing transaction or delivery of the underlying security upon
exercise of the option.
Many options are traded on registered securities exchanges. Options
traded on such exchanges are issued by the Options Clearing Corporation, a
clearing corporation which assumes responsibility for the completion of options
transactions.
The Fund will purchase call options only to close out a covered call
option it has written. When it appears that a covered call option written by the
Fund is likely to be exercised, the Fund may consider it appropriate to avoid
having to sell the underlying security. Or, the Fund may wish to extinguish a
covered call option which it has written in order to be free to sell the
underlying security to realize a profit on the previously written call option or
to write another covered call option on the underlying security. In all such
instances, the Fund can close out the previously written call option by
purchasing a call option on the same underlying security with the same exercise
price and expiration date. (The Fund may, under certain circumstances, also be
able to transfer a previously written call option.) The Fund will realize a
short-term capital gain if the amount paid to
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purchase the call option plus transaction costs is less than the premium
received for writing the covered call option. The Fund will realize a short-term
capital loss if the amount paid to purchase the call option plus transaction
costs is greater than the premium received for writing the covered call option.
A previously written call option can be closed out by purchasing an
identical call option only in a secondary market for the call option. Although
the Fund will generally write only those options for which there appears to be
an active secondary market, there is no assurance that a liquid secondary market
will exist for any particular option at any particular time, and for some
options no secondary market may exist. In such event it might not be possible to
effect a closing transaction in a particular option. If the Fund as a covered
call option writer is unable to effect a closing purchase transaction, it will
not be able to sell the underlying securities until the option expires or it
delivers the underlying securities upon exercise.
If a substantial number of the call options written by the Fund are
exercised, the Fund's rate of portfolio turnover may exceed historical levels.
This would result in higher transaction costs, including brokerage commissions.
The Fund will pay brokerage commissions in connection with the writing of
covered call options and the purchase of call options to close out previously
written options. Such brokerage commissions are normally higher than those
applicable to purchases and sales of portfolio securities.
In the past the Fund has qualified for, and elected to receive, the
special tax treatment afforded regulated investment companies under Subchapter M
of the Internal Revenue Code. Although the Fund intends to continue to qualify
for such tax treatment, in order to do so it must, among other things, derive
less than 30% of its gross income from gains from the sale or other disposition
of securities held for less than three months. Because of this, the Fund may be
restricted in the writing of call options where the underlying securities have
been held less than three months, in the writing of covered call options that
expire in less than three months, and in effecting closing purchases with
respect to options that were written less than three months earlier. As a
result, the Fund may elect to forego otherwise favorable investment
opportunities and may elect to avoid or delay effecting closing purchases or
selling portfolio securities, with the risk that a potential loss may be
increased or a potential gain may be reduced or turned into a loss.
Under the Internal Revenue Code of 1954, as amended, gain or loss
attributable to a closing transaction and premiums received by the Fund for
writing a covered call option that is not exercised may constitute short-term
capital gain or loss. Under provisions of the Tax Reform Act of 1986, effective
for taxable years
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beginning after October 22, 1986, a gain on an option transaction that qualifies
as a "designated hedge" transaction under Treasury regulations may be offset by
realized or unrealized losses on such designated transaction. The netting of
gain against such losses could result in a reduction in gross income from
options transactions for purposes of the 30 percent test.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Fund intends to enter into currency and other financial futures
contracts as a hedge against changes in prevailing levels of interest or
currency exchange rates to seek relative stability of principal and to establish
more definitely the effective return on securities held or intended to be
acquired by the Fund or as a hedge against changes in the prices of securities
or currencies held by the Fund or to be acquired by the Fund. The Fund's hedging
may include sales of futures as an offset against the effect of expected
increases in interest or currency exchange rates or securities prices and
purchases of futures as an offset against the effect of expected declines in
interest or currency exchange rates.
For example, when the Fund anticipates a significant market or market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when the Fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities which may then be purchased in an
orderly fashion. As such purchases are made, an equivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, the Fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of
the Fund's portfolio. To the extent that the Fund's portfolio changes in value
in correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by so doing, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Fund intends to engage in options transactions that are related to
commodity futures contracts for hedging purposes and in connection with the
hedging strategies described above.
Although techniques other than sales and purchases of futures contracts
and related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Fund does not intend to
take delivery of the instruments underlying futures contracts it holds, the Fund
does not intend to engage in such futures contracts for speculation.
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Futures Contracts
Futures contracts are transactions in the commodities markets rather
than in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed that specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges
and are standardized as to maturity date and underlying financial instrument.
The principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant (Broker) effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission (CFTC) and National Futures Association (NFA).
Interest Rate Futures Contracts
The sale of an interest rate futures contract creates an obligation by
the Fund, as seller, to deliver the type of financial instrument specified in
the contract at a specified future time for a specified price. The purchase of
an interest rate futures contract creates an obligation by the Fund, as
purchaser, to accept delivery of the type of financial instrument specified at a
specified future time for a specified price. The specific securities delivered
or accepted, respectively, at settlement date, are not determined until at or
near that date. The determination is in accordance with the rules of the
exchange on which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years,
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Government National Mortgage Association (GNMA) certificates, 90-
day domestic bank certificates of deposit, 90-day commercial paper,
and 90-day Eurodollar certificates of deposit. It is expected that
futures contracts trading in additional financial instruments will
be authorized. The standard contract size is $100,000 for futures
contracts in U.S. Treasury bonds, U.S. Treasury notes and GNMA
certificates, and $1,000,000 for the other designated contracts.
While U.S. Treasury bonds, U.S. Treasury bills and U.S. Treasury
notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S.
government agency, the futures contracts in U.S. government
securities are not obligations of the U.S. Treasury.
Index Based Futures Contracts
Stock Index Futures Contracts
A stock index assigns relative values to the common stocks included in
the index. The index fluctuates with changes in the market values of the common
stocks so included. stock index futures contract is a bilateral agreement by
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the closing value of the
stock index on the expiration date of the contract and the price at which the
futures contract is originally made. No physical delivery of the underlying
stocks in the index is made.
Currently, stock index futures contracts can be purchased or sold on
the Standard and Poor's Corporation (S&P) Index of 500 Stocks, the S&P Index of
100 Stocks, the New York Stock Exchange Composite Index, the Value Line Index
and the Major Market Index. It is expected that futures contracts trading in
additional stock indices will be authorized. The standard contract size is $500
times the value of the index.
The Fund does not believe that differences between existing stock
indices will create any differences in the price movements of the stock index
futures contracts in relation to the movements in such indices. However, such
differences in the indices may result in differences in correlation of the
futures with movements in the value of the securities being hedged.
Other Index Based Futures Contracts
It is expected that bond index and other financially based index
futures contracts will be developed in the future. It is anticipated that such
index based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed the Fund will sell interest rate index and
other index based futures contracts to
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hedge against changes which are expected to affect the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by the Fund with the Broker. This amount is known as
the initial margin. The nature of the initial margin in futures transactions is
different from that of a margin in security transactions. Futures contract
margin does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. The margin required for a particular futures contract is set by
the exchange on which the contract is traded, and may be significantly modified
from time to time by the exchange during the term of the contract.
