<PAGE>
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PROSPECTUS DECEMBER 20, 1995
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KEYSTONE DIVERSIFIED BOND FUND (B-2)
(FORMERLY NAMED KEYSTONE CUSTODIAN FUND, SERIES B-2)
200 BERKELEY STREET, BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-343-2898
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Keystone Diversified Bond Fund (B-2) (the "Fund") is a mutual fund whose
investment objective is maximum income without undue risk of principal. The Fund
invests primarily in corporate bonds that are normally characterized by liberal
returns and moderate price fluctuations.
The Fund seeks to maximize return with respect to a portion of its assets.
Such maximum return 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 (high yield bonds). Such high
yield, high risk bonds 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.
Your purchase payment is fully invested. There is no sales charge when you buy
the Fund's shares. The Fund may, however, impose a deferred sales charge, which
declines from 4% to 1%, if you redeem your shares within four 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 December 20, 1995, which has been filed with the
Securities and Exchange Commission and is incorporated by reference into this
prospectus. For a free copy, or for other information about the Fund, write to
the address or call the telephone number listed above.
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY.
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TABLE OF CONTENTS
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Page Page
Fee Table ........................ 2 How to Buy Shares ................. 11
Financial Highlights ............ 3 Distribution Plan ................. 12
Fund Description ................. 4 How to Redeem Shares .............. 14
Investment Objective and Policies 4 Shareholder Services .............. 16
Risk Factors ..................... 5 Performance Data .................. 17
Investment Restrictions .......... 8 Fund Shares ....................... 18
Pricing Shares ................... 8 Additional Information ............ 18
Dividends and Taxes .............. 9 Additional Investment Information . (i)
Fund Management and Expenses ..... 9
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
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<PAGE>
FEE TABLE
KEYSTONE DIVERSIFIED BOND FUND (B-2)
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 ...................................... 0.53%
12b-1 Fees(4) ........................................ 1.00%
Other Expenses ....................................... 0.28%
-----
Total Fund Operating Expenses ........................ 1.81%
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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: ............................ $ 58 $ 77 $ 98 $213
You would pay the following
expenses on the same investment,
assuming no redemption: ............ $ 18 $ 57 $ 98 $213
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES; ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
- ----------
(1) The deferred sales charge declines from 4% to 1% of amounts redeemed within
four calendar years after purchase. No deferred sales charge is imposed
thereafter.
(2) There is no fee for exchange orders received by the Fund directly from an
individual shareholder over the Keystone Automated Response Line ("KARL").
(For a description of KARL, see "Shareholder Services".)
(3) Expense ratios are for the Fund's fiscal year ended August 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. ("NASD").
(5) The Securities and Exchange Commission requires use of a 5% annual return
figure for purposes of this example. Actual return for the Fund may be
greater or less than 5%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE DIVERSIFIED BOND FUND (B-2)
(For a share outstanding throughout the year)
The following table contains important financial information about the Fund
and has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors.
The table appears in the Fund's Annual Report and should be read in conjunction
with the Fund's financial statements and related notes, which also appear,
together with the auditors' report, in the Fund's Annual Report. The Fund's
financial statements, related notes, and auditors' report are included in the
statement of additional information. Additional information about the Fund's
performance is contained in its Annual Report, which will be made available upon
request and without charge.
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
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1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE .... $15.28 $17.06 $16.44 $15.37 $15.51 $17.74 $17.99 $18.91 $20.08 $18.84
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Income from investment
operations:
Net investment
income ........... 1.06 1.06 1.28 1.33 1.33 1.53 1.71 1.78 1.83 2.07
Net gain (loss) on
investments and
closed futures
contracts ........ 0.11 (1.62) 0.70 1.14 0.17 (1.94) (0.13) (0.81) (1.01) 1.38
Net commissions paid
on fund share
sales (a) ........ 0 0 0 0 0 0 0 0 0 (0.21)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total from investment
operations ....... 1.17 (0.56) 1.98 2.47 1.50 (0.41) 1.58 0.97 0.82 3.24
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Less distributions from:
Net investment
income ........... (1.06) (1.22) (1.28) (1.33) (1.63) (1.61) (1.83) (1.85) (1.85) (2.00)
In excess of net (0.22) 0 (0.08) (0.07) (0.01) (0.21) 0 0 0 0
Tax basis return of
capital .......... (0.08) 0 0 0 0 0 0 0 0 0
Net realized gain on
investments ...... 0 0 0 0 0 0 0 (0.04) (0.14) 0
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total distributions (1.36) (1.22) (1.36) (1.40) (1.64) (1.82) (1.83) (1.89) (1.99) (2.00)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
NET ASSET VALUE END
OF YEAR ........... $15.09 $15.28 $17.06 $16.44 $15.37 $15.51 $17.74 $17.99 $18.91 $20.08
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
TOTAL RETURN (b) ... 8.13% (3.53%) 12.73% 16.88% 10.58% (2.44%) 9.23% 5.61% 4.20% 18.01%
RATIOS/SUPPLEMENTAL
DATA
Ratios to average net
assets:
Total expenses ..... 1.81% 1.75% 1.89% 1.99% 1.94% 1.89% 1.84% 1.68% 1.68% 1.00%
Net investment
income ........... 7.05% 6.48% 7.73% 8.29% 8.74% 9.26% 9.52% 9.82% 9.31% 10.37%
Portfolio turnover
rate ............. 178% 200% 133% 117% 101% 43% 47% 46% 74% 69%
Net assets end of $734,837 $814,245 $1,004,393 $902,339 $814,528 $860,615 $1,000,305 $838,892 $889,333 $558,734
<FN>
(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 August 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 the net investment
income.
(b) Excluding applicable sales charges.
</TABLE>
<PAGE>
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FUND DESCRIPTION
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The Fund is an open-end, diversified management investment company, commonly
known as a mutual fund. The Fund was created under Pennsylvania law as a common
law trust and has been offering its shares continuously since September 11,
1935. The Fund is one of twenty funds managed by Keystone Management, Inc.
("Keystone Management"), the Fund's investment manager, and is one of 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."
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INVESTMENT OBJECTIVE AND POLICIES
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The Fund's investment objective is to provide shareholders with maximum income
without undue risk of principal.
There can be no assurance that the Fund will achieve its investment objective
since there is uncertainty in every investment. 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.
The Fund will invest, under normal circumstances, at least 65% of its total
assets in bonds, debentures and income obligations that are normally
characterized by liberal returns and moderate price fluctuations. Such bonds,
which include both secured and unsecured debt obligations and may be of any
assigned rating by Standard & Poor's Corporation ("S&P") or Moody's Investors
Service ("Moody's") or unrated, as a group have possessed a fairly high degree
of dependability of interest payments. While the Fund's primary objective is
income, the Fund gives careful consideration to security of principal,
marketability and diversification.
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. The Fund seeks to maximize return with respect to a portion of its
assets. Such maximum return 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 (high yield bonds). Such
high yield, high risk bonds 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.
The Fund's investments may include fixed and adjustable rate or stripped
bonds, including zero coupon bonds and payment-in-kind ("PIK") securities,
debentures, notes, equipment trust certificates, United States ("U.S.")
government securities and debt securities convertible into or exchangeable for
preferred or common stock. The Fund may invest in preferred stock, including
adjustable rate preferred stock, and warrants, which can be used to purchase or
create otherwise permissible investments. The Fund may continue to hold
preferred or common stock received in connection with convertible or
exchangeable securities and may hold common stock received in connection with
the purchase of a permitted security.
When, in the opinion of Keystone, 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 U.S. government securities; instruments, including
certificates of deposit, demand and time deposits and bankers' acceptances, of
banks that 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 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 such securities 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 may employ new investment techniques with respect to such
options.
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 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 a further explanation of the types of investments and investment
techniques available to the Fund and the associated risks, see the section of
this prospectus entitled "Additional Investment Information" and the statement
of additional information.
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RISK FACTORS
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Like any investment, your investment in the Fund involves some degree 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.
Certain significant risks unique 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 greater detail in
"Additional Investment Information" at the back of the prospectus.
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.
NON-INVESTMENT GRADE BONDS
The Fund's flexible investment policy allows the Fund to invest a portion of its
assets in high yield, high risk bonds and similar securities. The degree to
which the Fund will hold such securities will, among other things, depend upon
its adviser's economic forecast and its judgment as to the comparative values
offered by high yield, high risk securities and higher quality issues. While the
Fund currently intends to invest less than 35% of its assets in high yield, high
risk securities, over the past 10 years portfolio holdings of high yield, high
risk securities have ranged from a low of approximately 25% of total assets to a
high of approximately 60%.
The Fund invests a portion of its assets aggressively and seeks to maximize
return on such assets over time from a combination of many factors, including
high current income and capital appreciation from high yield, high risk
securities. Such aggressive investing involves risks that are greater than the
risks of investing in higher quality debt securities. These risks are discussed
in greater detail below and include risks from (1) interest rate fluctuation;
(2) changes in credit status, including weaker overall credit condition of
issuers and risks of default; (3) industry, market and economic risk; (4)
volatility of price resulting from broad and rapid changes in the value of
underlying securities; and (5) greater price variability and credit risks of
certain high yield, high risk securities such as zero coupon bonds and PIK
securities.
