PAGE 1
Keystone Quality Bond Fund (B-1)
Seeks generous income and capital preservation from high quality bonds.
Dear Shareholder:
We are writing to report on the activities of Keystone Quality Bond Fund
(B-1) for the six-month period which ended April 30, 1996.
Performance
Your Fund returned -1.04% for the six-month period and 6.17% for the
twelve-month period which ended April 30, 1996. For the same periods, the
Lehman Aggregate Bond Index - a widely recognized index of corporate,
government and mortgage securities - returned 0.52% for the six-month period
and 8.63% for the twelve-month period.
Your Fund's returns, while trailing some indices, were consistent with the
results we expected from a conservatively managed portfolio of high quality
bond investments during a period of economic uncertainty.
Higher quality bond investments are principally affected - both positively
and adversely - by movements in interest rates. During the six-month fiscal
period, we saw two very different investment environments as interest rates
moved in different directions.
At the beginning of the period, from November 1995 through January 1996,
economists and professional investors were more concerned about the
possibility of recession. During this period, we witnessed a positive
environment for high quality bonds as interest rates continued to move down
and bond prices increased. Near the end of the period, from February through
April, economists and professional investors became concerned about the
possibilities of strong economic growth and a revival of inflation. During
this period, sparked by a February government report of unexpectedly strong
economic growth, long-term interest rates rose by almost a full percentage
point, from less than 6% to almost 7%, and bond prices fell.
While the greatest volatility in bond yields and bond prices may have passed,
this period of uncertainty has continued. It is Keystone's view, however,
that the interest rates may have increased further than the economic
fundamentals seem to warrant, and that we may witness a moderation in
interest rates and bond price movements as the year progresses. We believe
that the economy is growing moderately, and that inflation is likely to
remain subdued.
Keystone Quality Bond Fund (B-1) is designed for the conservative,
income-oriented investor. In pursuing this approach, we continued to invest
in the high quality fixed-income securities. We applied our intensive
research and selective allocation process to a variety of securities, which
included U.S. government obligations, mortgage-backed and asset-backed
securities, and high grade corporate bonds.
We believe your Fund's ability to diversify and be flexible are key elements
in navigating the changing market conditions investors have recently
experienced. As interest rates declined, we extended the Fund's average
maturity and emphasized long-term U.S. Treasury bonds. This helped the Fund
to maintain income during a period of declining interest rates, as well as
maximize price appreciation. We modified the portfolio's structure as that
trend reversed - shortening average maturity and building positions in
mortgage-backed and asset-backed securities. This strategy was designed to
enhance price stability and build income in this higher interest rate
environment.
(continued on next page)
<PAGE>
PAGE 2
Keystone Quality Bond Fund (B-1)
While we do not like to see price erosion, we believe that higher interest
rates can provide selective opportunities to the income-oriented investors.
The real return from bonds - the rate of interest less the rate of inflation
- - has been high by historical standards. With long-term Treasury bonds
yielding almost 7% and inflation, as measured by the Consumer Price Index, at
between 2.5% and 3%, real rates are approximately 4%. We think this
represents an excellent value for income-oriented investors. Near-term, we
expect high grade bonds to trade within a fairly narrow range as investors
assess the economy's strength. Further out, we look for stable to moderate
economic growth with low inflation, which should provide a favorable backdrop
for bonds. Keystone Quality Bond Fund (B-1) will continue to seek attractive
income and solid total returns for long-term investors.
Thank you for your continued support of Keystone Quality Bond Fund (B-1). If
you have any questions or comments about your investment, we encourage you to
write to us.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
Chairman and President
Keystone Investments, Inc.
/s/ George S. Bissell
George S. Bissell
Chairman of the Board
Keystone Funds
June 1996
[Graphic: Telephone Receiver]
[DALBAR Logo] Dalbar Key Honors
DALBAR Honoring Commitment to Excellence
Honors Commmitment To: Keystone was recently recognized by Dalbar, an
Investors independent mutual fund rating organization, for
1995 demonstrating a commitment to serving the needs of
customers. The award is intended to distinguish
companies who are committed to investors and have a
proven ability to provide good service.
[Graphic: Telephone ringing]
=============================================================================
Keystone Introduces Investment Insight Line for Shareholders
Now you can keep up-to-date on your fund's current strategy and outlook by
calling Keystone Investment Insight Line. You can hear Keystone portfolio
managers discuss their latest strategies. You can also listen to Keystone's
overall market outlook from James McCall, Chief Investment Officer. The
service is available 24 hours a day, seven days a week and updated at least
monthly.