Subsequent payments, called a variation margin, to the Broker and from
the Broker, are made on a daily basis as the value of the underlying instrument
or index fluctuates making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the Broker, and the Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its Custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its Custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments, and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is
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effected by an offsetting transaction in which the Fund enters into a futures
contract purchase for the same aggregate amount of the specific type of
financial instrument or index and same delivery date. If the price in the sale
exceeds the price in the offsetting purchase, the Fund is paid the difference
and thus realizes a gain. If the offsetting purchase price exceeds the sale
price, the Fund pays the difference and realizes a loss. Similarly, the closing
out of a futures contract purchase is effected by an offsetting transaction in
which the Fund enters into a futures contract sale. If the offsetting sale price
exceeds the purchase price, the Fund realizes a gain. If the purchase price
exceeds the offsetting sale price the Fund realizes a loss. The amount of the
Fund's gain or loss on any transaction is reduced or increased, respectively, by
the amount of any transaction costs incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e., on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase after allowance for
transaction costs represents the profit or loss to the Fund.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If the Fund is not able to enter into an offsetting
transaction, the Fund will continue to be required to maintain the margin
deposits on the contract and to complete the contract according to its terms.
Options on Currency and Other Financial Futures
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency and other financial futures contracts are similar
to options on stocks except that an option on a currency or other financial
futures contract gives the purchaser the right, in return for the premium paid,
to assume a position in a futures contract (a long position if the option is a
call and a short position if the option is a put) rather than to purchase or
sell stock, currency or other financial instruments at a specified exercise
price at any time during the period of the option. Upon exercise of the option,
the delivery of the futures position by the writer of the option to the holder
of the option will be accompanied by delivery of the accumulated balance in the
writer's futures margin account. This amount represents the amount by which the
market price of the futures contract at exercise exceeds, in the case of a call,
or is less than, in the case of a put, the exercise price of the option on the
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futures contract. If an option is exercised on the last trading day prior to the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and value of
the futures contract.
The Fund intends to use options on currency and other financial futures
contracts in connection with hedging strategies. In the future the Fund may use
such options for other purposes.
Purchase of Put Options on Futures Contracts
The purchase of protective put options on commodity futures contracts
is analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of stocks or debt instruments or a position in the futures contract upon which
the put option is based.
Purchase of Call Options on Futures Contracts
The purchase of a call option on a commodity futures contract
represents a means of obtaining temporary exposure to market appreciation at
limited risk. It is analogous to the purchase of a call option on an individual
stock which can be used as a substitute for a position in the stock itself.
Depending on the pricing of the option compared to either the futures contract
upon which it is based, or upon the price of the underlying financial instrument
or index itself, the purchase of a call option may be less risky than the
ownership of the interest rate or index based futures contract or the underlying
securities. Call options on commodity futures contracts may be purchased to
hedge against an interest rate increase or a market advance when the Fund is not
fully invested.
Use of New Investment Techniques Involving Currency or Other
Financial Futures Contracts or Related Options
The Fund may employ new investment techniques involving currency and
other financial futures contracts and related options. The Fund intends to take
advantage of new techniques in these areas which may be developed from time to
time and which are consistent with the Fund's investment objective. The Fund
believes that no additional techniques have been identified for employment by
the Fund in the foreseeable future other than those described above.
Limitations on Purchase and Sale of Futures Contracts and Related
Options on Such Futures Contracts
The Fund will not enter into a futures contract if, as a result
thereof, more than 5% of the Fund's total assets (taken at
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market value at the time of entering into the contract) would be committed to
margin deposits on such futures contracts.
The Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that the Fund owns or futures contracts will be purchased to protect
the Fund against an increase in the price of securities it intends to purchase.
The Fund does not intend to enter into futures contracts for speculation.
In instances involving the purchase of futures contracts by the Fund,
an amount of cash and cash equivalents, equal to the market value of the futures
contracts will be deposited in a segregated account with the Fund's Custodian
and/or in a margin account with a Broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
Federal Income Tax Treatment
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts as of the end of the year as well as those actually realized during
the year. Any gain or loss recognized with respect to a futures contract is
considered to be 60% long term and 40% short term, without regard to the holding
period of the contract. In the case of a futures transaction classified as a
"mixed straddle," the recognition of losses may be deferred to a later taxable
year. The federal income tax treatment of gains or losses from transactions in
options on futures is unclear.
In order for the Fund to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income. Any net gain realized
from the closing out of futures contracts, for purposes of the 90% requirement,
will be qualifying income. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of the Fund's annual gross income. The 1986 Tax Act added a
provision that effectively treats both positions in certain hedging transactions
as a single transaction for the purpose of the 30% requirement. The provision
provides that, in the case of any "designated hedge," increases and decreases in
the value of positions of the hedge are to be netted for the purposes of the 30%
requirement. However, in certain situations, in order to avoid realizing a gain
within a three month period, the Fund may be required to defer the closing out
of a contract beyond the time when it would otherwise be advantageous to do so.
<PAGE>
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Risks of Futures Contracts
Currency and other financial futures contracts prices are volatile and
are influenced, among other things, by changes in stock prices, market
conditions, prevailing interest rates and anticipation of future stock prices,
market movements or interest rate changes, all of which in turn are affected by
economic conditions, such as government fiscal and monetary policies and
actions, and national and international political and economic events.
At best, the correlation between changes in prices of futures contracts
and of the securities being hedged can be only approximate. The degree of
imperfection of correlation depends upon circumstances, such as variations in
speculative market demand for futures contracts and for securities, including
technical influences in futures contracts trading; differences between the
securities being hedged and the financial instruments and indexes underlying the
standard futures contracts available for trading, in such respects as interest
rate levels, maturities and creditworthiness of issuers, or identities of
securities comprising the index and those in the Fund's portfolio. A decision of
whether, when and how to hedge involves the exercise of skill and judgment, and
even a well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends.
Because of the low margin deposits required, futures trading involves
an extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the futures contract is deposited as margin, a 10% decrease in the
value of the futures contract would result in a total loss of the margin
deposit, before any deduction for the transaction costs, if the account were
then closed out, and a 15% decrease would result in a loss equal to 150% of the
original margin deposit. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable losses if, instead
of entering into the futures contract, it had invested in the underlying
financial instrument. Furthermore, in order to be certain that the Fund has
sufficient assets to satisfy its obligations under a futures contract, the Fund
will establish a segregated account in connection with its futures contracts
which will hold cash or cash equivalents equal in value to the current value of
the underlying instruments or indices less the margins on deposit.
Most U.S. futures exchanges limit the amount of fluctuaion
permitted in futures contract prices during a single trading day.
The daily limit establishes the maximum amount that the price of
<PAGE>
A-19
a futures contract may vary either up or down from the previous day's settlement
price at the end of a trading session. Once the daily limit has been reached in
a particular type of contract, no trades may be made on that day at a price
beyond that limit. The daily limit governs only price movement during a
particular trading day and therefore does not limit potential losses because the
limit may prevent the liquidation of unfavorable positions. Futures contract
prices have occasionally moved to the daily limit for several consecutive
trading days with little or no trading, thereby preventing prompt liquidation of
futures positions and subjecting some futures traders to substantial losses.
Risks of Options on Futures Contracts
In addition to the risks described above for currency and other
financial futures contracts, there are several special risks relating to options
on futures contracts. The ability to establish and close out positions on such
options will be subject to the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. The Fund will not purchase
options on any futures contract unless and until it believes that the market for
such options has developed sufficiently that the risks in connection with such
options are not greater than the risks in connection with the futures contracts.
Compared to the use of futures contracts, the purchase of options on such
futures contracts involves less potential risk to the Fund because the maximum
amount at risk is the premium paid for the options (plus transaction costs).
