<PAGE>
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, 1997. Following our letter is a
discussion with your Fund's manager and complete financial information.
PERFORMANCE
Your Fund returned 0.80% for the six-month period and 5.92% for the twelve-month
period which ended April 30, 1997. For the same periods, the Lehman Aggregate
Bond Index-- a widely recognized index of corporate, government and mortgage
securities-- returned 1.71% and 7.08%, respectively.
We believe your Fund performed satisfactorily in a difficult interest rate
environment, where interest rates rose in the first three months of the period
and declined in the last three months.
MARKET ENVIRONMENT
While interest rates finished the period at approximately the same level at
which they started, they experienced significant fluctuations during the six
months. During the period, the yield of the benchmark 30-year U.S. Treasury bond
swung from a low yield of 6.35% to a high yield of 7.17%. These fluctuations
resulted from investors' responses to reports of spurts and slowdowns in
economic growth. As investors monitored changes in economic activity, they
adjusted their outlooks for future inflation and Federal Reserve interest rate
policy, creating fluctuations in both interest rates and bond prices.
PORTFOLIO STRATEGY
We continued our strategy of focusing on bonds that would generate a high level
of income and present attractive relative value. Throughout, we emphasized high
credit quality. We downplayed strategies designed to anticipate interest rate
movements. This was particularly appropriate in light of the interest rate
environment over the past six months. As of April 30, 1997, the average maturity
of the Fund's portfolio was 11.9 years.
The Fund's structure reflects a thorough analysis of price relationships
between various fixed-income sectors and securities, as well as their potential
for capital appreciation. In terms of sectors, we invested primarily in
corporate bonds, mortgage-backed and asset-backed securities and foreign
government bonds, all of which tend to provide higher yields than U.S.
government securities. All of the Fund's foreign transactions were
currency-hedged into U.S. dollars to protect the portfolio from currency
fluctuations. While your Fund also invested in U.S. government securities, it
was usually done to maintain a neutral interest rate stance or to build
liquidity in anticipation of opportunity in other fixed-income sectors.
Keystone Quality Bond Fund (B-1) is designed for conservative, income-oriented
investors. We invest in a selection of high quality fixed-income securities,
which include among others, U.S. government obligations, mortgage-backed and
asset-backed securities, and high quality corporate bonds. As of April 30, 1997
the average quality of the Fund was AA.
OUTLOOK
Going forward, we expect further strength in employment growth, disposable
income and consumer confidence, which could lead to temporarily higher interest
rates. Longer-term, we believe the Federal Reserve Board's dedication to prevent
rising inflation will prove beneficial to fixed-income investors. We expect to
see solid, yet tempered economic growth and low inflation to create a positive
environment for high quality bonds.
-- CONTINUED--
<PAGE>
PAGE 2
KEYSTONE QUALITY BOND FUND (B-1)
We appreciate 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 (photo of (photo of
Albert H. Elfner, III Albert H. George S.
PRESIDENT Elfner, III Bissell
KEYSTONE INVESTMENT MANAGEMENT COMPANY appears here) appears here)
/s/ George S. Bissell
George S. Bissell
CHAIRMAN
KEYSTONE FUNDS
June 1997
<PAGE>
PAGE 3
A Discussion With
Your Fund Manager
(photo of
Christopher P. Conkey
appears here)
CHRISTOPHER P. CONKEY IS CHIEF INVESTMENT OFFICER OF KEYSTONE'S FIXED
INCOME GROUP AND WAS THE SENIOR PORTFOLIO MANAGER OF YOUR FUND FOR THE
SIX-MONTH PERIOD ENDING APRIL 30, 1997. MR. CONKEY IS ASSISTED BY GARY
PZEGEO, A KEYSTONE VICE PRESIDENT AND PORTFOLIO MANAGER.
Q WHAT DID INTEREST RATES DO OVER THE PAST SIX MONTHS?
A Interest rates fluctuated within a wide but well defined range, ending the
period at about where they started. The driving force behind this movement was
changing investor expectations of economic strength and its effect on future
inflation.
Economic activity accelerated in both the fourth quarter of 1996 and the first
quarter of 1997, raising concerns that stronger growth would stimulate future
inflation. The Federal Reserve Board validated these concerns when it raised the
Federal Funds rate by 1/4% in March 1997. The Federal Funds rate is the rate at
which banks lend to each other overnight and is a benchmark for short-term
interest rates. Despite this widespread anticipation of higher prices, inflation
has remained well contained. However, we continue to monitor signs of upward
pressure on wages.
Q WHAT STRATEGIES DID YOU USE IN MANAGING THE FUND?
A We continued to implement our strategy of emphasizing bonds that would
maximize the yield of the Fund and avoided trying to anticipate interest rate
movements. This was especially important over the last six months, as interest
rates first fell and then rose, before finishing largely unchanged. We based our
sector and security selections on relative value, as well as outlook for capital
appreciation. We chose what we believed to be the optimal mix of U.S. government
securities, corporate bonds, asset-backed and mortgage-backed securities and
foreign government bonds.
Q SPECIFICALLY, HOW DID YOU ALLOCATE THE FUND'S ASSETS?