Keystone Investment Insight Line 1-800-346-3858, Press 2
=============================================================================
<PAGE>
PAGE 3
A Discussion With
Your Fund Manager
Barbara A. McCue is vice president and senior portfolio manager of your Fund
and part of Keystone's high grade bond team. A Chartered Financial Analyst,
Mrs. McCue has more than 19 years of investment experience. She holds an MBA
from Boston University. Other members of the high grade bond team include
Christopher P. Conkey, team leader, and analysts David J. Bowers and Gary E.
Pzegeo. The team evaluates interest rate and credit risk in selecting high
quality bonds for Keystone fixed-income funds
Q What was the environment like for high grade bonds over the past six
months?
A The environment changed in February. The pace of job creation surged to
levels consistent with a much stronger rate of economic growth. Investors'
expectations changed from fear of recession to worries about the
inflationary consequences of robust growth. Interest rates reversed course
and began trending higher. Yields rose and bond prices fell during that
time.
Q What was the tone of the bond market at the end of the period?
A The bond market seemed to be in a transitional period, with prices trading
in a fairly narrow range. This type of activity is not unusual. Business
and economic cycles change; and with that comes a reevaluation of
investors' outlooks and price adjustments. As a clearer picture of the
economy begins to develop, we believe the uncertainty will fade and the
market will take on a more defined direction.
Q How was the portfolio structured over the past six months?
A From November to January, we structured the portfolio to take advantage of
the lower interest rate environment. To gain better price appreciation, we
lengthened the Fund's average maturity. We did this primarily by investing
in long-term U.S. Treasury bonds. We also reduced the Fund's holdings in
mortgage-backed securities, which tend to underperform in a declining
interest rate environment.
We restructured the portfolio in February and March when interest rates
began to rise. We shortened the Fund's average maturity, reduced our
position in long-term U.S. Treasuries and increased our holdings in
mortgage-backed and asset-backed securities. We also increased cash
equivalents. These changes enhanced price stability, and built liquidity
and income for this higher interest rate environment. Currently, the Fund's
average maturity stands at 10.2 years and its average quality is AA,
considered to be the second highest rating category.
Q What is your outlook for high grade bonds over the next six months?
A We have a constructive outlook over the longer term. As long as economic
growth stays near the current levels of 2%-2.5%, we believe the risk of
higher inflation and higher interest rates is low. In fact, we think that
the higher interest rates we've seen so far will probably have a dampening
effect on economic growth later this year.
- -----------------------------------[Pie Chart]----------------------------------
Portfolio Quality Summary
as of April 30, 1996
AAA (58.4%)
AA (20.2%)
A (12.3%)
BBB (9.1%)
(as a percentage of portfolio assets)
- -------------------------------------------------------------------------------
<PAGE>
PAGE 4
Keystone Quality Bond Fund (B-1)
Your Fund's Performance
- ----------------------------------[Mountain Chart]-----------------------------
Growth of an Investment in
Keystone Quality Bond Fund (B-1)
Initial Reinvested
Investment Distributions
4/86 10000 10000
4/87 9291 10195
4/88 8772 10454
4/89 8576 11131
4/90 8403 11865
4/91 8738 13432
4/92 8850 14699
4/93 8956 16100
4/94 8398 16102
4/95 8275 16910
4/96 8286 17953
A $10,000 investment in Keystone Quality Bond Fund (B-1) made on
April 30, 1986 with all distributions reinvested was worth $17,953 on
April 30, 1996. Past performance is no guarantee of future results.
- --------------------------------------------------------------------------------
- --------------------------------[Pie Chart]------------------------------------
Asset Allocation
as of April 30, 1996
Corporate bonds (21.7%)
U.S. government (20.2%)
Foreign (19.2%)
Asset-backed securities (13.6%)
Mortgage-backed (12.5%)
Collateralized mortgage obligations (10.7%)
Other(1) (2.1%)
(as a percentage of portfolio assets)
(1)Includes other assets and liabilities.
- --------------------------------------------------------------------------------
Six-Month Performance as of April 30, 1996
=============================================================================
Total return* -1.04%
Net asset value 10/31/95 $15.42
4/30/96 $14.84
Dividends 0.43
Capital gains None
* Before deduction of contingent deferred sales charge (CDSC).