However, there may be circumstances when the use of an option on a futures
contract would result in a loss to the Fund, even though the use of a futures
contract would not, such as when there is no movement in the level of the
futures contract.
FOREIGN CURRENCY TRANSACTIONS
The Fund may invest in securities of foreign issuers. When the Fund
invests in foreign securities they usually will be denominated in foreign
currencies and the Fund temporarily may hold funds in foreign currencies. Thus,
the Fund's share value will be affected by changes in exchange rates.
Forward Currency Contracts
As one way of managing exchange rate risk, the Fund may engage in
forward currency exchange contracts (agreements to purchase or sell currencies
at a specified price and date). Under the contract, the exchange rate for the
transaction (the amount of currency the Fund will deliver or receive when the
contract is completed) is fixed when the Fund enters into the contract. The Fund
usually will enter into these contracts to stabilize the U.S. dollar value of a
security it has agreed to buy or sell. The Fund
<PAGE>
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also may use these contracts to hedge the U.S. dollar value of a security it
already owns, particularly if the Fund expects a decrease in the value of the
currency in which the foreign security is denominated. Although the Fund will
attempt to benefit from using forward contracts, the success of its hedging
strategy will depend on Keystone's ability to predict accurately the future
exchange rate between foreign currencies and the U.S. dollar. The value of the
Fund's investments denominated in foreign currencies will depend on the relative
strength of those currencies and the U.S. dollar, and the Fund may be affected
favorably or unfavorably by changes in the exchange rates or exchange control
regulations between foreign currencies and the dollar. Changes in foreign
currency exchange rates also may affect the value of dividends and interest
earned, gains and losses realized on the sale of securities and net investment
income and gains, if any, to be distributed to shareholders by the Fund.
Currency Futures Contracts
Currency futures contracts are bilateral agreements under which two
parties agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the United States is regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission (CFTC) and National Futures Association
(NFA). Currently the only national futures exchange on which currency futures
are traded is the International Monetary Market of the Chicago Mercantile
Exchange. Foreign currency futures trading is conducted in the same manner and
subject to the same regulations as trading in interest rate and index based
futures. The Fund intends to engage in currency futures contracts for hedging
purposes, and not for speculation. The Fund may engage in currency futures
contracts for other purposes if authorized to do so by the Board. The hedging
strategies that will be used by the Fund in connection with foreign currency
futures contracts are similar to those described above for forward foreign
currency exchange contracts.
Currently, currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark, Swiss and French Francs,
C$100,000 for the Canadian Dollar, Y12,500,000 for the Yen, and 1,000,000 for
the Peso. In contrast to Forward Currency Exchange Contracts which can be traded
at any time, only four value dates per year are available, the third Wednesday
of March, June, September and December.
<PAGE>
A-21
Foreign Currency Options Transactions
Foreign currency options (as opposed to futures) are traded in a
variety of currencies in both the United States and Europe. On the Philadelphia
Stock Exchange, for example, contracts for half the size of the corresponding
futures contracts on the Chicago Board Options Exchange are traded with up to
nine months maturity in Marks, Sterling, Yen, Swiss francs and Canadian dollars.
Options can be exercised at any time during the contract life and require a
deposit subject to normal margin requirements. Since a futures contract must be
exercised, the Fund must continually make up the margin balance. As a result, a
wrong price move could result in the Fund losing more than the original
investment as it cannot walk away from the futures contract as it can an option
contract.
The Fund will purchase call and put options and sell such options to
terminate an existing position. Options on foreign currency are similar to
options on stocks except that an option on an interest rate and/or index based
futures contract gives the purchaser the right, in return for the premium paid,
to purchase or sell foreign currency, rather than to purchase or sell stock, at
a specified exercise price at any time during the period of the option.
The Fund intends to use foreign currency option transactions in
connection with hedging strategies.
Purchase of Put Options on Foreign Currencies
The purchase of protective put options on a foreign currency is
analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of foreign stocks or foreign debt instruments or a position in the foreign
currency upon which the put option is based.
Purchase of Call Options on Foreign Currencies
The purchase of a call option on foreign currency represents a means of
obtaining temporary exposure to market appreciation at limited risk. It is
analogous to the purchase of a call option on an individual stock which can be
used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the foreign currency upon which it is
based, or upon the price of the foreign stock or foreign debt instruments, the
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
<PAGE>
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The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies in order to take advantage of new techniques in these areas
which may be developed from time to time and which are consistent with the
Fund's investment objective. The Fund believes that no additional techniques
have been identified for employment by the Fund in the foreseeable future other
than those described above.
Currency Trading Risks
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk and country risk.
Exchange Rate Risk
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure called an open position is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques such
as foreign currency forward and futures contracts and options on foreign
currency are intended to be used by the Fund to reduce exchange rate risk.
Maturity Gaps and Interest Rate Risk
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange currency holdings, which is
the total of its outstanding spot and forward or futures contracts.
Foreign currency transactions often involve borrowing short term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
Credit Risk
Whenever the Fund enters into a foreign exchange contract, it faces a
risk, however small, that the counterparty will not perform under the contract.
As a result there is a credit risk, although no extension of "credit" is
intended. To limit credit risk, the Fund intends to evaluate the
creditworthiness of each other party.
<PAGE>
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The Fund does not intend to trade more than 5% of its net assets under foreign
exchange contracts with one party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges a Fund relies on
each contract being completed. If the contract is not performed, then the Fund's
hedge is eliminated, and the Fund is exposed to any changes in exchange rates
since the contract was originated. To put itself in the same position it would
have been in had the contract been performed, the Fund must arrange a new
transaction. However, the new transaction may have to be arranged at an adverse
exchange rate. The trustee for a bankrupt company may elect to perform those
contracts which are advantageous to the company but disclaim those contracts
which are disadvantageous, resulting in losses to the Fund.
Another form of credit risk stems from the time zone differences
between the U.S. and foreign nations. If the Fund sells sterling it generally
must pay pounds to a counterparty earlier in the day than it will be credited
with dollars in New York. In the intervening hours, the buyer can go into
bankruptcy or can be declared insolvent. Thus, the dollars may never be credited
to the Fund.
Country Risk
At one time or another, virtually every country has interfered with
international transactions in its currency. Interference has taken the form of
regulation of the local exchange market, restrictions on foreign investment by
residents or limits on inflows of investment funds from abroad. Governments take
such measures for example to improve control over the domestic banking system or
to influence the pattern of receipts and payments between residents and
foreigners. In those cases, restrictions on the exchange market or on
international transactions are intended to affect the level or movement of the
exchange rate. Occasionally a serious foreign exchange shortage may lead to
payment interruptions or debt servicing delays, as well as interference in the
exchange market. It has become increasingly difficult to distinguish foreign
exchange or credit risk from country risk.
Changes in regulations or restrictions usually do have an important
exchange market impact. Most disruptive are changes in rules which interfere
with the normal payments mechanism. If government regulations change and a
counterparty is either forbidden to perform or is required to do something
extra, then the Fund might be left with an unintended open position or an
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unintended maturity mismatch. Dealing with such unintended long or short
positions could result in unanticipated costs to the Fund.
Other changes in official regulations influence international
investment transactions. If one of the factors affecting the buying or selling
of a currency changes, the exchange rate is likely to respond. Changes in such
controls often are unpredictable and can create a significant exchange rate
response.