A In terms of sectors, we emphasized corporate bonds, mortgage-backed and
asset-backed securities and foreign bonds. These sectors enhanced the income of
the Fund. We selected each sector-- as well as the bonds within each
sector-- based on relative value and the potential for capital appreciation.
While we also invested in U.S. government securities, we used that sector
primarily to maintain a neutral interest rate stance; and to enhance liquidity
in anticipation of opportunity in other sectors.
FUND PROFILE
OBJECTIVE: Seeks generous income and capital preservation from high quality
bonds.
INCEPTION DATE: September 11, 1935
AVERAGE MATURITY: 11.9 years
NET ASSETS: $192,920,024
<PAGE>
PAGE 4
KEYSTONE QUALITY BOND FUND (B-1)
During the period, 5%-15% of the Fund's net assets were invested in the
government bonds of Canada, Germany, Spain and the United Kingdom. All of these
transactions were currency-hedged. Foreign bonds outperformed many domestic
investment alternatives. Providing higher yields and solid capital appreciation,
they benefited from their countries' positive economic fundamentals which
included declining fiscal deficits and low inflation. During the period, we took
profits in the foreign sector and reallocated assets to U.S. government
securities. At that time, we believed the U.S. offered better relative value and
greater potential for declining interest rates.
Q WHAT IS YOUR OUTLOOK FOR THE NEXT SIX MONTHS?
A We believe that interest rates could rise over the near-term and decline
longer-term. Employment, income growth and consumer activity continue to be
strong; and investors remain concerned that this strength creates pressures for
future inflation. With this sentiment in the market, we would not be surprised
to see investors nudge interest rates higher. We also think the Federal Reserve
Board may raise interest rates again, in a preemptive move to keep inflation
low.
Longer-term, we think that economic activity will remain solid, but that there
will be a tempering in its rate of growth. We expect inflation to be
well-contained. Historically, a climate of steady economic growth and low
inflation has provided a positive environment for bonds.
(Diamond appears here)
THIS COLUMN IS INTENDED TO ANSWER QUESTIONS ABOUT YOUR FUND.
IF YOU HAVE A QUESTION YOU WOULD LIKE ANSWERED, PLEASE WRITE TO:
EVERGREEN KEYSTONE INVESTMENT SERVICES, INC.
ATTN: SHAREHOLDER COMMUNICATIONS
201 SOUTH COLLEGE STREET, SUITE 400,
CHARLOTTE, N.C. 28288-1195
<PAGE>
PAGE 5
Your Fund's
Performance
(Chart appears here with the following head and plot points:)
Growth of an investment in
Keystone Quality Bond Fund (B-1)
4/87 4/89 4/91 4/93 4/95 4/97
Reinvested Distributions (Customer to fill in plot points)
Initial Investment
A $10,000 investment in Keystone Quality Bond Fund (B-1) made on April 30, 1987
with all distributions reinvested was worth $18,652 on April 30, 1997. Past
performance is no guarantee of future results.
<TABLE>
<CAPTION>
SIX-MONTH PERFORMANCE AS OF APRIL 30, 1997
<S> <C> <C> <C>
Total return* 0.80%
Net asset value 10/31/96 $15.19
4/30/97 $14.92
Dividends $0.39
Capital gains None
</TABLE>
* BEFORE DEDUCTION OF CONTINGENT DEFERRED SALES CHARGE (CDSC).
[CAPTION]
<TABLE>
<CAPTION>
HISTORICAL RECORD AS OF APRIL 30, 1997
<S> <C> <C> <C>
IF YOU IF YOU DID
CUMULATIVE TOTAL RETURN REDEEMED NOT REDEEM
<S> <C> <C> <C>
1-year 2.92% 5.92%
5-year 29.37% 29.37%
10-year 86.52% 86.52%
AVERAGE ANNUAL TOTAL RETURN
1-year 2.92% 5.92%
5-year 5.29% 5.29%
10-year 6.43% 6.43%
</TABLE>
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 their original cost.
You may exchange shares for another Keystone fund by phone or in writing. You
may also exchange funds through the Evergreen Keystone Express Line. The Fund
reserves the right to change or terminate the exchange offer.
<PAGE>
PAGE 6
KEYSTONE QUALITY BOND FUND (B-1)
SCHEDULE OF INVESTMENTS-- APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
FIXED INCOME (96.1%)
CORPORATE BONDS & NOTES (31.0%)
<C> <S> <C>
AIRCRAFT (1.1%)
$ 2,000,000 Boeing Co.,
7.88%, 4/15/43.............. $ 2,080,060
BANK & FINANCE (13.4%)
2,000,000 ABN AMRO Holdings N.V.,
7.30%, 12/1/26.............. 1,843,280
3,500,000 AmSouth Bancorp., Subord. Deb.
6.75%, 11/1/25.............. 3,378,375
1,500,000 Associates Corp. North
America,
Sr. Notes,
7.63%, 3/1/00............... 1,535,205
1,250,000 Commercial Credit Corp.
