<PAGE>
- --------------------------------------------------------------------------------
PROSPECTUS NOVEMBER 30, 1995
- --------------------------------------------------------------------------------
KEYSTONE HIGH INCOME BOND FUND (B-4)
(FORMERLY KEYSTONE CUSTODIAN FUND, SERIES B-4)
200 BERKELEY STREET, BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-343-2898
- --------------------------------------------------------------------------------
Keystone High Income Bond Fund (B-4) (the "Fund") is a mutual fund whose
investment objective is generous income. The Fund invests primarily in
corporate bonds, and its portfolio ordinarily includes a substantial number of
bonds that, as a class, sell at discounts from par value. The generous income
sought by the Fund is ordinarily associated with high yield, high risk bonds
and similar securities in the lower rating categories of the recognized rating
agencies or with securities that are unrated.
Your purchase payment is fully invested. There is no sales charge when you
buy the Fund's shares. The Fund may impose a deferred sales charge, which
declines from 4% to 1%, if you redeem your shares within four 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 November 30, 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.
THE FUND MAY INVEST UP TO 100% OF ITS ASSETS IN LOWER RATED BONDS, COMMONLY
KNOWN AS "JUNK BONDS," WHICH ENTAIL GREATER RISKS, INCLUDING RISKS OF DEFAULT,
UNTIMELY INTEREST AND PRINCIPAL PAYMENTS AND PRICE VOLATILITY, THAN THOSE
FOUND IN HIGHER RATED SECURITIES. LOWER RATED BONDS MAY ALSO PRESENT PROBLEMS
OF LIQUIDITY AND VALUATION. INVESTORS SHOULD CAREFULLY CONSIDER THESE RISKS
BEFORE INVESTING. SEE "FUND OBJECTIVE AND POLICIES," PAGE 4; "RISK FACTORS,"
PAGE 5.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Page Page
Fee Table ........................................ 2 How to Buy Shares ............................ 11
Financial Highlights ............................. 3 Distribution Plan ............................ 13
Fund Description ................................. 4 How to Redeem Shares ......................... 15
Fund Objective and Policies ...................... 4 Shareholder Services ......................... 16
Risk Factors ..................................... 5 Performance Data ............................. 18
Investment Restrictions .......................... 8 Fund Shares .................................. 18
Pricing Shares ................................... 9 Additional Information ....................... 18
Dividends and Taxes .............................. 9 Additional Investment Information ............ (i)
Fund Management and Expenses ..................... 10
</TABLE>
- --------------------------------------------------------------------------------
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.
- --------------------------------------------------------------------------------
<PAGE>
FEE TABLE
KEYSTONE HIGH INCOME BOND FUND (B-4)
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 the 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 ............................................ 0.57%
12b-1 Fees(4) ............................................ 0.99%
Other Expenses ............................................. 0.47%
----
Total Fund Operating Expenses .............................. 2.03%
====
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: ..................... $60 $84 $109 $236
You would pay the following expenses
on the same investment, assuming
no redemption: ................... $21 $64 $109 $236
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 three calendar years after the year of 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 July 31, 1995.
(4) Long-term shareholders may pay more than the economic equivalent of the
maximum front end sales charges permitted by rules adopted by the National
Association of Securities Dealers, Inc.
(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 HIGH INCOME BOND FUND (B-4)
(For a share outstanding throughout the year)
The following table contains important financial information relating to
the Fund and has been audited by KPMG Peat Marwick LLP, the Fund's independent
auditors. The table has been taken from 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 independent auditors' report, in the
Fund's Annual Report. The Fund's financial statements, related notes, and
independent 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 JULY 31,
----------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
------ ------ ------ ------ ------ ------ ------ ------ ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE
BEGINNING OF YEAR . $ 4.68 $ 5.13 $ 4.74 $ 4.19 $ 5.02 $ 6.38 $ 6.91 $ 7.66 $ 8.08 $ 7.92
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Income from investment operations:
Net investment income 0.38 0.38 0.45 0.49 0.61 0.68 0.83 0.80 0.81 0.89
Net gain (loss) on
investments and
foreign currency
related transactions (0.15) (0.38) 0.44 0.58 (0.72) (1.18) (0.51) (0.71) (0.26) 0.35
Net commissions paid
on fund share sales(a) 0 0 0 0 0 0 0 0 0 (0.08)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total from investment
operations ...... 0.23 0 0.89 1.07 (0.11) (0.50) 0.32 0.09 0.55 1.16
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
LESS DISTRIBUTIONS FROM:
Net investment
income ............ (0.37) (0.38) (0.45) (0.50) (0.72) (0.78) (0.85) (0.84) (0.90) (1.00)
In excess of net
investment income . (0.02) (0.07) (0.05) (0.02) 0 (0.08) 0 0 0 0
Tax basis return of
capital ........... (0.10) 0 0 0 0 0 0 0 0 0
Net realized gain on
investments ....... 0 0 0 0 0 0 0 0 (0.07) 0
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total distributions (0.49) (0.45) (0.50) (0.52) (0.72) (0.86) (0.85) (0.84) (0.97) (1.00)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
NET ASSET VALUE END
OF YEAR ........... $ 4.42 $ 4.68 $ 5.13 $ 4.74 $ 4.19 $ 5.02 $ 6.38 $ 6.91 $ 7.66 $ 8.08
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
TOTAL RETURN(b) .... 5.66% (0.41)% 20.28% 27.25% 0.03% (7.84)% 4.95% 1.66% 7.15% 15.27%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Total expenses .... 2.03% 1.84% 2.06% 2.17% 2.34% 2.06% 1.97% 1.82% 1.65% 0.86%
Net investment
income ........... 8.64% 7.57% 9.30% 10.86% 14.64% 12.77% 12.36% 11.29% 10.26% 10.93%
Portfolio turnover
rate .............. 82% 110% 125% 94% 78% 45% 75% 81% 135% 87%
Net assets end of
year (thousands) .. $764,965 $766,283 $972,164 $841,757 $710,590 $820,940 $1,188,660 $1,274,673 $1,464,891 $1,569,038
(a)Prior to June 30, 1987, net commissions paid on new sales of shares under the Fund's Rule 12b-1 Distribution Plan had 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 July 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)Excluding applicable sales charges.
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
FUND DESCRIPTION
- --------------------------------------------------------------------------------
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 thirty
funds managed or advised by Keystone Investment Management Company (formerly
Keystone Custodian Funds, Inc.) ("Keystone"), the Fund's investment adviser.
Keystone and Keystone Management are, from time to time, collectively referred
to as "Keystone."
- --------------------------------------------------------------------------------
FUND OBJECTIVE AND POLICIES
- --------------------------------------------------------------------------------
INVESTMENT OBJECTIVE
The Fund's investment objective is to provide shareholders with generous
income.
The investment objective of the Fund cannot be changed without a vote of the
holders of a majority (as defined in the 1940 Act) of the Fund's outstanding
shares.
There is no assurance that the Fund will achieve its investment objective
since there is uncertainty in every investment.
INVESTMENTS AND INVESTMENT POLICIES
The Fund will invest, under normal circumstances, at least 65% of its total
assets in bonds, debentures and other income obligations, and its portfolio
ordinarily includes a substantial number of bonds, debentures and other income
obligations, which, as a class, sell at discounts from par value and are rated
by Standard & Poor's Corporation ("S&P") or Moody's Investors Service, Inc.
("Moody's") as below investment grade, i.e., S&P rating below BBB and Moody's
rating below BAA.
The Fund may purchase securities with any rating or may purchase unrated
securities, which are not necessarily of lower quality than rated securities,
but may not be as attractive to as many buyers. While Keystone performs its
own credit analyses of the Fund's investments and does not rely on ratings
assigned by rating services, bonds rated below investment grade generally
involve greater volatility of price and risk of principal and income than
bonds in the higher rating categories and are, on balance, considered
predominantly speculative.
In addition to its other investment options, the Fund may invest in limited
partnerships, including master limited partnerships, and may invest up to 25%
of its assets in foreign securities. The Fund may also invest in
participations in bank loans.
When market conditions warrant, the Fund may adopt a defensive position to
preserve shareholders' capital by investing in money market instruments. Such
instruments, which must mature within one year of their purchase, consist of
United States ("U.S.") government securities; instruments, including
certificates of deposit, demand and time deposits and bankers' acceptances, of
banks which are members of the Federal Deposit Insurance Corporation and have
assets of at least $1 billion, including U.S. branches of foreign banks and
foreign branches of U.S. banks; prime commercial paper, including master
demand notes; and repurchase agreements secured by U.S. government securities.
The Fund's investments may include fixed and adjustable rate or stripped
bonds, including zero coupon bonds and payment-in-kind securities ("PIKs"),
debentures, notes, equipment trust certificates, U.S. government securities
and debt securities convertible into or exchangeable for preferred or common
stock. The Fund may continue to hold preferred or common stock received in
connection with convertible or exchangeable securities. The Fund may also
invest in units consisting of debt securities with stock or warrants to buy
stock attached.
The Fund may also invest in preferred stock, including convertible preferred
stock and adjustable rate preferred stock, warrants, which may be used to
create other permissible investments, and common stock of issuers that are
objects of acquisition attempts, are undergoing reorganization through
bankruptcy or otherwise, or are in the process of refinancing. Investments in
common stocks of such issuers are expected to provide the Fund with the
opportunity to receive high-yielding, fixed-income securities. Investments in
common stocks will be limited to those stocks that Keystone believes will
assist the Fund in achieving its investment objective.
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.
The Fund may write covered call and put options. The Fund may also purchase
call and put options, including call and put options to close out existing
positions, and employ new investment techniques with respect to such options.
The Fund currently does not intend to invest more than 5% of its assets in
options transactions.
The Fund may enter into reverse repurchase agreements and firm commitment
and when-issued transactions for securities and currencies. In addition, the
Fund may enter into currency and other financial futures contracts and engage
in related options transactions for hedging purposes and not for speculation
and may employ new investment techniques with respect to such futures
contracts and related options transactions.
In addition to the options, futures contracts and forwards mentioned above,
the Fund may also invest in certain other types of derivative instruments,
including collateralized mortgage obligations, structured notes, interest rate
swaps, index swaps, currency swaps and caps and floors. These basic vehicles
can also be combined to create more complex products called hybrid derivatives
or structured securities.
Investments in foreign securities, options transactions and other complex or
derivative securities involve certain risks. For an explanation of these
risks, see "Risk Factors," the section of this prospectus entitled "Additional
Investment Information" and the statement of additional information.
For further information generally about the types of investments and
investment techniques available to the Fund and the associated risks, see
"Additional Investment Information" and the statement of additional
information.
- --------------------------------------------------------------------------------
RISK FACTORS
- --------------------------------------------------------------------------------
Like any investment, your investment in the Fund involves an element of
risk. Before you invest in the Fund, you should carefully evaluate your
ability to assume the risks your investment in the Fund poses. YOU CAN LOSE
MONEY BY INVESTING IN THE FUND. YOUR INVESTMENT IS NOT GUARANTEED. A DECREASE
IN THE VALUE OF THE FUND'S PORTFOLIO SECURITIES CAN RESULT IN A DECREASE IN
THE VALUE OF YOUR INVESTMENT.
The Fund seeks generous income ordinarily from high yielding, high risk
bonds, commonly known as "junk bonds." This investment approach involves risks
greater than a more conservative approach.
Certain risks related to the Fund are discussed below. To the extent not
discussed in this section, specific risks attendant to individual securities
or investment practices are discussed in "Additional Investment Information."
By itself the Fund does not constitute a balanced investment program. You
should take into account your own investment objectives as well as your other
investments when considering an investment in the Fund.
Should the Fund need to raise cash to meet a large number of redemptions it
might have to sell portfolio securities at a time when it would be
disadvantageous to do so.
NONINVESTMENT GRADE BONDS
Since 1935, the Fund has had continuous experience investing in bonds
selling at a substantial discount from par, convertible bonds, noninvestment
grade bonds and other securities that as a class may be considered high yield,
high risk securities.
Prior to the 1980's, corporate bonds were primarily issued to finance growth
and development. Noninvestment grade bonds were predominantly bonds that often
traded at discounts from par because the company's credit ratings had been
downgraded. The rapid growth of the noninvestment grade sector of the bond
market during the 1980's was largely attributable to the issuance of such
bonds to finance corporate reorganizations. An economic downturn could
severely disrupt the market for high yield, high risk bonds and adversely
affect the value of outstanding bonds and the ability of issuers to repay
principal and interest.
Although the change in the size and characteristics of the market may result
in higher risks associated with individual bonds, Keystone believes that an
effective program of broad diversification can, over time, enable the Fund to
successfully achieve its investment objective while reducing the risk of
investing in individual noninvestment grade bonds.
While an investment in the Fund provides opportunities to maximize return
over time, investors should be aware of the following risks associated with
noninvestment grade bonds:
(1) Securities rated BB or lower by S&P or BA or lower by Moody's are
considered predominantly speculative with respect to the ability of the issuer
to meet principal and interest payments.
(2) The lower ratings of certain securities held by the Fund reflect a
greater possibility that adverse changes in the financial condition of the
issuer or in general economic conditions, or both, or an unanticipated rise in
interest rates may impair the ability of the issuer to make payments of
interest and principal, especially if the issuer is highly leveraged. Such
issuer's ability to meet its debt obligations may also be adversely affected
by specific corporate developments, the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing.
Also, an economic downturn or an increase in interest rates may increase the
potential for default by the issuers of these securities.
(3) The value of certain securities held by the Fund may be more susceptible
to real or perceived adverse economic, company or industry conditions and
publicity than is the case for higher quality securities.
(4) The values of certain securities, like those of other fixed income
securities, fluctuate in response to changes in interest rates. When interest
rates decline, the value of a portfolio invested in bonds can be expected to
rise. Conversely, when interest rates rise, the value of a portfolio invested in
bonds can be expected to decline. For example, in the case of an investment in a
fixed-income security, if interest rates increase after the security is
purchased, the security, if sold prior to maturity, may return less than its
cost. The prices of noninvestment grade bonds, however, are generally less
sensitive to interest rate changes than the prices of higher-rated bonds;
noninvestment grade bonds are more sensitive to adverse or positive economic
changes or individual corporate developments.
(5) The secondary market for certain securities held by the Fund may be less
liquid at certain times than the secondary market for higher quality debt
securities, which may have an adverse effect on market price and the Fund's
ability to dispose of particular issues and may also make it more difficult
for the Fund to obtain accurate market quotations for purposes of valuing its
assets.
(6) Zero coupon bonds and PIKs involve additional special considerations.
Zero coupon bonds do not require the periodic payment of interest. PIK bonds
are debt obligations that provide that the issuer may, at its option, pay
interest on such bonds in cash or in the form of additional debt obligations.
Such investments may experience greater fluctuation in value due to changes in
interest rates than debt obligations that pay interest currently. Even though
these investments do not pay current interest in cash, the Fund is nonetheless
required by tax laws to accrue interest income on such investments and to
distribute such amounts at least annually to shareholders. Thus, the Fund
could be required at times to liquidate investments in order to fulfill its
intention to distribute substantially all of its net income as dividends.
The generous income sought by the Fund is ordinarily associated with
securities in the lower rating categories of the recognized rating agencies or
with securities that are unrated. Such securities are generally rated BB or
lower by S&P or BA or lower by Moody's. The Fund may invest in securities that
are rated as low as D by S&P and C- by Moody's. It is possible for securities
rated D or C-, respectively, to have defaulted on payments of principal and/or
interest at the time of investment. The section of this prospectus entitled
"Additional Investment Information" describes these rating categories. The
Fund intends to invest in D rated debt only in cases when, in Keystone's
judgment, there is a distinct prospect of improvement in the issuer's
financial position as a result of the completion of reorganization or
otherwise. The Fund may also invest in unrated securities that, in Keystone's
judgment, offer comparable yields and risks to those of securities that are
rated, as well as in non-investment quality zero coupon bonds or PIKs.