Many major countries have moved toward liberalization of exchange and
payments restrictions in recent years or accepted the principle that
restrictions should be relaxed. A few industrial countries have moved in the
other direction. Important liberalizations were carried out by Switzerland, the
United Kingdom and Japan. They dismantled mechanisms for restricting either
foreign exchange inflows (Switzerland), outflows (Britain) or elements of both
(Japan). By contrast, France and Mexico have tightened foreign exchange
controls.
Overall, many exchange markets are still heavily restricted. Several
countries limit access to the forward market to companies financing documented
export or import transactions in an effort to insulate the market from purely
speculative activities. Some of these countries permit local traders to enter
into forward contracts with residents but prohibit certain forward transactions
with nonresidents. By comparison, other countries have strict controls on
exchange transactions by residents, but permit free exchange transactions
between local traders and non-residents. A few countries have established tiered
markets, funneling commercial transactions through one market and financial
transactions through another. Outside the major industrial countries, relatively
free foreign exchange markets are rare and controls on foreign currency
transactions are extensive.
Another aspect of country risk has to do with the possibility that the
Fund may be dealing with a foreign trader whose home country is facing a
payments problem. Even though the foreign trader intends to perform on its
foreign exchange contracts, the contracts are tied to other external liabilities
the country has incurred. As a result performance may be delayed, and can result
in unanticipated cost to the Fund. This aspect of country risk is a major
element in the Fund's credit judgment as to with whom it will deal and in what
amounts.
<PAGE>
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EXHIBIT A
GLOSSARY OF TERMS
Class of Options. Options covering the same underlying security.
Clearing Corporation. The Options Clearing Corporation, Trans
Canada Options, Inc., The European Options Clearing Corporation B.V., or the
London Options Clearing House.
Closing Purchase Transaction. A transaction in which an investor who is
obligated as a writer of an option or seller of a futures contract terminates
his obligation by purchasing on an Exchange an option of the same series as the
option previously written or futures contract identical to the futures contract
previously sold, as the case may be. (Such a purchase does not result in the
ownership of an option or futures contract.)
Closing Sale Transaction. A transaction in which an investor who is the
holder or buyer of an outstanding option or futures contract liquidates his
position as a holder or seller by selling an option of the same series as the
option previously purchased or futures contract identical to the futures
contract previously purchased. (Such sale does not result in the investor
assuming the obligations of a writer or seller.)
Covered Call Option Writer. A writer of a call option who, so long as
he remains obligated as a writer, owns the shares of the underlying security or
holds on a share for share basis 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, or, if greater than the exercise price of the call written, the
difference is maintained by the writer in cash, U.S. Treasury bills or other
high grade, short term obligations in a segregated account with the writer's
broker or custodian.
Covered Put Option Writer. A writer of a put option who, so long as he
remains obligated as a writer, has deposited Treasury bills with a value equal
to or greater than the exercise price with a securities depository and has
pledged them to the Options Clearing Corporation for the account of the
broker-dealer carrying the writer's position or holds on a share for share basis
a put on the same security as the put written where the exercise price of the
put held is equal to or greater than the exercise price of the put written, or,
if less than the exercise price of the put written, the difference is maintained
by the writer in cash, U.S. Treasury bills or other high grade, short term
obligations in a segregated account with the writer's broker or custodian.
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Securities Exchange. A securities exchange on which call and put
options are traded. The U.S. Exchanges are as follows: The Chicago Board Options
Exchange; American Stock Exchange; New York Stock Exchange; Philadelphia Stock
Exchange; and Pacific Stock Exchange. The foreign securities exchanges in Canada
are the Toronto Stock Exchange and the Montreal Stock Exchange; in the
Netherlands, the European Options Exchange; and in the United Kingdom, the Stock
Exchange (London).
Those issuers whose common stocks have been approved by the Exchanges
as underlying securities for options transactions are listed in various
financial publications.
Commodities Exchange. A commodities exchange on which futures contracts
are traded which is regulated by exchange rules that have been approved by the
Commodity Futures Trading Commission. The U.S. exchanges are as follows: The
Board of Trade of the City of Chicago, Chicago Mercantile Exchange,
International Monetary Market (a division of the Chicago Mercantile Exchange),
the Kansas City Board of Trade and the New York Futures Exchange.
Exercise Price. The price per unit at which the holder of a call option
may purchase the underlying security upon exercise or the holder of a put option
may sell the underlying security upon exercise.
Expiration Date. The latest date when an option may be
exercised or a futures contract must be completed according to its
terms.
Hedging. An action taken by an investor to neutralize an investment
risk by taking an investment position that will move in the opposite direction
as the risk being hedged so that a loss (or gain) on one will tend to be offset
by a gain (or loss) on the other.
Option. Unless the context otherwise requires,the term "option" means
either a call or put option issued by a Clearing Corporation, as defined above.
A call option gives a holder the right to buy from such Clearing Corporation the
number of shares of the underlying security covered by the option at the stated
exercise price by the filing of an exercise notice prior to the expiration time
of the option. A put option gives a holder the right to sell to a Clearing
Corporation the number of shares of the underlying security covered by the put
at the stated exercise price by the filing of an exercise notice prior to the
expiration time of the option. The Fund will sell ("write") and purchase puts
only on U.S. Exchanges.
Option Period. The time during which an option may be
exercised, generally from the date the option is written through
its expiration date.
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Premium. The price of an option agreed upon between the buyer
and writer or their agents in a transaction on the floor of an
Exchange.
Series of Options. Options covering the same underlying
security and having the same exercise price and expiration date.
Stock Index. A stock index assigns relative values to the common stocks
included in the index, and the index fluctuates with changes in the market
values of the common stocks so included.
Index Based Futures Contract. An index based futures contract is a
bilateral agreement pursuant to which a party agrees to buy or deliver at
settlement an amount of cash equal to $500 times the difference between the
closing value of an index on the expiration date and the price at which the
futures contract is originally struck. Index based futures are traded on
Commodities Exchanges. Currently index based futures contracts can be purchased
or sold with respect to the Standard & Poor's Corporation (S&P) 500 Stock Index
and S&P 100 Stock Index on the Chicago Mercantile Exchange, the New York Stock
Exchange Composite Index on the New York Futures Exchange and the Value Line
Stock Index and Major Market Index on the Kansas City Board of Trade.
Underlying Security. The security subject to being purchased
upon the exercise of a call option or subject to being sold upon
the exercise of a put option.