These risks provide the opportunity for maximizing return over time on a
portion of the Fund's assets, but may result in greater upward and downward
movement of the net asset value per share of the Fund. As a result, they should
be carefully considered by investors. The portion of the Fund's assets invested
in high yield, high risk securities may vary and may at times be substantial.
The maximum return sought by the Fund with respect to a portion of its assets
is ordinarily associated with securities in the lower rating categories of the
recognized rating agencies or with securities that are unrated. Such high yield,
high risk 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. For a description of these rating categories see "Additional
Investment Information." 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. 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 and
PIK securities.
While 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 PlKs 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 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 20.36% 0%
AA 9.07% 0%
A 9.40% 0%
BBB 11.47% 0%
BB 9.12% 0.80%
B 19.47% 1.45%
CCC 0.72% .06%
CC and below 0% 0%
Unrated* 2.31%
U.S. Governments,
equities and others 18.08%
------
TOTAL 100.00%
======
Since the Fund takes an aggressive approach to investing a portion of its
assets, 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. Keystone also considers the ratings of
Moody's and S&P assigned to various securities, but does not rely solely on
ratings assigned by Moody's and S&P 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.
Income and yields on high yield, high risk securities, as on all securities,
will fluctuate over time.
RULE 144A SECURITIES
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.
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
information on derivatives, see "Additional Investment Information."
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INVESTMENT RESTRICTIONS
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The Fund has adopted the fundamental restrictions summarized 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
restrictions are set forth in the statement of additional information.
The Fund may not do the following: (1) invest more than 5% of its total
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 up to 25% of
its total 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; and (3) invest
more than 25% of its total 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.
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PRICING SHARES
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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 currently is
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 short-term investments having maturities of more than sixty
days for which market quotations are readily available at current market value.
Where market quotations are not available, such instruments are valued at fair
value as determined by the Board of Trustees. Short-term investments that are
purchased with maturities of sixty days or less (including all master demand
notes) 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 when purchased that are held on the sixtieth day prior to
maturity are valued at amortized cost (market value on the sixtieth day adjusted
for amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market, and in any case reflects fair value as
determined by the Board of Trustees.
The Fund believes that reliable market quotations are generally not readily
available for purposes of valuing fixed income securities. As a result,
depending on the particular securities owned by the Fund, it is likely that most
of the valuations for such securities will be based upon their fair value
determined under procedures that have been approved by the 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.
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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 distributes its net investment income to shareholders 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.
Distributions are payable in additional shares of the Fund or, at the
shareholder's option (which must be exercised before the record date for the
distribution), in cash. Fund distributions in the form of additional shares are
made at net asset value without the imposition of a sales charge. 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 Fund's shares are held. 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 may also 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.
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FUND MANAGEMENT AND EXPENSES
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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 Keystone
Custodian Funds and to certain other funds in the Keystone Family of Funds.
The Fund pays Keystone Management a fee for its services at the annual rate
set forth below:
AGGREGATE
ANNUAL NET ASSET VALUE
MANAGEMENT OF THE SHARES
FEE INCOME OF THE FUND
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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 currently 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"),
located at 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 fiscal year ended August 31, 1995, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$3,982,976 which represented 0.53% of the Fund's average net assets. Of such
amount paid to Keystone Management, $3,385,529 was paid to Keystone for its
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
The Fund will pay all of its expenses. In addition to the investment advisory
and management fees discussed above, the principal expenses that 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 will pay its
brokerage commissions, interest charges and taxes. For the fiscal year ended
August 31, 1995, the Fund paid 1.81% of its average net assets in expenses.
During the fiscal year ended August 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, $26,592 for certain
accounting services and $1,674,129 for transfer agent services. KIRC is a
wholly-owned subsidiary of Keystone.
PORTFOLIO MANAGER
Christopher P. Conkey has been the Fund's portfolio manager since January,
1995. He is a Keystone Senior Vice President and has over twelve 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 August 31, 1994
and 1995 were 200% and 178%, respectively. High portfolio turnover may involve
correspondingly greater brokerage commissions and other transaction costs, which
will be borne directly by the Fund, as well as additional realized gains and/or
losses to shareholders. The Fund pays brokerage commissions in connection with
the writing of options and effecting the closing purchase or sale transactions,
as well as for certain purchases and sales of portfolio securities.
For further information about brokerage and distributions, see the statement
of additional information.
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HOW TO BUY SHARES
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You may purchase 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 Fund shares by
mailing to the Fund, c/o Keystone Investor Resource Center, Inc., 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 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 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. During
the fiscal year ended August 31, 1995, the Fund recovered $32,800 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. No deferred sales charge is payable on permitted
exchanges of shares between the Funds in the Keystone Investments Family of
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
deemed 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) 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 upon redemption of Fund shares 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 trustee for a single account. See the statement of additional
information for more details.
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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
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 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 limitations 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. In addition, the Principal
Underwriter generally reallows to brokers or others 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 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
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 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 (the
"Independent Trustees") authorize such payments, the effect would 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 August 31, 1995, the Fund recovered $32,800 in deferred
sales charges. During the year, the Fund paid the Principal Underwriter
$7,545,356 under the Distribution Plan. For the year ended August 31, 1995, the
Principal Underwriter also received $941,583 in deferred sales charges. The
amount paid by the Fund under its Distribution Plan, net of deferred sales
charges, was $7,512,556 (1.00% 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 $3,216,034. At August 31, 1995, unpaid
distribution costs amounted to $22,382,869 (3.05% of net assets as of August 31,
1995).
At each Trustee's meeting (usually quarterly), the Independent Trustees of the
Fund consider whether to authorize payments to such extent until the next
quarterly Trustees' meeting and, pursuant to such authorizations, such payments
are made. Except as described above, the Fund has no obligation to pay any
portion of this amount, and the times, conditions for payment of any remainder,
and amount, if any, to be paid by the Fund are solely within the discretion of
the Independent Trustees.
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 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.
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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., P.O. 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.
REDEMPTION OF SHARES IN GENERAL
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 as explained in this paragraph may be avoided by purchasing
shares 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 the
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. To engage in telephone
transactions generally, you must complete the appropriate sections of the Funds
application.
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 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.
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SHAREHOLDER SERVICES
- --------------------------------------------------------------------------------
Details on all shareholder services may be obtained from KIRC 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 any of the other funds in the Keystone Fund Family, 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 any of the funds
in the Keystone Fund Family, other than Keystone Precious Metals Holdings, Inc.
("KPMH"), Keystone Tax Exempt Trust ("KTET") or Keystone Tax Free Fund ("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. You
may exchange your shares for another Keystone fund for a $10 fee by calling or
writing to Keystone. The exchange fee is waived for individual investors who
make an exchange using KARL. 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 fee for any exchange.
Orders to exchange shares of the Fund for shares of Keystone Liquid Trust
("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 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 retirement 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;
and Money Purchase Pension 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 shareholder's
checking account monthly and used to purchase Fund shares.
AUTOMATIC WITHDRAWAL PLAN
Under an Automatic Withdrawal Plan, shareholders may arrange for regular
monthly or quarterly fixed withdrawal payments. Each payment must be at least
$100 and may be as much as 1% per month or 3% per quarter of the total net asset
value of the Fund shares in the shareholder's account when the Automatic
Withdrawal Plan is opened. Fixed withdrawal payments are not subject to a
deferred sales charge. Excessive withdrawals may decrease or deplete the value
of a shareholder's account.
OTHER SERVICES
Under certain circumstances shareholders may, within 30 days after a
redemption, reinstate their accounts at current net asset value.
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PERFORMANCE DATA
- --------------------------------------------------------------------------------
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.
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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 transferable, redeemable 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
("Declaration of Trust") and under the 1940 Act. As provided in the Fund's
Declaration of Trust, 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.
Under Massachusetts law, it is possible that a Fund shareholder may be held
personally liable for the Fund's obligations. However, the Fund's Declaration of
Trust provides that shareholders shall not be subject to any personal liability
for the Fund's obligations and provides indemnification from Fund assets for any
shareholder held personally liable for the Fund's obligations. Disclaimers of
such liability are included in each Fund agreement.
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ADDITIONAL INFORMATION
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KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519, is a
wholly-owned subsidiary of Keystone and serves as the Fund's transfer agent and
dividend disbursing agent.
When the Fund determines from its records that more than one account in the
Fund is registered in the name of a shareholder or shareholders having the same
address, upon written notice to those shareholders, the Fund intends, when an
annual report or semi-annual report of the Fund is required to be furnished, to
mail one copy of such report to that address.
Except as otherwise stated in this prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in this prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
<PAGE>
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ADDITIONAL INVESTMENT INFORMATION
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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 which 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 which are rated Ca by Moody's represent obligations which are speculative
in a high degree. Such issues are often in default or have other market
shortcomings. Bonds which 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 "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 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
under the note at any time up to the full amount provided by the note agreement,
or to decrease the amount. The borrower may repay up to the full amount of the
note without penalty. Notes acquired by the Fund must 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 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 may 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
limits such investments to commercial paper rated A-1 by S&P, Prime-1 by Moody's
and F-1 by Fitch Investors Service, Inc.).