Keystone considers the ratings of Moody's and S&P assigned to various
securities, but does not rely solely on such ratings because (1) Moody's and S&P
assigned ratings are based largely on historical financial data and may not
accurately reflect the current financial outlook of companies, and (2) there can
be large differences among the current financial conditions of issuers within
the same rating category.
The following table shows the weighted average percentages of the Fund's
assets invested at the end of each month during the last fiscal year in
securities assigned to the various rating categories by S&P and in unrated
securities determined by Keystone to be of comparable quality. Since the
percentages in this table are based on month-end averages throughout the
Fund's fiscal year, they do not reflect the Fund's holdings at any one point
in time. The percentages in each category may be higher or lower on any day
than those shown in the table.
*UNRATED SECURITIES
OF COMPARABLE
RATED SECURITIES QUALITY AS
AS PERCENTAGE OF PERCENTAGE OF
RATING FUND'S ASSETS FUND'S ASSETS
- ---- ----------------- -------------------
AAA 0.00% 0.00%
AA 0.00% 0.00%
A 0.42% 0.00%
BBB 0.00% 0.00%
BB 18.52% 1.67%
B 48.43% 10.26%
CCC 2.24% 4.83%
CC 0.00% 0.00%
C 0.00% 0.00%
CA 0.00% 0.00%
Unrated* 16.76%
U.S. governments,
cash, equities
and others 13.63%
-------
TOTAL 100.00%
-------
Since the Fund takes an aggressive approach to investing, Keystone tries to
maximize the return by controlling risk through diversification, credit
analysis, review of sector and industry trends, interest rate forecasts and
economic analysis. Keystone's analysis of securities focuses on values based
on factors such as interest or dividend coverage, asset values, earnings
prospects and the quality of management of the company. In making investment
recommendations, Keystone also considers current income, potential for capital
appreciation, maturity structure, quality guidelines, coupon structure,
average yield, percentage of zeros and PIKs, percentage of non-accruing items
and yield to maturity.
Income and yields on high yield, high risk securities, as on all securities,
will fluctuate over time.
RULE 144A SECURITES
The Fund may invest in restricted securities, including securities eligible
for resale pursuant to Rule 144A under the Securities Act of 1933 (the "1933
Act"). Generally, Rule 144A establishes a safe harbor from the registration
requirements of the 1933 Act for resales by large institutional investors of
securities not publicly traded in the U.S. The Fund may purchase Rule 144A
securities when such securities present an attractive investment opportunity
and otherwise meet the Fund's selection criteria. The Board of Trustees has
adopted guidelines and procedures pursuant to which the liquidity of the
Fund's Rule 144A securities is determined by Keystone, and the Board of
Trustees monitors Keystone's implementation of such guidelines and procedures.
At the present time, the Fund cannot accurately predict exactly how the
market for Rule 144A securities will develop. A Rule 144A security that was
readily marketable upon purchase may subsequently become illiquid. In such an
event, the Board of Trustees will consider what action, if any, is
appropriate.
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 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 U.S. Investments in foreign securities also may
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.
DERIVATIVE SECURITIES
With respect to derivative or structured securities, the market value of
such securities may vary depending on the manner in which such securities have
been structured. As a result, the value of such investments may change at a
more rapid rate than that of traditional fixed income securities.
For more detailed information on derivatives, see "Additional Investment
Information" and the statement of additional information.
- --------------------------------------------------------------------------------
INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
The Fund has adopted the fundamental restrictions set forth below, which may
not be changed without the approval of a 1940 Act majority of the Fund's
outstanding shares. These restrictions and certain other fundamental and
nonfundamental restrictions are set forth in detail in the statement of
additional information.
Generally, the Fund may not do the following: (1) invest more than 5% of its
assets, computed at market value at the time of purchase, in the securities of
any one issuer (other than U.S. government securities) except that not more
than 25% of its assets may be invested without regard to this limit; (2)
borrow money, except that the Fund may 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 enter into reverse repurchase
agreements (bank borrowings and reverse repurchase agreements, in aggregate,
shall not exceed 10% of the value of the Fund's net assets); and (3) invest
more than 25% of its assets in securities of issuers in the same industry.
In addition, the Fund may, notwithstanding any other investment policy or
restriction, invest all of its assets in the securities of a single open-end
management investment company with substantially the same fundamental
investment objectives, policies and restrictions as the Fund. The Fund does
not currently intend to implement this policy and would do so only if the
Trustees were to determine such action to be in the best interest of the Fund
and its shareholders. In the event of such implementation, the Fund will
comply with such requirements as to written notice to shareholders as are then
in effect.
- --------------------------------------------------------------------------------
PRICING SHARES
- --------------------------------------------------------------------------------
The net asset value of a Fund share is computed each day on which the New
York Stock Exchange (the "Exchange") is open as of the close of trading on the
Exchange (currently 4:00 p.m. Eastern time for the purpose of pricing Fund
shares), except on days when changes in the value of the Fund's securities do
not affect the current net asset value of its shares. The Exchange is
currently closed on weekends, New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
The net asset value per share is arrived at by determining the value of all of
the Fund's assets, subtracting all liabilities and dividing the result by the
number of shares outstanding.
The Fund values the money market instruments it purchases as follows: short-
term money market instruments 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 current market value; and money market instruments 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.
All other investments are valued at market value or, when market quotations
are not readily available, at fair value as determined in good faith by the
Board of Trustees.
The Fund believes that reliable market quotations are generally not readily
available for purposes of valuing certain 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 Board of
Trustees. The Board of Trustees has authorized the use of a pricing service to
determine the fair value of certain of the Fund's fixed income securities and
other securities. Securities for which market quotations are readily available
are valued on a consistent basis at the price quoted that, in the opinion of
the Trustees or the person designated by the 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.
- --------------------------------------------------------------------------------
DIVIDENDS AND TAXES
- --------------------------------------------------------------------------------
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code. The Fund qualifies if,
among other things, it distributes to its shareholders at least 90% of its net
investment income for its fiscal year. The Fund also intends to make timely
distributions, if necessary, sufficient in amount to avoid the nondeductible
4% excise tax imposed on a regulated investment company when it fails to
distribute, with respect to each calendar year, at least 98% of its ordinary
income for such calendar year and 98% of its net capital gains for the one-
year period ending on October 31 of such calendar year. If the Fund qualifies
and if it distributes substantially all of its net investment income and net
capital gains, if any, to shareholders, it will be relieved of any federal
income tax liability.
Any taxable dividend declared in October, November or December to
shareholders of record in such month and paid by the following January 31 will
be includable in the taxable income of the shareholder as if paid on December
31 of the year in which the dividend was declared. The Fund will make
distributions from its net investment income on or about the 5th day of each
month and net capital gains, if any, at least annually.
As of April 1, 1995, in compliance with a recent ruling issued by the
Internal Revenue Service, the Fund treats its 12b-1 fees for tax purposes as
operating expenses rather than capital charges.
The Fund makes distributions in additional shares of the Fund or, at the
shareholder's election (which must be made before the record date for the
distribution), in cash. Income dividends and net short-term gains
distributions are taxable as ordinary income and net long-term gains
distributions are taxable as capital gains regardless of how long the
shareholder has held the Fund's shares. If Fund shares held for less than six
months are sold at a loss, however, such loss will be treated for tax purposes
as a long-term capital loss to the extent of any long-term capital gains
dividends received. Dividends and distributions also may be subject to state
and local taxes. The Fund advises its shareholders annually as to the federal
tax status of all distributions made during the year.
- --------------------------------------------------------------------------------
FUND MANAGEMENT AND EXPENSES
- --------------------------------------------------------------------------------
FUND MANAGEMENT
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.
INVESTMENT MANAGER
Keystone Management, organized in 1989, is a wholly-owned subsidiary of
Keystone. 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 funds in the
Keystone Fund Family and to certain other funds in the Keystone Investments
Family of Funds.
The Fund pays Keystone Management a fee for its services at the annual rate
of:
ANNUAL AGGREGATE NET ASSET VALUE
MANAGEMENT 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.
Pursuant to its Investment Management Agreement with the Fund (the
"Management Agreement"), 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
with Keystone (the "Advisory Agreement"), under which Keystone provides
investment, advisory and management services to the Fund.
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; and (3) providing services
to the Fund's shareholders in connection with federal and state taxation and
distributions of income and capital gains.
INVESTMENT ADVISER
Keystone, the Fund's investment adviser, 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
Investments, Inc. (formerly "Keystone Group, Inc.") ("Keystone Investments"),
200 Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation predominantly owned by current and
former members of management of Keystone and its affiliates. The shares of
Keystone Investments 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, Edward F. Godfrey and Ralph J. Spuehler, Jr. Keystone
Investments provides accounting, bookkeeping, legal, personnel and general
corporate services to Keystone Management, Keystone, their affiliates and the
Keystone Investments Family of 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 the Management Agreement.
During the year ended July 31, 1995, the Fund paid or accrued to Keystone
Management investment management and administrative services fees of
$4,040,007, which represented 0.57% of the Fund's average net assets. Of such
amount paid to Keystone Management, $3,434,006 was paid to Keystone for
investment advisory services to the Fund.
The Fund has adopted a Code of Ethics incorporating policies on personal
securities trading as recommended by the Investment Company Institute.
FUND EXPENSES
In addition to the investment advisory and management fees discussed above,
the principal expenses the Fund is expected to pay include, but are not
limited to, expenses of its transfer agent, its custodian and its independent
auditors; expenses under its Distribution Plan; fees of its Independent
Trustees ("Independent Trustees"); expenses of shareholders' and Trustees'
meetings; fees payable to government agencies, including registration and
qualification fees of the Fund and its shares under federal and state
securities laws; expenses of preparing, printing and mailing Fund
prospectuses, notices, reports and proxy material; and certain extraordinary
expenses. In addition to such expenses, the Fund pays its brokerage
commissions, interest charges and taxes. For the fiscal year ended July 31,
1995, the Fund paid 2.03% of its average net assets in expenses.
During the fiscal year ended July 31, 1995, the Fund paid or accrued to
Keystone Investor Resource Center, Inc. ("KIRC"), the Fund's transfer and
dividend disbursing agent, and Keystone Investments $28,703 for certain
accounting services and $2,189,924 for transfer agent fees. KIRC is a wholly-
owned subsidiary of Keystone.
PORTFOLIO MANAGER
Donald M. Keller has been the Fund's portfolio manager since 1987. Mr. Keller
is a Keystone Senior Vice President and has more than 37 years of experience in
fixed-income investing.
SECURITIES TRANSACTIONS
Under policies established by the Board of Trustees, Keystone selects
broker-dealers to execute transactions subject to the receipt of best
execution. When selecting broker-dealers to execute portfolio transactions for
the Fund, Keystone may consider the number of shares of the Fund sold by such
broker-dealers. In addition, broker-dealers executing portfolio transactions
may, from time to time, be affiliated with the Fund, Keystone Management,
Keystone, the Fund's principal underwriter or their affiliates.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rates for the fiscal years ended July 31, 1994
and 1995 were 110% and 82%, respectively. High portfolio turnover may involve
correspondingly greater brokerage commissions and other transaction costs,
which would be borne directly by the Fund, as well as additional realized
gains and/or losses to shareholders. For further information about brokerage
and distributions, see the statement of additional information.
- --------------------------------------------------------------------------------
HOW TO BUY SHARES
- --------------------------------------------------------------------------------
Shares of the Fund may be purchased from any broker-dealer that has a
selling agreement with Keystone Investment Distributors Company (formerly
named Keystone Distributors, Inc.) (the "Principal Underwriter"), the Fund's
principal underwriter. The Principal Underwriter, a wholly-owned subsidiary of
Keystone, is located at 200 Berkeley Street, Boston, Massachusetts 02116-5034.
In addition, you may open an account for the purchase of shares of the Fund
by mailing to the Fund, c/o KIRC, P.O. Box 2121, Boston, Massachusetts 02106-
2121, a completed account application and a check payable to the Fund. Or you
may telephone 1-800-343-2898 to obtain the number of an account to which you
can wire or electronically transfer funds and then send in a completed account
application. Subsequent investments in any amount may be made by check, by
wiring federal funds or by an electronic funds transfer ("EFT").
The Fund's shares are sold at the net asset value per share next computed
after it receives the purchase order. The initial purchase must be at least
$1,000 except for purchases by participants in certain retirement plans for
which the minimum is waived. There is no minimum for subsequent purchases.
Purchase payments are fully invested at net asset value. There are no sales
charges on purchases of Fund shares at the time of purchase.
CONTINGENT DEFERRED SALES CHARGE
With certain exceptions, when shares are redeemed within four calendar years
after their purchase, a contingent deferred sales charge may be imposed at
rates ranging from a maximum of 4% of amounts redeemed during the same
calendar year of purchase to 1% of amounts redeemed during the third calendar
year after the year of purchase. No contingent deferred sales charge is
imposed on amounts redeemed thereafter or on shares purchased through
reinvestment of dividends. If imposed, the contingent deferred sales charge is
deducted from the redemption proceeds otherwise payable to you. Prior to July
8, 1992, the Fund retained the deferred sales charge. 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
NASD, paid to the Principal Underwriter. For the fiscal year ended July 31,
1995, the Fund recovered $43,777 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 a 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; (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.
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.
In addition, no contingent deferred sales charge is imposed on a redemption
of shares of the Fund in the event of (1) death or disability of the
shareholder; (2) a lump-sum distribution from a 401(k) plan or other benefit
plan qualified under the Employee Retirement Income Security Act of 1974
("ERISA"); (3) automatic withdrawals from ERISA plans if the shareholder is at
least 59 1/2 years old; (4) involuntary redemptions of accounts having an
aggregate net asset value of less than $1,000; (5) automatic withdrawals under
an automatic withdrawal plan of up to 1% per month of the shareholder's initial
account balance; (6) withdrawals consisting of loan proceeds to a retirement
plan participant; (7) financial hardship withdrawals made by a retirement plan
participant; or (8) withdrawals consisting of returns of excess contributions or
excess deferral amounts made to a retirement plan participant.
WAIVER OF DEFERRED SALES CHARGE
Shares also may be sold, to the extent permitted by applicable law, at net
asset value without the payment of commissions or the imposition of a
contingent deferred sales charge to (1) certain officers, Directors, Trustees
and employees of the Fund, Keystone Management, Keystone and certain of their
affiliates; (2) registered representatives of firms with dealer agreements
with the Principal Underwriter; and (3) a bank or trust company acting as a
trustee for a single account. See the statement of additional information for
more details.
- --------------------------------------------------------------------------------
DISTRIBUTION PLAN
- --------------------------------------------------------------------------------
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. The Fund's
Distribution Plan provides that the Fund may expend up to 0.3125% quarterly
(approximately 1.25% annually) of the 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 currently 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 services 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
charges paid by shareholders to the Principal Underwriter).
Payments under the Distribution Plan are currently made to the Principal
Underwriter (which may reallow all or part to others, such as dealers) (1) as
commissions for Fund shares sold and (2) as shareholder service fees in
respect of shares maintained by the recipients on the Fund's books for
specified periods. Amounts paid or accrued to the Principal Underwriter under
(1) and (2) in the aggregate may not exceed the annual limitation referred to
above. The Principal Underwriter generally reallows to brokers or others a
commission equal to 4% of the price paid for each Fund share sold 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 recipients on the books of the Fund for specified
periods.