Putable Asset Trust,
6.45%, 10/18/99 (c)......... 1,241,000
2,000,000 Export Import Bank of Korea,
Notes,
7.10%, 3/15/07.............. 2,001,800
5,000,000 General Motors Acceptance
Corp.,
Notes,
7.13%, 5/1/01............... 5,009,050
2,485,000 International Lease Finance
Corp.,
Notes,
6.25%, 10/15/00............. 2,440,543
2,000,000 Mellon Bank Capital II,
8.00%, 1/15/27.............. 1,960,860
4,500,000 Sun Canada Financial Co.,
6.63%, 12/15/07 (c)......... 4,275,180
2,265,000 Wachovia Corp., Subord. Notes,
6.61%, 10/1/25.............. 2,207,492
25,892,785
CONSUMER GOODS (1.8%)
3,500,000 Mattel, Inc., Notes,
6.75%, 5/15/00.............. 3,493,280
DIVERSIFIED COMPANIES (0.6%)
2,000,000 Grand Metro Investment Corp.,
Co. Gtd.,
0.00%, 1/6/04
(Eff. Yield 8.13%) (d)...... 1,245,400
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
CORPORATE BONDS & NOTES (CONTINUED)
<C> <S> <C>
INSURANCE (1.2%)
$ 2,000,000 AMBAC, Inc., Deb.,
9.38%, 8/1/11............... $ 2,340,700
OIL (5.2%)
3,000,000 Occidental Petroleum Corp.,
Deb.,
10.13%, 9/15/09............. 3,609,120
2,452,474 Oslo Seismic Services, Inc.,
1st Pfd. Mtg. Notes,
8.28%, 6/1/11 (c)........... 2,490,929
4,000,000 Tennessee Gas Pipeline Co.,
Deb.,
7.50%, 4/1/17............... 3,964,966
10,065,015
RETAIL (1.3%)
2,500,000 Kohl's Corp., Notes,
7.38%, 10/15/11............. 2,448,700
TELECOMMUNICATIONS (1.8%)
3,000,000 GTE Corp., Notes,
8.75%, 11/1/21.............. 3,391,500
TOBACCO (1.5%)
3,000,000 Philip Morris Companies, Inc.,
Sr. Notes,
7.20%, 2/1/07............... 2,877,000
TRANSPORTATION (1.5%)
3,000,000 Golden State Petroleum
Transportation Corp., Deb.,
8.04%, 2/1/19 (c)........... 2,922,656
UTILITIES (1.6%)
2,000,000 Citizens Utilities Co.,
7.05%, 10/1/46.............. 1,838,740
1,250,000 Korea Electric & Power Corp.,
Deb.,
7.00%, 2/1/27............... 1,215,650
3,054,390
TOTAL CORPORATE BONDS & NOTES
<CAPTION>
(COST-- $60,710,386)........................ 59,811,486
<C> <S> <C>
</TABLE>
<PAGE>
PAGE 7
SCHEDULE OF INVESTMENTS-- APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
COLLATERALIZED MORTGAGE
OBLIGATIONS (22.7%)
<C> <S> <C>
Asset Securitization Corp.:
$ 1,000,000 Series 1997-D4 Class A2,
7.41%, 4/14/27
(Est. Mat. 2011) (a)........ $ 1,013,906
1,416,414 Series 1996-D3 Class A3,
7.71%, 10/13/26
(Est. Mat. 2009) (a)........ 1,426,594
888,227 Criimi Mae Financial Corp.,
Series 1 Class A,
7.00%, 1/1/33,
(Est. Mat. 2005) (a)........ 847,424
FHLMC:
3,500,000 Series 1701 Class PH,
6.50%, 3/15/09
(Est. Mat. 2005) (a)........ 3,377,500
1,650,000 Series 117 Class G,
8.50%, 1/15/21
(Est. Mat. 2009) (a)........ 1,718,146
FNMA REMIC Trust:
3,500,000 Series 1996-17 Class A,
6.00%, 8/25/04
(Est. Mat. 2002) (a)........ 3,352,344
2,800,000 Series 1993-156 Class B,
6.50%, 4/25/18
(Est. Mat. 2003) (a)........ 2,649,500
5,000,000 Series 1993-G09 Class H,
7.00%, 12/25/20
(Est. Mat. 2004) (a)........ 4,846,875
2,500,000 Series 1993-38 Class L,
5.00%, 8/25/22
(Est. Mat. 2007) (a)........ 2,076,550
1,850,000 GS Mortgage Security Corp.,
Series 1996-PL Class A2,
7.41%, 2/15/27
(Est. Mat. 2006) (a)........ 1,794,789
2,997,109 Independent National Mortgage
Corp.,
Series 1997-A Class A,
7.84%, 11/1/26
(Est. Mat. 2006) (a)........ 2,929,674
1,317,367 KS Mortgage Capital LP,
Series 1995-1 Class A1,
7.04%, 4/20/02
(Est. Mat. 1999) (a) (c).... 1,314,897
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
COLLATERALIZED MORTGAGE
OBLIGATIONS (CONTINUED)
<C> <S> <C>
$ 2,700,000 Merrill Lynch Trust,
Series 35 Class G,