Historical Record as of April 30, 1996
=============================================================================
If you If you did
Cumulative total return redeemed not redeem
1-year 3.17% 6.17%
5-year 33.67% 33.67%
10-year 79.53% 79.53%
Average annual total return
1-year 3.17% 6.17%
5-year 5.98% 5.98%
10-year 6.03% 6.03%
The "if you redeemed" returns reflect the deduction of the 3% contingent
deferred sales charge for those investors who sold Fund shares after one
calendar year. Investors who retained their fund investment earned the
returns reported in the second column of the table. The investment return and
principal value will fluctuate so that your shares, when redeemed, may be
worth more or less than the original cost. You may exchange your shares for
another Keystone fund by phone or in writing for a $10 fee. The exchange fee
is waived for individual investors who make an exchange using Keystone's
Automated Response Line (KARL). The Fund reserves the right to change or
terminate the exchange offer.
<PAGE>
PAGE 5
SCHEDULE OF INVESTMENTS--April 30, 1996
(Unaudited)
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
==========================================================================================================
<S> <C> <C> <C> <C> <C>
FIXED INCOME (97.9%)
CORPORATE BONDS & NOTES (21.7%)
AUTOMOTIVE (1.1%)
General Motors Corp. Notes 7.700% 2016 $ 3,000,000 $ 2,984,430
--------------------------------------------------------------------------------------------------------
BANK & FINANCE (14.7%)
Advanta National Bank,
Wilmington, DE Sr. Notes 5.810 1997 3,000,000 2,989,680
Contingent
Arkwright CSN Trust Surplus Notes 9.625 2026 1,000,000 1,005,620
Barnett Banks, Inc. Notes (Subord.) 10.875 2003 4,500,000 5,339,250
Bear Stearns Cos., Inc. Sr. Notes 5.750 2001 2,000,000 1,905,640
Donaldson Lufkin & Jenrette,
Inc. Med. Term Notes 5.625 2016 3,000,000 2,844,375
General Electric Capital
Corp. Deb. 8.750 2007 4,000,000 4,483,200
Huntington Bancshares, Inc. Med. Term Notes 5.680 1998 3,500,000 3,426,465
International Bank for
Reconstruction & Development Deb. 8.250 2016 5,000,000 5,451,550
NationsBank Corp. Notes (Subord.) 7.750 2015 3,000,000 2,998,800
Provident Bank, Cincinnati,
OH Sr. Notes 6.125 2000 3,500,000 3,377,780
Lehman Holdings, Inc. Med. Term Notes 7.870 1997 2,500,000 2,537,800
Smith Barney Holdings, Inc. Notes 6.000 1997 2,000,000 1,999,840
--------------------------------------------------------------------------------------------------------
38,360,000
--------------------------------------------------------------------------------------------------------
CONSUMER GOODS (2.3%)
Procter & Gamble, ESOP Series A Deb. 9.360 2021 5,000,000 5,912,000
--------------------------------------------------------------------------------------------------------
OIL (2.3%)
Atlantic Richfield Co. Deb. 9.875 2016 4,000,000 4,918,520
Occidental Petroleum Corp. Sr. Notes 9.625 1999 1,000,000 1,005,250
--------------------------------------------------------------------------------------------------------
5,923,770
--------------------------------------------------------------------------------------------------------
UTILITIES (1.3%)
First Mtg. Med.
Texas Utilities Electric Co. Term Notes 6.270 2000 3,500,000 3,426,815
--------------------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS & NOTES (Cost--$57,562,529) 56,607,015
========================================================================================================
UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (20.2%)
FHLB Deb. 7.000 2001 3,900,000 3,892,688
FHLB Deb. 8.700 2005 1,000,000 1,031,410
FHLMC Deb. 7.830 2004 2,000,000 2,016,700
U.S. Treasury Notes 7.750 2000 7,250,000 7,585,313
U.S. Treasury Notes 6.375 2002 4,500,000 4,464,135
U.S. Treasury Notes 6.500 2005 10,000,000 9,868,700
U.S. Treasury Bonds 7.875 2021 16,200,000 17,660,592
U.S. Treasury Bonds 6.000 2026 7,000,000 6,220,130
--------------------------------------------------------------------------------------------------------
TOTAL UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (Cost--$55,601,469) 52,739,668
========================================================================================================
<PAGE>
PAGE 6
Keystone Quality Bond Fund (B-1)
FOREIGN BONDS (NON U.S. DOLLARS) (15.2%)
Canada (Commonwealth of) Deb. 7.500% 2003 15,000,000 $10,947,400
Canadian Dollars
Canada (Commonwealth of) Deb. 8.750 2005 18,000,000 14,060,227
Canadian Dollars
Germany (Federal Republic of) Deb. 6.875 2005 9,250,000 6,281,468
German Marks