If the Fund is unable to pay the Principal Underwriter a commission on a
new sale because the annual maximum (0.75% of average daily net assets) has
been reached, the Principal Underwriter intends, but is not obligated, to
continue to accept new orders for the purchase of Fund shares and to pay or
accrue commissions and service fees in excess of the amount it currently
receives from the Fund. While the Fund is under no contractual obligation to
pay the Principal Underwriter such amounts that exceed the Distribution Plan
limitation, the Principal Underwriter intends to seek full payment of such
charges from the Fund (together with interest at the rate of prime plus 1%) at
such time in the future as, and to the extent that, payment thereof by the
Fund would be within permitted limits. The Principal Underwriter currently
only intends to seek payment of interest on such charges paid or accrued by
the Principal Underwriter subsequent to July 7, 1992. If the Fund's
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, the
Principal Underwriter will ask the Independent Trustees to take whatever
action they deem appropriate under the circumstances with respect to payment
of such amounts.
During the year ended July 31, 1995, the Fund paid the Principal Underwriter
$7,116,706 under the Distribution Plan. For the year ended July 31, 1995, the
Principal Underwriter also received $771,318 in deferred sales charges. The
amount paid by the Fund under its Distribution Plan, net of deferred sales
charges, was $7,072,929 (0.99% of the Fund's average daily net asset value).
During the year, the Principal Underwriter paid commissions on new sales and
service fees to dealers and others of $3,857,337. At July 31, 1995, unpaid
distribution costs amounted to $8,317,347 (1.09% of net assets at July 31,
1995).
The amounts and purposes of expenditures under the Distribution Plan must
be reported to the Independent Trustees quarterly. The Independent Trustees
may require or approve changes in the 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 Fund's
Independent Trustees or by vote of a majority of the outstanding voting shares
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 votes of the majority of both (1) the Fund's Trustees
and (2) the Independent Trustees, cast in person at a meeting called for the
purpose of voting on such amendment.
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.
Whether any expenditure under the Distribution Plan is subject to a state
expense limit depends 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.
ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS
Upon written notice to dealers, the Principal Underwriter, at its own
expense, may periodically sponsor programs that offer additional compensation
in connection with sales of Fund shares. Participation in such programs may be
available to all dealers or to selected dealers who have sold or are expected
to sell significant amounts of shares. Additional compensation may also
include financial assistance to dealers in connection with preapproved
seminars, conferences and advertising. No such programs or additional
compensation will be offered to the extent they are prohibited by the laws of
any state or any self-regulatory agency, such as the NASD.
The Principal Underwriter may, at its own expense, pay concessions in
addition to those described above to dealers that satisfy certain criteria
established from time to time by the Principal Underwriter. These conditions
relate to increasing sales of shares of the Keystone funds over specified
periods and certain other factors. Such payments may, depending on the
dealer's satisfaction of the required conditions, be periodic and may be up to
0.25% of the value of shares sold by such dealer.
The Principal Underwriter also may pay banks and other financial services
firms that facilitate transactions in shares of the Fund for their clients a
transaction fee up to the level of the payments made allowable to dealers for
the sale of such shares as described above.
The Glass-Steagall Act currently limits the ability of a depository
institution (such as a commercial bank or a savings and loan association) to
become an underwriter or distributor of securities. In the event the Glass-
Steagall Act is deemed to prohibit depository institutions from accepting
payments under the arrangement described above, or should Congress relax
current restrictions on depository institutions, the Fund's Board of Trustees
will consider what action, if any, is appropriate.
In addition, state securities laws on this issue may differ from the
interpretations of federal law expressed herein, and banks and financial
institutions may be required to register as dealers pursuant to state law.
- --------------------------------------------------------------------------------
HOW TO REDEEM SHARES
- --------------------------------------------------------------------------------
Fund shares may be redeemed for cash at the redemption value upon written
order by the shareholder(s) to the Fund, c/o Keystone Investor Resource
Center, Inc., Box 2121, Boston, Massachusetts 02106-2121, and presentation to
the Fund of a properly endorsed share certificate if certificates have been
issued. The signature(s) of the shareholder(s) on the written order and
certificates must be guaranteed. The redemption value is the net asset value
adjusted for fractions of a cent and may be more or less than the
shareholder's cost depending upon changes in the value of the Fund's portfolio
securities between purchase and redemption. The Fund may impose a deferred
sales charge at the time of redemption of certain shares as explained in "How
to Buy Shares." If imposed, the Fund deducts the deferred sales charge from
the redemption proceeds otherwise payable to the shareholder.
At various times the Fund may be requested to redeem shares for which it
has not yet received good payment. In such a case the Fund will mail the
redemption proceeds upon clearance of the purchase check, which may take up to
15 days or more. Any delay may be avoided by purchasing shares either with a
certified check drawn on a U.S. bank or by bank wire of funds. Although the
mailing of a redemption check may be delayed, the redemption value will be
determined and the redemption processed in the ordinary course of business
upon receipt of proper documentation. In such a case, after redemption and
prior to the release of the proceeds, no appreciation or depreciation will
occur in the value of the redeemed shares, and no interest will be paid on the
redemption proceeds. If the mailing of a redemption check has been delayed,
the check will be mailed promptly after good payment has been collected.
The Fund computes the redemption value at the close of the Exchange at the
end of the day on which it has received all proper documentation from the
shareholder. Payment of the amount due on redemption, less any applicable
deferred sales charge, will be made within seven days thereafter.
Shareholders also may redeem their shares through their broker-dealers. The
Principal Underwriter, acting as agent for the Fund, stands ready to
repurchase Fund shares upon orders from dealers as follows: redemption
requests received by broker-dealers prior to that day's close of trading on
the Exchange and transmitted to the Fund prior to its close of business that
day will receive the net asset value per share computed at the close of
trading on the Exchange on the same day. Redemption requests received by
broker-dealers after that day's close of trading on the Exchange and
transmitted to the Fund prior to the close of business on the next business
day will receive the next business day's net asset value price. The Principal
Underwriter will pay the redemption proceeds, less any applicable deferred
sales charge, to the dealer placing the order within seven days thereafter,
assuming it has received proper documentation. The Principal Underwriter
charges no fees for this service, but the shareholder's broker-dealer may do
so.
For the protection of shareholders, 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 KIRC'S POLICIES. The Fund and
KIRC may waive this requirement, but may also require additional documents in
certain cases. Currently, the requirement for a signature guarantee has been
waived on redemptions of $50,000 or less where the account address of record
has been the same for a minimum period of 30 days. The Fund and KIRC reserve
the right to withdraw this waiver at any time.
If the Fund receives a redemption or repurchase order, but the shareholder
has not clearly indicated the amount of money or number of shares involved,
the Fund cannot execute the order. In such cases, the Fund will request the
missing information from the shareholder and process the order the day it
receives such information.
TELEPHONE
Under ordinary circumstances, you may redeem up to $50,000 from your account
by telephone by calling toll free 1-800-343-2898.
In order to insure that instructions received by KIRC are genuine when you
initiate a telephone transaction, you will be asked to verify certain criteria
specific to your account. At the conclusion of the transaction, you will be
given a transaction number confirming your request, and written confirmation
of your transaction will be mailed the next business day. Your telephone
instructions will be recorded. 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.
If the redemption proceeds are less than $2,500, they will be mailed by
check. If they are $2,500 or more, they will be mailed, wired or sent by EFT
to your previously designated bank account as you direct. If you do not
specify how you wish your redemption proceeds to be sent, they will be mailed
by check. If you cannot reach the Fund by telephone, you should follow the
procedures for redeeming by mail or through a broker as set forth above.
SMALL ACCOUNTS
Because of the high cost of maintaining small accounts, the Fund reserves
the right to redeem your account if its value has fallen below $1,000, the
current minimum investment level, as a result of your redemptions (but not as
a result of market action). You will be notified in writing and allowed 60
days to increase the value of your account to the minimum investment level. No
contingent deferred sales charges are applied to such redemptions.
GENERAL
The Fund reserves the right at any time to terminate, suspend or change the
terms of any redemption method described in this prospectus, except redemption
by mail, and to impose fees.
Except as otherwise noted, neither the Fund, KIRC nor the Principal
Underwriter assumes responsibility for the authenticity of any instructions
received by any of them from a shareholder in writing, over the Keystone
Automated Response Line ("KARL") or by telephone. KIRC will employ reasonable
procedures to confirm that instructions received over KARL or by telephone are
genuine. Neither the Fund, KIRC nor the Principal Underwriter will be liable
when following instructions received over KARL or by telephone that KIRC
reasonably believes to be genuine.
The Fund may temporarily suspend the right to redeem its shares when (1) the
Exchange is closed, other than customary weekend and holiday closings; (2)
trading on the Exchange is restricted; (3) the Fund cannot dispose of its
investments or fairly determine their value; or (4) the Securities and
Exchange Commission, for the protection of shareholders, so orders.
- --------------------------------------------------------------------------------
SHAREHOLDER SERVICES
- --------------------------------------------------------------------------------
Details on all shareholder services may be obtained from KIRC by writing or
by calling toll free 1-800-343-2898.
KEYSTONE AUTOMATED RESPONSE LINE
KARL offers shareholders specific fund account information and price and
yield quotations as well as the ability to effect account transactions,
including investments, exchanges and redemptions. Shareholders may access KARL
by dialing toll free 1-800-346-3858 on any touch-tone telephone, 24 hours a
day, seven days a week.
EXCHANGES
A shareholder who has obtained the appropriate prospectus may exchange
shares of the Fund for shares of certain other funds in the Keystone Fund
Family, Keystone Precious Metals Holdings, Inc. ("KPMH"), Keystone
International Fund Inc. ("KIF"), Keystone Tax Free Fund ("KTFF"), Keystone Tax
Exempt Trust ("KTET") or Keystone Liquid Trust ("KLT") on the basis of their
respective net asset values by calling toll free 1-800-343-2898 or by writing
KIRC at P.O. Box 2121, Boston, Massachusetts 02106-2121. Fund shares purchased
by check may be exchanged for shares of the named funds, other than KPMH, KTET
or KTFF, after 15 days, provided good payment for the purchase of Fund shares
has been collected. In order to exchange Fund shares for shares of KPMH, KTET
or KTFF, a shareholder must have held Fund shares for a period of at least six
months. There is no exchange fee for exchanges initiated by an individual
investor through KARL; other exchanges made by phone are subject to a $10
exchange fee. If the shares being tendered for exchange have been held for
less than four years and are still subject to a deferred sales charge, such
charge will carry over to the shares being acquired in the exchange
transaction. The Fund reserves the right, after 60 days notice to
shareholders, to terminate this exchange offer or to change its terms,
including the right to change the service fee for any exchange.
Orders to exchange shares of the Fund for shares of KLT will be executed by
redeeming the shares of the Fund and purchasing shares of KLT at the net asset
value of KLT shares determined after the proceeds from such redemption become
available, which may be up to seven days after such redemption. In all other
cases, orders for exchanges received by the Fund prior to 4:00 p.m. Eastern
time on any day the funds are open for business will be executed at the
respective net asset values determined as of the close of business that day.
Orders for exchanges received after 4:00 p.m. Eastern time on any business day
will be executed at the respective net asset values determined at the close of
the next business day.
An excessive number of exchanges may be disadvantageous to the Fund.
Therefore, the Fund, in addition to its right to reject any exchange, reserves
the right to terminate the exchange privilege of any shareholder who makes
more than five exchanges of shares of the funds in a year or three in a
calendar quarter.
An exchange order must comply with the requirements for a redemption or
repurchase order and must specify the dollar value or number of shares to be
exchanged. Exchanges are subject to the minimum initial purchase requirements
of the fund being acquired. An exchange constitutes a sale for federal income
tax purposes.
The exchange privilege is available only in states where shares of the fund
being acquired may legally be sold.
RETIREMENT PLANS
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 KIRC toll free
at 1-800-247-4075 or write to KIRC at P.O. Box 2121, Boston, Massachusetts
02106-2121.
AUTOMATIC INVESTMENT PLAN
Shareholders may take advantage of investing on an automatic basis by
establishing an automatic investment plan. Funds are drawn on a share-
holder'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.
- --------------------------------------------------------------------------------
PERFORMANCE DATA
- --------------------------------------------------------------------------------
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., Standard & Poor's Corporation, Ibbotson Associates or
other industry publications.
- --------------------------------------------------------------------------------
FUND SHARES
- --------------------------------------------------------------------------------
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.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
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.
<PAGE>
- --------------------------------------------------------------------------------
ADDITIONAL INVESTMENT INFORMATION
- --------------------------------------------------------------------------------
DESCRIPTION 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.
CORPORATE BOND RATINGS
Higher yields are usually available on securities that are lower rated or
that are unrated. Bonds rated BAA by Moody's are considered as medium grade
obligations, which are neither highly protected nor poorly secured. Debt
rated BBB by S&P is regarded as having an adequate capacity to pay interest
and repay principal, although adverse economic conditions 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. Lower rated securities are
usually defined as BAA or lower by Moody's or BBB or lower by S&P. The Fund
may purchase unrated securities, which are not necessarily of lower quality
than rated securities, but may not be attractive to as many buyers. Debt rated
BB, B, CCC, CC and C by S&P 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. Debt
rated CI by S&P is debt (income bonds) on which no interest is being paid.
Debt rated D by S&P is in default and payment of interest and/or repayment of
principal is in arrears. The Fund intends to invest in D-rated debt only in
cases where, in Keystone's judgment, there is a distinct prospect of
improvement in the issuer's financial position as a result of the completion
of reorganization or otherwise. Bonds that are rated CAA by Moody's are of
poor standing. Such issues may be in default or there may be present elements
of danger with respect to principal or interest. Bonds that are rated CA by
Moody's represent obligations that are speculative in a high degree. Such
issues are often in default or have other market shortcomings. Bonds that are
rated C by Moody's are the lowest rated class of bonds, and issues so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing.
ZERO COUPON BONDS
A zero coupon "stripped" bond represents ownership in serially maturing
interest payments or principal payments on specific underlying notes and
bonds, including coupons relating to such notes and bonds. The interest and
principal payments are direct obligations of the issuer. Coupon zero coupon
bonds of any series mature periodically from the date of issue of such series
through the maturity date of the securities related to such series. Principal
zero coupon bonds mature on the date specified therein, which is the final
maturity date of the related securities. Each zero coupon bond entitles the
holder to receive a single payment at maturity. There are no periodic interest
payments on a zero coupon bond. Zero coupon bonds are offered at discounts
from their face amounts.
In general, owners of zero coupon bonds have substantially all the rights
and privileges of owners of the underlying coupon obligations or principal
obligations. Owners of zero coupon bonds have the right upon default on the
underlying coupon obligations or principal obligations to proceed directly and
individually against the issuer and are not required to act in concert with
other holders of zero coupon bonds.
For federal income tax purposes, a purchaser of principal zero coupon bonds
or coupon zero coupon bonds (either initially or in the secondary market) is
treated as if the buyer had purchased a corporate obligation issued on the
purchase date with an original issue discount equal to the excess of the
amount payable at maturity over the purchase price. The purchaser is required
to take into income each year as ordinary income an allocable portion of such
discounts determined on a "constant yield" method. Any such income increases
the holder's tax basis for the zero coupon bond, and any gain or loss on a
sale of the zero coupon bonds relative to the holder's basis, as so adjusted,
is a capital gain or loss. If the holder owns both principal zero coupon bonds
and coupon zero coupon bonds representing interest in the same underlying
issue of securities, a special basis allocation rule (requiring the aggregate
basis to be allocated among the items sold and retained based on their
relative fair market value at the time of sale) may apply to determine the
gain or loss on a sale of any such zero coupon bonds.
PAYMENT-IN-KIND SECURITIES
Payment-in-kind securities pay interest in either cash or additional
securities, at the issuer's option, for a specified period. The issuer's
option to pay in additional securities typically ranges from one to six years,
compared to an average maturity for all PIK securities of eleven years. Call
protection and sinking fund features are comparable to those offered on
traditional debt issues.
PIKs, like zero coupon bonds, are designed to give an issuer flexibility in
managing cash flow. Several PIKs are senior debt. In other cases, where PIKs
are subordinated, most senior lenders view them as equity equivalents.