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the Federal
Reserve System having at least $1 billion in assets, primary dealers in U.S.
government securities or other financial institutions believed by Keystone to be
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 will be 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, such as
U.S. government securities or other high grade debt securities, 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
which 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
consititute 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 reverse repurchase agreements are subject to the
percentage limit on borrowings imposed under the 1940 Act.
"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 the Fund is able to meet its
obligations under these contracts, for example a separate account of liquid
assets equal to the value of such purchase commitments may be maintained until
payment is made. When issued, delayed delivery and forward commitment agreements
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.
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 United States. Investments in foreign securities may also be subject to
other risks different from those affecting U.S. investments, including local
political or economic developments, expropriation or nationalization of
assets,imposition of withholding taxes on dividend or interest payments and
currency blockage (which would prevent cash from being brought back to the
U.S.). These risks are carefully considered by Keystone prior to the purchase of
these securities.
LOANS OF SECURITIES TO BROKER-DEALERS
The Fund may lend securities to brokers and dealers pursuant to agreements
requiring that the loans be continuously secured by cash or securities of the
U.S. government, its agencies or instrumentalities, or any combination of cash
and such securities, as collateral equal at all times in value to at least the
market value of the securities loaned. Such securities loans will not be made
with respect to the Fund if as a result the aggregate of all outstanding
securities loans exceeds 15% of the value of the Fund's total assets taken at
their current value. The Fund continues to receive interest or dividends on the
securities loaned and simultaneously earns interest on the investment of the
cash loan collateral in U.S. Treasury notes, certificates of deposit, other
high-grade, short-term obligations or interest bearing cash equivalents.
Although voting rights attendant to securities loaned pass to the borrower, such
loans may be called at any time and will be called so that the securities may be
voted by the Fund if, in the opinion of the Fund, a material event affecting the
investment is to occur. There may be risks of delay in receiving additional
collateral or in recovering the securities loaned or even loss of rights in the
collateral should the borrower of the securities fail financially. Loans may
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 in furtherance of 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. This 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"). 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]
B2-P 12/95
27M
KEYSTONE
Photo:
Mother and
daughter
sitting in
wagon
DIVERSIFIED
BOND FUND (B-2)
[LOGO]
PROSPECTUS AND
APPLICATION
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE DIVERSIFIED BOND FUND (B-2)
(FORMERLY NAMED KEYSTONE CUSTODIAN FUND, SERIES B-2)
DECEMBER 20, 1995
This statement of additional information is not a prospectus, but
relates to, and should be read in conjunction with, the prospectus of Keystone
Diversified Bond Fund (B-2) (formerly named Keystone Custodian Fund, Series B-2)
(the "Fund") dated December 20, 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.
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TABLE OF CONTENTS
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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
The Trust Agreement 10
Investment Manager 12
Investment Adviser 14
Trustees and Officers 16
Principal Underwriter 19
Brokerage 20
Standardized Total Return
and Yield Quotations 23
Additional Information 23
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-16
#10160648
<PAGE>
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THE FUND'S OBJECTIVE AND POLICIES
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The Fund is an open-end, diversified management investment company. The
Fund's investment objective is to provide shareholders with maximum income
without undue risk of principal. To achieve this objective, the Fund invests
primarily in bonds and obligations that are normally characterized by liberal
returns and moderate price fluctuations. Such bonds, which include both secured
and unsecured debt obligations, as a group possess a fairly high degree of
dependability of interest payments. While the Fund's primary objective is
income, the Fund gives careful consideration to security of principal,
marketability and diversification. The Fund invests primarily in securities of
domestic companies, but may also invest up to 25% of its assets in foreign
securities. On August 31, 1995, the Fund owned foreign securities equal to 6%
(denominated in US dollars) of its net assets.
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INVESTMENT RESTRICTIONS
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None of the restrictions enumerated in this paragraph may be changed
without a vote of the holders of a majority, as defined in the Investment
Company Act of 1940 (the "1940 Act"), of the Fund's outstanding shares.
The Fund will not do 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;
(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 limited 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.
If a percentage limit is satisfied at the time of investment or
borrowing, a later increase or decrease resulting from a change in the value of
a security or a decrease in Fund assets is not a violation of the limit.
The Fund has no current intention of attempting to increase its net
income by borrowing and currently intends to repay any borrowings made in
accordance with the third investment restriction enumerated above before it
makes any additional investments.
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 such securities 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 state securities
authority that, so long as the state authority requires and shares of the Fund
are registered for sale in that state, the Fund will (1) limit its purchase of
warrants to 5% of net assets, of which 2% may be warrants not listed on the New
York or American Stock Exchange; (2) not invest in real estate limited
partnership interests; and (3) not invest in oil, gas or other mineral leases.
Additional restrictions adopted by the Fund, which may be changed by
the Board of Trustees, provide that the Fund may not purchase or retain
securities of an issuer if, to the knowledge of the Fund, officers, Trustees or
Directors of the Fund, Keystone Management, Inc. ("Keystone Management") or
Keystone Investment Management Company (formerly Keystone Custodian Funds, Inc.)
("Keystone"), each owning beneficially more than 1/2 of 1% of the securities of
such issuer, own, in the aggregate, more than 5% of the securities of such
issuer, or such persons or management personnel of the Fund, Keystone Management
or Keystone have a substantial beneficial interest in the securities of such
issuer. Portfolio securities of the Fund may not be purchased from or sold or
loaned to Keystone Management, Keystone or any affiliate thereof or any of their
Directors, officers or employees.
In order to permit the sale of Fund shares in certain states, the Fund
may make commitments more restrictive than the investment restrictions described
above. Should the Fund determine that any such commitment is no longer in the
best interests of the Fund, it will revoke the commitment by terminating sales
of its shares in the state involved.
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VALUATION OF SECURITIES
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Current value for the Fund's portfolio securities is determined in the
following manner:
Securities that are traded on an established exchange are valued on the
basis of the last sales price on the exchange where the securities are primarily
traded prior to the time of the valuation. Securities traded in the
over-the-counter market, for which complete quotations are readily available,
are valued at the mean of the bid and asked prices at the time of valuation.
Short-term money market instruments that are purchased with maturities of sixty
days or less are valued at amortized cost (original purchase cost as adjusted
for amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market. Short-term money market instruments
maturing in more than sixty days for which market quotations are readily
available are valued at current market value. 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; and
in any case reflects fair value as determined by the Fund's Board of Trustees.
The Board of Trustees values the following at prices it deems in good
faith to be fair: (1) securities, including restricted securities, for which
complete quotations are not readily available; (2) listed securities, if in the
Fund's opinion the last sales price does not reflect a current market value or
if no sale occurred; and (3) other assets. While market quotations may be
readily available for certain 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 Board of Trustees, which determines valuations
for normal, institutional-size trading units of such securities using methods
based on market transactions for comparable securities and various relationships
between securities that are generally recognized by institutional traders.
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DISTRIBUTIONS AND TAXES
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The Fund ordinarily makes distributions in shares of the Fund or, at
the option of the shareholder, in cash. All shareholders may reinvest dividends
without being subject to a deferred sales charge when shares so purchased are
redeemed. Shareholders who have opted prior to the record date to receive shares
with regard to capital gains and/or income distributions will have the number of
such shares determined on the basis of the share value computed at the end of
the day on the record date after adjustment for the distribution. Net asset
value is used in computing the appropriate number of shares in both a capital
gains distribution and an income distribution reinvestment.
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 that distribution and future gains 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 70% corporate dividends received deduction. Distributed long-term
capital gains are taxable as such to the shareholder whether received in cash or
in additional Fund shares and regardless of the period of time Fund shares have
been held by the shareholder. Distributions designated by the Fund as capital
gains dividends are not eligible for the 70% corporate dividends received
deduction. If the net asset value of shares were 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. Shareholders of the
Fund will be advised annually of the federal tax status of distributions.
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SALES CHARGES
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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. During the fiscal year ended August 31, 1995, the
Fund recovered $32,800 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 Fund imposes the deferred
sales charge according to the following schedule: 4% of amounts redeemed during
the calendar year of purchase; 3% of amounts redeemed during the calendar year
after the year of purchase; 2% of amounts redeemed during the second calendar
year after the year of purchase; and 1% of amounts redeemed during the third
calendar year after the year of purchase. No deferred sales charge is imposed on
amounts redeemed thereafter.
The following example will illustrate 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 (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 contingent deferred sales
charge on 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 deemed to be the year
shares tendered for exchange were originally purchased.
Shares also may be sold, to the extent permitted by applicable law,
regulations, interpretations or exemptions, at net asset value without the
imposition of a deferred sales charge upon redemption of such 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.
No contingent deferred sales charge is imposed on a redemption of
shares of the Fund purchased by a bank or trust company in a single account in
the name of such bank or trust company as trustee if the initial investment in
shares of the Fund, any other 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.
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 591/2 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 11/2% 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.