Spain (Kingdom of) Deb. 10.150 2006 1,000,000,000 8,345,991
Spanish Pesetas
--------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (NON U.S. DOLLARS) (Cost--$40,795,232) 39,635,086
========================================================================================================
ASSET-BACKED SECURITIES (13.6%)
AT&T, Universal Master Card Series 1995-2
Trust Class A 5.950 2002 $5,000,000 4,865,600
Chemical Master Credit Card Series 1995-2
Trust Class A 6.230 2003 4,000,000 3,935,000
Contimortgage Home Equity Series 1995-4
Loans Class A4 6.330 2010 5,000,000 4,920,313
Dayton Hudson Credit Card Series 1995-1
Trust Class A 6.100 2002 3,000,000 2,984,070
First Security Auto Grantor Series 1995-A
Trust Class A 6.250 2001 2,538,168 2,541,737
Fleet Financial Home Equity Series 1990-1
Trust Class AS 6.700 2006 3,384,714 3,402,686
Merrill Lynch Mortgage Series 1991-D
Investors, Inc. Class A 9.000 2011 633 648
Merrill Lynch Mortgage Series 1991-G
Investors, Inc. Class B 9.150 2011 3,698,153 3,818,638
Merrill Lynch Mortgage Series 1992-B
Investors, Inc. Class B 8.500 2012 2,180,000 2,224,843
Old Kent Auto Receivable Series 1995-A
Trust Class A 6.200 2001 2,847,090 2,849,425
Sears Credit Account Master Series 1996-1
Trust II Class A 6.200 2002 3,000,000 2,968,230
University Support Services,
Inc. Series 1992-D 9.074 2007 1,040,000 1,040,000
--------------------------------------------------------------------------------------------------------
TOTAL ASSET-BACKED SECURITIES (Cost--$35,625,130) 35,551,190
========================================================================================================
COLLATERALIZED MORTGAGE OBLIGATIONS (10.7%)
American Southwest Financial
Services (Est. Mat. 1998) Series 1994-C2
(a) Class A3 8.000 2010 4,400,000 4,467,375
Criimi Mae Financial Corp. Series 1
(Est. Mat. 2029) (a) Class A 7.000 2033 1,000,000 949,363
FNMA REMIC Trust (Est. Mat. Series 1993-156
2008) (a) Class B 6.500 2018 2,800,000 2,585,604
FNMA REMIC Trust (Est. Mat. Series 1992-181
2007) (a) Class PK 6.500 2021 4,000,000 3,671,560
<PAGE>
PAGE 7
COLLATERALIZED MORTGAGE OBLIGATIONS (continued)
FNMA REMIC Trust (Est. Mat. Series 1993-38
2009) (a) Class L 5.000% 2022 $ 2,500,000 $ 2,028,800
KS Mortgage Capital LP (Est. Series 1995-1
Mat. 2000) (a) Class A1 6.983 2002 3,012,493 3,016,258
Merrill Lynch Mortgage
Investors, Inc. (Est. Mat. Series 1992-D
2003) (a) Class B 8.500 2017 2,580,533 2,634,414
Paine Webber Mortgage
Acceptance Corp. IV (Est. Series 1993-5
Mat. 1999) (a) Class A3 6.875 2008 1,985,180 1,982,699
Residential Funding Corp. Series 1994-S15
(Est. Mat. 1998) (a) Class A1 7.750 2024 3,538,831 3,576,414
Ryland Acceptance Corp. (Est. Series 1988-E, 2
Mat. 2009) (a) PAC 7.950 2019 2,000,000 2,967,830
--------------------------------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost--$28,250,409) 27,880,317
========================================================================================================
MORTGAGE-BACKED SECURITIES (8.9%)
FHLMC Pool #607352 7.992 2022 2,966,067 3,081,930
FNMA 7.000 2025 11,000,000 10,604,660
FNMA Pool #338867 6.500 2011 5,100,000 4,938,993
GNMA 6.500 2025 5,000,000 4,689,050
--------------------------------------------------------------------------------------------------------
TOTAL MORTGAGE-BACKED SECURITIES (Cost--$23,359,840) 23,314,633
========================================================================================================
FOREIGN BONDS (U.S. DOLLARS) (4.0%)
Bayer Corp. (c) Notes 7.125 2015 3,000,000 2,865,390
Dresdner Bank A.G. Deb. (Subord.) 7.250 2015 5,000,000 4,812,550
Royal Bank Scotland Group Notes (Subord.) 6.375 2011 3,000,000 2,667,900
--------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (U.S. DOLLARS) (Cost--$11,209,225) 10,345,840
========================================================================================================
MORTGAGE PASS-THROUGH CERTIFICATES (3.6%)
FHLMC Pool #303865 8.500 1997 53,535 55,106
FNMA Pool #303664 6.500 2008 6,600,361 6,429,147
Structured Asset Securities Series 1996-CFL
Corp. Class B 6.303 2028 2,963,625 2,825,168
--------------------------------------------------------------------------------------------------------
TOTAL MORTGAGE PASS-THROUGH CERTIFICATES (Cost--$9,619,502) 9,309,421
========================================================================================================
TOTAL FIXED INCOME (Cost--$262,023,336) 255,383,170
========================================================================================================
</TABLE>
<PAGE>
PAGE 8
Keystone Quality Bond Fund (B-1)
<TABLE>