An advantage of PIKs for the issuer -- as with zero coupon securities -- is
that interest payments are automatically compounded (reinvested) at the stated
coupon rate, which is not the case with cash-paying securities. However, PIKs
are gaining popularity over zeros since interest payments in additional
securities can be monetized and are more tangible than accretion of a
discount.
As a group, PIK bonds trade flat (i.e., without accrued interest). Their
price is expected to reflect an amount representing accreted interest since
the last payment. PIKs generally trade at higher yields than comparable cash-
paying securities of the same issuer. Their premium yield is the result of the
lesser desirability of non-cash interest, the more limited audience for non-
cash paying securities, and the fact that many PIKs have been issued to equity
investors who do not normally own or hold such securities.
Calculating the true yield on a PIK security requires a discounted cash flow
analysis if the security (ex interest) is trading at a premium or a discount
because the realizable value of additional payments is equal to the current
market value of the underlying security, not par.
Regardless of whether PIK securities are senior or deeply subordinated,
issuers are highly motivated to retire them because they are usually their
most costly form of capital.
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.
Master demand notes may permit daily fluctuations in the interest rate and
daily changes in the amount borrowed. The Fund has the right to increase the
amount 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 purchased 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 are
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 the
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 note
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 or 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
creditworthy. 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 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 the Fund.
"WHEN ISSUED" AND "FORWARD COMMITMENT" TRANSACTIONS
The Fund may also purchase securities on a when issued or delayed delivery
basis and may purchase or sell securities on a forward commitment basis. When
issued and delayed delivery transactions arise when securities are purchased
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 in the Section of this Exhibit 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. However, no payment or delivery is made by the Fund 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 a 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 firm 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 for the purpose of acquiring portfolio securities or currencies
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.
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 only be made 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 use derivatives while seeking to achieve 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 Fund is permitted to use derivatives
for one or more of these purposes. 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. Keystone
is not an aggressive user of derivatives with respect to the Fund. However,
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 Associated ("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, the Fund may also invest in
CMOs with rates that move inversely to market rates ("inverse floaters").
An inverse floater bears an interst 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.
BRADY BONDS. Brady Bonds are created through the exchange of existing
commercial bank loans to foreign entities for new obligations in connection
with debt restructurings under a plan introduced by former U.S. Secretary of
the Treasury, Nicholas F. Brady (the "Brady Plan"). Brady Bonds have been
issued only recently, and, accordingly, do not have a long payment history.
They may be collateralized or uncollateralized and issued in various
currencies (although most are U.S. dollar-denominated) and they are actively
traded in the over-the-counter secondary market.
U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed-rate
par bonds or floating rate discount bonds, are generally collateralized in
full as to principal due at maturity by U.S. Treasury zero coupon obligations
that have the same maturity as the Brady Bonds. Interest payments on these
Brady Bonds generally are collateralized by cash or securities in an amount
that, in the case of fixed rate bonds, is equal to at least one year of
rolling interest payments based on the applicable interest rate at that time
and is adjusted at regular intervals thereafter. Certain Brady Bonds are
entitled to "value recovery payments" in certain circumstances, which in
effect constitute supplemental interest payments, but generally are not
collateralized. Brady Bonds are often viewed as having up to four valuation
components: (1) collateralized repayment of principal at final maturity, (2)
collateralized interest payments, (3) uncollateralized interest payments, and
(4) any uncollateralized repayment of principal at maturity (these
uncollateralized amounts constitute the "residual risk"). In the event of a
default with respect to collateralized Brady Bonds as a result of which the
payment obligations of the issuer are accelerated, the U.S. Treasury zero
coupon obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments that would have then been due on the Brady Bonds in the
normal course. In addition, in light of the residual risk of Brady Bonds and,
among other factors, the history of defaults with respect to commercial bank
loans by public and private entities of countries issuing Brady Bonds,
investments in Brady Bonds are to be viewed as speculative.
<PAGE>
KEYSTONE
FUND FAMILY
Quality Bond Fund (B-1)
Diversified Bond Fund (B-2)
High Income Bond Fund (B-4)
Balanced Fund (K-1)
Strategic Growth Fund (K-2)
Growth and Income Fund (S-1)
Mid-Cap Growth Fund (S-3)
Small Company Growth Fund (S-4)
International Fund
Precious Metals Holdings
Tax Free Fund
Tax Exempt Trust
Liquid Trust
[LOGO] KEYSTONE
INVESTMENTS
Keystone Investment Distributors Company
200 Berkeley Street
Boston, Massachusetts 02116-5034
[recycle symbol]
B4-P 11/95
38M
KEYSTONE
Photo:
Father and son,
on park bench
HIGH INCOME
BOND FUND (B-4)
[LOGO]
PROSPECTUS AND
APPLICATION
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE HIGH INCOME BOND FUND (B-4)
NOVEMBER 30, 1995
This statement of additional information is not a prospectus, but
relates to, and should be read in conjunction with, the prospectus of Keystone
High Income Bond Fund (B-4) (formerly named Keystone Custodian Fund, Series B-4)
(the "Fund") dated November 30, 1995. A copy of the prospectus may be obtained
from Keystone Investment Distributors Company (formerly named Keystone
Distributors, Inc.) (the "Principal Underwriter"), the Fund's 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 23
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-16
#105101ea
<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 generous income. To
achieve this objective, the Fund invests primarily in corporate bonds, and its
portfolio ordinarily includes a substantial number of bonds that, as a class,
sell at discounts from par value and are rated by Standard & Poor's Corporation
("S&P") as below investment grade (BBB). While Keystone Management, Inc.
("Keystone Management") and Keystone Investment Management Company (formerly
named "Keystone Custodian Funds, Inc.") ("Keystone"), the Fund's investment
manager and adviser, respectively, perform their own credit analyses of the
Fund's investments and do not rely on ratings assigned by rating services, bonds
rated below investment grade are, on balance, considered predominantly
speculative.
On May 1, 1995, the Fund changed its name from Keystone Custodian Fund,
Series B-4 to its present name.
- --------------------------------------------------------------------------------
INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
The following restrictions are fundamental and may not 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 United States ("U.S.") government, its agencies or instrumentalities;
(2) invest more than 5% of the value of its total assets in companies
which have been in operation for less than three years;
(3) 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 (bank borrowings and reverse repurchase agreements, in
aggregate, shall not exceed 10% of the value of the Fund's net assets);
(4) 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");
(5) 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;
(6) invest for the primary purpose of exercising control over or
management of any issuer;
(7) make margin purchases or short sales of securities;
(8) make loans, except that the Fund may make, purchase or hold debt
securities and other debt investments, including loans, consistent with its
investment objective lend portfolio securities valued at not more than 15% of
its total assets to broker-dealers, and enter into repurchase agreements;
(9) 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
(10) 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.
With respect to the first investment restriction above, said restriction
applies only to 75% of the Fund's assets.
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 its net
assets.
Although not fundamental restrictions or policies requiring a
shareholders' vote to change, the Fund has undertaken to a securities authority
of a foreign country that, so long as the shares of the Fund are registered for
sale in that country (1) the Fund will not invest in the securities of other
investment companies, including unit investment trusts; (2) the Fund will not
invest in real estate investment trusts or limited partnerships whose purpose is
to acquire real estate for investment purposes only, in accordance with
principles of diversification; (3) upon payment of the purchase price, shares of
corresponding value shall be issued without undue delay in accordance with Rule
22(c)(1) of the 1940 Act; (4) the Fund will suspend the right of redemption only
in accordance with Rule 22(e) of the 1940 Act; (5) all cash and securities of
the Fund shall be received by and disbursed or delivered by or through the
Fund's custodian or transfer agent; (6) amounts borrowed from the Fund's
custodian bank for extraordinary or emergency purposes pursuant to the third
fundamental investment restriction enumerated above shall not exceed 10% of the
Fund's net asset value; (7) the Fund will maintain its present election under
Rule 18(f) of the 1940 Act to redeem in kind only in accordance with the
provisions of such Rule; and (8) assets of the Fund may not be pledged or
otherwise encumbered nor be transferred or assigned for the purpose of securing
a debt except in the course of portfolio trading.
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.
In order to permit the sale of Fund shares in certain states or foreign
countries, 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 or country involved.
If a percentage limit is satisfied at the time of investment or
borrowing, a later increase or decrease resulting from a change in asset value
of a security or a decrease in Fund assets is not a violation of the limit.
- --------------------------------------------------------------------------------
VALUATION OF SECURITIES
- --------------------------------------------------------------------------------
Current values for the Fund's portfolio securities are determined in
the following manner:
(1) Securities traded on an established exchange are valued on the
basis of the last sales price on the exchange where 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.
(2) Short-term 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. In any case, such valuation reflects fair
value as determined by the Board of Trustees.
(3) Short-term money market instruments having maturities of 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. In any case, such valuation reflects fair
value as determined by the Board of Trustees.
(4) The following securities are valued at prices deemed in good faith
to be fair under procedures established by the Board of Trustees: (a)
securities, including restricted securities, for which complete quotations are
not readily available, and (b) 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 fair value determined
under the procedures that have been approved by the Board of Trustees. The 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 the 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 makes distributions in shares of the Fund or, at
the option of the shareholder, in cash. Distributions are taxable whether paid
in cash or in shares. All shareholders may reinvest dividends and distributions
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.
The Fund will make distributions from its net investment income on or
about the 5th day of each month and net capital gains, if any, at least
annually.
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 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 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. Such dividends and distributions may also be subject to state and
local taxes.
When the Fund makes a distribution, it intends to distribute only its
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 income
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 the Principal Underwriter. For the year ended July 31, 1995, the Fund
recovered $43,777 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; (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 contingent deferred sales
charge is imposed 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 1995 and on a given date in 1996 the value of
the investor's account has grown through investment performance and reinvestment
of distributions to $12,000. On such date in 1996, 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 proceeds (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
payment of commissions or 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
Investments, Inc. (formerly named "Keystone Group, Inc.") ("Keystone
Investments"), Harbor Capital Management Company, Inc., their subsidiaries and
the Principal Underwriter 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
Fund shares 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 fund in the Keystone Investments Family of Funds (as
hereinafter defined), 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 (as hereinafter defined)
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.
The Fund's prospectus enumerates certain additional deferred sales
charge waivers.
- --------------------------------------------------------------------------------
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 pursuant to
Rule 12b-1 (the "Distribution Plan").
The Fund's Distribution Plan provides that the Fund may expend up to
0.3125% quarterly (approximately 1.25% annually) of the 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 charges paid by
shareholders to the Principal Underwriter).
Payments under the Distribution Plan are currently made to the
Principal Underwriter (which may reallow all or part to others, such as dealers)
(1) as commissions for Fund shares sold; and (2) as shareholder service fees in
respect of shares maintained by the recipients outstanding on the Fund's books
for specific periods. Amounts paid or accrued to the Principal Underwriter under
(1) and (2) in the aggregate may not exceed the annual limitation referred to
above. The Principal Underwriter generally reallows to brokers or others a
commission equal to 4% of the price paid for each Fund share sold 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 recipients on the books of the Fund for specified
periods.
If the Fund is unable to pay the Principal Underwriter a commission on
a new sale because the annual maximum (0.75% of average daily net assets) has
been reached, the Principal Underwriter 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
the Principal Underwriter such amounts that exceed the Distribution Plan
limitation, the Principal Underwriter intends to seek full payment of such
amounts from the Fund (together with interest at the rate of prime plus 1%) at
such time in the future as, and to the extent that, payment thereof by the Fund
would be within permitted limits. The Principal Underwriter currently intends to
seek payment of interest only on such charges paid or accrued by the Principal
Underwriter 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, the
Principal Underwriter 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 Rule 12b-1 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 Fund's 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.
During the fiscal year ended July 31, 1995, the Fund paid the Principal
Underwriter $7,116,706 under the Distribution Plan, of which amount the
Principal Underwriter received $3,259,369 after payment of commissions and
service fees to others of $3,857,337.
Whether any expenditure under the Distribution 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 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
- --------------------------------------------------------------------------------
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 of Trust Agreement"). The Restatement of Trust Agreement
restructured the Fund so that its operation would be substantially similar to
that of most other mutual funds. The Restatement of Trust Agreement 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 of Trust
Agreement 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 of Trust Agreement.
DESCRIPTION OF SHARES
The Restatement of Trust Agreement authorizes the issuance of an
unlimited number of shares of beneficial interest and the creation of additional
series and/or classes of series of shares of the Fund. 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 a
Pennsylvania common law trust could possibly be held 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 of Trust Agreement (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 of Trust Agreement, the Fund does
not hold annual meetings. 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 of Trust Agreement 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 or
unless and 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 of Trust Agreement 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 of Trust Agreement 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 funds in the Keystone Fund Family and to
certain other funds in the Keystone Investments Family of Funds.
Except as otherwise noted below, pursuant to an Investment Management
Agreement with the Fund dated August 19, 1993 ("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 under the Management
Agreement 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 provision 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
another 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; and (3) providing services to the Fund's
shareholders in connection with federal and state taxation and distributions of
income and capital gains.
The Fund pays Keystone Management a fee for its services at the annual
rate of:
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 on each business day and paid daily.
The Fund is subject to certain annual state 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 fees, 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 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 the Management Agreement, 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 with Keystone dated August 19, 1993 ("Advisory Agreement") 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 Investments, 200 Berkeley
Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation predominantly owned by current
and former members of management of Keystone and its affiliates. The shares of
Keystone Investments 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, Edward F. Godfrey and Ralph J. Spuehler, Jr. Keystone Investments
provides accounting, bookkeeping, legal, personnel and general corporate
services to Keystone Management, Keystone, their affiliates and the Keystone
Investments Family of 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 the Advisory Agreement and subject to the supervision of
the Fund's Board of Trustees, Keystone 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 objective and restrictions. The Advisory
Agreement stipulates that Keystone shall provide office space, all necessary
office facilities, equipment and personnel in connection with its services under
the Advisory Agreement and pay or reimburse the Fund for the compensation of
officers and trustees of the Fund 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 July 31, 1993, the Fund paid or accrued to
Keystone Management for investment management and administrative services fees
of $4,857,419, which represented 0.56% of the Fund's average net assets. Of such
amount paid to Keystone Management, $4,128,806 was paid to Keystone for its
services to the Fund.
During the fiscal year ended July 31, 1994, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$4,829,247 which represented 0.52% of the Fund's average net assets. Of such
amount paid to Keystone Management, $4,104,859 was paid to Keystone for its
services to the Fund.
During the fiscal year ended July 31, 1995, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$4,040,007, which represented 0.57% of the Fund's average net assets. Of such
amount paid to Keystone Management, $3,434,006 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, Chief Executive Officer and Trustee of the
Fund; Chairman of the Board, President, Director and Chief Executive
Officer of Keystone Investments; President, Chief Executive Officer and
Trustee or Director of all 30 funds in the Keystone Investments Family
of Funds; Director and Chairman of the Board, Chief Executive Officer
and Vice Chairman of Keystone; Chairman of the Board and Director of
Keystone Institutional Company, Inc. ("Keystone Institutional")
(formerly named Keystone Investment Management Corporation), 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
Keystone Asset Corporation, Keystone Capital Corporation, and Keystone
Trust Company; Director of the Principal Underwriter, KIRC, and
Fiduciary Investment Company, Inc. ("FICO"); Director of Boston
Children's Services Association; Trustee of Anatolia College, Middlesex
School, and Middlebury College; Member, Board of Governors, New England
Medical Center; former Director and President of Hartwell Keystone
Advisers, Inc. ("Hartwell Keystone"); former Director and Vice
President of Robert Van Partners, Inc.; and former Trustee of Neworld
Bank.