8.45%, 11/1/18
(Est. Mat. 2007) (a)........ $ 2,826,549
1,000,000 Morgan Stanley Capital I,
Series 1996-WF Class 1B,
6.59%, 11/15/28
(Est. Mat. 2005) (a) (c).... 949,062
1,106,788 Paine Webber Mortgage
Acceptance Corp. IV,
Series 1993-5 Class A3,
6.88%, 6/25/08
(Est. Mat. 1998) (a)........ 1,104,713
3,000,000 RASTA,
Series 1996-AS Class A3,
7.75%, 9/25/26
(Est. Mat. 1999) (a)........ 3,003,517
3,500,000 Residential Accredit Loans,
Inc.,
Series 1996-QS4 Class AI10,
7.90%, 8/25/26
(Est. Mat. 2014) (a)........ 3,496,582
2,212,212 Residential Funding Corp.,
Series 1994-S15 Class A1,
7.75%, 7/25/24
(Est. Mat. 1998) (a)........ 2,219,114
2,793,863 Ryland Acceptance Corp.,
Series 1988-E, 2 PAC,
7.95%, 1/1/19
(Est. Mat. 2005) (a)........ 2,800,848
<CAPTION>
TOTAL COLLATERALIZED MORTGAGE
OBLIGATIONS (COST-- $44,099,671)........... 43,748,584
<C> <S> <C>
<CAPTION>
ASSET-BACKED SECURITIES (16.2%)
<C> <S> <C>
2,000,000 Auto Receivables Trust,
Series 1995-D,
6.40%, 4/20/03.............. 1,981,945
1,000,000 ContiMortgage Home Equity
Loans, Inc.,
Series 1996-4 Class A9,
6.88%, 1/15/28.............. 967,870
3,100,000 CoreStates Home Equity Trust,
Series 1996-1 Class A4,
7.00%, 6/15/12.............. 3,019,594
4,400,000 Ford Credit Auto Owner Trust,
Series 1996-B Class A4,
6.30%, 1/15/01.............. 4,378,000
</TABLE>
<PAGE>
PAGE 8
KEYSTONE QUALITY BOND FUND (B-1)
SCHEDULE OF INVESTMENTS-- APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
ASSET-BACKED SECURITIES (CONTINUED)
<C> <S> <C>
$ 4,000,000 Headlands Mortgage Securities,
Inc., Series 1997-2 Class
A10,
7.75%. 5/25/27.............. $ 4,012,500
Merrill Lynch Mortgage Investors, Inc.:
371 Series 1991-D Class A,
9.00%, 7/15/11.............. 378
3,420,522 Series 1991-G Class B,
9.15%, 10/15/11............. 3,566,955
1,867,508 Series 1992-B Class B,
8.50%, 4/15/12.............. 1,906,015
2,170,712 Series 1992-D Class B,
8.50%, 6/15/17.............. 2,236,593
3,000,000 Olympic Auto Receivables,
Series 1996-C,
6.80%, 3/15/02.............. 3,008,130
3,300,000 Southern Pacific Secured
Assets Corp.,
Series 1996-3 Class A4,
7.60%, 10/25/27............. 3,262,875
765,000 University Support Services,
Inc.,
Series 1992-D,
9.07%, 11/1/07.............. 764,522
2,100,000 World Omni Automobile
Lease Trust,
Series 1997 Class A4,
6.90%, 5/5/20............... 2,114,112
<CAPTION>
TOTAL ASSET-BACKED SECURITIES
(COST-- $30,926,386)....................... 31,219,489
<C> <S> <C>
<CAPTION>
UNITED STATES GOVERNMENT
(AND AGENCY) ISSUES (13.3%)
<C> <S> <C>
1,000,000 FHLB, Deb.,
8.70%, 1/12/05.............. 1,014,530
FHLMC:
2,250,000 Deb.,
6.70%, 1/5/07............... 2,211,322
2,000,000 Deb.,
7.80%, 9/12/16.............. 2,029,380
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
UNITED STATES GOVERNMENT
(AND AGENCY) ISSUES (CONTINUED)
<C> <S> <C>
U.S. Treasury Bonds:
$ 1,000,000 6.50%, 11/15/26............. $ 939,220
1,200,000 7.88%, 2/15/21.............. 1,311,744
U.S. Treasury Notes:
1,600,000 6.50%, 10/15/06............. 1,573,744
16,500,000 6.63%, 3/31/02.............. 16,530,855
<CAPTION>
TOTAL UNITED STATES GOVERNMENT
(AND AGENCY) ISSUES
(COST-- $25,607,659)....................... 25,610,795
<C> <S> <C>
<CAPTION>
FOREIGN BONDS (NON U.S. DOLLARS) (8.3%)
<C> <S> <C>
7,250,000 CD Canadian Government, Deb.,
8.75%,12/1/05............... 5,926,110
Germany (Republic of), Deb.:
6,652,000 DM 6.50%, 7/15/03................ 4,100,364
9,750,000 DM 6.88%, 5/12/05................ 6,080,942
<CAPTION>
TOTAL FOREIGN BONDS (NON U.S.