<CAPTION>
Interest Maturity Maturity Market
Rate Date Value Value
=============================================================================================
<S> <C> <C> <C> <C>
REPURCHASE AGREEMENT (0.9%)
Keystone Joint Repurchase Agreement
(Investments in repurchase agreements,
in a joint trading account, purchased
4/30/96) (b) (Cost--$2,403,000) 5.340% 5/1/96 $2,403,356 $ 2,403,000
===========================================================================================
TOTAL INVESTMENTS (Cost--$264,426,336) 257,786,170
OTHER ASSETS AND LIABILITIES--NET (1.2%) 3,228,412
-------------------------------------------------------------------------------------------
NET ASSETS (100%) $261,014,582
===========================================================================================
</TABLE>
(a) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected prepayment rates. Changes in interest
rates can cause the estimated maturity to differ from the listed dates.
(b) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at April 30, 1996.
(c) Securities that may be resold to "qualified institutional buyers" under
Rule 144A or securities offered pursuant to Section 4(2) of the Federal
Securities Act of 1933, as amended. These securities have been determined
to be liquid under guidelines established by the Board of Trustees.
Legend of Portfolio Abbreviations
FHLB--Federal Home Loan Bank
FHLMC--Federal Home Loan Mortgage Corporation
FNMA--Federal National Mortgage Association
GNMA--Government National Mortgage Association
REMIC--Real Estate Mortgage Investment Conduit
SCHEDULE OF FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
U.S. Value
at In Net Unrealized
Exchange April 30, Exchange Appreciation/
Date 1996 for U.S. $ (Depreciation)
================================================================================================
<S> <C> <C> <C> <C> <C>
Forward Foreign Currency Exchange Contracts to Sell:
Contracts to Deliver
================================================================================================
5/10/96 10,200,000 German Marks $ 6,666,514 $ 6,931,231 $264,717
5/31/96 35,298,460 Canadian Dollars 25,939,777 25,920,408 (19,369)
7/10/96 1,080,500,000 Spanish Pesetas 8,459,271 8,561,128 101,857
------------
Net Unrealized Appreciation on Forward Foreign Currency Exchange
Contracts $347,205
============
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 9
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout each period)
<TABLE>
<CAPTION>
Six Months
Ended
April 30, Year Ended October 31,
1996 1995 1994 1993 1992 1991
================================================================================================
(Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Net asset value beginning
of period $15.42 $14.44 $16.40 $15.92 $15.92 $15.11
------------------------------------------------------------------------------------------------
Income from investment
operations:
Net investment income 0.38 0.87 0.76 0.96 1.04 1.08
Net realized and
unrealized gain (loss)
on investments, closed
futures contracts and
forward foreign currency
related transactions (0.53) 1.05 (1.76) 0.66 0.15 0.99
------------------------------------------------------------------------------------------------
Total from investment
operations (0.15) 1.92 (1.00) 1.62 1.19 2.07
------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.43) (0.87) (0.76) (0.96) (1.04) (1.08)
In excess of net
investment income 0 (0.05) (0.09) (0.18) (0.15) (0.18)
Tax basis return of
capital 0 (0.02) (0.11) 0 0 0
------------------------------------------------------------------------------------------------
Total distributions (0.43) (0.94) (0.96) (1.14) (1.19) (1.26)
------------------------------------------------------------------------------------------------
Net asset value end of
period $14.84 $15.42 $14.44 $16.40 $15.92 $15.92
================================================================================================
Total return (a) (1.04%) 13.69% (6.27%) 10.50% 7.71% 14.09%
Ratios/supplemental data
Ratios to average net
assets:
Total expenses (b) 1.95%(c) 1.96% 1.86% 1.94% 2.01% 2.04%
Net investment income 4.97%(c) 5.86% 5.05% 5.85% 6.40% 6.95%
Portfolio turnover rate 108% 244% 169% 190% 102% 158%
------------------------------------------------------------------------------------------------
Net assets end of period
(thousands) $261,015 $310,791 $327,276 $458,925 $456,912 $453,528
================================================================================================
</TABLE>
(a) Excluding applicable sales charges.