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other Keystone
Investments 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 Investments 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 Investments; Chairman of the Board and Trustee or Director of
all other Keystone Investments Funds; former 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 Investments; and former Chief Executive Officer of
the Fund.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other
Keystone Investments 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 Investments 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 Investments 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
Investments 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 Investments
and Keystone.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other
Keystone Investments 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 Investments 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
Investments 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
Investments Funds; Partner, Farrell, Fritz, Caemmerer, Cleary, Barnosky
& Armentano, P.C.; former President, Nassau County Bar Association; and
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 Investments Funds; Director, Senior Vice President,
Chief Financial Officer and Treasurer of Keystone Investments, the
Principal Underwriter, Keystone Asset Corporation, Keystone Capital
Corporation, Keystone Trust Company; Treasurer of Keystone
Institutional, and FICO; Treasurer and Director of Keystone Management,
and Keystone Software; Vice President and Treasurer of KFIA; and
Director of KIRC; former Treasurer and Director of Hartwell Keystone;
former Treasurer of Robert Van Partners, Inc.
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice President of all
other Keystone Investments Funds; and President of Keystone.
KEVIN J. MORRISSEY: Treasurer of the Fund; Treasurer of all other Keystone
Investments Funds; Vice President of Keystone Investments; Assistant
Treasurer of FICO and Keystone; and former Vice President and Treasurer
of KIRC.
DONALD M. KELLER: Vice President of the Fund; Vice President of KFIA; and Senior
Vice President of Keystone.
GILMAN C. GUNN, III: Vice President of the Fund; Vice President of certain other
Keystone Investments Funds; and Senior Vice President of Keystone.
RICHARD M. CRYAN: Vice President of the Fund; Vice President of a certain other
Keystone Investment Fund; Vice President of KFIA; and Senior Vice
President of Keystone.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the Fund; Senior
Vice President and Secretary of all other Keystone Investments Funds;
Senior Vice President, General Counsel and Secretary of Keystone;
Senior Vice President, General Counsel, Secretary and Director of the
Principal Underwriter, Keystone Management and Keystone Software;
Senior Vice President and General Counsel of Keystone Institutional;
Senior Vice President, General Counsel and Director of FICO and KIRC;
Vice President and Secretary of KFIA; Senior Vice President, General
Counsel and Secretary of Keystone Investments, Keystone Asset
Corporation, Keystone Capital Corporation and Keystone Trust Company;
former Senior Vice President and Secretary of Hartwell Keystone, and
Robert Van Partners, Inc.
* 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 Investments and several of
its affiliates including Keystone, the Keystone Management, the Principal
Underwriter, and KIRC. Mr. Elfner and Mr. Bissell both own shares of Keystone
Investments. Mr. Elfner is Chairman of the Board, Chief Executive Officer and
Director of Keystone Investments. Mr. Bissell is a Director of Keystone
Investments.
For the fiscal year ended July 31, 1995, none of the Trustees and
officers of Keystone received any direct remuneration from the Fund. For the
fiscal year ended July 31, 1995, the nonaffiliated Trustees of the Fund received
$36,136 in retainers and fees from the Fund. For the year ended December 31,
1994, aggregate compensation received by the Independent Trustees on a complex
wide basis was $585,990. As of October 31, 1995, the Trustees and officers of
Keystone beneficially owned less than 1% of the Fund's then outstanding shares.
The address of all Trustees and officers of the Fund and the address of
the Fund is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
- --------------------------------------------------------------------------------
PRINCIPAL UNDERWRITER
- --------------------------------------------------------------------------------
Pursuant to a Principal Underwriting Agreement by and between the Fund
and the Principal Underwriter (the "Underwriting Agreement"), the Principal
Underwriter acts as the Fund's principal underwriter. The Principal Underwriter,
located at 200 Berkeley Street, Boston, Massachusetts 02116-5034, is a
wholly-owned subsidiary of Keystone. The Principal Underwriter, as agent, has
agreed to use its best efforts to find purchasers for the Fund's shares. The
Principal Underwriter 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 the Principal Underwriter will bear the expense of
preparing, printing and distributing advertising and sales literature and
prospectuses used by it. In its capacity as principal underwriter, the Principal
Underwriter 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 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 the Principal Underwriter's judgment it could
benefit the sales of Fund shares, the Principal Underwriter 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 year ended July 31, 1995, the Fund paid the Principal
Underwriter $7,116,706 under the Distribution Plan, of which amount the
Principal Underwriter received $3,259,369 after payments of commissions on new
sales and service fees to dealers and others of $3,857,337. During the year, the
Principal Underwriter also received $771,318 in contingent deferred sales
charges.
- --------------------------------------------------------------------------------
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. Such
considerations are judgmental and are weighed by management 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
which is fair and equitable to the Fund.
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 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 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 July 31, 1993, 1994 and 1995 the Fund paid
no brokerage commissions.
In no instance are portfolio securities purchased from or sold to
Keystone Management, Keystone, the Principal Underwriter or any of their
affiliated persons, as defined in the 1940 Act and rules and regulations issued
thereunder.
- --------------------------------------------------------------------------------
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 that 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 five and ten year
periods ending July 31, 1995 were 61.11% and 95.66%, respectively. The
compounded average rates of return for the one, five and ten year periods ended
July 31, 1995 were 2.83%, 10.01% and 6.94%, 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 July 31, 1995 was 7.45%.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is custodian of all securities and cash of the Fund (the
"Custodian"). The Custodian may hold securities of some foreign issuers outside
the U.S. 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, 99 High Street, Boston, Massachusetts 02110,
Certified Public Accountants, are the Fund's independent auditors.
KIRC, 101 Main Street, Cambridge, MA 02142-1519, is a wholly-owned
subsidiary of Keystone and serves as transfer agent and dividend disbursing
agent for the Fund.
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.
On October 31, 1995, Merrill Lynch, Pierce, Fenner & Smith, Attn: Book
Entry, 4800 Deer Lake Drive E 3rd Floor, Jacksonville, FL 32246-6484 owned of
record 8.786% of the Fund's shares.
<PAGE>
- --------------------------------------------------------------------------------
APPENDIX
- --------------------------------------------------------------------------------
CORPORATE BOND RATINGS
A. S&P CORPORATE BOND RATINGS
A S&P corporate bond rating is a current assessment of the creditworthiness
of an obligor, including obligors outside the U.S., 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 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 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.
6. CI - The rating CI is reserved for income bonds on which no interest is
being paid.
7. D - Debt rated D is in default, and payment of interest and/or repayment
of principal is in arrears.
B. MOODY'S CORPORATE BOND RATINGS
Moody's ratings are as follows:
1. Aaa - Bonds which 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 which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
3. A - Bonds which 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 which suggest a susceptibility to impairment sometime in the future.
4. Baa - Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
5. Ba - Bonds which 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 which 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.
7. Caa - Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
8. Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other market
shortcomings.
9. C - Bonds which are rated as C are the lowest rated class of bonds and
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 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.
ZERO COUPON "STRIPPED" BONDS
A zero coupon "stripped" bond represents ownership in serially maturing
interest payments or principal payments on specific underlying notes and bonds,
including coupons relating to such notes and bonds. The interest and principal
payments are direct obligations of the issuer. Coupon zero coupon bonds of any
series mature periodically from the date of issue of such series through the
maturity date of the securities related to such series. Principal zero coupon
bonds mature on the date specified therein, which is the final maturity date of
the related securities. Each zero coupon bond entitles the holder to receive a
single payment at maturity. There are no periodic interest payments on a zero
coupon bond. Zero coupon bonds are offered at discounts from their face amounts.
In general, owners of zero coupon bonds have substantially all the rights and
privileges of owners of the underlying coupon obligations or principal
obligations. Owners of zero coupon bonds have the right upon default on the
underlying coupon obligations or principal obligations to proceed directly and
individually against the issuer and are not required to act in concert with
other holders of zero coupon bonds.
For federal income tax purposes, a purchaser of principal zero coupon bonds
or coupon zero coupon bonds (either initially or in the secondary market) is
treated as if the buyer had purchased a corporate obligation issued on the
purchase date with an original issue discount equal to the excess of the amount
payable at maturity over the purchase price. The purchaser is required to take
into income each year as ordinary income an allocable portion of such discounts
determined on a "constant yield" method. Any such income increases the holder's
tax basis for the zero coupon bond, and any gain or loss on a sale of the zero
coupon bonds relative to the holder's basis, as so adjusted, is a capital gain
or loss. If the holder owns both principal zero coupon bonds and coupon zero
coupon bonds representing interest in the same underlying issue of securities, a
special basis allocation rule (requiring the aggregate basis to be allocated
among the items sold and retained based on their relative fair market values at
the time of sale) may apply to determine the gain orloss on a sale of any such
zero coupon bonds items.
PAYMENT-IN-KIND SECURITIES
Payment-in-kind ("PIK") securities pay interest in either cash or additional
securities, at the issuer's option, for a specified period. The issuer's option
to pay in additional securities typically ranges from one to six years, compared
to an average maturity for all PIK securities of eleven years. Call protection
and sinking fund features are comparable to those offered on traditional debt
issues.
PIKs, like zero coupon bonds, are designated to give an issuer flexibility in
managing cash flow. Several PIKs are senior debt. In other cases, where PIKs are
subordinated, most senior lenders view them as equity equivalents.
An advantage of PIKs for the issuer - as with zero coupon securities - is
that interest payments are automatically compounded (reinvested) at the stated
coupon rate, which is not the case with cash-paying securities. However, PIKs
are gaining popularity over zeros since interest payments in additional
securities can be monetized and are more tangible than accretion of a discount.
As a group, PIK bonds trade flat (i.e., without accrued interest). Their
price is expected to reflect an amount representing accreted interest since the
last payment. PIKs generally trade at higher yields than comparable cash-paying
securities of the same issuer. Their premium yield is the result of the lesser
desirability of non-cash interest, the more limited audience for non-cash paying
securities, and the fact that many PIKs have been issued to equity investors who
do not normally own or hold such securities.
Calculating the true yield on a PIK security requires a discounted cash flow
analysis if the security (ex interest) is trading at a premium or a discount,
because the realizable value of additional payments is equal to the current
market value of the underlying security, not par.
Regardless of whether PIK securities are senior or deeply subordinated,
issuers are highly motivated to retire them because they are usually their most
costly form of capital. Sixty-eight percent of the PIK debentures issued prior
to 1987 have already been redeemed, and approximately 35% of the over $10
billion PIK debentures issued through year-end 1988 have been retired.
EQUIPMENT TRUST CERTIFICATES
Equipment Trust Certificates are a mechanism for financing the purchase of
transportation equipment, such as railroad cars and locomotives, trucks,
airplanes and oil tankers.
Under an equipment trust certificate, the equipment is used as the security
for the debt and title to the equipment is vested in a trustee. The trustee
leases the equipment to the user, i.e., the railroad, airline, trucking or oil
company. At the same time equipment trust certificates in an aggregate amount
equal to a certain percentage of the equipment's purchase price are sold to
lenders. The trustee pays the proceeds from the sale of certificates to the
manufacturer. In addition, the company using the equipment makes an initial
payment of rent equal to their balance of the purchase price to the trustee,
which the trustee then pays to the manufacturer. The trustee collects lease
payments from the company and uses the payments to pay interest and principal on
the certificates. At maturity, the certificates are redeemed and paid, the
equipment is sold to the company and the lease is terminated.
Generally, these certificates are regarded as obligations of the company that
is leasing the equipment and are shown as liabilities on its balance sheet.
However, the company does not own the equipment until all the certificates are
redeemed and paid. In the event the company defaults under its lease, the
trustee terminates the lease. If another lessee is available, the trustee leases
the equipment to another user and makes payments on the certificates from new
lease rentals.
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.
MOODY'S PREFERRED STOCK RATINGS
Preferred stock ratings and their definitions are as follows:
1. aaa: An issue which 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 which 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 which 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 which 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 which 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.
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 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.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated A-1 by
S&P, PRIME-1 by Moody's or F-1 by Fitch Investors Service, Inc. (Fitch). 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.
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 which 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 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 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 DEPOSITS
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 which 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.
The Fund will not acquire time deposits or obligations issued by the
International Bank for Reconstruction and Development, the Asian Development
Bank or the Inter-American Development Bank. Additionally, the Fund does not
currently intend to purchase such foreign securities (except to the extent that
certificates of deposit of foreign branches of U.S. banks may be deemed foreign
securities) or purchase certificates of deposit, bankers' acceptances or other
similar obligations issued by foreign banks.
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
WRITING COVERED OPTIONS
The Fund writes only covered options. Options written by the Fund will
normally have expiration dates of not more than nine months from the date
written. The exercise price of the options may be below, equal to, or above the
current market values of the underlying securities at the times the options are
written.
Unless the option has been exercised, the Fund may close out an option it has
written by effecting a closing purchase transaction, whereby it purchases an
option covering the same underlying security and having the same exercise price
and expiration date ("of the same series") as the one it has written. If the
Fund desires to sell a particular security on which it has written a call
option, it will effect a closing purchase transaction prior to or concurrently
with the sale of the security. If the Fund is able to enter into a closing
purchase transaction, the Fund will realize a profit (or loss) from such
transaction if the cost of such transaction is less (or more) than the premium
received from the writing of the option.
An option position may be closed out only in a secondary market for an option
of the same series. 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.
Because the Fund intends to qualify as a regulated investment company under
the Internal Revenue Code, the extent to which the Fund may write covered call
options and enter into so-called "straddle" transactions involving put and call
options may be limited.
Many options are traded on registered securities exchanges. Options traded on
such exchanges are issued by the Options Clearing Corporation (OCC), a clearing
corporation which assumes responsibility for the completion of options
transactions.
PURCHASING PUT AND CALL OPTIONS
The Fund can close out a put or call option it has written by effecting a
closing purchase transaction; for example, the Fund may close out a put or call
option it has written by buying an option identical to the one it has written.
If, however, a secondary market does not exist at a time the Fund wishes to
effect a closing sale transaction, the Fund will have to exercise the option to
realize any profit. If a covered call option writer cannot effect a closing
transaction, it cannot sell the underlying securities until the option expires
or is exercised. In addition, in a transaction in which the Fund does not own
the security underlying a put option it has purchased, the Fund would be
required, in the absence of a secondary market, to purchase the underlying
security before it could exercise the option, thereby incurring additional
transaction costs.
The Fund will not purchase a put option if, as a result of such purchase,
more than 10% of its total assets would be invested in premiums for such
options. The Fund's ability to purchase put and call options may be limited by
the Internal Revenue Code's requirements for qualification as a regulated
investment company.
OPTION WRITING AND RELATED RISKS
The Fund may write covered call and put options. A call option gives the
purchaser of the option the right to buy, and the writer the obligation to sell,
the underlying security at the exercise price during the option period.
Conversely, a put option gives the purchaser the right to sell, and the writer
the obligation to buy, the underlying security at the exercise price during the
option period.
So long as the obligation of the writer continues, the writer may be assigned
an exercise notice by the broker-dealer through whom the option was sold. The
exercise notice would require the writer to deliver, in the case of a call, or
take delivery of, in the case of a put, the underlying security against payment
of the exercise price. This obligation terminates upon expiration of the option,
or at such earlier time as the writer effects a closing purchase transaction by
purchasing an option of the same series as the one previously sold. Once an
option has been exercised, the writer may not execute a closing purchase
transaction. For options traded on national securities exchanges (Exchanges), to
secure the obligation to deliver the underlying security in the case of a call
option, the writer of the option is required to deposit in escrow the underlying
security or other assets in accordance with the rules of the OCC, an institution
created to interpose itself between buyers and sellers of options. Technically,
the OCC assumes the order side of every purchase and sale transaction on an
Exchange and by doing so, gives its guarantee to the transaction.