DOLLARS) (COST-- $17,577,850).............. 16,107,416
<C> <S> <C>
<CAPTION>
MORTGAGE-BACKED SECURITIES (3.1%)
<C> <S> <C>
$ 7,633 FHLMC Pool #303865,
8.50%, 10/1/97.............. 7,865
6,220,971 FNMA Pool #303664,
6.50%, 12/1/08.............. 6,076,458
<CAPTION>
TOTAL MORTGAGE-BACKED SECURITIES
(COST-- $6,242,370)........................ 6,084,323
<C> <S> <C>
<CAPTION>
FOREIGN BONDS (U.S. DOLLARS) (1.5%)
(COST-- $3,098,550)
<C> <S> <C>
3,000,000 Bayer Corp., Notes,
7.13%, 10/1/15 (c).......... 2,838,000
<CAPTION>
TOTAL FIXED INCOME
(COST-- $188,262,872)...................... 185,420,093
<C> <S> <C>
</TABLE>
<PAGE>
PAGE 9
SCHEDULE OF INVESTMENTS-- APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
REPURCHASE AGREEMENT (2.6%)
(COST-- $4,961,000)
<C> <S> <C>
$ 4,961,000 Keystone Joint Repurchase Agreement,
(Investments in repurchase agreements
in a joint trading account,
purchased 4/30/97, maturity
value $4,961,758)
5.50%, 5/1/97 (b).......... $ 4,961,000
<CAPTION>
VALUE
<C> <S> <C>
<CAPTION>
TOTAL INVESTMENTS
(COST-- $193,223,872) 98.7% $190,381,093
<C> <S> <C>
<CAPTION>
OTHER ASSETS AND LIABILITIES--
NET 1.3% 2,538,931
<C> <S> <C>
<CAPTION>
NET ASSETS 100.0% $192,920,024
<C> <S> <C>
</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, 1997.
(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.
(d) Effective yield (calculated at date of purchase) is the yield at which the
bond accretes on an annualized basis until maturity date.
LEGEND OF PORTFOLIO ABBREVIATIONS:
CD-- Canadian Dollar
DM-- German Deutsche Mark
FHLB-- Federal Home Loan Bank
FHLMC-- Federal Home Loan Mortgage Corporation
FNMA-- Federal National Mortgage Association
PAC-- Planned Amortization Class
RASTA-- Residential Asset Securitization Trust Association
REMIC-- Real Estate Mortgage Investment Conduit
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
EXCHANGE U.S. $ VALUE AT IN EXCHANGE UNREALIZED
DATE APRIL 30, 1997 FOR U.S. $ APPRECIATION
<S> <C> <C> <C> <C>
<CAPTION>
Foward Foreign Currency Exchange Contracts to Sell:
Contracts to Deliver
<S> <C> <C> <C> <C>
5/9/97 18,688,000 German Deutsche Marks 10,797,750 11,409,941 $612,191
5/27/97 8,530,350 Canadian Dollars 6,117,884 6,303,835 185,951
$798,142
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 10
KEYSTONE QUALITY BOND FUND (B-1)
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
APRIL 30, 1997 YEAR ENDED OCTOBER 31,
(UNAUDITED) 1996 1995 1994 1993 1992 1991 1990 1989
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE BEGINNING
OF PERIOD $15.19 $15.42 $14.44 $16.40 $15.92 $15.92 $15.11 $15.85 $15.71
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income 0.38 0.75 0.87 0.76 0.96 1.04 1.08 1.11 1.21
Net realized and
unrealized gain (loss)
on investments
and foreign currency
related transactions (0.26) (0.16) 1.05 (1.76) 0.66 0.15 0.99 (0.53) 0.25
Total from investment
operations 0.12 0.59 1.92 (1.00) 1.62 1.19 2.07 0.58 1.46
LESS DISTRIBUTIONS FROM:
Net investment income (0.39) (0.76) (0.87) (0.76) (0.96) (1.04) (1.08) (1.18) (1.32)
In excess of net
investment income 0 0 (0.05) (0.09) (0.18) (0.15) (0.18) (0.14) 0
Tax basis return of
capital 0 (0.06) (0.02) (0.11) 0 0 0 0 0
Total distributions (0.39) (0.82) (0.94) (0.96) (1.14) (1.19) (1.26) (1.32) (1.32)
NET ASSET VALUE END OF
PERIOD $14.92 $15.19 $15.42 $14.44 $16.40 $15.92 $15.92 $15.11 $15.85
TOTAL RETURN (A) 0.80% 3.99% 13.69% (6.27%) 10.50% 7.71% 14.09% 3.93% 9.82%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net
assets:
Total expenses 2.01%(b) 1.95% 1.96% 1.86% 1.94% 2.01% 2.04% 1.95% 1.82%
Expenses excluding
indirectly paid
expenses 2.00%(b) 1.93% 1.94% -- -- -- -- -- --
Net investment income 5.09%(b) 5.06% 5.86% 5.05% 5.85% 6.40% 6.95% 7.45% 7.61%
Portfolio turnover rate 99% 231% 244% 169% 190% 102% 158% 117% 116%
NET ASSETS END OF PERIOD
(THOUSANDS) $192,920 $228,649 $310,791 $327,276 $458,925 $456,912 $453,528 $408,330 $462,425
<CAPTION>
1988
<S> <C>
NET ASSET VALUE BEGINNING
OF PERIOD $15.52
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income 1.19
Net realized and
unrealized gain (loss)
on investments
and foreign currency
related transactions 0.32
Total from investment
operations 1.51
LESS DISTRIBUTIONS FROM:
Net investment income (1.32)
In excess of net
investment income 0
Tax basis return of
capital 0
Total distributions (1.32)
NET ASSET VALUE END OF
PERIOD $15.71
TOTAL RETURN (A) 10.09%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net
assets:
Total expenses 1.64%
Expenses excluding
indirectly paid
expenses --
Net investment income 7.49%
Portfolio turnover rate 153%
NET ASSETS END OF PERIOD
(THOUSANDS) $447,454
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 11
STATEMENT OF ASSETS AND LIABILITIES
APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
<S> <C>
ASSETS
Investments at market value
(identified cost-- $193,223,872) $190,381,093
Cash 37,094
Foreign currency (cost-- $3,505) 3,492
Receivable for investments sold 7,063,719
Interest receivable 2,595,196
Net unrealized appreciation on forward
foreign
currency exchange contracts 798,142
Receivable for closed forward foreign
currency
exchange contracts 72,557
Receivable for Fund shares sold 9,747
Prepaid expenses and other assets 91,815
Total assets 201,052,855
LIABILITIES
Payable for investments purchased 7,082,738
Payable for Fund shares redeemed 516,018
Distributions to shareholders 311,189
Distribution fees payable 150,764
Due to related parties 36,387
Accrued expenses and other liabilities 35,735
Total liabilities 8,132,831
NET ASSETS $192,920,024
NET ASSETS REPRESENTED BY
Paid-in capital $223,406,039
Accumulated distributions in excess of net
investment income (452,062)
Accumulated net realized loss on investments
and foreign currency related transactions (27,921,856)
Net unrealized depreciation on investments
and foreign currency related transactions (2,112,097)
Total net assets $192,920,024
NET ASSET VALUE PER SHARE
Net assets of $192,920,024 4 12,927,464
shares outstanding $ 14.92
</TABLE>
STATEMENT OF OPERATIONS
SIX MONTHS ENDED APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME
Interest (net of withholding taxes
of $2,920) $7,446,588
EXPENSES
Distribution Plan expenses $1,048,603
Management fee 641,936
Transfer agent fees 276,715
Custodian fees 62,086
Professional fees 21,869
Trustees' fees and expenses 19,998
Other 43,670
Total expenses 2,114,877
Less: Expenses paid indirectly (13,174)
Net expenses 2,101,703
Net investment income 5,344,885
NET REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS AND FOREIGN
CURRENCY RELATED TRANSACTIONS
Net realized gain on:
Investments 2,043,813
Foreign currency related
transactions 1,342,440
Net realized gain on investments
and foreign currency related
transactions 3,386,253
Net change in unrealized
appreciation (depreciation) on:
Investments (7,628,379)
Foreign currency related
transactions 689,048
Net change in unrealized
appreciation (depreciation) on
investments and foreign currency
related transactions (6,939,331)
Net realized and unrealized loss on
investments and foreign currency
related transactions (3,553,078)
Net increase in net assets
resulting from operations $1,791,807
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 12
KEYSTONE QUALITY BOND FUND (B-1)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
APRIL 30, 1997 YEAR ENDED
(UNAUDITED) OCTOBER 31, 1996
<S> <C> <C>
OPERATIONS
Net investment income $ 5,344,885 $ 13,390,061
Net realized gain (loss) on investments and foreign currency related transactions 3,386,253 (2,183,664)
Net change in unrealized appreciation (depreciation) on investments and foreign
currency related transactions (6,939,331) (1,936,653)
Net increase in net assets resulting from operations 1,791,807 9,269,744
DISTRIBUTIONS TO SHAREHOLDERS FROM
Net investment income (5,396,962) (13,289,851)
Tax basis return of capital 0 (950,184)
Total distributions to shareholders (5,396,962) (14,240,035)
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold 13,436,496 44,210,094
Payments for shares redeemed (48,890,087) (130,171,813)
Net asset value of shares issued in reinvestment of dividends and distributions 3,329,611 8,789,681
Net decrease in net assets resulting from capital share transactions (32,123,980) (77,172,038)
Total decrease in net assets (35,729,135) (82,142,329)
NET ASSETS
Beginning of period 228,649,159 310,791,488
End of period [including accumulated distributions in excess of net investment
income as follows: 1997-- ($452,062) and 1996-- ($399,985)] $192,920,024 $228,649,159
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 13
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Keystone Quality Bond Fund (B-1) (the "Fund") is a Pennsylvania common law trust
for which Keystone Investment Management Company ("Keystone") is the Investment
Adviser and Manager. Keystone was formerly a wholly-owned subsidiary of Keystone
Investments, Inc. ("KII") and is currently a subsidiary of First Union Keystone,
Inc. First Union Keystone, Inc. is a wholly-owned subsidiary of First Union
National Bank of North Carolina which in turn is a wholly-owned subsidiary of
First Union Corporation ("First Union"). The Fund is registered under the
Investment Company Act of 1940, as amended (the "1940 Act"), as a diversified,
open-end investment management company. The Fund's investment objective is to
provide the highest possible income consistent with preservation of principal.