(b) Beginning with the year ended October 31, 1995, the "Ratio of total
expenses to average net assets" includes indirectly paid expenses.
Excluding indirectly paid expenses, the expense ratios would have been
1.93% (annualized) for the six months ended April 30, 1996 and 1.94% for
the year ended October 31, 1995.
(c) Annualized.
See Notes to Financial Statements.
<PAGE>
PAGE 10
Keystone Quality Bond Fund (B-1)
STATEMENT OF ASSETS AND LIABILITIES
April 30, 1996 (Unaudited)
=====================================================================
Assets (Note 1)
Investments at market value (identified cost--
$264,426,336) $257,786,170
Cash 171
Receivable for:
Investments sold 14,890,003
Interest 3,947,800
Fund shares sold 9,888
Net unrealized appreciation on forward foreign
currency exchange contracts 347,205
Prepaid expenses and other assets 64,043
-------------------------------------------------------------------
Total assets 277,045,280
-------------------------------------------------------------------
Liabilities (Notes 2 and 4)
Payable for:
Investments purchased 15,309,069
Fund shares redeemed 204,170
Distributions to shareholders 421,887
Accrued reimbursable expenses 2,541
Other accrued expenses 93,031
-------------------------------------------------------------------
Total liabilities 16,030,698
-------------------------------------------------------------------
Net assets $261,014,582
===================================================================
Net assets represented by (Note 1)
Paid-in capital $294,206,831
Accumulated distributions in excess of net
investment income (1,443,274)
Accumulated net realized loss on investments and
forward foreign currency related transactions (25,433,229)
Net unrealized depreciation on investments,
forward foreign currency exchange contracts and
related transactions (6,315,746)
-------------------------------------------------------------------
Total net assets $261,014,582
===================================================================
Net asset value per share (Note 2)
Net assets of $261,014,582 / 17,593,490 shares
outstanding $14.84
===================================================================
STATEMENT OF OPERATIONS
Six Months Ended April 30, 1996 (Unaudited)
=====================================================================
Investment income (Note 1)
Interest $ 9,942,338
--------------------------------------------------------------------
Expenses (Notes 2 and 4)
Management fee $ 849,025
Transfer agent fees 342,916
Accounting, auditing and legal fees 28,294
Custodian fees 81,650
Printing 13,731
Trustees' fees and expenses 14,861
Distribution Plan expenses 1,441,837
Registration fees 25,095
Other 4,884
--------------------------------------------------------------------
Total expenses 2,802,293
Less: Expenses paid indirectly
(Note 4) (17,659)
--------------------------------------------------------------------
Net expenses 2,784,634
--------------------------------------------------------------------
Net investment income 7,157,704
--------------------------------------------------------------------
Net realized and unrealized loss on
investments and forward foreign
currency related transactions (Notes
1 and 3)
Net realized gain on:
Investments 3,303,291
Forward foreign currency related
transactions 312,908
--------------------------------------------------------------------
Net realized gain on investments and
forward foreign currency related
transactions 3,616,199
--------------------------------------------------------------------
Net change in unrealized
appreciation (depreciation) on:
Investments (13,404,053)
Forward foreign currency related
transactions 324,420
--------------------------------------------------------------------
Net change in unrealized
depreciation on investments and
forward foreign currency related
transactions (13,079,633)
--------------------------------------------------------------------
Net realized and unrealized loss on
investments and forward foreign
currency related transactions (9,463,434)
--------------------------------------------------------------------
Net decrease in net assets resulting from
operations ($ 2,305,730)
====================================================================
See Notes to Financial Statements.