<PAGE>
Keystone B-1 High Grade Bond Fund
(Keystone Custodian Fund, Series, B-1)
SCHEDULE OF INVESTMENTS--October 31, 1994
See Notes to Schedule of Investments
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
<S> <C> <C> <C> <C>
FIXED INCOME (93.1%)
ADJUSTABLE RATE MORTGAGE SECURITIES (4.1%)
FHLMC, Cap 10.938%, Margin 2.175% + CMT, Resets every 4 months 5.688 2023 $ 8,703,980 $ 8,703,980
FNMA, Cap 10.684%, Margin 2.834% + CMT, Resets Semi-Annually 5.322 2023 4,719,592 4,791,849
TOTAL ADJUSTABLE RATE MORTGAGE SECURITIES (Cost--$13,819,075) 13,495,829
COLLATERALIZED MORTGAGE OBLIGATIONS (6.4%)
Advanta Home Equity Loan (estimated maturity date 2004) (a), Series
1991-2A 8.800 2006 2,207,779 2,232,617
Merrill Lynch Mortgage Investors, Inc. (estimated maturity date 2001)
(a), Series 1991-D Class A 9.000 2011 1,121 1,135
Merrill Lynch Mortgage Investors, Inc. (estimated maturity date 2001)
(a), Series 1992-B Class B 8.500 2012 2,844,267 2,849,984
Merrill Lynch Mortgage Investors, Inc. (estimated maturity date 2004)
(a), Series 1991-G Class B 9.150 2011 4,512,270 4,552,384
Merrill Lynch Mortgage Investors, Inc. (estimated maturity date 2004)
(a), Series 1992-D Class B 8.500 2017 3,362,493 3,328,969
Paine Webber Mortgage Acceptance Corp. (estimated maturity date 2008)
(a), Series 1993-5 Class A 3 6.875 2008 2,939,885 2,884,762
Sears Mortgage Securities Corp. (estimated maturity date 2021) (a),
Series 1992-6 Class M 1 8.150 2022 859,570 786,506
Security Pacific Acceptance Corp. (estimated maturity date 2002) (a),
Series 1992-1 Class B 9.150 2012 2,679,186 2,667,451
University Support Services, Inc. (estimated maturity date 2003) (a),
Series 1992-D 9.000 2007 1,545,000 1,552,725
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost--$21,135,740) 20,856,533
MORTGAGE PASS-THROUGH CERTIFICATES (20.6%)
FHLMC PC Pool #303865 8.500 1997 195,220 195,747
FHLMC PC Pool #555218 9.000 2021 12,355,589 12,550,065
FNMA Pool #050926 6.000 2008 477,912 432,511
FNMA Pool #125306 8.000 2024 9,969,507 9,620,574
FNMA Pool #248519 6.000 2008 15,241,170 13,793,258
GNMA Pool #001849 8.500 2024 7,640,456 7,470,914
GNMA Pool #001886 9.000 2024 4,900,000 4,924,500
GNMA Pool #336169 7.500 2023 4,795,155 4,451,966
GNMA Pool #351171 7.500 2023 4,982,839 4,626,217
GNMA Pool #376042 7.500 2024 4,901,615 4,550,806
GNMA Pool #388262 7.500 2024 5,000,323 4,642,451
TOTAL MORTGAGE PASS-THROUGH CERTIFICATES (Cost--$71,053,536) 67,259,009
FOREIGN BONDS (U.S. DOLLARS) (4.7%)
Kansallis Osake Pankki, New York, Subord. Notes 10.000 2002 $ 5,000,000 $ 5,378,950
See Notes to Schedule of Investments
<PAGE>
Interest Maturity Par Market
Rate Date Value Value
FOREIGN BONDS (U.S. DOLLARS)--continued
Nova Scotia Province, Canada, Debenture 9.125 2021 $5,500,000 $ 5,417,610
Rolls Royce Capital, Gtd. Debenture 7.125 2003 5,000,000 4,571,050
TOTAL FOREIGN BONDS (Cost--$17,391,423) 15,367,610
CORPORATE BONDS (33.8%)
Automotive (1.3%)
Ford Holdings, Inc., Debenture 9.250 2000 4,000,000 4,185,520
BANKING (4.1%)
Barnett Banks, Florida, Med. Term Notes 10.875 2003 4,500,000 5,129,955
Comerica Bank, Detroit, Michigan, Sr. Bank Notes 5.950 1997 3,000,000 2,885,340
NCNB Corp., North Carolina, Subord. Notes 10.200 2015 5,000,000 5,535,150
13,550,445
Consumer Goods (1.6%)
Procter & Gamble, ESOP, Series A Debenture 9.360 2021 5,000,000 5,364,300
Finance (7.2%)
Chrysler Financial Corp., Sr. Notes 9.500 1999 3,545,000 3,744,194
Discover Credit Corp., Med. Term Notes 8.350 1999 5,000,000 5,042,100
Ford Motor Credit, Med. Term Notes 6.125 1995 5,000,000 4,980,500
General Motors Acceptance Corp., Med. Term Notes 7.375 1999 5,000,000 4,852,350
Household Finance Corp., Notes 7.625 1999 5,000,000 4,925,800
23,544,944
Natural Gas (1.3%)
Tennessee Gas Pipeline Co., Debenture 6.000 2011 5,500,000 4,071,760
Office & Business Equipment (1.2%)
International Business Machines, Debenture 8.375 2019 4,000,000 3,791,680
Oil (2.9%)
Atlantic Richfield Co., Debenture 9.875 2016 5,500,000 6,026,130
Chevron Corp. Profit Sharing Savings Plan, Amort. Notes 8.110 2004 3,500,000 3,491,985
9,518,115
Pharmaceutical (2.3%)
Upjohn Co. ESOP, Sinking Fund Debenture 9.790 2004 7,000,000 7,401,310
Telecommunications (7.3%)
Bell Atlantic Financial Services, Inc., Med. Term Notes 4.460 1996 7,300,000 7,112,171
Cincinnati Bell, Inc., Debenture 9.100 2000 7,000,000 7,253,750
GTE Northwest, Inc., Debenture 7.375 2001 3,000,000 2,892,930
GTE South, Inc., Debenture 7.250 2002 5,500,000 5,206,520
U S West Financial Services, Inc., Med. Term Notes 8.850 1999 1,500,000 1,544,100
24,009,471
<PAGE>
Interest Maturity Par Market
Rate Date Value Value
Utilities (4.6%)
Cincinnati Gas & Electric Co., First Mortgage Bond 10.200 2020 3,000,000 3,271,920
DQU II Funding Corp., Collateralized Lease Bond 8.700 2016 5,000,000 4,509,000
Texas Utilities Electric Co., First
Mortgage Bond 9.750 2021 2,000,000 2,081,680
Texas Utilities Electric Co., First Mortgage Bond 7.875 2023 6,000,000 5,266,320
15,128,920
TOTAL CORPORATE BONDS (Cost--$117,221,703) 110,566,465
UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (23.5%)
FHLMC, Debenture 7.830 2004 5,000,000 4,773,400
FHLMC, Debenture 8.350 2004 5,500,000 5,408,810
U.S. Treasury Notes 6.500 1997 12,000,000 11,857,440
U.S. Treasury Bonds 7.875 2021 30,550,000 29,743,174
U.S. Treasury Notes 8.000 1996 24,700,000 25,232,532
TOTAL UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (Cost--$85,460,564) 77,015,356
TOTAL FIXED INCOME (Cost--$326,082,041) $304,560,802
Interest Maturity Maturity Market
Rate Date Value Value
SHORT-TERM INVESTMENTS (5.8%)
REPURCHASE AGREEMENTS (5.8%)
Prudential Bache, purchased 10/31/94
(Collateralized by $22,211,000 FHLMC, 5.392%, 09/01/23) 4.780 11/01/94 18,991,521 18,989,000
TOTAL SHORT-TERM INVESTMENTS (Cost--$18,989,000) 18,989,000
TOTAL INVESTMENTS (Cost--$345,071,041)(b) 323,549,802
OTHER ASSETS AND LIABILITIES--NET (1.1%) 3,725,734
NET ASSETS (100.0%) $327,275,536
</TABLE>
Notes to Schedule of Investments:
(a) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected pre-payment rates. Changes in interest rates
can cause the estimated maturity to differ from the listed date.
(b) The cost of investments for federal income tax purposes is identical.
Gross unrealized appreciation and depreciation of investments based on
identified tax cost, at October 31, 1994, are as follows:
Gross unrealized appreciation $ 728,620
Gross unrealized depreciation (22,249,859)
Net unrealized depreciation $(21,521,239)
Legend of Portfolio Abbreviations:
CMT--1, 3, or 5 year Constant Maturity Treasury Index.