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DISTRIBUTION PLAN
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Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear expenses of distributing their shares if they
comply with various conditions, including adoption of a Distribution Plan
containing certain provisions set forth in Rule 12b-1. The Fund bears some of
the costs of selling its shares under a Distribution Plan adopted on June 1,
1983 pursuant to Rule 12b-1 (the "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 rule 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) (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 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
repay the Principal Underwriter for such amounts in excess of Distribution Plan
limitations, the Principal Underwriter intends to seek full payment of such
charges from the Fund (together with interest 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. If under changing conditions the Principal Underwriter were to seek
payment of interest on such amounts, any such interest payments also would have
to be approved by the Independent Trustees (and possibly the shareholders).
The total amounts paid by the Fund under the foregoing arrangements may
not exceed the maximum Distribution Plan limit specified above, and the amounts
and purposes of expenditures under the Distribution Plan must be reported to the
Fund's Rule 12b-1 Trustees ("Rule 12b-1 Trustees") quarterly. The Fund's Rule
12b-1 Trustees may require or approve changes in the implementation or operation
of the Distribution Plan, and may require that total expenditures by the Fund
under the Distribution Plan be kept within limits lower than the maximum amount
permitted by the Distribution Plan as stated above. If such costs are not
limited by the Independent Trustees, such costs could, for some period of time,
be higher than such costs permitted by most other plans presently adopted by
other investment companies.
The Distribution Plan may be terminated at any time by vote of the Rule
12b-1 Trustees, or by vote of a majority of the outstanding voting securities of
the Fund. Any change in the Distribution Plan that would materially increase the
distribution expenses of the Fund provided for in the Distribution Plan requires
shareholder approval. Otherwise, the Distribution Plan may be amended by votes
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.
During the fiscal year ended August 31, 1995, the Fund paid the
Principal Underwriter $7,545,356 under the Distribution Plan. During the fiscal
year, the Principal Underwriter received $5,813,521 after payment of commissions
on new sales and service fees to dealers and others of $3,216,034.
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.
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THE TRUST AGREEMENT
- --------------------------------------------------------------------------------
The Fund is a Pennsylvania common law trust established under a
Restatement of Trust Agreement, amended and restated as of December 19, 1989
(the "Declaration of Trust"). The Declaration of Trust 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 Declaration of Trust 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 Declaration of Trust.
DESCRIPTION OF SHARES
The Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest and the creation of additional series and/or
classes of series of Fund shares. Each share represents an equal proportionate
interest in the Fund with each other share of that class. Upon liquidation,
shares are entitled to a pro rata share in the net assets of their class of Fund
shares. Shareholders shall have no preemptive or conversion rights. Shares are
transferable. The Fund currently intends to issue only one class of shares.
SHAREHOLDER LIABILITY
Pursuant to court decisions or other theories of law, shareholders of 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 Declaration of Trust (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 Declaration of Trust, 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 Declaration of Trust 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 meeting as described above, no further meetings of shareholders
for the purpose of electing Trustees will be held, unless required by law or
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 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 Declaration of Trust 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 Declaration of Trust 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.
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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. 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 (the "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
objective 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 shall 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
such other investment adviser, as investment adviser, will provide substantially
all the services to be provided by Keystone Management under the Management
Agreement. The Management Agreement also permits Keystone Management to delegate
to Keystone or another investment adviser substantially all of the investment
manager's rights, duties and obligations under the Management Agreement.
Services performed by Keystone Management include (1) performing research and
planning with respect to (a) the Fund's qualification as a regulated investment
company under Subchapter M of the Internal Revenue Code, (b) tax treatment of
the Fund's portfolio investments, (c) tax treatment of special corporate actions
(such as reorganizations), (d) state tax matters affecting the Fund, and (e) the
Fund's distributions of income and capital gains; (2) preparing the Fund's
federal and state tax returns; 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 set forth below:
Aggregate Net
Annual Asset Value of the
Management Fee Income Shares of the Fund
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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 state annual expense limitations, the
most restrictive of which is as follows:
2.5% of the first $30 million of Fund average net assets;
2.0% of the next $70 million of Fund average net assets; and
1.5% of Fund average net assets over $100 million.
Capital charges and certain expenses, including a portion of the Fund's
Distribution Plan expenses, are not included in the calculation of the state
expense limitation. This limitation may be modified or eliminated in the future.
As a continuing condition of registration of shares in a state,
Keystone Management has agreed to reimburse the Fund annually for certain
operating expenses incurred by the Fund in excess of certain percentages of the
Fund's average daily net assets. Keystone Management is not required, however,
to make such reimbursements to the extent it would result in the Fund's
inability to qualify as a regulated investment company under provisions of the
Internal Revenue Code. This condition may be modified or eliminated in the
future.
The Management Agreement will continue in effect 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.
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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 (the "Advisory Agreement") with Keystone under which Keystone provides
investment advisory and management services to the Fund.
Keystone, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, has provided investment advisory and management services to
investment companies and private accounts since it was organized in 1932.
Keystone is a wholly-owned subsidiary of Keystone Investments, 200 Berkeley
Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation privately owned by current and
former members of Keystone's management, certain employees 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.
Pursuant to the Advisory Agreement and subject to the supervision of
the Fund's Board of Trustees, Keystone manages and administers the Fund's
operation and manages the investment and reinvestment of the Fund's assets in
conformity with the Fund's investment 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 shall pay or reimburse the Fund for the compensation
of Fund officers and Trustees who are affiliated with the investment adviser and
will 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 Fund's 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 August 31, 1993, the Fund paid or accrued
to Keystone Management investment management and administrative services fees of
$4,866,030, which represented 0.52% of the Fund's average net assets. Of such
amount paid to Keystone Management, $4,136,126 was paid to Keystone for its
services to the Fund.
During the fiscal year ended August 31, 1994, the Fund paid or accrued
to Keystone Management investment management and administrative services fees of
$4,624,138 which represented 0.50% of the Fund's average net assets. Of such
amount paid to Keystone Management, $3,930,517 was paid to Keystone for its
services to the Fund.
During the fiscal year ended August 31, 1995, the Fund paid or accrued
to Keystone Management investment management and administrative services fees of
$3,982,976, representing 0.53% of the Fund's average net assets. Of such amount
paid to Keystone Management, $3,385,529 was paid to Keystone for its services to
the Fund.
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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, Inc. ("Keystone Investments"); President,
Chief Executive Officer and Trustee or Director of all other funds in the
Keystone Investments Family of Funds; Director and Chairman of the Board
and Chief Executive Officer 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, Inc. ("Keystone
Management"), Keystone Software Inc. ("Keystone Software"); former Director
and President of Hartwell Keystone Advisers, Inc. ("Hartwell Keystone");
Director and President of Keystone Asset Corporation, Keystone Capital
Corporation, and Keystone Trust Company; Director of Keystone Investment
Distributors Company ("the Principal Underwriter"), Keystone Investor
Resource Center, Inc. ("KIRC"), and Fiduciary Investment Company, Inc.
("FICO"); former Director and Vice President of Robert Van Partners, Inc.;
Director of Boston Children's Services Association; Trustee of Anatolia
College, Middlesex School, and Middlebury College; Member, Board of
Governors, New England Medical Center; and former Trustee of Neworld Bank.
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of 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
funds in the Keystone Investments Family of 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 funds in the Keystone Investments Family of Funds; 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; former Director and
Chairman of the Board of Hartwell Keystone; and former Chief Executive
Officer of the Fund.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of 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 funds
in the Keystone Investments Family of 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 funds in
the Keystone Investments Family of 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 funds in
the Keystone Investments Family of 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
funds in the Keystone Investments Family of 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 funds
in the Keystone Investments Family of 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 funds in
the Keystone Investments Family of 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 funds in
the Keystone Investments Family of Funds; Partner, Farrell, Fritz,
Caemmerer, Cleary, Barnosky & Armentano, P.C.; former President, Nassau
County Bar Association; former Associate Dean and Professor of Law, St.
John's University School of Law.
EDWARD F. GODFREY: Senior Vice President of the Fund; Senior Vice President of
all other funds in the Keystone Investments Family of Funds; Director,
Senior Vice President, Chief Financial Officer and Treasurer of Keystone
Investments, the Principal Underwriter, Keystone Asset Corporation,
Keystone Capital Corporation, and Keystone Trust Company; Treasurer of
Keystone Institutional, and FICO; Treasurer and Director of Keystone
Management and Keystone Software; Vice President and Treasurer of KFIA;
Director of KIRC; former Treasurer and Director of Hartwell Keystone and
Keystone; and former Treasurer of Robert Van Partners, Inc.
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice President of all
other funds in the Keystone Investments Family of Funds; and President of
Keystone.
KEVIN J. MORRISSEY: Treasurer of the Fund; Treasurer of all other funds in the
Keystone Investments Family of Funds; Vice President of Keystone
Investments; Assistant Treasurer of FICO and Keystone; and former Vice
President and Treasurer of KIRC.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the Fund; Senior
Vice President and Secretary of all other funds in the Keystone Investments
Family of 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; and former Senior Vice
President and former 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. Bissell and Mr. Elfner are "interested persons" by virtue of their
positions as officers and/or Directors of Keystone Investments and several of
its affiliates including Hartwell Keystone, the Principal Underwriter and KIRC.