<PAGE>
PAGE 11
STATEMENTS OF CHANGES IN NET ASSETS
Six Months
Ended Year Ended
April 30, October 31,
1996 1995
============================================================================
(Unaudited)
Operations (Notes 1 and 3)
Net investment income $ 7,157,704 $ 18,237,187
Net realized gain (loss) on investments,
closed futures contracts and forward
foreign currency related transactions 3,616,199 (6,749,977)
Net change in unrealized appreciation
(depreciation) on investments and
forward foreign currency related
transactions (13,079,633) 28,285,126
--------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations (2,305,730) 39,772,336
--------------------------------------------------------------------------
Distributions to shareholders from
(Note 1)
Net investment income (8,025,766) (18,237,187)
In excess of net investment income 0 (763,245)
Tax basis return of capital 0 (472,154)
--------------------------------------------------------------------------
Total distributions to shareholders (8,025,766) (19,472,586)
--------------------------------------------------------------------------
Capital share transactions (Note 2)
Proceeds from shares sold 29,727,680 78,243,761
Payments for shares redeemed (74,133,715) (126,927,895)
Net asset value of shares issued in
reinvestment of dividends and
distributions 4,960,625 11,900,336
--------------------------------------------------------------------------
Net decrease in net assets resulting
from capital share transactions (39,445,410) (36,783,798)
--------------------------------------------------------------------------
Total decrease in net assets (49,776,906) (16,484,048)
--------------------------------------------------------------------------
Net assets:
Beginning of period 310,791,488 327,275,536
--------------------------------------------------------------------------
End of period [including accumulated
distributions in excess of net
investment income as follows:
1996--($1,443,274) and
1995--($575,212)] (Note 1) $261,014,582 $ 310,791,488
==========================================================================
See Notes to Financial Statements.
<PAGE>
PAGE 12
Keystone Quality Bond Fund (B-1)
NOTES TO FINANCIAL STATEMENTS (Unaudited)
(1.) Significant Accounting Policies
Keystone Quality Bond Fund (B-1) (the "Fund") is a common law trust for which
Keystone Management, Inc. ("KMI") is the investment manager and Keystone
Investment Management Company ("Keystone") is the investment adviser. The
Fund is registered under the Investment Company Act of 1940, as amended (the
"1940 Act"), as a diversified, open-end investment company. The Fund seeks
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.
Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. ("KII"),
a Delaware corporation. KII is privately owned by an investor group
consisting predominantly of current and former members of management of
Keystone and its affiliates. Keystone Investor Resource Center, Inc.
("KIRC"), a wholly-owned subsidiary of Keystone, is the Fund's transfer agent
and dividend disbursing 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,
which requires management to make estimates and assumptions that affect
amounts reported herein. Although actual results could differ from these
estimates, any such differences are expected to be immaterial to the net
assets of the Fund.
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
deems in good faith to be fair: (1) securities (including restricted
securities) for which complete quotations are not readily available, and (2)
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 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. 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 that are generally recognized by
institutional traders.
B. 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, the value of which 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,
<PAGE>
PAGE 13
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 are limited to transactions
with dealers or domestic banks believed to present minimal credit risks. The
Fund takes constructive receipt of all securities underlying repurchase
agreements until such agreements expire.
Pursuant to an exemptive order issued by the Securities and Exchange
Commission, the Fund, along with certain other Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are collateralized by U.S.
Treasury and/or Federal Agency obligations.
C. The Fund enters into currency and other financial futures contracts as a
hedge against changes in interest or currency exchange rates. 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 purposes, any futures
contracts that 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 be able to complete the obligations of the contract.
D. Foreign currency amounts are translated into U.S. 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 respective dates of such transactions. Net
unrealized foreign exchange gains (losses) are a component of unrealized
appreciation (depreciation) on investments and forward foreign currency
related transactions.
E. The Fund may enter into forward foreign currency exchange contracts
("contracts") to settle purchases and sales of securities denominated in a
foreign currency and to hedge certain foreign currency assets. Contracts are
recorded at the forward rate and 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.
F. Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are computed on the
identified cost basis. Interest income is recorded on the accrual basis and
dividend income is recorded on the ex-dividend date. All discounts are
amortized for both financial reporting and federal income tax purposes.
G. The Fund distributes net investment income to shareholders monthly and net
capital gains, if any, annually. Distributions are recorded at the close of
business on the ex-dividend date. Distributions are determined from taxable
net investment income and net capital gains and can differ from book basis
net investment income and net capital gains. The significant differences
between financial statement amounts available for distribution and
distributions made in accordance with income tax regulations are primarily
<PAGE>
PAGE 14
Keystone Quality Bond Fund (B-1)
due to the different treatment of 12b-1 expenses prior to April 1995,
differences in the treatment of paydown losses and the deferral of losses for
income tax purposes that have been recognized for financial statement
purposes.
H. 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 is 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 any excise tax liability by making the required distributions under
the Internal Revenue Code.
(2.) Capital Share Transactions
The Fund's Declaration of Trust 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:
Six Months Year Ended
Ended October 31,
April 30, 1996 1995
- -----------------------------------------------------------------
Sales 1,926,499 5,215,666
Redemptions (4,805,295) (8,523,861)
Reinvestment of dividends
and distributions 323,385 799,017
- -----------------------------------------------------------------
Net decrease (2,555,411) (2,509,178)
=================================================================
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted pursuant to Rule 12b-1 under the 1940 Act. Under the
Distribution Plan, the Fund pays Keystone Investment Distributors Company
("KIDC"), the Fund's 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 KIDC in connection
with the Distribution Plan, and subject to the limitations discussed below,
KIDC generally pays dealers or others a commission equal to 4.00% of the
price paid to the Fund for each sale of a Fund share 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 dealers or others and maintained on the books of the Fund for
specified periods.