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
require 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. VALUATION OF SECURITIES
U.S. Government obligations held by the Fund are valued at the mean between the
over-the-counter bid and asked prices as furnished by an independent pricing
service. Listed corporate bonds, other fixed-income securities, mortgage and
other asset-backed securities, and other related securities are valued at prices
provided by an independent pricing service. In determining value for normal
institutional-size transactions, the pricing service uses methods based on
market transactions for comparable securities and various relationships between
securities which are generally recognized by institutional traders. Securities
for which valuations are not available from an independent pricing service
(including restricted securities) are valued at fair value as determined in good
faith according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. REPURCHASE AGREEMENTS
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 fully collateralized by U.S. Treasury and/or
Federal Agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the collateral
daily and will require the seller to provide additional collateral in the event
the market value of the securities pledged falls below the carrying value of the
repurchase agreement.
C. REVERSE REPURCHASE AGREEMENTS
The Fund enters into reverse repurchase agreements with qualified third-party
broker-dealers. Interest on the value of reverse repurchase agreements is based
upon competitive market rates at the time of issuance. At the time the Fund
enters into a reverse repurchase agreement, it will establish and maintain a
segregated account with its custodian containing liquid assets having a value
not less than the repurchase price (including accrued interest). If the
counterparty to the transaction is rendered insolvent, the ultimate realization
of the securities to be repurchased by the Fund may be delayed or limited.
D. FOREIGN CURRENCY
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into United States dollars as
follows:
<PAGE>
PAGE 14
KEYSTONE QUALITY BOND FUND (B-1)
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 gain (loss) resulting from changes in foreign currency exchange
rates is a component of net unrealized appreciation (depreciation) on
investments and foreign currency related transactions. Net realized foreign
currency gains and losses resulting from changes in exchange rates include
foreign currency gains and losses between trade date and settlement date on
investment securities transactions, foreign currency transactions and the
difference between the amounts of interest and dividends recorded on the books
of the Fund and the amount actually received. The portion of foreign currency
gains and losses related to fluctuations in exchange rates between the initial
purchase trade date and subsequent sale trade date is included in realized gain
(loss) on foreign currency related transactions.
E. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to settle portfolio purchases and sales of securities denominated in
a foreign currency and to hedge certain foreign currency assets or liabilities.
Forward 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 bears
the risk of an unfavorable change in the foreign currency exchange rate
underlying the forward contract and is subject to the credit risk that the other
party will not fulfill their obligations under the contract. Forward contracts
involve elements of market risk in excess of the amounts reflected in the
statement of assets and liabilities.
F. SECURITY TRANSACTIONS AND INVESTMENT INCOME
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 includes
amortization of discounts.
G. FEDERAL INCOME TAXES
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 (the
"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 also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income taxes is required.
H. DISTRIBUTIONS
The Fund distributes net investment income monthly and net capital gains, if
any, at least annually. Distributions to shareholders are recorded at the close
of business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. These differences are primarily due to differing
treatment for paydown gains (losses) and foreign currency related transactions
for income tax purposes that have been recognized for financial statement
purposes.
<PAGE>
PAGE 15
2. CAPITAL SHARE TRANSACTIONS
The Fund's Trust Agreement, as amended and restated, 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:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED
4/30/97 10/31/96
<S> <C> <C>
Shares sold 889,910 2,902,677
Shares redeemed (3,240,696) (8,577,419)
Shares issued in
reinvestment of
dividends and
distributions 222,503 581,588
Net decrease (2,128,283) (5,093,154)
</TABLE>
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) were as follows for the six months ended April 30, 1997:
<TABLE>
<CAPTION>
COST OF PROCEEDS FROM
PURCHASES SALES
<S> <C> <C>
Non-U.S. Government $103,862,951 $ 148,886,635
U.S. Government 99,782,061 89,637,339
</TABLE>
The average daily balance of reverse repurchase agreements outstanding during
the six months ended April 30, 1997 was approximately $4,320,000 at a weighted
average interest rate of 4.59%. The maximum amount of borrowing during the six
months ended April 30, 1997 was $11,290,271 (including accrued interest).
As of October 31, 1996, the Fund had a capital loss carryover for federal
income tax purposes of approximately $30,627,000 which expires as follows:
$2,251,000-- 1998; $20,145,000-- 2002; $6,153,000-- 2003 and $2,078,000-- 2004.
4. DISTRIBUTION PLANS
The Fund bears some of the costs of selling its shares under a Distribution Plan
(the "Plan") adopted pursuant to Rule 12b-1 under the 1940 Act. Under the Plan,
the Fund pays its principal underwriter amounts which are calculated and paid
monthly.