The principal reason for writing options on a securities portfolio is to
attempt to realize, through the receipt of premiums, a greater return than would
be realized on the underlying securities alone. In return for the premium, the
covered call option writer has given up the opportunity for profit from a price
increase in the underlying security above the exercise price so long as the
option remains open, but retains the risk of loss should the price of the
security decline. Conversely, the put option writer gains a profit, in the form
of a premium, so long as the price of the underlying security remains above the
exercise price, but assumes an obligation to purchase the underlying security
from the buyer of the put option at the exercise price, even though the price of
the security may fall below the exercise price, at any time during the option
period. If an option expires, the writer realizes a gain in the amount of the
premium. Such a gain may, in the case of a covered call option, be offset by a
decline in the market value of the underlying security during the option period.
If a call option is exercised, the writer realizes a gain or loss from the sale
of the underlying security. If a put option is exercised, the writer must
fulfill his obligation to purchase the underlying security at the exercise
price, which will usually exceed the then market value of the underlying
security. In addition, the premium paid for the put effectively increases the
cost of the underlying security, thus reducing the yield otherwise available
from such securities.
Because the Fund can write only covered options, it may at times be unable to
write additional options unless it sells a portion of its portfolio holdings to
obtain new debt securities against which it can write options. This may result
in higher portfolio turnover and correspondingly greater brokerage commissions
and other transaction costs.
To the extent that a secondary market is available the covered option writer
may close out options it has written prior to the assignment of an exercise
notice by purchasing, in a closing purchase transaction, an option of the same
series as the option previously written. If the cost of such a closing purchase,
plus transaction costs, is greater than the premium received upon writing the
original option, the writer will incur a loss on the transaction.
OPTIONS TRADING MARKETS
Options which the Fund will trade are generally listed on Exchanges.
Exchanges on which such options currently are traded are the Chicago Board
Options Exchange and the American, New York, 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 would 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 the prospectus and the statement of additional
information.
The staff of the Commission is of the view that the premiums which 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 fundamental investment restriction prohibiting it from
investing more than 10% of its total assets (taken at current value) in any
combination of illiquid assets and securities. The Fund intends to request that
the Commission staff reconsider its view. It is the intention of the Fund to
comply with the staff's current position and the outcome of such
reconsideration.
SPECIAL CONSIDERATIONS APPLICABLE TO OPTIONS
On Treasury Bonds and Notes. Because trading interest in U.S. Treasury bonds
and notes tends to center on the most recently auctioned issues, new series of
options with expirations to replace expiring options on particular issues will
not be introduced indefinitely. Instead, the expirations introduced at the
commencement of options trading on a particular issue will be allowed to run
their course, with the possible addition of a limited number of new expirations
as the original ones expire. Options trading on each series of bonds or notes
will thus be phased out as new options are listed on the more recent issues, and
a full range of expiration dates will not ordinarily be available for every
series on which options are traded.
ON TREASURY BILLS. Because the deliverable U.S. Treasury bill changes from
week to week, writers of U.S. Treasury bill call options cannot provide in
advance for their potential exercise settlement obligations by acquiring and
holding the underlying security. However, if the Fund holds a long position in
U.S. Treasury bills with a principal amount corrresponding to the option
contract size, the Fund may be hedged from a risk standpoint. In addition, the
Fund will maintain in a segregated account with its Custodian liquid assets
maturing no later than those which would be deliverable in the event of an
assignment of an exercise notice to ensure that it can meet its open option
obligations.
ON GNMA CERTIFICATES. Options on GNMA certificates are not currently traded
on any Exchange. However, the Fund may purchase and write such options in the
over-the-counter market or, should they commence trading, on any Exchange.
Since the remaining principal balance of GNMA certificates declines each
month as a result of mortgage payments, the Fund, as a writer of a covered GNMA
call holding GNMA certificates as "cover" to satisfy its delivery obligation in
the event of assignment of an exercise notice, may find that its GNMA
certificates no longer have a sufficient remaining principal balance for this
purpose. Should this occur, the Fund will enter into a closing purchase
transaction or will purchase additional GNMA certificates from the same pool (if
obtainable) or replacement GNMA certificates in the cash market in order to
remain covered.
A GNMA certificate held by the Fund to cover an option position in any but
the nearest expiration month may cease to present cover for the option in the
event of a decline in the GNMA coupon rate at which new pools are originated
under the FHA/VA loan ceiling in effect at any given time. Should this occur,
the Fund will no longer be covered, and the Fund will either enter into a
closing purchase transaction or replace the GNMA certificate with a certificate
which represents cover. When the Fund closes its position or replaces the GNMA
certificate, it may realize an unanticipated loss and incur transaction costs.
RISKS PERTAINING TO THE SECONDARY MARKET. An option position may be closed
out only in a secondary market for an option of the same series. Although the
Fund will generally purchase or 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 closing transactions in particular options, with the result that the
Fund would have to exercise its options in order to realize any profit and might
incur transaction costs in connection therewith. If the Fund as a covered call
option writer is unable to effect a closing purchase transaction in a secondary
market, it will not be able to sell the underlying security until the option
expires or it delivers the underlying security upon exercise.
Reasons for the absence of a liquid secondary market include the following:
(i) insufficient trading interest in certain options; (ii) restrictions imposed
on transactions; (iii) trading halts, suspensions or other restrictions imposed
with respect to particular classes or series of options or underlying
securities; (iv) interruption of the normal operations on an Exchange or by a
broker; (v) inadequacy of the facilities of an Exchange, the OCC or a broker
handle current trading volume; or (vi) a decision by one or more Exchanges or a
broker to discontinue the trading of options (or a particular class or series of
options), in which event the secondary market in that class or series of options
would cease to exist, although outstanding options that had been issued as a
result of trades would generally continue to be exercisable in accordance with
their terms.
The hours of trading for options on U.S. government securities may not
conform to the hours during which the underlying securities are traded. To the
extent that the option markets close before the markets for the underlying
securities, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
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 which 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.
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 which specify currencies, financial instruments or
financially based indices 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, 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. A 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
indices 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 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
initial margin. The nature of initial margin in futures transactions is
different from that of 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 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 a specified dollar amount times
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
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
futures contract. If an option is exercised 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
analagous 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 currency or other financial 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 currency or other financial 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 AND 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 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 which 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.
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 indices 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 fluctuation permitted in
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of 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 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 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 rate 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 CFTC and 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 only for
hedging purposes, and not for speculation. The Fund may enter into currency
futures contracts for other purposes if authorized to do so by the Board. The
hedging strategies which 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 and 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.
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 analagous 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.
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. 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 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 recently 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>
- ------------------------------------
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
SCHEDULE OF INVESTMENTS--July 31, 1995
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
===================================================================================================================================
<S> <C> <C> <C> <C> <C>
FIXED INCOME (84.1%)
INDUSTRIAL BONDS & NOTES (81.6%)
ADVERTISING & PUBLISHING (0.7%)
Lamar Advertising Co. Sr. Secd. Notes 11.000% 2003 $ 5,000,000 $ 5,050,000
- -----------------------------------------------------------------------------------------------------------------------------------
AEROSPACE (1.7%)
SabreLiner, Inc. Sr. Notes 12.500 2003 10,000,000 8,800,000
Transdigm, Inc. Sr. Notes (Subord.) 13.000 2000 5,000,000 4,575,000
- -----------------------------------------------------------------------------------------------------------------------------------
13,375,000
- -----------------------------------------------------------------------------------------------------------------------------------
AIR TRANSPORTATION (2.3%)
CHC Helicopter Corp. Sr. Notes (Subord.) 11.500 2002 10,500,000 9,135,000
Continental Airlines, Inc. Sr. Equip. Trust Cert. 16.000 1999 1,328,323 1,328,323
Northwest Airlines Trust #2 Aircraft Notes (Subord.) 13.875 2008 5,000,000 5,600,000
US Africa Airways (6/02/94--$3,500,000)
(b) (c) (e) (f) Sr. Secd. Notes 12.000 1999 3,500,000 1,610,000
- -----------------------------------------------------------------------------------------------------------------------------------
17,673,323
- -----------------------------------------------------------------------------------------------------------------------------------
AMUSEMENTS (3.8%)
Affinity Group, Inc. Gtd. Sr. Notes (Subord.) 11.500 2003 7,000,000 7,017,500
El Comandante Capital Corp. 1st Mtge. Notes 11.750 2003 7,500,000 7,050,000
Grand Palais Casinos, Inc. (8/15/94--
$7,750,000) (c) (f) Sr. Secd. PIK Notes 18.250 1997 7,750,000 7,750,000
Hemmeter Enterprises, Inc. (12/14/93--
$8,000,000) (c) (e) Unit (Sr. Secd .PIK Notes/Wts.) 12.000 2000 16,097,838 6,922,070
Starcraft Corp. (b) (c) (e) Notes (Subord.) 16.500 1998 6,925,000 138,500
- -----------------------------------------------------------------------------------------------------------------------------------
28,878,070
- -----------------------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE (0.1%)
Exide Corp. (h) Sr. Notes 10.000 2005 1,000,000 1,037,500
- -----------------------------------------------------------------------------------------------------------------------------------
BROADCASTING (1.0%)
Outlet Broadcast, Inc. Sr. Notes (Subord. 10.875 2003 4,000,000 4,120,000
People's Choice T.V. Corp.
(Eff. Yield 12.47%) (d) Sr. Disc. Notes 0.000 2004 8,000,000 3,800,000
- -----------------------------------------------------------------------------------------------------------------------------------
7,920,000
- -----------------------------------------------------------------------------------------------------------------------------------
BUILDING MATERIALS (4.6%)
Alpine Group, Inc. (h) Sr. Notes 12.250 2003 6,000,000 5,520,000
Associated Materials, Inc. Sr. Notes (Subord.) 11.500 2003 10,000,000 9,200,000
HMH Properties, Inc. (5/18/95-$7,706,960) (c) Sr. Secd. Notes 9.500 2005 8,000,000 7,860,000
Koppers Industries, Inc. Sr. Notes 8.500 2004 8,000,000 7,760,000
Schuller International Group, Inc. Sr. Notes 10.875 2004 4,500,000 4,916,250
- -----------------------------------------------------------------------------------------------------------------------------------
35,256,250
- -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Schedule of Investments.
<PAGE>
- -----------------------------------
SCHEDULE OF INVESTMENTS--July 31, 1995
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
===================================================================================================================================
<S> <C> <C> <C> <C> <C>
CAPITAL GOODS (1.0%)
Lanesborough Corp. (f) Sr. Secd. Notes (Subord.) 10.000% 2000 $11,026,000 $ 7,718,200
- -----------------------------------------------------------------------------------------------------------------------------------
CHEMICALS (2.5%)
Key Plastics, Inc. Sr. Notes, Series B 14.000 1999 8,500,000 8,585,000
Scotts Co. Sr. Notes (Subord.) 9.875 2004 3,000,000 3,195,000
Sherritt Gordon Ltd. Sr. Notes 9.750 2003 7,000,000 7,000,000
- -----------------------------------------------------------------------------------------------------------------------------------
18,780,000
- -----------------------------------------------------------------------------------------------------------------------------------
CONSUMER GOODS (4.7%)
Drypers Corp. Sr. Notes, Series B 12.500 2002 9,601,000 9,024,940
International Semi-Tech Electronics, Inc.
(Eff. Yield 11.96%) (d) Sr. Secd. Disc. Notes 0.000 2003 14,000,000 7,455,000
Pathmark Stores, Inc. Sr. Notes (Subord.) 9.625 2003 3,000,000 2,970,000
Revlon Worldwide Corp. (Eff. Yield 15.52%) (d) Sr. Secd. Disc. Notes 0.000 1998 10,000,000 7,125,000
Revlon Consumer Products Corp. Sr. Notes (Subord.) 10.500 2003 9,000,000 9,045,000
- -----------------------------------------------------------------------------------------------------------------------------------
35,619,940
- -----------------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED COMPANIES (0.9%)
Jordan Industries, Inc. S. Notes 10.375 2003 7,500,000 7,068,750
- -----------------------------------------------------------------------------------------------------------------------------------
FINANCE (2.0%)
American Life Holding Co. Sr. Notes (Subord.) 11.250 2004 3,770,000 3,958,500
PMI Acquisition Corp. Sr. Notes (Subord.) 10.250 2003 1,750,000 1,798,125
Premium Standard Farms (9/29/93-- $11,033,649)
(Eff. Yield 12.00%) (c) (d) Sr. Sec. Disc. Notes 0.000 2003 7,124,000 5,200,520
Sahara Finance Corp. Gtd. 1st Mtge. Notes 12.125 1996 3,953,541 4,032,612
- -----------------------------------------------------------------------------------------------------------------------------------
14,989,757
- -----------------------------------------------------------------------------------------------------------------------------------
FOODS (5.4%)
Cott Corp. Sr. Notes 9.375 2005 5,000,000 5,025,000
Iowa Select Farms (Eff. Yield 13.72%)
(2/04/94--$14,480,865) (c) (d) (f) Unit (Sr. Disc. Notes/Wts.) 0.000 2004 34,470,000 16,618,332
Iowa Select Farms (Eff. Yield 15.26%)
(8/02/94--$8,977,379) (c) (d) (f) Unit (Sr. Disc. Notes/Wts.) 0.000 2004 21,370,000 10,302,691
PM Holdings Corp. (Eff. Yield 11.62%) (d) Unit (Sr. Disc. Notes/Wts.) 0.000 2005 8,812,000 4,560,210
Specialty Foods Acquisition Corp.
(Eff. Yield 10.70%) (d) Sr. Secd. Disc. Deb. 0.000 2005 8,750,000 4,484,375
- -----------------------------------------------------------------------------------------------------------------------------------
40,990,608
- -----------------------------------------------------------------------------------------------------------------------------------
HEALTHCARE SERVICES (0.8%)
Community Health Systems, Inc. Sr. Deb. (Subord.) 10.250 2003 6,000,000 6,390,000
(continued on next page)
<PAGE>
- ------------------------------------
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
SCHEDULE OF INVESTMENTS--July 31, 1995
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
===================================================================================================================================
<S> <C> <C> <C> <C> <C>
HEALTHCARE SERVICES (continued)
Livingwell, Inc. (5/28/86--$1,972,500)(b)(c)(e) Sr. Deb. (Subord.) 14.125% 1996 $ 2,200,000 $ 44,000
Livingwell, Inc. (5/28/86--$2,153,250)(b)(c)(e) Sr. Deb. (Subord.) 13.125 2001 2,000,000 40,000
- -----------------------------------------------------------------------------------------------------------------------------------
6,474,000
- -----------------------------------------------------------------------------------------------------------------------------------
HOTELS (0.2%)
Santa Fe Hotel, Inc. Unit (1st Mtge. Notes/Wts.) 11.000 2000 1,970,000 1,753,300
- -----------------------------------------------------------------------------------------------------------------------------------
INSURANCE (2.7%)
Chartwell Re Corp. Sr. Notes 10.250 2004 5,500,000 5,252,500
Reliance Group Holdings, Inc. Sr. Deb. (Subord.) 9.750 2003 16,000,000 5,680,000
- -----------------------------------------------------------------------------------------------------------------------------------
20,932,500
- -----------------------------------------------------------------------------------------------------------------------------------
METALS & MINING (3.8%)
Algoma Steel, Inc. 1st Mtge. Notes 12.375 2005 5,500,000 5,170,000
Inland Steel Co. Unsecd. Notes 12.750 2002 10,000,000 11,175,000
NS Group, Inc. Units (Sr. Secd. Notes/Wts.) 13.500 2003 4,000,000 3,845,000
Russell Metals, Inc. Sr. Notes 10.250 2000 7,890,000 7,416,600
UCAR Global Enterprises, Inc. Sr. Secd. Notes 12.000 2005 1,000,000 1,101,250
- -----------------------------------------------------------------------------------------------------------------------------------
28,707,850
- -----------------------------------------------------------------------------------------------------------------------------------
NATURAL GAS (2.0%)
TransTexas Gas Corp. Sr. Secd. Notes 11.500 2002 14,500,000 15,080,000
- -----------------------------------------------------------------------------------------------------------------------------------
OIL (5.0%)
Chatwins Group, Inc. Sr. Notes 13.000 2003 9,500,000 7,885,000
Crown Central Petroleum Corp. Sr. Notes 10.875 2005 5,250,000 5,565,000
errity Oil & Gas Corp. Sr. Notes (Subord.) 11.750 2004 1,000,000 910,000
Kelley Oil & Gas Sr. Notes 13.500 1999 7,000,000 6,860,000
Plains Resources, Inc. Sr. Notes (Subord.) 12.000 1999 10,000,000 10,400,000
Wainoco Oil Corp. Sr. Notes 12.000 2002 6,000,000 6,240,000
- -----------------------------------------------------------------------------------------------------------------------------------
37,860,000
- -----------------------------------------------------------------------------------------------------------------------------------
OIL SERVICES (1.4%)
Dual Drilling Co. Sr. Notes (Subord.) 9.875 2004 5,550,000 5,217,000
Gulf Canada Resources Ltd. Sr. Deb. (Subord.) 9.625 2005 5,175,000 5,226,750
- -----------------------------------------------------------------------------------------------------------------------------------
10,443,750
- -----------------------------------------------------------------------------------------------------------------------------------
PAPER & PACKAGING (3.8%)
Container Corp. of America Gtd. Sr. Notes, Series B 10.750 2002 6,000,000 6,390,000
Gaylord Container Corp. (Eff. Yield 8.25%) (d) Sr. Notes 0.000 2005 8,000,000 8,100,000
Gaylord Container Corp. Sr. Notes 11.500 2001 3,000,000 3,232,500
Owens-Ilinois, Inc. Sr. Deb. 11.000 2003 2,000,000 2,205,000
Rainy River Forest Products, Inc. Sr. Secd. Notes 10.750 2001 2,750,000 2,915,000
See Notes to Schedule of Investments.