See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the period)
<TABLE>
<CAPTION>
Year Ended October 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value:
Beginning of year $ 16.40 $ 15.92 $ 15.92 $ 15.11 $ 15.85 $ 15.71 $ 15.52 $ 17.30 $ 16.15 $ 15.45
Income from
investment
operations
Investment
income--net 0.76 0.96 1.04 1.08 1.11 1.21 1.19 1.20 1.50 1.63
Net gains (losses)
on investments
and foreign
currency related
transactions (1.76) 0.66 0.15 0.99 (0.53) 0.25 0.32 (1.59) 1.56 0.94
Net commisions
paid on fund
share sales(a) 0 0 0 0 0 0 0 0 (0.20) (0.19)
Total from
investment
operations (1.00) 1.62 1.19 2.07 0.58 1.46 1.51 (0.39) 2.86 2.38
Less distributions
from:
Investment
income--net (0.76) (0.96) (1.04) (1.08) (1.18) (1.32) (1.32) (1.39) (1.64) (1.68)
In excess of
investment
income-- net(b) (0.09) (0.18) (0.15) (0.18) (0.14) 0 0 0 0 0
Tax basis return
of capital (0.11) 0 0 0 0 0 0 0 0 0
Realized gains on
investments and
foreign currency
related
transactions--net 0 0 0 0 0 0 0 0 (0.07) 0
Total
distributions (0.96) (1.14) (1.19) (1.26) (1.32) (1.32) (1.32) (1.39) (1.71) (1.68)
Net asset value:
End of year $ 14.44 $ 16.40 $ 15.92 $ 15.92 $ 15.11 $ 15.85 $ 15.71 $ 15.52 $ 17.30 $ 16.15
Total return(c) (6.27%) 10.50% 7.71% 14.09% 3.93% 9.82% 10.09% (2.44%) 18.13% 16.23%
Ratios/supplemental
data
Ratios to average
net assets:
Operating and
management
expenses 1.86% 1.94% 2.01% 2.04% 1.95% 1.82% 1.64% 1.56% 1.00% 1.09%
Investment
income--net 5.05% 5.85% 6.40% 6.95% 7.45% 7.61% 7.49% 7.32% 8.37% 10.14%
Portfolio turnover
rate 169% 190% 102% 158% 117% 116% 153% 127% 97% 48%
Net assets, end of
year (thousands) $327,276 $458,925 $456,912 $453,528 $408,330 $462,425 $447,454 $440,836 $348,107 $105,351
<FN>
(a) Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution Plan has been treated for both
financial statement and tax purposes as capital charges. On June 11,
1987, the Securities and Exchange Commission adopted a rule which
required for financial statements for the periods ended on or after June
30, 1987, that net commissions paid under Rule 12b-1 be treated as
operating expenses rather than capital charges. Accordingly, beginning
with the year ended October 31, 1987, the Fund's financial statements
reflect 12b-1 Distribution Plan expenses (i.e., shareholder service fees
plus commissions paid net of deferred sales charges received by the Fund)
as a component of net investment income.
(b) Effective November 1, 1993, the fund adopted Statement of Position 93-2:
"Determination, Disclosure, and Financial Statement Presentation of
Income, Capital Gain and Return of Capital Distributions by Investment
Companies". As a result, distribution amounts exceeding book basis net
investment income (or tax basis net income on a temporary basis) are
presented as "Distributions in excess of investment income--net".
Similarly, capital gain distributions in excess of book basis capital
gains (or tax basis capital gains on a temporary basis) are presented as
"Distributions in excess of realized capital gains". Prior to the date of
adoption of the Statement of Position, distribution amounts exceeding
book basis investment income--net were presented as "distributions from
paid-in capital".
(c) Without contingent deferred sales charge (CDSC).
</FN>
</TABLE>
See Notes to Financial Statements.
<PAGE>
Keystone B-1 High Grade Bond Fund
(Keystone Custodian Fund, Series, B-1)
STATEMENT OF ASSETS AND LIABILITIES--
October 31, 1994
Assets:
Investments at market value (identified
cost--$345,071,041) (Note 1) $323,549,802
Cash 451
Receivable for:
Fund shares sold 4,915,662
Interest 5,424,748
Prepaid expenses 49,089
Total assets 333,939,752
Liabilities:
Payable for:
Fund shares redeemed 5,905,888
Income distribution 703,858
Other accrued expenses 54,470
Total liabilities 6,664,216
Net assets $327,275,536
Net assets represented by (Note 1):
Paid-in capital $371,897,091
Accumulated distributions in excess of investment
income--net (703,858)
Accumulated realized gains (losses) on investments
and foreign currency related transactions--net (22,396,458)
Net unrealized appreciation (depreciation) on
investments (21,521,239)
Total net assets applicable to outstanding shares
of beneficial interest ($14.44 a share on
22,658,079 shares outstanding) (Note 2) $327,275,536
See Notes to Financial Statements.
STATEMENT OF OPERATIONS--
Year Ended October 31, 1994
Investment income (Note 1):
Interest (net of withholding taxes of
$63,493) $ 26,876,169
Expenses (Notes 2 and 4):
Management fee $ 2,193,546
Transfer agent fees 903,104
Accounting, auditing, and legal 42,800
Custodian fees 171,960
Printing 21,369
Trustees' fees and expenses 41,769
Distribution Plan expenses 3,769,765
Registration fees 53,861
Miscellaneous expenses 26,024
Total expenses 7,224,198
Investment income--net 19,651,971
Net realized and unrealized gain
(loss) on investments and forward
foreign currency exchange related
transactions (Notes 1 and 3):
Net realized loss on:
Investments (21,836,216)
Foreign currency related
transactions 1,198,568
Realized gain (loss) on investments
and forward foreign currency
related transactions--net (20,637,648)
Net change in unrealized appreciation
(depreciation) on investments:
Beginning of year 3,395,279
End of year (21,521,239)
Net change in unrealized appreciation
or depreciation (24,916,518)
Net loss on investments and foreign
currency related transactions (45,554,166)
Net decrease in net assets resulting
from operations ($ 25,902,195)
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended October 31,
1994 1993
<S> <C> <C>
Operations:
Investment income--net (Note 1) $ 19,651,971 $ 26,801,447
Realized gain (loss) on investments and foreign currency related
transactions--net (Notes 1 and 3) (20,637,648) 18,724,375
Net change in unrealized appreciation or depreciation (24,916,518) 191,629
Net increase (decrease) in net assets resulting from operations (25,902,195) 45,717,451
Net equalization charges and credits (Note 1) -0- (9,641)
Distributions to shareholders from (Notes 1 and 5):
Investment income--net (19,651,971) (26,791,806)
In excess of investment income--net (1,885,034) (5,390,591)
Tax basis return of capital (2,544,603) -0-
Total distributions to shareholders (24,081,608) (32,182,397)
Capital share transactions (Note 2):
Proceeds from shares sold 146,861,304 113,059,959
Payments for shares redeemed (243,065,758) (145,688,384)
Net asset value of shares issued in reinvestment of distributions from net
investment income--net and in excess of net investment income--net 14,538,531 21,116,007
Net increase (decrease) in net assets resulting from capital share transactions (81,665,923) (11,512,418)
Total increase (decrease) in net assets (131,649,726) 2,012,995
Net assets:
Beginning of year 458,925,262 456,912,267
End of year [Including undistributed investment income--net (distributions in
excess of investment income--net) as follows:
October 31, 1994--$(703,858) and October 31, 1993-- $(1,137,489)](Note 1) $ 327,275,536 $ 458,925,262
</TABLE>
See Notes to Financial Statements.