On December 11, 1996, the Fund entered into a principal underwriting agreement
with Evergreen Keystone Distributor, Inc. (formerly, Evergreen Funds
Distributor, Inc.) ("EKD"), a wholly-owned subsidiary of The BISYS Group Inc.
Prior to December 11, 1996, Evergreen Keystone Investment Services, Inc.
(formerly, Keystone Investment Distributors Company) ("EKIS"), a wholly-owned
subsidiary of Keystone, served as the Fund's principal underwriter.
Under the Plan, the Fund pays a distribution fee which may not exceed 1.00% of
the Fund's average daily net assets. Of that amount, 0.75% is used to pay
distribution expenses and 0.25% may be used to pay service fees.
Contingent deferred sales charges paid by redeeming shareholders are paid to
EKD or its predecessor.
The Plan may be terminated at any time by vote of the Independent Trustees or
by vote of a majority of the outstanding voting shares of the Fund. However,
after the termination of the Plan, and at the discretion of the Independent
Trustees, payments to EKIS and/or EKD may continue as compensation for services
which had been earned while the Plan was in effect.
EKD intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof would be within permitted limits.
At April 30, 1997 total unpaid distribution costs were $8,422,778.
5. INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT AND OTHER AFFILIATED
TRANSACTIONS
Under an investment advisory and management agreement dated December 11, 1996,
Keystone serves as the Investment Adviser and Manager to the Fund. Keystone
provides the Fund with investment advisory and management services. In return,
Keystone is paid a management fee, computed at an annual rate of 2.00%
<PAGE>
PAGE 16
KEYSTONE QUALITY BOND FUND (B-1)
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 average daily net asset value of the Fund.
Prior to December 11, 1996, Keystone Management, Inc. ("KMI"), a wholly-owned
subsidiary of Keystone, served as Investment Manager to the Fund and provided
investment management and administrative services. Under an investment advisory
agreement between KMI and Keystone, Keystone served as the Investment Adviser
and provided investment advisory and management services to the Fund. In return
for its services, Keystone received an annual fee equal to 85% of the management
fee received by KMI.
During the six months ended April 30, 1997, the Fund paid or accrued $14,382
to Keystone for certain accounting services. Evergreen Keystone Service Company
(formerly, Keystone Investor Resource Center, Inc.), a wholly-owned subsidiary
of Keystone, serves as the Fund's transfer and dividend disbursing agent.
Officers of the Fund and affiliated Trustees receive no compensation directly
from the Fund.
6. EXPENSE OFFSET ARRANGEMENT
The Fund has entered into an expense offset arrangement with its custodian. For
the six months ended April 30, 1997, the Fund incurred total custody fees of
$62,086 and received a credit of $13,174 pursuant to this expense offset
arrangement, resulting in a net custody expense of $48,912. The assets deposited
with the custodian under this expense offset arrangement could have been
invested in income-producing assets.
<PAGE>
PAGE 17
ADDITIONAL INFORMATION
(UNAUDITED)
Shareholders of the Fund considered and acted upon the proposals listed below at
a special meeting of shareholders held Monday, December 9, 1996. In addition,
below each proposal are the results of that vote.
1. TO ELECT THE FOLLOWING TRUSTEES:
<TABLE>
<CAPTION>
AFFIRMATIVE WITHHELD
<S> <C> <C>
Frederick Amling 9,563,926 326,591
Laurence B. Ashkin 9,559,675 330,842
Charles A. Austin III 9,564,546 325,971
Foster Bam 9,561,429 329,088
George S. Bissell 9,557,891 332,626
Edwin D. Campbell 9,564,531 325,986
Charles F. Chapin 9,564,296 326,221
K. Dun Gifford 9,566,511 324,006
James S. Howell 9,563,039 327,478
Leroy Keith, Jr. 9,563,551 326,966
F. Ray Keyser 9,563,661 326,856
Gerald M. McDonnell 9,565,174 325,343
Thomas L. McVerry 9,564,296 326,221
William Walt Pettit 9,562,124 328,393
David M. Richardson 9,564,660 325,857
Russell A. Salton, III M.D. 9,563,049 327,468
Michael S. Scofield 9,566,481 324,036
Richard J. Shima 9,564,645 325,872
Andrew J. Simons 9,558,242 332,275
</TABLE>
2. TO APPROVE AN INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT BETWEEN THE FUND
AND KEYSTONE INVESTMENT MANAGEMENT COMPANY:
<TABLE>
<S> <C>
Affirmative 9,363,597
Against 187,893
Abstain 339,027
</TABLE>
<PAGE>
KEYSTONE
FAMILY OF FUNDS
(Diamond appears here)
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 Evergreen Keystone funds, contact
your financial adviser or call Evergreen Keystone.
(Logo appears here
Evergreen Keystone
Funds)
P.O. Box 2121 (Recycle logo appears here)
Boston, Massachusetts 02106-2121
B1-R REV01
6/97
KEYSTONE
(Photo of senior citizens with bikes appears here)
QUALITY
BOND FUND (B-1)
(Logo appears here
Evergreen Keystone
Funds)
SEMI-ANNUAL REPORT
APRIL 30, 1997
<PAGE>