Mr. Bissell and Mr. Elfner own shares of Keystone Investments. Mr. Bissell is a
Director of Keystone Investments. Mr. Elfner is Chairman of the Board, Chief
Executive Officer and Director of Keystone Investments.
During the fiscal year ended August 31, 1995, no Trustee affiliated
with Keystone or any officer received any direct remuneration from the Fund.
During this same period, the nonaffiliated Trustees received $40,014 in
retainers and fees from the Fund. For the twelve month period ended December 31,
1995, aggregate compensation paid to Independent Trustees on a complex wide
basis was $289,022. As of August 31, 1995, the Trustees, officers and members of
the Advisory Board of Keystone beneficially owned less than 1% of the Fund's
outstanding shares.
The address of all the Fund's Trustees, officers and Advisory Board
members is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
- --------------------------------------------------------------------------------
PRINCIPAL UNDERWRITER
- --------------------------------------------------------------------------------
Pursuant to a Principal Underwriting Agreement ("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 Delaware corporation wholly-owned by Keystone. The Principal
Underwriter, as agent, has agreed to use its best efforts to find purchasers for
the 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.
For the fiscal years ended August 31, 1993 and 1994, the Principal
Underwriter earned commissions of $4,799,745 and $5,118,615, respectively, after
allowing commissions and service fees of $8,804,930 and $5,770,600,
respectively, to retail dealers under the Distribution Plan. For the fiscal year
ended August 31, 1995, the Principal Underwriter received $5,813,521 after
payments of commissions on new sales and services to dealers and others of
$3,216,034.
- --------------------------------------------------------------------------------
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, Keystone Management, 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 that 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 August 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 one, five and ten year
periods ended August 31, 1995 were 5.17% (including contingent deferred sales
charge), 51.98% and 110.34%, respectively. The average annual compounded returns
for the five and ten year periods ended August 31, 1995 were 8.73% and 7.72%,
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 current yield of the Fund for the 30-day period ended August 31,
1995 was 6.78%.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is the custodian of all securities and cash of the Fund
(the "Custodian"). The Custodian may hold securities of some foreign issuers
outside the 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, Massachusetts 02142, a wholly owned
subsidiary of Keystone, acts 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.
On October 31, 1995, Merrill Lynch, Pierce, Fenner & Smith, Att.: Book
Entry, 4800 Deer Lake Drive E, 3rd Floor, Jacksonville, FL 32246-6484 owned
13.265% of the Fund's then outstanding shares.
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 Fund's 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.
<PAGE>
Keystone Diversified Bond Fund (B-2)
(formerly Keystone Custodian Fund, Series B-2)
SCHEDULE OF INVESTMENTS--August 31, 1995
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
=============================================================================================================
<S> <C> <C> <C> <C> <C>
FIXED INCOME (91.1%)
CONVERTIBLE BONDS (0.4%)
RESTAURANTS (0.4%)
Boston Market, Inc. Conv. Deb.
(Subord.) 4.500% 2004 $ 3,250,000 $ 3,083,438
- -------------------------------------------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(Cost $3,250,000) 3,083,438
- -------------------------------------------------------------------------------------------------------------
INDUSTRIAL BONDS & NOTES (50.3%)
ADVERTISING & PUBLISHING (0.7%)
Outlet Broadcast, Inc. Sr. Notes (Subord.) 10.875 2003 4,375,000 4,725,000
- -------------------------------------------------------------------------------------------------------------
AMUSEMENTS (1.3%)
Affinity Group, Inc. Gtd. Sr. Notes
(Subord.) 11.500 2003 3,000,000 3,007,500
Boyd Gaming Corp. Sr. Notes (Subord.) 10.750 2003 3,000,000 3,105,000
Six Flags Theme Parks, Inc.
(Effective Yield 11.123%) (c)
(f) Sr. Disc. Notes 0.000 2005 4,250,000 3,113,125
- -------------------------------------------------------------------------------------------------------------
9,225,625
- -------------------------------------------------------------------------------------------------------------
AUTOMOTIVE (1.5%)
Olympic Automobile Series 1995 C Class
A2 6.200 2002 10,730,000 10,717,875
- -------------------------------------------------------------------------------------------------------------
BROADCASTING (2.0%)
Continental Cablevision, Inc. Sr. Deb. 9.500 2013 7,750,000 8,089,063
MFS Communications, Inc.
(Effective Yield 9.373%) (c) Sr. Disc. Notes 0.000 2004 4,000,000 2,980,000
Sinclair Broadcast Group, Inc. Sr. Notes (Subord.) 10.000 2005 3,575,000 3,610,750
- -------------------------------------------------------------------------------------------------------------
14,679,813
- -------------------------------------------------------------------------------------------------------------
BUILDING MATERIALS (1.3%)
Associated Materials, Inc. Sr. Notes (Subord.) 11.500 2003 2,000,000 1,840,000
HMH Properties, Inc. (f) Sr. Secd. Notes 9.500 2005 5,000,000 4,800,000
Schuller International Group, Inc. Sr. Notes 10.875 2004 3,000,000 3,285,000
- -------------------------------------------------------------------------------------------------------------
9,925,000
- -------------------------------------------------------------------------------------------------------------
CAPITAL GOODS (1.2%)
Inland Steel Industries, Inc. Notes 12.750 2002 4,200,000 4,714,500
Tenneco, Inc. Notes 10.375 2000 3,555,000 4,092,338
- -------------------------------------------------------------------------------------------------------------
8,806,838
- -------------------------------------------------------------------------------------------------------------
CHEMICALS (1.4%)
Key Plastics, Inc. Sr. Notes Series B 14.000 1999 6,500,000 6,565,000
Uniroyal Chemical Corp. Investors
Holding, Inc. Sr. Notes (Subord.) 11.000 2003 4,000,000 4,020,000
- -------------------------------------------------------------------------------------------------------------
10,585,000
- -------------------------------------------------------------------------------------------------------------
See Notes to Schedule of Investments.
8
<PAGE>
CONSUMER GOODS (1.7%)
Coty, Inc. Sr. Notes (Subord.) 10.250% 2005 $ 4,500,000 $ 4,635,000
Drypers Corp. Sr. Notes Series B 12.500 2002 5,000,000 2,750,000
Ralphs Grocery Co. Sr. Notes 10.450 2004 5,000,000 4,887,500
- -------------------------------------------------------------------------------------------------------------
12,272,500
- -------------------------------------------------------------------------------------------------------------
DIVERSIFIED COMPANIES (2.5%)
General Electric Capital Corp. Notes 8.750 2007 10,275,000 11,822,621
Jordan Industries, Inc. Sr. Notes 10.375 2003 5,000,000 4,637,500
Jordan Industries, Inc. Sr. Disc. Deb.
(Effective Yield 11.740%) (c) (Subord.) 0.000 2005 3,000,000 1,815,000
- -------------------------------------------------------------------------------------------------------------
18,275,121
- -------------------------------------------------------------------------------------------------------------
FINANCE (13.9%)
American Life Holding Co. Sr. Notes (Subord.) 11.250 2004 4,000,000 4,200,000
Banc One Credit Card Master Trust Series 1994-A
Class A 7.150 1998 7,260,000 7,346,176
Comerica, Inc. Subord. Notes 7.250 2007 5,000,000 5,038,650
Commercial Credit Group, Inc. Notes 10.000 2009 5,000,000 6,163,400
Commercial Credit Group, Inc. Notes 10.000 2008 6,000,000 7,368,180
Corestates Home Equity Loan Notes 6.650 2009 1,563,106 1,552,414
European Investment Bank Deb. 9.125 2002 6,750,000 7,684,808
Ford Motor Credit Co. Notes 6.750 2008 9,000,000 8,707,590
General Motors Acceptance Corp. Med. Term Notes 7.375 1998 3,300,000 3,371,742
Marine Midland Asset Backed 8.000 2024 4,579,169 4,476,138
MBNA Master Credit Card Trust II Series 1995-C
Class A 6.450 2008 9,000,000 8,797,500
Norwest Corp. Med. Term Notes 6.500 2005 9,250,000 9,001,453
Paine Webber Group, Inc. Notes 8.250 2002 6,650,000 6,934,953
Premium Standard Farms Finance L P Sr. Secd. Disc.
(b) (h) Exch. Notes 12.000 2003 9,577,000 6,991,210
Sears Roebuck Acceptance Corp. Med. Term Notes 6.240 1999 3,725,000 3,673,446
Standard Credit Card Trust Series 1990 Class A 9.500 1998 6,890,000 7,230,159
Tembec Finance Corp. Sr. Notes 9.875 2005 3,700,000 3,700,000
- -------------------------------------------------------------------------------------------------------------
102,237,819
- -------------------------------------------------------------------------------------------------------------
FOODS (2.2%)
Brunos, Inc. Sr. Notes 10.500 2005 3,500,000 3,403,750
Cott Corp. Quebec Sr. Notes 9.375 2005 5,000,000 5,000,000
PM Holdings Corp. Units (Sr. Disc.