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone B-1 High Grade Bond Fund (the "Fund") is a common law trust for
which Keystone Management, Inc. ("KMI") is the Investment Manager and
Keystone Custodian Funds, Inc. ("Keystone") is the Investment Adviser. The
Fund is registered under the Investment Company Act of 1940 as a diversified
open-end investment company.
Keystone is a wholly-owned subsidiary of Keystone Group, Inc. ("KGI"), a
Delaware corporation. KGI is privately owned by an investor group consisting
of members of current management of Keystone. Keystone Investor Resource
Center, Inc. ("KIRC"), a wholly-owned subsidiary of Keystone, is the Fund's
transfer agent.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles.
A. Investments are usually valued at the closing sales price, or, in the
absence of sales and for over-the-counter securities, the mean of bid and
asked quotations. Management values the following securities at prices it
determined in good faith, by or under the direction of the Board of Trustees,
to be fair: (a) securities (including restricted securities) for which
complete quotations are not readily available and (b) listed securities if,
in the opinion of management, the last sales price does not reflect a current
value or if no sale occurred. Short-term investments maturing in sixty days
or less are valued at amortized cost (original purchase cost as adjusted for
amortization of premium or accretion of discount) which when combined with
accrued interest approximates market. Short-term investments maturing in more
than sixty days for which market quotations are readily available are valued
at current market value. Short-term investments maturing in more than sixty
days when purchased which are held on the sixtieth day prior to maturity are
valued at amortized cost (market value on the sixtieth day adjusted for
amortization of premium or accretion of discount) which when combined with
accrued interest approximates market. Investments denominated in a foreign
currency are adjusted daily to reflect changes in exchange rates. Market
quotations are not considered to be readily available for long-term corporate
bonds and notes; such investments are stated at fair value on the basis of
valuations furnished by a pricing service, approved by the Trustees, which
determines valuations for normal, institutional-size trading units of such
securities using methods based on market transactions for comparable
securities and various relationships between securities which are generally
recognized by institutional traders. Securities traded in foreign currency
amounts are translated into United States dollars as follows: market value of
investments, assets, and liabilities at the daily rate of exchanges;
purchases and sales of investments, income, and expenses at the rate of
exchange prevailing on the respective dates of such transactions.
A futures contract is an agreement between two parties to buy and sell a
specific amount of a commodity, security, financial instrument, or, in the
case of a stock index, cash at a set price on a future date. Upon entering
into a futures contract, the Fund is required to deposit with a broker an
amount ("initial margin") equal to a certain percentage of the purchase price
indicated in the futures contract. Subsequent payments ("variation margin")
are made or received by the Fund each day, as the value of the underlying
instrument or index fluctuates, and are recorded for book purposes as
unrealized gains or losses by the Fund. For federal tax
<PAGE>
purposes, any futures contracts which remain open at fiscal year-end are
marked-to-market and the resultant net gain or loss is included in federal
taxable income. In addition to market risk, the Fund is subject to the credit
risk that the other party will not complete the obligations of the contract.
Foreign currency amounts are translated into United States dollars as
follows: market value of investments, assets and liabilities at the daily
rate of exchange, purchases and sales of investments, income and expenses at
the rate of exchange prevailing on the repective dates of such transactions.
Net unrealized foreign exchange gains/losses are a component of unrealized
appreciation/depreciation of investments.
B. Securities transactions are accounted for on the trade date. Realized
gains and losses are recorded on the identified cost basis. Interest income
is recorded on the accrual basis and dividend income is recorded on the
ex-dividend date. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
C. The Fund has qualified, and intends to qualify in the future, as a
regulated investment company under the Internal Revenue Code of 1986, as
amended ("Internal Revenue Code"). Thus, the Fund expects to be relieved of
any federal income tax liability by distributing all of its net taxable
investment income and net taxable capital gains, if any, to its shareholders.
The Fund intends to avoid excise tax liability by making the required
distributions under the Internal Revenue Code.
D. For the year ended October 31, 1993, the Fund used the accounting practice
known as equalization by which a portion of the proceeds from sales and the
costs of redemptions of capital shares (equivalent on a per share basis to
the amount of undistributed net investment income on the date of the
transactions) was credited or charged to undistributed income. As a result,
undistributed net investment income per share was not affected by sales or
redemptions of shares. Effective November 1, 1993 the Fund discontinued
equalization accounting.
E. When the Fund enters into a repurchase agreement (a purchase of securities
whereby the seller agrees to repurchase the securities at a mutually agreed
upon date and price), the repurchase price of the securities will generally
equal the amount paid by the Fund plus a negotiated interest amount. The
seller under the repurchase agreement will be required to provide securities
("collateral") to the Fund whose value will be maintained at an amount not
less than the repurchase price, and which generally will be maintained at
101% of the repurchase price. The Fund monitors the value of collateral on a
daily basis, and if the value of collateral falls below required levels, the
Fund intends to seek additional collateral from the seller or terminate the
repurchase agreement. If the seller defaults, the Fund would suffer a loss to
the extent that the proceeds from the sale of the underlying securities were
less than the repurchase price. Any such loss would be increased by any cost
incurred on disposing of such securities. If bankruptcy proceedings are
commenced against the seller under the repurchase agreement, the realization
on the collateral may be delayed or limited. Repurchase agreements entered
into by the Fund will be limited to transactions with dealers or domestic
banks believed to present minimal credit risks, and the Fund will take
constructive receipt of all securities underlying repurchase agreements until
such agreements expire.
F. In connection with portfolio purchases and sales of securities denominated
in a foreign currency, the Fund
<PAGE>
may enter into forward foreign currency exchange contracts ("contracts").
Additionally, from time to time, the Fund may enter into forward foreign
currency exchange contracts to hedge certain foreign currency assets.
Contracts are recorded at market value and are marked-to-market daily.
Realized gains and losses arising from such transactions are included in net
realized gain (loss) on foreign currency related transactions. The Fund is
subject to the credit risk that the other party will not complete the
obligations of the contract.
G. The Fund distributes net investment income to shareholders monthly and
net capital gains annually. Distributions from net investment income are
based on tax basis net income. Dividends from taxable net investment income
can exceed the Fund's book basis net investment income. Effective November 1,
1993, the Fund adopted Statement of Position 93-2: Determination, Disclosure,
and Financial Statement Presentation of Income, Capital Gain and Return of
Capital Distributions by Investment Companies. As a result of this statement,
the Fund changed the classification of distributions to shareholders to
better disclose the differences between financial statement amounts available
for distribution and amounts distributed to comply with income tax
regulations. Accordingly, the following reclassifications have been made as
of October 31, 1993: a decrease in paid-in capital of $2,034,650, a decrease
in undistributed investment income--net of $1,137,489, and an increase in
accumulated realized gains (losses) on investments and foreign currency
related transactions--net of $3,172,139. Differences between book basis
investment income--net available for distribution and tax basis investment
income--net available for distribution are primarily attributable to
differences in the treatment of 12b-1 Distribution Plan charges and foreign
currency gains and losses.