<PAGE>
- -------------------------------------
SCHEDULE OF INVESTMENTS--July 31, 1995
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
===================================================================================================================================
<S> <C> <C> <C> <C> <C>
PAPER & PACKAGING (continued)
Stone Container Corp. 1st Mtge. Notes 10.750% 2002 $ 5,990,000 $ 6,349,400
- -----------------------------------------------------------------------------------------------------------------------------------
29,191,900
- -----------------------------------------------------------------------------------------------------------------------------------
RESTAURANTS (3.6%)
Boston Chicken, Inc. (Eff. Yield 8.32%) (d) Liquid Yld. Option Notes 0.000 2015 20,000,000 4,975,000
Flagstar Corp. Sr. Notes 10.875 2002 7,200,000 6,768,000
Great American Cookie Co., Inc. Sr. Secd. Notes 10.875 2001 10,000,000 8,600,000
Pantry, Inc. Sr. Notes 12.000 2000 7,500,000 7,425,000
- -----------------------------------------------------------------------------------------------------------------------------------
27,768,000
- -----------------------------------------------------------------------------------------------------------------------------------
RETAIL (7.3%)
Big 5 Holdings, Inc. Sr. Notes (Subord.) 13.625 2002 4,800,000 4,920,000
Cole National Group, Inc. Sr. Notes 11.250 2001 5,000,000 4,875,000
Finlay Fine Jewelry Corp. Sr. Notes 10.625 2003 6,000,000 5,820,000
Hills Stores Co. Sr. Notes 10.250 2003 5,000,000 4,781,250
Pamida, Inc. Sr. Notes (Subord.) 11.750 2003 9,475,000 8,432,750
Penn Traffic Co. Sr. Notes 8.625 2003 5,000,000 4,575,000
Penn Traffic Co. Sr. Notes (Subord.) 9.625 2005 4,000,000 3,590,000
Service Merchandise Co. Sr. Deb. (Subord.) 9.000 2004 10,000,000 8,450,000
Southland Corp. 1st Priority Sr. Deb.Subord.) 5.000 2003 13,000,000 10,010,000
- -----------------------------------------------------------------------------------------------------------------------------------
55,454,000
- -----------------------------------------------------------------------------------------------------------------------------------
TECHNOLOGY (1.9%)
Ampex Corp. (Eff. Yield 9.56%) (c) (d) (f) Disc. Conv. Bonds, Series C 0.000 1997 10,273,000 14,279,470
- -----------------------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS (14.4%)
Adelphia Communications Corp. Sr. Notes 12.500 2002 12,000,000 12,360,000
American Media Operations, Inc. Sr. Notes (Subord.) 11.625 2004 7,000,000 7,455,000
Bell Cablemedia PLC (Eff. Yield 10.67%) (d) Sr. Disc. Notes 0.000 2004 5,000,000 3,325,000
Cablevision Systems Corp. Sr. Disc. Notes 9.875 2013 3,400,000 3,706,000
Cencall Communications Corp.
(Eff. Yield 13.42%) (d) Sr. Disc. Notes 0.000 2004 10,000,000 5,350,000
Continental Cablevision, Inc. Sr. Deb. 9.000 2008 5,000,000 5,150,000
Continental Cablevision, Inc. Sr. Deb. 9.500 2013 7,000,000 7,350,000
Comcast Celluar Corp. (Eff. Yield 13.42%) (d) Part. Disc. Notes 0.000 2000 18,000,000 13,230,000
Diamond Cable (Eff. Yield 11.57%) (d) Sr. Disc. Notes 0.000 2004 5,000,000 3,275,000
Marcus Cable (Eff. Yield 13.15%) (d) Sr. (Subord.) Disc. Notes 0.000 2005 6,000,000 3,420,000
Marcus Cable (Eff. Yield12.06%) (d) Sr. Disc. Notes 0.000 2004 12,000,000 8,115,000
MFS Communication (Eff. Yield 8.60%) (d) Sr. Disc. Notes 0.000 2004 10,000,000 7,200,000
Mobile Telecommunication Technology Sr. (Subord.) Disc. Notes 13.500 2002 10,000,000 10,950,000
Pagemart, Inc. (Eff. Yield 10.36%) (d) Unit (Sr. Disc. Notes/Wts.) 0.000 2003 18,050,000 11,732,500
Paging Network Inc. Sr. Notes (Subord.) 10.125 2007 2,500,000 2,550,000
Rogers Cablesystems Ltd. Sr. Secd. 2nd Priority Note 10.000 2005 1,000,000 1,047,500
(continued on next page)
<PAGE>
- ------------------------------------
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
SCHEDULE OF INVESTMENTS--July 31, 1995
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
===================================================================================================================================
<S> <C> <C> <C> <C> <C>
TELECOMMUNICATIONS (continued)
Videotron Group Ltd. Deb. (Subord.) Voting Co 10.625% 2005 $ 3,750,000 $ 3,993,750
- -----------------------------------------------------------------------------------------------------------------------------------
110,209,750
- -----------------------------------------------------------------------------------------------------------------------------------
TRANSPORTATION (3.0%)
Eletson Holdings, Inc. 1st Mtge. Notes 9.250 2003 8,000,500 7,680,480
Gearbulk Holding Ltd. Sr. Notes 11.250 2004 7,000,000 7,350,000
Viking Star Shipping, Inc. 1st Pfd. Ship. Mtge. Notes 9.625 2003 8,000,000 8,160,000
- -----------------------------------------------------------------------------------------------------------------------------------
23,190,480
- -----------------------------------------------------------------------------------------------------------------------------------
UTILITIES (1.0%)
Consolidated Hydro, Inc. (6/15/93--
$8,811,783) (Eff. Yield 12.26%) (c) (d) Sr. Disc. Notes 0.000 2003 13,400,000 7,437,000
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL INDUSTRIAL BONDS & NOTES
(Cost--$633,454,626) 623,139,398
- -----------------------------------------------------------------------------------------------------------------------------------
FOREIGN BONDS (U.S. DOLLARS) (2.5%)
Indah Kiat International Finance Co. B.V. Gtd. Secd. Notes 11.875 2002 8,000,000 8,080,000
Polsindo Eka Perkasa Sr. Notes 13.000 2004 6,000,000 6,120,000
Telefonica de Argentina S.A. Unsecd. Deb. 11.875 2004 2,775,000 2,761,125
YPF Sociedad Anonima Unsecd. Deb. 8.000 2004 3,000,000 2,610,180
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (U.S. DOLLARS) (Cost--$19,369,496) 19,571,305
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME (Cost--$652,824,122) 642,710,703
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Shares
<S> <C> <C>
===================================================================================================================================
COMMON STOCKS/RIGHTS/WARRANTS (10.8%)
Ampex Corp. (e) (f) 512 2,224
Ampex Corp., Class A (e) (f) 196,392 834,666
Ampex Corp., Class C (e) (f) 3,629,294 15,424,500
Ampex Corp., wts. (e) (f) 1,007,308 4,281,059
Chatwins Group, Inc., wts.(e) 9,500 4,750
CHC Helicopter Corp., wts.(e) 84,000 84,000
Cookies USA, Inc., wts. (e) 1,800 72,000
Dial Page, Inc., wts. (e) 9,510 19,020
Dimac Corp. (e) 55,481 880,761
EMC Corp. (e) 341,836 7,819,499
Finlay Enterprises, Inc. (e) 4,533 70,261
Grand Palais Casinos, Inc., Series A, wts. (8/15/94--$2,507) (c) (e) (f) 250,735 1,895,559
Grand Palais Casinos, Inc., Series B, wts. (8/15/94--$1,368) (c) (e) (f) 136,765 1,033,941
Grand Palais Casinos, Inc., Series C, wts. (8/15/94--$12,080) (c) (e) (f) 1,208,088 12,081
Grand Palais Casinos, Inc., Ltd. Liab. Int.(8/15/94--$0) (c) (e) (f) 931,379 9,314
Grand Palais Casinos, Inc., wts. (1/28/93--$680,643) (c) (e) (f) 680,643 5,145,661
HDA Management Corp., wts. (e) 5,500 29,150
</TABLE>
See Notes to Schedule of Investments.
<PAGE>
- -------------------------------------
SCHEDULE OF INVESTMENTS--July 31, 1995
<TABLE>
<CAPTION>
Market
Shares Value
<S> <C> <C>
===================================================================================================================================
COMMON STOCKS/RIGHTS/WARRANTS (continued)
Hemmeter Enterprises Inc., wts. (12/14/93--$140,400) (c) (e) 270,532 $ 271
Hemmeter Enterprises, Inc., wts. (12/22/93--$846,280) (c) (e) 695,643 696
Hollywood Casino Corp., Class A (e) 971,665 66,443
Lanesborough Corp. (e) (f) 15,141 151
Pagemart, Inc., wts. (e) 83,030 98,180
PM Holdings Corp. (e) 2,964 3
Purity Supreme, Inc. wts. (11/30/92-$4,330) (c) (e) 22,525 225
Sabreliner Corp., wts. (e) 10,000 10
Specialty Equipment Cos., Inc. (e) (f) 1,860,700 23,607,631
Specialty Foods Acquisition Corp. (8/10/93-$0) (c) (e) 131,250 229,688
Transdigm Inc., wts. (e) 39,894 398,940
UCC Investors Holding Inc., Class A (e) 1,178,622 11,491,563
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS/RIGHTS/WARRANTS (Cost--$23,421,865) 82,712,247
===================================================================================================================================
PREFERRED STOCK (1.4%)
Ampex Corp. (11/22/92--$23,987,332) (c) (e) (f) 24,562 11,052,911
US Africa Airways (6/02/94--$11,000,000) (b) (c) (e) (f) 11,000 0
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCK (Cost--$34,987,331) 11,052,911
===================================================================================================================================
MISCELLANEOUS INVESTMENT (0.0%)
Gold River Hotel and Casino Corp.
(Cost--$424,084) Liquidating R.E. Trust 10,775,000 107,750
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL MISCELLANEOUS INVESTMENT (Cost--$424,084) 107,750
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Interest Maturity Maturity
Rate Date Value
===================================================================================================================================
<S> <C> <C> <C> <C>
SHORT-TERM INVESTMENTS (1.8%)
REPURCHASE AGREEMENT (1.8%)
Keystone Joint Repurchase Agreement
(Investments in repurchase agreements, in a
joint trading account, purchased 7/31/95)
(Cost--$13,939,000) (g) 5.833% 08/01/95 $13,941,258 3,939,000
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS (Cost--$13,939,000) 13,939,000
===================================================================================================================================
TOTAL INVESTMENTS (Cost--$725,596,402) (a) 750,522,611
- -----------------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES--NET (1.9%) 14,442,275
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSETS (100.0%) $764,964,886
===================================================================================================================================
(continued on next page)
</TABLE>
<PAGE>
- -----------------------------------
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
Notes to Schedule of Investments:
(a) The cost of investments for federal income tax purposes amounted to
$729,582,378. Gross unrealized appreciation and depreciation of investments,
based on identified tax cost, at July 31, 1995, are as follows:
Gross unrealized appreciation $ 81,927,902
Gross unrealized depreciation $(60,987,669)
------------
Net unrealized appreciation $ 20,940,233
============
(b) Securities which have defaulted on payment of interest and/or principal. The
Fund has ceased accruing income on those so identified. At July 31, 1995,
the fair value of these securities was $1,832,500 (0.2% of the Fund's net
assets).
(c) All or a portion of these securities are restricted securities (i.e.,
securities which may not be publicly sold without registration under the
Federal Securities Act of 1933) which are valued using market quotations
where readily available. In the absence of market quotations, the securities
are valued based upon their fair value determined under procedures approved
by the Board of Trustees. The Fund may make investments in an amount up to
15% of the value of the Fund's net assets in such securities. Dates of
acquisition and costs are set forth in parentheses after the title of the
restricted securities. On the date of acquisition there were no market
quotations on similar securities and the above securities were valued at
acquisition cost. At July 31, 1995, the fair value of these restricted
securities was $97,582,930 (13% of the Fund's net assets at July 31, 1995).
The Fund will not pay the cost of disposition of the above restricted
securities other than ordinary brokerage fees, if any.
(d) Effective yield (calculated at date of purchase) is the yield at which the
bond accretes on an annual basis until maturity date.
(e) Non-income-producing security.
(f) Affiliated issuers are those in which the Fund's holdings of an issuer
represent 5% or more of the outstanding voting securities of the issuer. The
Fund has never owned enough of the outstanding voting securities of any
issuer to have control (as defined in the Investment Company Act of 1940) of
that issuer. At July 31, 1995, the fair value of these securities was
$121,578,391 (16% of the Fund's net assets).
(g) The repurchase agreements are fully collateralized by U.S. Government and/or
agency obligations based on market prices at July 31, 1995.
(h) Securities that may be resold to "qualified institutional buyers" under Rule
144A or securities offered pursuant to Section 4(2) of the Securities Act of
1933, as amended. These securities have been determined to be liquid under
guidelines established by the Board of Trustees.
See Notes to Financial Statements.