To the extent Fund shares 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
4.00%, applied to the lesser of the net asset value of shares redeemed or the
total cost of such shares.
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. Rules adopted by the
National Association of Securities Dealers, Inc. ("NASD") limit the annual
expenditures that the Fund may incur under the Distribution Plan to 1.00%, 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 also limits the aggregate
amount that 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 1.00% on unpaid amounts thereof (less any
contingent deferred sales charges paid by the shareholders to KIDC).
KIDC intends, but is not obligated, to continue to pay or accrue distribution
charges that exceed current annual payments permitted to be received by KIDC
from the Fund. KIDC intends to seek full payment of such charges from the
Fund (together with annual interest thereon at the prime rate plus 1.00%) at
such
<PAGE>
PAGE 15
time in the future as, and to the extent that, payment thereof by the Fund
would be within permitted limits. KIDC currently intends to seek payment of
interest only on such charges paid or accrued by KIDC subsequent to
January 1, 1992.
Commencing 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 rules, been paid to KIDC rather than to the Fund. During the six
months ended April 30, 1996, KIDC received $142,234 in deferred sales
charges.
During the six months ended April 30, 1996, the Fund paid $1,441,837 under
its Distribution Plan, all of which was paid to KIDC. During the six months
ended April 30, 1996, KIDC paid commmissions on new sales and service fees to
dealers and others of $594,465. At April 30, 1996, unpaid distribution costs
amounted to $9,961,319 (3.82% of the Fund's net assets at April 30, 1996).
(3.) Securities Transactions
As of October 31, 1995, the Fund had a capital loss carryover for federal
income tax purposes of approximately $28,549,000 which expires as follows:
1998--$2,251,000; 2002--$20,145,000; and 2003--$6,153,000.
For the six months ended April 30, 1996, purchases and sales of investment
securities (excluding short-term securities) were as follows:
Cost of Proceeds
Purchases from Sales
-------------------------------------------------------------
Investments (excluding U.S.
Government obligations) $130,015,724 $ 99,235,266
U.S Government obligations 171,323,454 234,300,226
=============================================================
(4.) Investment Management Agreement and Other Transactions
Under the terms of the Investment Management Agreement between KMI and the
Fund, KMI provides investment management and administrative services to the
Fund. In return, KMI is paid a management fee computed and paid daily at a
rate of 2.0% of the Fund's gross investment income plus an amount determined
by applying percentage rates, which start at 0.50% and decline, 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, 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 six months ended April 30, 1996, the Fund paid or accrued to KMI
investment management and administrative services fees of $849,025 which
represented 0.59% of the Fund's average net assets on an annualized basis. Of
such amount paid to KMI, $721,671 was paid to Keystone for its services to
the Fund.
During the six months ended April 30, 1996, the Fund paid or accrued $9,131
to KII as reimbursment for certain accounting services and $342,916 to KIRC
for transfer agent fees.
The Fund has entered into an expense offset arrangement with its custodian.
For the six months ended April 30, 1996, the Fund paid custody fees in the
amount of $63,991 and received a credit of $17,659 pursuant to the expense
offset arrangement, resulting in a total expense of $81,650. The assets
deposited with the custodian under the expense offset arrangement could have
been invested in income-producing assets.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the Fund. Officers of Keystone and affiliated Trustees receive no
compensation directly from the Fund.
(5.) Distributions to Shareholders
A distribution of net investment income of $0.065 per share was declared
payable on June 6, 1996 to shareholders of record May 24, 1996. This
distribution is not reflected in the accompanying financial statements.
<PAGE>
[COVER]
KEYSTONE
FAMILY OF FUNDS
[diamond]
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Liquid Trust
Mid-Cap Growth Fund (S-3)
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Keystone funds, contact your
financial adviser or call Keystone.
[Keystone logo] KEYSTONE
INVESTMENTS
P.O. Box 2121
Boston, Massachusets 02106-2121
B1-R-6/96
16.5M [Recycle logo]
K E Y S T O N E
[Photo: 2 people walking bicycles through the woods]
QUALITY
BOND FUND (B-1)
[Keystone logo]
SEMIANNUAL REPORT
APRIL 30, 1996