(2.) Capital Share Transactions
The Trust Agreement authorizes the issuance of an unlimited number of shares
of beneficial interest with a par value of $1.00. Transactions in shares of
the Fund were as follows:
Year Ended October 31,
1994 1993
Shares sold 9,718,655 7,000,489
Shares redeemed (15,997,010) (9,024,427)
Shares issued in
reinvestment of
distributions from
investment income--net
and distributions in
excess of investment
income--net 951,580 1,311,126
Net decrease (5,326,775) (712,812)
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted pursuant to Rule 12b-1 under the Investment Company Act of 1940.
Under the Distribution Plan, the Fund pays Keystone Distributors, Inc.
("KDI"), the principal underwriter and a wholly-owned subsidiary of Keystone,
amounts which in total may not exceed the Distribution Plan maximum.
In connection with the Distribution Plan and subject to the limitations
discussed below, Fund shares are offered for sale at net asset value without
any initial sales charge. From the amounts received by KDI in connection with
the Distribution Plan, and subject to the limitations discussed below, KDI
generally pays brokers or others a commission equal to 4% of the price paid
to the Fund for each sale of Fund shares as well as a shareholder service fee
at a rate of 0.25% per annum of the net asset value of shares sold by such
<PAGE>
brokers or others and remaining outstanding on the books of the Fund for
specified periods.
To the extent Fund shares purchased prior to July 8, 1992, are redeemed
within four calendar years of original issuance, the Fund may be eligible to
receive a deferred sales charge from the investor as partial reimbursement
for sales commissions previously paid on those shares. This charge is based
on declining rates, which begin at 4.0%, applied to the lesser of the net
asset value of shares redeemed or the total cost of such shares.
Commencing on July 8, 1992, contingent deferred sales charges applicable to
shares of the Fund issued after January 1, 1992 have, to the extent permitted
by the NASD Rule, been paid to KDI rather than to the Fund. During the year,
KDI received $534,553 in contingent deferred sales charges.
The Distribution Plan provides that the Fund may incur certain expenses which
may not exceed a maximum amount equal to 0.3125% of the Fund's average daily net
assets for any calendar quarter (approximately 1.25% annually) occurring after
the inception of the Distribution Plan. A rule of the National Association of
Securities Dealers, Inc. ("NASD Rule") limits the annual expenditures which the
Fund may incur under the Distribution Plan to 1%, of which 0.75% may be used to
pay such distribution expenses and 0.25% may be used to pay shareholder service
fees. The NASD Rule also limits the aggregate amount which the Fund may pay for
such distribution costs to 6.25% of gross share sales since the inception of the
Fund's Distribution Plan, plus interest at the prime rate plus 1% on unpaid
amounts thereof (less any contingent deferred sales charges paid by the
shareholders to KDI).
The Fund has operated its Distribution Plan in accordance with both the Plan
and the NASD Rule since July 8, 1992, except that until July 7, 1993, maximum
annual payments with respect to Net Asset Value as represented by shares sold
prior to January 1, 1992 remained at the current rate of 0.3125% quarterly
(approximately 1.25% annually).
KDI intends, but is not obligated, to continue to pay or accrue distribution
charges which exceed current annual payments permitted to be received by KDI
from the Fund. KDI intends to seek full payment of such charges from the Fund
(together with annual interest thereon at the prime rate plus one percent) at
such time in the future as, and to the extent that, payment thereof by the
Fund would be within permitted limits. KDI currently intends to seek payment
of interest only on such charges paid or accrued by KDI subsequent to January
1, 1992.
During the year ended October 31, 1994, the Fund recovered $98,756 in
contingent deferred sales charges. During the year, the Fund paid KDI
$3,868,521 under the Distribution Plan. The amount paid by the Fund under its
Distribution Plan, net of contingent deferred sales charges, was $3,769,765
(0.97% of the Fund's average daily net asset value during the year). For the
year ended October 31, 1994, KDI received $1,856,670 after payments of
commissions on new sales and service fees to dealers and others of
$2,011,851.
At October 31, 1994, KDI's total unreimbursed Distribution Plan expenses
amounted to $12,643,676, of which $469,768 was incurred in the year ended
October 31, 1994 (3.86% of the Fund's net asset value as of October 31,
1994). The right to certain portions of this amount, if and when receivable,
was assigned by KDI in 1988 in connection with a financial transaction. As of
October 31, 1994, $10,956,671 of the amount remained outstanding.
<PAGE>
(3.) Securities Transactions
As of October 31, 1994, the Fund had a capital loss carryover for federal
income tax purposes of approximately $22,396,000 which expires as follows:
1998--$2,251,000; 2002--$20,145,000. For the year ended October 31, 1994,
purchases and sales of investment securities were as follows:
Cost of Proceeds
Purchases from Sales
Investments (excluding
U.S. Government
obligations) $ 299,808,442 $ 327,583,553
U.S. Government
obligations 320,056,931 377,135,753
Short-term investments 5,217,577,434 5,267,487,434
$5,837,442,807 $5,972,206,740
(4.) Investment Management and Transactions With Affiliates
Under the terms of the Investment Management Agreement between KMI and the
Fund, dated December 29, 1989, KMI provides investment management and
administrative services to the Fund. In return, KMI is paid a management fee
computed and paid daily. The management fee is calculated at a rate of 2.0%
of the Fund's gross investment income plus an amount determined by applying
percentage rates starting at 0.50% and declining as net assets increase to
0.25% per annum, to the net asset value of the Fund. KMI has entered into an
Investment Advisory Agreement with Keystone, dated December 29, 1989, under
which Keystone provides investment advisory and management services to the
Fund and receives for its services an annual fee representing 85% of the
management fee received by KMI. During the year ended October 31, 1994, the
Fund paid or accrued to KMI investment management and administrative services
fees of $2,193,546 which represented 0.56% of the Fund's average net assets
on an annualized basis. Of such amount paid to KMI, $1,864,514 was paid to
Keystone for its services to the Fund.
During the year ended October 31, 1994, the Fund paid or accrued to KIRC and
KGI $22,036 as reimbursement for certain accounting services and to KIRC
$903,104 for transfer agent fees.
(5.) Distributions to Shareholders
A distribution of net investment income of $0.078 per share was declared
payable by December 6, 1994 to shareholders of record November 21, 1994. This
distribution is not reflected in the accompanying financial statements.
Federal Tax Status--Fiscal 1994
Distributions (Unaudited)
During the fiscal year ended October 31, 1994, the Fund paid or accrued
income dividends of $0.96 per share. Of this amount, $0.11 per share is a
non-taxable return of capital. The remaining $0.85 per share is taxable to
shareholders as ordinary income in the year in which received by them or
credited to their accounts and none are eligible for the corporate dividends
received deduction.
The above figures may differ from those cited in Note 5 and elsewhere in this
report due to differences in the calculation of income and capital gains for
accounting (book) purposes and Internal Revenue Service (tax) purposes.
In January, 1995, we will send you complete information on the distributions
paid during the calendar year to help you in completing your federal tax
return.
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Custodian Fund, Series B-1
We have audited the accompanying statement of assets and liabilities of
Keystone Custodian Fund, Series B-1, including the schedule of investments,
as of October 31, 1994, and the related statement of operations for the year
then ended, the statements of changes in net assets for each of the years in
the two-year period then ended, and the financial highlights for each of the
years in the ten-year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
supplementary information based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of October 31, 1994, by correspondence with the custodian
and brokers. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Custodian Fund, Series B-1, as of October 31, 1994, the results of
its operations for the year then ended, the changes in its net assets for
each of the years in the two-year period then ended, and the financial
highlights for each of the years in the ten-year period then ended in
conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Boston, Massachusetts
December 2, 1994