Notes/Wts.) 11.500 2005 4,812,000 2,502,240
Specialty Foods Corp. Sr. Notes (Subord.)
Series B 11.250 2003 5,250,000 5,145,000
- -------------------------------------------------------------------------------------------------------------
16,050,990
- -------------------------------------------------------------------------------------------------------------
HEALTHCARE (0.5%)
Ornda Healthcorp Sr. Notes (Subord.) 11.375 2004 3,000,000 3,300,000
- -------------------------------------------------------------------------------------------------------------
(continued on next page)
9
<PAGE>
- -------------------------------------------------------------------------------------------------------------
INSURANCE (4.2%)
CCP Insurance Sr. Notes 10.500% 2004 $ 5,000,000 $ 5,237,500
Chartwell Re Corp. Sr. Notes 10.250 2004 4,000,000 3,940,000
MBIA, Inc. Deb. 9.375 2011 15,000,000 17,701,050
Reliance Group Holdings, Inc. Sr. Deb. (Subord.) 9.750 2003 4,000,000 3,880,000
- -------------------------------------------------------------------------------------------------------------
30,758,550
- -------------------------------------------------------------------------------------------------------------
MISCELLANEOUS (0.7%)
Los Angeles, California Fire Safety
Improvements
Assessment Dist. #1 8.480 2015 5,000,000 5,181,250
- -------------------------------------------------------------------------------------------------------------
NATURAL GAS (0.7%)
TransTexas Gas Corp. Sr. Secd. Notes 11.500 2002 5,000,000 5,237,500
- -------------------------------------------------------------------------------------------------------------
OFFICE & BUSINESS EQUIPMENT (0.4%)
Specialty Equipment Companies,
Inc. Sr. Notes (Subord.) 11.375 2003 2,500,000 2,625,000
- -------------------------------------------------------------------------------------------------------------
OIL (2.0%)
Occidental Petroleum Corp. Med. Term Notes 6.350 2000 1,900,000 1,852,405
Occidental Petroleum Corp. Med. Term Notes 6.240 2000 5,550,000 5,383,334
Plains Resources, Inc. Sr. Notes (Subord.) 12.000 1999 4,000,000 4,120,000
Wainoco Oil Corp. Sr. Notes 12.000 2002 3,250,000 3,315,000
- -------------------------------------------------------------------------------------------------------------
14,670,739
- -------------------------------------------------------------------------------------------------------------
PAPER & PACKAGING (1.4%)
Owens Illinois, Inc. Deb. 11.000 2003 4,500,000 4,916,250
Rainy River Forest Products, Inc. Sr. Secd. Notes 11.000 2001 5,000,000 5,350,000
- -------------------------------------------------------------------------------------------------------------
10,266,250
- -------------------------------------------------------------------------------------------------------------
RETAIL (2.2%)
Big 5 Holdings, Inc. Sr. Notes (Subord.) 13.625 2002 1,000,000 980,000
Cole National Group, Inc. Sr. Notes 11.250 2001 4,000,000 3,960,000
Hills Stores Co. Sr. Notes 10.250 2003 3,500,000 3,325,000
Pamida, Inc. Sr. Notes (Subord.) 11.750 2003 4,500,000 3,960,000
Service Merchandise Co. Sr. Deb. (Subord.) 9.000 2004 5,000,000 4,175,000
- -------------------------------------------------------------------------------------------------------------
16,400,000
- -------------------------------------------------------------------------------------------------------------
SERVICES (1.1%)
Comcast Cellular Corp. (Effective
Yield 11.732%) (c) Sr. Part. Notes 0.000 2000 7,380,000 5,535,000
Community Health Systems, Inc. Sr. Deb. (Subord.) 10.250 2003 2,500,000 2,637,500
Santa Fe Hotel, Inc. 1st Mtge. Notes 11.000 2000 530,000 471,700
- -------------------------------------------------------------------------------------------------------------
8,644,200
- -------------------------------------------------------------------------------------------------------------
See Notes to Schedule of Investments.
10
<PAGE>
- -------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS (3.2%)
Adelphia Communications Corp. Sr. Notes 12.500% 2002 $ 3,000,000 $ 3,045,000
Pagemart, Inc. (Effective Yield Unit (Sr. Disc.
12.250%) (c) Notes/Wts.) 0.000 2003 3,050,000 1,986,313
Rogers Cablesystems Ltd. Sr. Secd. 2nd
Priority Note 10.000 2005 5,500,000 5,651,250
Time Warner Entertainment Co. Notes 8.875 2012 7,500,000 8,027,325
Videotron Group Ltd. Voting Conv. Deb.
(Subord.) 10.625 2005 5,000,000 5,225,000
- -------------------------------------------------------------------------------------------------------------
23,934,888
- -------------------------------------------------------------------------------------------------------------
TRANSPORTATION (1.9%)
California Petroleum Transport
Corp. 1st Mtge. Notes 8.520 2015 5,000,000 5,252,450
Eletson Holdings, Inc. 1st Mtge. Notes 9.250 2003 4,999,500 4,799,520
Gearbulk Holding Ltd. Sr. Notes 11.250 2004 4,000,000 4,180,000
- -------------------------------------------------------------------------------------------------------------
14,231,970
- -------------------------------------------------------------------------------------------------------------
UTILITIES (2.3%)
Chugach Electric Association, Inc. 1st Mtge. Bds. 9.140 2022 13,150,000 14,683,290
Montana Power Co. 1st Mtge. Notes 7.700 1999 2,400,000 2,496,792
- -------------------------------------------------------------------------------------------------------------
17,180,082
- -------------------------------------------------------------------------------------------------------------
TOTAL INDUSTRIAL BONDS & NOTES (Cost--$368,010,432) 369,932,010
- -------------------------------------------------------------------------------------------------------------
FOREIGN BONDS (U.S. DOLLARS)
(6.0%)
Gulf Canada Resources Ltd. Sr. Notes (Subord.) 9.625 2005 3,500,000 3,500,000
Indah Kiat International Finance Gtd. Sr. Secd.
Co. B. V. Notes 11.875 2002 4,000,000 4,080,000
Ispat Mexicana S.A. Sr. Unsecd. Deb. 10.375 2001 5,000,000 4,400,000
Manitoba Province, Canada Deb. 9.625 1999 8,750,000 9,637,600
Midland Amern Capital Corp Gtd. Notes 12.750 2003 2,500,000 2,931,475
Northern Telecom Ltd. Notes 8.250 1996 3,500,000 3,556,140
Republic of Argentina Sr. Notes 8.375 2003 5,500,000 4,028,750
Republic of Argentina Sr. Notes 5.000 2023 3,500,000 1,645,000
Wharf International Capital 1994
Ltd. Gtd. Notes 8.875 2004 10,000,000 10,258,300
- -------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (U.S. DOLLARS) (Cost--$42,126,720) 44,037,265
- -------------------------------------------------------------------------------------------------------------
ADJUSTABLE RATE MORTGAGE SECURITIES (1.4%)
FNMA Pool #070119 Cap 12.018%, Margin
2.000% + CMT 7.173 2017 3,265,861 3,361,796
FNMA Pool #124289 Cap 13.432%, Margin
2.005% + CMT 7.678 2021 6,844,955 7,027,852
- -------------------------------------------------------------------------------------------------------------
TOTAL ADJUSTABLE RATE MORTGAGE SECURITIES (Cost--$10,473,461) 10,389,648
- -------------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS (16.7%)
Chase Mortgage Finance Corp. Series 1992 F Class 8.250 2007 421,552 420,642
(Est. Mat. 1995) (g) A4
(continued on next page)
11
<PAGE>
COLLATERALIZED MORTGAGE OBLIGATIONS (continued)
Collateralized Mortgage Investors
Trust
(Est. Mat. 1996) (g) Series 6 Class D 8.800% 2006 $ 5,000,000 $ 5,060,750
Debartolo Capital Partnership
(Est. Mat. 2000) (g) Commercial Mtge. 7.610 2004 9,000,000 9,185,625
Class B
FHA Pool #02043143 (Est. Mat.
1999) (g) Blair House Project 9.125 2034 3,284,180 3,382,706
FHA Pool #02043143 (Est. Mat.