<PAGE>
- --------------------------------
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the year)
<TABLE>
<CAPTION>
Year Ended July 31,
----------------------------------------------------------------
1995 1994 1993 1992 1991
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value
beginning of year $4.68 $5.13 $4.74 $4.19 $5.02
- -----------------------------------------------------------------------------------------------
Income from investment
operations
Net investment income 0.38 0.38 0.45 0.49 0.61
Net gain (loss) on
investments and foreign
currency related
transactions (0.15) (0.38) 0.44 0.58 (0.72)
Net commissions paid on
fund share sales (a) 0 0 0 0 0
- -----------------------------------------------------------------------------------------------
Total from investment
operations 0.23 0 0.89 1.07 (0.11)
- -----------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.37) (0.38) (0.45) (0.50) (0.72)
In excess of net
investment income (0.02) (0.07) (0.05) (0.02) 0
Tax basis return of
capital (0.10) 0 0 0 0
Net realized gain
on investments 0 0 0 0 0
- -----------------------------------------------------------------------------------------------
Total distributions (0.49) (0.45) (0.50) (0.52) (0.72)
- -----------------------------------------------------------------------------------------------
Net asset value end of
year $4.42 $4.68 $5.13 $4.74 $4.19
- -----------------------------------------------------------------------------------------------
Total return (b) 5.66% (0.41%) 20.28% 27.25% 0.03%
Ratios/supplemental
data
Ratios to average
net assets:
Total expenses 2.03% 1.84% 2.06% 2.17% 2.34%
Net investment income 8.64% 7.57% 9.30% 10.86% 14.64%
Portfolio turnover rate 82% 110% 125% 94% 78%
- -----------------------------------------------------------------------------------------------
Net assets end of year
(thousands) $764,965 $766,283 $972,164 $841,757 $710,590
- -----------------------------------------------------------------------------------------------
<CAPTION>
Year Ended July 31,
----------------------------------------------------------------------
1990 1989 1988 1987 1986
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value
beginning of year $6.38 $6.91 $7.66 $8.08 $7.92
- -----------------------------------------------------------------------------------------------------
Income from investment
operations
Net investment income 0.68 0.83 0.80 0.81 0.89
Net gain (loss) on
investments and foreign
currency related
transactions (1.18) (0.51) (0.71) (0.26) 0.35
Net commissions paid on
fund share sales (a) 0 0 0 0 (0.08)
- -----------------------------------------------------------------------------------------------------
Total from investment
operations (0.50) 0.32 0.09 0.55 1.16
- -----------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.78) (0.85) (0.84) (0.90) (1.00)
In excess of net
investment income (0.08) 0 0 0 0
Tax basis return of
capital 0 0 0 0 0
Net realized gain
on investments 0 0 0 (0.07) 0
- -----------------------------------------------------------------------------------------------------
Total distributions (0.86) (0.85) (0.84) (0.97) (1.00)
- -----------------------------------------------------------------------------------------------------
Net asset value end of
year $5.02 $6.38 $6.91 $7.66 $8.08
- -----------------------------------------------------------------------------------------------------
Total return (b) (7.84%) 4.95% 1.66% 7.15% 15.27%
Ratios/supplemental
data
Ratios to average
net assets:
Total expenses 2.06% 1.97% 1.82% 1.65% 0.86%
Net investment income 12.77% 12.36% 11.29% 10.26% 10.93%
Portfolio turnover rate 45% 75% 81% 135% 87%
- -----------------------------------------------------------------------------------------------------
Net assets end of year
(thousands) $820,940 $1,188,660 $1,274,673 $1,464,891 $1,569,038
- -----------------------------------------------------------------------------------------------------
</TABLE>
(a) Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution Plan had 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 July
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) Excluding applicable sales charges.
See Notes to Financial Statements.
<PAGE>
- -----------------------------------
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
STATEMENT OF ASSETS AND LIABILITIES
July 31, 1995
===================================================================
Assets: (Note 1):
Investments at market value:
Unaffiliated issuers (identified cost--
$615,784,470) $ 628,944,220
Affiliated issuers (identified
cost--$109,811,932) 121,578,391
- -------------------------------------------------------------------
Total investments 750,522,611
- -------------------------------------------------------------------
Cash 464
Receivable for:
Investments sold 5,703,655
Fund shares sold 615,775
Interest 12,376,289
Prepaid expenses 114,771
Other assets 2,730,610
- -------------------------------------------------------------------
Total assets 772,064,175
- -------------------------------------------------------------------
Liabilities (Notes 2, 4 and 5):
Payable for:
Investments purchased 2,835,296
Fund shares redeemed 1,484,812
Distributions to shareholders 2,427,260
Due to related parties 64,597
Other accrued expenses 287,324
- -------------------------------------------------------------------
Total liabilities 7,099,289
- -------------------------------------------------------------------
Net assets $ 764,964,886
===================================================================
Net assets represented by (Note 1):
Paid-in capital $1,267,014,064
Accumulated distributions in excess of net
investment income (5,828,773)
Accumulated net realized gain (loss) on
investments
and foreign currency related transactions (521,146,614)
Net unrealized appreciation (depreciation) on
investments 24,926,209
- -------------------------------------------------------------------
Total net assets applicable to outstanding
shares of beneficial interest ($4.42 a share on
173,052,313 shares outstanding) $ 764,964,886
===================================================================
STATEMENT OF OPERATIONS
Year Ended July 31, 1995
===================================================================
Investment income (Note 1):
Interest:
Unaffiliated issuers (net of
withholding taxes of $40,615) $ 71,311,621
Affiliated issuers 4,336,292
- ---------------------------------------------------------------------
Total income 75,647,913
- ---------------------------------------------------------------------
Expenses (Notes 2 and 4):
Management fee $ 4,040,007
Transfer agent fees 2,189,924
Accounting, auditing and legal 675,522
Custodian fees 255,265
Printing 29,440
Trustees' fees and expenses 36,136
Distribution Plan expenses 7,072,929
Registration fees 80,171
Miscellaneous 35,167
- ---------------------------------------------------------------------
Total expenses 14,414,561
- ---------------------------------------------------------------------
Net investment income 61,233,352
- ---------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments and foreign currency
related transactions (Notes 1 and 3):
Net realized gain (loss) on:
Investments (88,173,005)
Foreign currency related
transactions (3,645,039)
- ---------------------------------------------------------------------
Net realized gain (loss) on
investments and foreign currency
related transactions (91,818,044)
- ---------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on investments 71,736,709
- ---------------------------------------------------------------------
Net gain (loss) on investments and
foreign currency related
transactions (20,081,335)
- ---------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations $ 41,152,017
=====================================================================
See Notes to Financial Statements.
<PAGE>
- -----------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended July 31,
------------------------------
1995 1994
===============================================================================================================
<S> <C> <C>
Operations: (Note 1):
Net investment income $ 61,233,352 $ 70,189,475
Net realized gain (loss) on investments and foreign currency related
transactions (91,818,044) (62,808,562)
Net change in unrealized appreciation (depreciation) on investments 71,736,709 2,197,734
- ---------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting from operations 41,152,017 9,578,647
- ---------------------------------------------------------------------------------------------------------------
Distributions to shareholders from (Notes 1 and 5):
Net investment income (60,319,059) (70,189,475)
In excess of net investment income (3,043,529) (13,314,817)
Tax basis return of capital (17,099,886) 0
- ---------------------------------------------------------------------------------------------------------------
Total distributions to shareholder (80,462,474) (83,504,292)
- ---------------------------------------------------------------------------------------------------------------
Capital share transactions (Note 2):
Proceeds from shares sold 233,171,940 407,409,983
Payments for shares redeemed (240,425,711) (587,387,928)
Net asset value of shares issued in reinvestment of dividends and
distributions 45,245,958 48,023,003
- ---------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting from capital share
transactions 37,992,187 (131,954,942)
- ---------------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets (1,318,270) (205,880,587)
- ---------------------------------------------------------------------------------------------------------------
Net assets:
Beginning of year 766,283,156 972,163,743
- ---------------------------------------------------------------------------------------------------------------
End of year [including accumulated distributions in excess of net investment
income as follows: 1995--($5,828,773)
and 1994--($3,533,049)] (Note 1) $ 764,964,886 $ 766,283,156
===============================================================================================================
</TABLE>
See Notes to Financial Statements.
<PAGE>
- -----------------------------------
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone High Income Bond Fund (B-4) (formerly Keystone Custodian Fund, Series
B-4), (the "Fund") is a common law trust for which Keystone Management, Inc.
("KMI") is the Investment Manager and Keystone Investment Management Company
(formerly 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 Investments Inc.
(fomerly Keystone Group, Inc.) ("KII"), a Delaware corporation. KII is
privately owned by an investor group consisting of members 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.
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 deems in
good faith 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. Short-term 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.
The Fund enters into currency and other financial futures contracts as a
hedge against changes in interest or currency 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 which remain open at fiscal year-end
<PAGE>
- ---------------------------------
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.
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 respective 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 no later than one business day
after 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. All discounts are amortized for both
financial reporting and federal income tax purposes. Distributions to
shareholders are recorded at the close of business on the record 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 any excise tax liability by making the required distributions under the
Internal Revenue Code.
D. 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 the 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.
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.
E. The Fund may enter into forward foreign currency exchange contracts
("contracts") to settle portfolio purchases and sales of securities denominated
in a foreign currency and 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
<PAGE>
- -----------------------------------
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
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. The Fund distributes net investment income monthly and net capital gains, if
any, annually. Distributions are determined in accordance with income tax
regulations. The significant differences between financial statement amounts
available for distribution and distributions made in accordance with income tax
regulations are primarily due to the different treatment of 12b-1 expenses prior
to April 1995 and the deferral of losses for income tax purposes.
(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
1995 1994
- -------------------------------------------------------
Shares sold 53,793,683 79,109,683
Shares redeemed (55,102,608) (114,282,869)
Shares issued in
reinvestment of
dividends and
distributions 10,479,964 9,447,901
- -------------------------------------------------------
Net increase
(decrease) 9,171,039 (25,725,285)
=======================================================
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 Investment Distributors
Company (formerly Keystone Distributors, Inc.) ("KIDC"), 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 above, 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 above, KIDC
generally pays dealers or others a commission equal to 4.00% 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 brokers
or others and remaining outstanding 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 year (approximately 1.25% annually) occuring 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 will limit the aggregate amount which the Fund may pay
for such distribution costs to 6.25% of
<PAGE>
- ---------------------------------------
gross share sales since the inception of the Fund's 12b-1 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 which 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 one percent) at
such 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 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 KIDC rather than to the Fund.
During the year ended July 31, 1995, the Fund paid KIDC $7,116,706 under its
Distribution Plan. The amount paid by the Fund under its Distribution Plan, net
of deferred sales charges, was $7,072,929 (0.99% of the Fund's average daily net
asset value). During the year ended July 31, 1995, KIDC received $4,444,407
after payments of commissions on new sales to dealers and others of $3,857,337.
Under the NASD Rule, the maximum uncollected amount for which KIDC may seek
payment from the Fund under its distribution Plan is $8,317,347 (1.09% of the
Fund's net assets at July 31, 1995).
(3.) Securities Transactions
Realized gains and losses are recorded on the identified cost basis. As of July
31, 1995, the Fund had a capital loss carryover for federal income tax purposes
of approximately $517,160,000 which expires as follows: 1996--$16,070,000;
1997--$43,981,000; 1998--$93,048,000; 1999--$91,149,000; 2000--$122,350,000;
2002--$44,605,000; 2003--$105,957,000). For the year ended July 31, 1995,
purchases and sales of investment securities were as follows:
Cost of Proceeds
Purchases from Sales
- ------------------------------------------------------
Portfolio securities $ 565,320,150 $ 555,960,176
Short-term
investments 4,061,739,572 4,084,334,365
- ------------------------------------------------------
$4,627,059,722 $4,640,294,541
======================================================
(4.) Investment Management and Transactions with Affiliates
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 and is based upon
both Fund net assets and gross income earned by the Fund. The fee is calculated
at a rate of 2.0% of the Fund's gross investment income plus an amount
determined by applying percentage rates, that 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 year ended July 31, 1995, the Fund paid or accrued
to KMI investment management and administrative services fees of $4,040,007
which represented 0.57% of
<PAGE>
- -----------------------------------
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
the Fund's average net assets. Of such amount paid to KMI, $3,434,006 was
paid to Keystone for its services to the Fund.
During the year ended July 31, 1995, the Fund paid or accrued to KII $28,703
for certain accounting services and to KIRC $2,189,924 for transfer agent fees.
(5.) Distributions to Shareholders
A distribution of net investment income of $0.035 per share was declared payable
on September 7, 1995 to shareholders of record August 25, 1995. This
distribution is not reflected in the accompanying financial statements.
<PAGE>
- ----------------------------------------
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone High Income Bond Fund (B-4)
(formerly Keystone Custodian Fund, Series B-4)
We have audited the accompanying statements of assets and liabilities of
Keystone High Income Bond Fund (B-4), including the schedule of investments, as
of July 31, 1995, 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 financial highlights
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 July
31, 1995 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 High Income Bond Fund (B-4) as of July 31, 1995, 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
September 1, 1995
<PAGE>
<TABLE>
Keystone High Income Bond Fund (B-4)
Schedule of Advances to and Investments in Affiliates
(As Required by Rule 12-14 of Regulation S-X)
As of and for the Year Ended July 31, 1995
<CAPTION>
Market Value Market Value 1995
Issuer Description July 31, 1994 Additions Deletions July 31, 1995 Income
- ------ ----------- ------------- ---------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Ampex Corp Disc. Conv. Bonds $ 6,574,420 7,705,050 0 14,279,470 765,938
Ampex Corp. Common Stock 0 2,224 0 2,224 0
Ampex Corp. Common Stock, Class A 0 834,666 0 834,666 0
Ampex Corp. Common Stock, Class C 0 15,424,500 0 15,424,500 0
Ampex Corp. Preferred Stock 0 11,052,911 0 11,052,911 0
Ampex Corp. Warrants 0 4,281,059 0 4,281,059 0
Cherokee Inc. Sr. (Subord.) PIK Notes 2,293,901 0 2,293,901 0 0
Cherokee Inc. Common Stock 210,000 0 210,000 0 0
Cherokee Inc. Warrants, Series A 153 0 153 0 0
Cherokee Inc. Warrants, Series B 192 0 192 0 0
Cherokee Inc. Warrants, Series C 575 0 575 0 0
Grand Palais Casinos, Inc. Secd. PIK Notes 4,511,108 0 4,511,108 0 0
Grand Palais Casinos, Inc. Secd. PIK Notes 3,846,121 0 3,846,121 0 0
Grand Palais Casinos, Inc. Secd. PIK Notes 1,510,057 0 1,510,057 0 0
Grand Palais Casinos, Inc. Sr. PIK Notes 0 7,750,000 0 7,750,000 0
Grand Palais Casinos, Inc. Limited Liability Interest 0 9,314 0 9,314 0
Grand Palais Casinos, Inc. Warrants 11,911,253 0 6,765,592 5,145,661 0
Grand Palais Casinos, Inc. Warrants, Series A 0 1,895,559 0 1,895,559 0
Grand Palais Casinos, Inc. Warrants, Series B 0 1,033,941 0 1,033,941 0
Grand Palais Casinos, Inc. Warrants, Series C 0 12,081 0 12,081 0
Iowa Select Farms Units (Sr. Disc Notes/wts) 14,477,400 2,140,932 0 16,618,332 2,131,334
Iowa Select Farms Units (Sr. Disc Notes/wts) 0 10,302,691 0 10,302,691 1,318,892
Lanesborough Corp Sr. Secd. Notes 0 7,718,200 0 7,718,200 120,128
Lanesborough Corp Common Stock 0 151 0 151 0
SHRP Ltd. Sr. Secd. Notes 6,012,500 0 6,012,500 0 0
Specialty Equipment Cos., Inc. Common Stock 20,130,000 3,477,631 0 23,607,631 0
St. Johnsbury Trucking, Inc. Units 6,300,000 0 6,300,000 0 0
St. Johnsbury Trucking, Inc. Common Stock, Class A 430 0 430 0 0
St. Johnsbury Trucking, Inc. Common Stock, Class B 2,758 0 2,758 0 0
Sun Carriers Inc. Common Stock 1,780 0 1,780 0 0
U.S. Africa Airways Sr. Secd. Notes 3,500,000 0 1,890,000 1,610,000 0
U.S. Africa Airways Preferred Stock 11,000 0 11,000 0 0
Uniroyal Chemical Acquisition
Corp. Common Stock 19,807,086 0 19,807,086 0 0
---------- ---------- ---------- ---------- ---------
Totals $101,100,734 73,640,910 53,163,253 121,578,391 4,336,292
============ ========== ========== =========== =========
</TABLE>