1999) (g) Blair House Project 10.250 2034 2,508,755 2,584,018
FHLMC (Est. Mat. 2010) (g) Series G8 Class SB
inverse floater 9.600 2023 191,912 144,894
FHLMC (Est. Mat. 2005) (g) Series 1615 Class
SB inverse floater 3.214 2008 5,265,900 3,218,781
FHLMC (Est. Mat. 2005) (g) Series 1666 inverse
floater 5.360 2024 7,101,893 4,678,159
FHLMC (Est. Mat. 1999) (g) Series 1684 Class
JC 5.507 2020 6,161,109 6,072,543
FHLMC (Est. Mat. 1999) (g) Series 1684 Class
JD COFI inverse IO 3.493 2020 6,385,302 381,123
FHLMC (Est. Mat. 2004) (g) Series 1360 Class
PK 10.000 2020 5,000,000 5,638,650
FNMA REMIC Trust (Est. Mat. 2001) Series 1992 117
(g) Class K 7.500 2021 7,250,000 7,261,745
FNMA REMIC Trust (Est. Mat. 2007) Series 1993 038
(g) Class L 5.000 2022 5,000,000 4,117,750
Green Tree Financial Corp. (Est. Series 1994 A Class
Mat. 1998) (g) A 6.900 2004 3,222,499 3,183,217
Green Tree Financial Corp. (Est. Series 1994 B Class
Mat. 1997) (g) A 7.850 2004 3,551,783 3,551,783
Merrill Lynch Mortgage Investors, Series 1992 D Class
Inc. (Est. Mat. 1999) (g) B 8.500 2017 3,081,199 3,192,461
The Money Store Home Equity Trust Series 1995 A Class
(Est. Mat. 1997) (g) A 7.925 2014 7,270,000 7,431,031
Paine Webber Mortgage Acceptance Series 1993 5 Class
Corp. IV (Est. Mat. 1997) (g) A3 6.875 2008 5,553,412 5,553,412
Prudential Home Mortgage Series 1992 A Class
(Est. Mat. 2001) (g) 2B2 (Subord.) 7.900 2022 14,000,000 12,950,000
Prudential Home Mortgage Series 1995 A Class
(Est. Mat. 2007) (g) B (Subord.) 8.980 2025 6,440,073 6,472,274
Residential Funding Mortgage
Securities I Series 1994 S15
(Est. Mat. 1997) (g) Class A1 7.750 2024 7,404,153 7,540,611
U.S. Home Equity Loan (Est. Mat. Series 1991 2 Class
1997) (g) B 9.125 2021 4,569,000 4,698,897
Volvo Car Finance Grantor Trust
(Effective Yield 6.62%) Series 1993 2 Class
(Est. Mat. 1996) (c) (f) (g) A 0.000 1997 4,601,203 4,363,235
Zale Funding Trust (Est. Mat. Series 1994 1 Class
1999) (f) (g) A2 7.325 2003 11,000,000 11,292,188
- -------------------------------------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost--$123,014,375) 122,376,495
- -------------------------------------------------------------------------------------------------------------
MORTGAGE PASS-THROUGH CERTIFICATE (1.0%)
Resolution Trust Corp. Mortgage Series 1995 Class
Pass-Through (Cost $7,137,846) 2C 7.500 2028 7,250,000 7,277,188
- -------------------------------------------------------------------------------------------------------------
See Notes to Schedule of Investments.
12
<PAGE>
- -------------------------------------------------------------------------------------------------------------
UNITED STATES GOVERNMENT ISSUES (15.3%)
U.S. Treasury Notes 6.500% 2005 $ 5,000,000 $ 5,076,550
U.S. Treasury Notes 6.750 2000 15,500,000 15,899,583
U.S. Treasury Notes 7.500 2002 3,200,000 3,429,984
U.S. Treasury Notes 7.875 2004 16,700,000 18,450,828
U.S. Treasury Notes 8.875 1998 14,350,000 15,547,364
U.S. Treasury Notes 8.875 2000 9,750,000 10,845,315
U.S. Treasury Bonds 6.875 2025 7,500,000 7,707,450
U.S. Treasury Bonds 7.625 2025 31,730,000 35,354,201
- -------------------------------------------------------------------------------------------------------------
TOTAL UNITED STATES GOVERNMENT ISSUES (Cost--$112,908,472) 112,311,275
- -------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME (Cost--$666,921,306) 669,407,319
=============================================================================================================
COMMON STOCKS/RIGHTS/WARRANTS (0.9%)
Hollywood Casino Corp. (d) 611,665 5,160,923
Pagemart, Inc., wts. (b) (d) (f) 14,030 56,120
PM Holdings Corp. (d) 2,964 3
Purity Supreme, Inc. wts. (d) 34,655 347
Reliance Group Holdings, Inc. wts.
(d) 67,904 135,808
Santa Fe Hotel, Inc. wts. (d) 53,000 530
Uniroyal Chemical Corp. Investors
Holding, Inc. (d) 119,971 1,244,699
- -------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS/RIGHTS/WARRANTS (Cost--$173,560) 6,598,430
=============================================================================================================
SHORT-TERM INVESTMENTS (6.6%)
United States Government or Agency
Issues (4.7%)
Federal Home Loan Bank Discount
Notes 1995 20,000,000 19,943,400
U.S. Treasury Bills 1995 14,800,000 14,695,068
- -------------------------------------------------------------------------------------------------------------
TOTAL UNITED STATES GOVERNMENT OR AGENCY ISSUES (Cost $34,636,447) 34,638,468
- -------------------------------------------------------------------------------------------------------------
Maturity
Value
- -------------------------------------------------------------------------------------------------------------
REPURCHASE AGREEMENT (1.9%)
Goldman Sachs Group LP, purchased 8/31/95, (Collateralized
by $13,894,431 FHLMC, 6.257%, 4/1/31) (Cost $13,633,000)
(e) 5.820 9/1/95 $13,635,204 13,633,000
- -------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS (Cost--$48,269,447) 48,271,468
=============================================================================================================
TOTAL INVESTMENTS (Cost--$715,364,313) (a) (98.6%) 724,277,217
- -------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES--NET (1.4%) 10,560,063
- -------------------------------------------------------------------------------------------------------------
NET ASSETS (100%) $734,837,280
=============================================================================================================
(continued on next page)
</TABLE>
13
<PAGE>
Notes to Schedule of Investments:
(a) The cost of investments for federal income tax purposes amounted to
$715,969,343. Gross unrealized appreciation and depreciation of
investments, based on identified tax cost, at August 31, 1995, are as
follows:
Gross unrealized appreciation $ 19,064,680
Gross unrealized depreciation (10,756,806)
-----------
Net unrealized appreciation $ 8,307,874
===========
(b) Illiquid securities which may not be sold or disposed of in the ordinary
course of business within seven days at approximately the current market
value. The combined value of such securities at August 31, 1995 was
$7,047,330 (1.0% of the Fund's net assets at August 31, 1995).
(c) Effective yield (calculated at date of purchase) is the yield at which
the bond accretes on an annual basis until maturity date.
(d) Non-income-producing security.
(e) The repurchase ageements are fully collateralized by U.S. Government
and/or agency obligations based on market prices at August 31, 1995.
(f) 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.
(g) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected pre-payment rates. Changes in interest
rates can cause the estimated maturity to differ from the listed date.
The estimated maturity dates are unaudited.
(h) Securities valued in good faith by management under procedures approved
by the Fund's Board of Trustees. At August 31, 1995, the fair value of
these securities was $6,991,210 (1.0% of the Fund's net assets at August
31, 1995).
Legend of Portfolio Abbreviations:
CMO--Collateralized Mortgage Obligation
CMT--1, 3 or 5 year Constant Maturity Treasury Index
COFI--Cost of Funds Index
FHLMC--Federal Home Loan Mortgage Corporation
FNMA--Federal National Mortgage Association
GNMA--Government National Mortgage Association
IO--Interest Only
REMIC--Real Estate Mortgage Investment Conduit
See Notes to Financial Statements.
14
<PAGE>
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the year)
<TABLE>
<CAPTION>
Year Ended August 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 $15.28 $17.06 $16.44 $15.37 $15.51 $17.74 $17.99 $18.91 $20.08 $18.84
- -----------------------------------------------------------------------------------------------------------------------------------
Income from
investment
operations:
Net
investment
income 1.06 1.06 1.28 1.33 1.33 1.53 1.71 1.78 1.83 2.07
Net gain
(loss) on
investments
and closed
futures
contracts 0.11 (1.62) 0.70 1.14 0.17 (1.94) (0.13) (0.81) (1.01) 1.38
Net
commissions
paid on
fund share
sales (a) 0 0 0 0 0 0 0 0 0 (0.21)
- -----------------------------------------------------------------------------------------------------------------------------------
Total from
investment
operations 1.17 (0.56) 1.98 2.47 1.50 (0.41) 1.58 0.97 0.82 3.24
- -----------------------------------------------------------------------------------------------------------------------------------
Less
distributions
from:
Net
investment
income (1.06) (1.22) (1.28) (1.33) (1.63) (1.61) (1.83) (1.85) (1.85) (2.00)
In excess of
net
investment
income (0.22) 0 (0.08) (0.07) (0.01) (0.21) 0 0 0 0
Tax basis
return of
capital (0.08) 0 0 0 0 0 0 0 0 0
Net realized
gain on
investments 0 0 0 0 0 0 0 (0.04) (0.14) 0
- -----------------------------------------------------------------------------------------------------------------------------------
Total
distributions (1.36) (1.22) (1.36) (1.40) (1.64) (1.82) (1.83) (1.89) (1.99) (2.00)
- -----------------------------------------------------------------------------------------------------------------------------------
Net asset
value end
of year $15.09 $15.28 $17.06 $16.44 $15.37 $15.51 $17.74 $17.99 $18.91 $20.08
- -----------------------------------------------------------------------------------------------------------------------------------
Total return
(b) 8.13% (3.53%) 12.73% 16.88% 10.58% (2.44%) 9.23% 5.61% 4.20% 18.01%
Ratios/supple-
mental data
Ratios to
average net
assets:
Total
expenses 1.81% 1.75% 1.89% 1.99% 1.94% 1.89% 1.84% 1.68% 1.68% 1.00%
Net
investment
income 7.05% 6.48% 7.73% 8.29% 8.74% 9.26% 9.52% 9.82% 9.31% 10.37%
Portfolio
turnover
rate 178% 200% 133% 117% 101% 43% 47% 46% 74% 69%
- -----------------------------------------------------------------------------------------------------------------------------------
Net assets
end of year
(thousands) $734,837 $814,245 $1,004,393 $902,339 $814,528 $860,615 $1,000,305 $838,892 $889,333 $558,734
- -----------------------------------------------------------------------------------------------------------------------------------
</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 August 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.
15
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
August 31, 1995
===================================================================
Assets: (Note 1):
Investments at market value
(identified cost--$715,364,313) $ 724,277,217
Cash 103
Receivable for:
Investments sold 3,705,516
Fund shares sold 354,497
Interest 11,346,054
Prepaid expenses 116,450
- -------------------------------------------------------------------
Total assets 739,799,837
- -------------------------------------------------------------------
Liabilities (Notes 2, 4 and 5):
Payable for:
Investments purchased 244,800
Fund shares redeemed 2,341,151
Distributions to shareholders 2,237,949
Due to related parties 13,385
Other accrued expenses 125,272
- -------------------------------------------------------------------
Total liabilities 4,962,557
- -------------------------------------------------------------------
Net assets $ 734,837,280
===================================================================
Net assets represented by (Note 1):
Paid-in capital $ 897,724,605
Accumulated distributions in excess of net
investment income (2,237,949)
Accumulated net realized gain (loss) on investments (169,562,280)
Net unrealized appreciation (depreciation) on
investments 8,912,904
- -------------------------------------------------------------------
Total net assets applicable to outstanding
shares of beneficial interest ($15.09 a
share on 48,710,058 shares outstanding) $ 734,837,280
===================================================================
STATEMENT OF OPERATIONS
Year Ended August 31, 1995
===================================================================
Investment income (Note 1):
Interest $ 67,051,003
- -------------------------------------------------------------------
Expenses (Notes 2 and 4):
Management fee $ 3,982,976
Transfer agent fees 1,674,129
Accounting, auditing and legal 88,904
Custodian fees 259,614
Printing 34,214
Trustees' fees and expenses 40,014
Distribution plan expenses 7,512,556
Registration fees 46,386
Miscellaneous 51,615
- -------------------------------------------------------------------
Total expenses 13,690,408
- -------------------------------------------------------------------
Net investment income 53,360,595
- -------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments and
closed futures contracts (Notes 1 and 3):
Net realized gain (loss) on:
Investments (24,643,115)
Closed futures contracts (627,562)
- -------------------------------------------------------------------
Net realized gain (loss) on
investments
and closed futures contracts (25,270,677)
- -------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on investments 29,299,264
- -------------------------------------------------------------------
Net gain (loss) on investments and
closed futures contracts 4,028,587
- -------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations $ 57,389,182
===================================================================
See Notes to Financial Statements.
16
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended August 31,
------------------------------
1995 1994
==========================================================================================================
<S> <C> <C>
Operations:
Net investment income $ 53,360,595 $ 60,539,075
Net realized gain (loss) on investments and closed futures contracts (25,270,677) (14,280,675)
Net change in unrealized appreciation (depreciation) on investments 29,299,264 (77,265,931)
- ----------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting from operations 57,389,182 (31,007,531)
- ----------------------------------------------------------------------------------------------------------
Distributions to shareholders from (Notes 1 and 5):
Net investment income (53,360,595) (70,243,075)
In excess of net investment income (11,593,245) 0
Tax basis return of capital (3,726,265) 0
- ----------------------------------------------------------------------------------------------------------
Total distributions to shareholders (68,680,105) (70,243,075)
- ----------------------------------------------------------------------------------------------------------
Capital share transactions (Note 2):
Proceeds from shares sold 115,263,649 128,708,064
Payments for shares redeemed (222,230,419) (257,623,056)
Net asset value of shares issued in reinvestment of dividends and
distributions 38,850,254 40,016,840
- ----------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting from capital share
transactions (68,116,516) (88,898,152)
- ----------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets (79,407,439) (190,148,758)
- ----------------------------------------------------------------------------------------------------------
Net assets:
Beginning of year 814,244,719 1,004,393,477
- ----------------------------------------------------------------------------------------------------------
End of year [Accumulated distributions in excess of net investment
income as follows: 1995--($2,237,949) and 1994--($6,280,569)] (Note 1) $ 734,837,280 $ 814,244,719
==========================================================================================================
</TABLE>
See Notes to Financial Statements.
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Diversified Bond Fund (B-2) (formerly Keystone Custodian Fund,
Series B-2), (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. 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 are marked-to-market and the resultant net gain or
18
<PAGE>
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 gain (loss) on foreign currency related transactions.
19
<PAGE>
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, differences in the treatment of paydown losses
and the deferral of losses for income tax purposes that have been recognized
for financial statement 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 August 31,
1995 1994
- ----------------------------------------------------------
Shares sold 7,685,412 7,793,456
Shares redeemed (14,886,517) (15,835,294)
Shares issued in
reinvestment of
dividends and
distributions 2,612,246 2,454,488
- ----------------------------------------------------------
Net increase (decrease) (4,588,859) (5,587,350)
==========================================================
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 below, Fund shares are offered for sale at net asset value without
any initial sales charge. From the amounts received by KIDC in connection
with the Distribution Plan, and subject to the limitations discussed below,
KIDC generally pays dealers or others a commission equal to 4.00% of the
price paid to the Fund for each sale of 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.
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.
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
20
<PAGE>
Fund may pay for such distribution costs to 6.25% of 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.
During the year ended August 31, 1995, the Fund paid KIDC $7,545,356 under
its Distribution Plan. The amount paid by the Fund under its Distribution
Plan, net of deferred sales charges, was $7,512,556 (1.00% of the Fund's
average daily net asset value). During the year ended August 31, 1995, KIDC
received $5,813,521 after payments of commissions on new sales to dealers and
others of $3,216,034.
Under the NASD Rule, the maximum uncollected amount for which KIDC may
seek payment from the Fund under its distribution Plan is $22,382,869 (3.05%
of the Fund's net assets at August 31, 1995).
(3.) Securities Transactions
As of August 31, 1995, the Fund had a capital loss carryover for federal
income tax purposes of approximately $149,889,000 which expires as follows:
1998--$38,243,000; 1999--$85,002,000; and 2003--$26,644,000. For the year
ended August 31, 1995, purchases and sales of investment securities were as
follows:
Cost of Proceeds
Purchases from Sales
- ---------------------------------------------------------
Portfolio securities $1,303,878,601 $1,394,796,648
Short-term investments 3,233,485,118 3,233,177,500
- ---------------------------------------------------------
$4,537,363,719 $4,627,974,148
=========================================================
(4.) Investment Management and Transactions with Affiliates
Under the terms of the Investment Management Agreement between KMI and the
Fund, 1989, KMI provides investment management and administrative services to
the Fund. In return, KMI is paid a management fee computed and paid daily
which 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 August 31,
1995, the Fund paid or accrued to KMI investment management and
administrative services fees of $3,982,976 which represented 0.53% of the
Fund's average net assets. Of such amount paid to KMI, $3,385,529 was paid to
Keystone for its services to the Fund.
During the year ended August 31, 1995, the Fund paid or accrued to KII
$26,592 for certain accounting services and to KIRC $1,674,129 for transfer
agent fees.
(5.) Distributions to Shareholders
A distribution of net investment income of $0.10 per share was declared
payable by October 5, 1995 to shareholders of record September 25, 1995. This
distribution is not reflected in the accompanying financial statements.
21
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Trustees
Keystone Diversified Bond Fund (B-2)
(formerly Keystone Custodian Fund, Series B-2)
We have audited the accompanying statement of assets and liabilities of
Keystone Diversified Bond Fund (B-2), including the schedule of investments,
as of August 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 August 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 Diversified Bond Fund (B-2) as of August 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 29, 1995
22
<PAGE>
<TABLE>
<CAPTION>
Schedule VII
Keystone Diversified Bond Fund (B-2)
Schedule of Short-Term Borrowings
(as required by Rule 12-10 of Regulation S-X)
Year ended August 31, 1995
(1.) (2.) (3.)
Maximum amount Average amount Weighted average
Category of aggregate Balance at Weighted average outstanding outstanding interest rate
short-term borrowing end of period interest rate during the period during the period during the period
- -------------------- ------------- ---------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
Reverse Repurchase Agreement 0 0 $30,000,000 7,877,128 5.70%
- -----------
1. Amount represents maximum borrowings outstanding at any week end during the year ended August 31, 1995.
2. Average borrowing is determined by dividing the sum of (principal borrowed times the number of days outstanding) by the
total number of days the fund had borrowings outstanding during the year.
3. Weighted average interest rate is determined by dividing the annualized interest paid on borrowings by the average amount
outstanding.
</TABLE>
