<PAGE>
PAGE 1
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SEEKS GENEROUS INCOME AND CAPITAL PRESERVATION FROM A BROAD SPECTRUM OF BONDS.
Dear Shareholder:
We are writing to report to you on the performance of Keystone Diversified Bond
Fund (B-2) for the six-month period which ended February 28, 1997. Following our
report, we have included a discussion with your Fund's management team and
complete financial information.
PERFORMANCE
Your Fund returned 7.16% for the six-month period and 7.92% for the twelve-month
period, which ended February 28, 1997. These return figures include both price
changes and reinvested dividends. With such strong performance, your Fund ranked
10th out of the 123 funds in its competitive group for the past year, according
to Lipper Analytical Services.
The Lehman Aggregate Bond Index, a broad-based index of corporate, government
and mortgage-backed securities, returned 5.38% and 5.35% respectively, for the
same six and twelve-month periods.
We believe your fund performed very well. The returns were achieved despite a
period of market uncertainty in the U.S. in the first half of 1996. Over the
past twelve months, your Fund's management made several strategic portfolio
adjustments which we believe enhanced total return. Your Fund's flexible
investment philosophy, as well as management's thorough research, enabled us to
capitalize on relative value, worldwide.
MARKET ENVIRONMENT
Fixed-income investors benefited from a positive market environment over the
past six months. The economic uncertainties and interest rate volatility that
had characterized the fixed-income market in early 1996 began to subside by
mid-year. At that time, reports confirmed moderate economic growth and low
inflation. This calmed investors' concerns about burgeoning inflation and the
need for a more restrictive monetary policy. As investors became more confident
that this favorable economic climate would continue, interest rates stabilized
and eventually trended downward.
INVESTMENT STRATEGY
We employed your Fund's flexible investment philosophy to select those sectors
and securities that we believed offered the best relative value. A prime focus
of this strategy was to choose those bonds that we thought would perform best in
an atmosphere of steady economic growth and low inflation. This included a
combination of high-grade and high-yield corporate bonds, mortgage-backed
securities and collateralized mortgage obligations (CMOs) and U.S government
securities.
Specifically, in the high-grade corporate bond sector we emphasized banks and
finance and restructured the Fund in terms of credit quality. We reduced the
Fund's reliance on AAA-rated and AA-rated bonds, in light of the positive
economic environment and reallocated assets to BBB-rated bonds to increase
yield. Your Fund also had a meaningful position in high-yield bonds, which are
bonds that are rated "BB" and below. High yield debt was the top-performing U.S.
fixed-income sector in 1996. As the yield advantage offered by high yield vs.
high grade narrowed over the period, we realized profits and shifted assets
towards higher-rated securities.
Mortgage-backed securities, collateralized mortgage obligations and U.S.
government securities also played important roles in our investment strategy.
Mortgage-backed securities and CMOs provided high credit quality and an
attractive stream of income to the portfolio. We built your Fund's position in
U.S. government securities by reducing holdings in
-- CONTINUED--
<PAGE>
PAGE 2
KEYSTONE DIVERSIFIED BOND FUND (B-2)
the foreign government sector, realizing attractive gains. When we shifted those
assets to U.S. government securities, we also extended the Fund's average
maturity, which locked-in high yields for a longer period of time.
As of February 28, 1997, the average rating of your Fund was A+. Its average
maturity stood at 12.8 years.
OUTLOOK
As we look ahead, we anticipate the atmosphere of moderate economic growth and
low inflation of the past few months to continue. We would not be surprised to
see periods of volatility, however, as investors monitor developments within the
economy. We expect these fluctuations to be short-term in nature and to be
contained within a narrow range. An environment of moderate economic growth and
low inflation historically has been positive for fixed-income investors.
Combined with your Fund's ability to be flexible and diversify, we are confident
that many opportunities lie ahead.
KEYSTONE ACQUIRED BY FIRST UNION CORPORATION
We are pleased to inform you that Keystone has been acquired by First Union
Corporation. First Union, based in Charlotte, N.C., is the nation's sixth
largest bank holding company with assets of approximately $130 billion. Keystone
Investment Management Company will continue to be the investment adviser,
responsible for managing your Fund's portfolio. Your Fund will continue to be
managed with the same style and philosophy as in the past.
First Union also owns another mutual fund management company, Evergreen Asset
Management Corp. Together, Evergreen and Keystone manage approximately $30
billion in assets. Service and marketing will now be conducted under the
"Evergreen Keystone Funds" umbrella.
Thank you for your continued support of Keystone Diversified Bond Fund (B-2).
If you have any comments about your investment, we encourage you to write to us.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
CHAIRMAN
KEYSTONE INVESTMENT MANAGEMENT COMPANY
/s/ George S. Bissell
George S. Bissell
CHAIRMAN OF THE BOARD
KEYSTONE FUNDS
April 1997
<PAGE>
PAGE 3
A Discussion With
Your Fund's Manager
(Photo of Christopher P. Conkey
appears here)
CHRISTOPHER P. CONKEY IS CHIEF INVESTMENT OFFICER OF KEYSTONE'S FIXED
INCOME GROUP AND IS THE PORTFOLIO MANAGER OF YOUR FUND. A CHARTERED
FINANCIAL ANALYST, MR. CONKEY HAS 12 YEARS OF EXPERIENCE MANAGING
FIXED-INCOME INVESTMENTS. HE HOLDS A BA IN ECONOMICS FROM CLARK UNIVERSITY
AND AN MBA IN FINANCE FROM BOSTON UNIVERSITY. TOGETHER WITH ANALYSTS DAVID
J. BOWERS AND GARY E. PZEGEO, THE TEAM EVALUATES THE ECONOMIC
ENVIRONMENT IN SELECTING BONDS FOR YOUR FUND.
Q WHAT WAS THE ENVIRONMENT LIKE FOR FIXED-INCOME SECURITIES OVER THE PAST SIX
MONTHS?
A The environment was positive, both in the U.S. and in certain foreign
countries. In the U.S., an increasingly favorable economic climate and strong
demand from foreign investors drove interest rates lower. In the foreign sector,
countries including Germany, the United Kingdom, Canada and Spain experienced
what we consider to be an atmosphere of positive economic, political and social
change. This change created a positive atmosphere for their fixed-income
securities and pushed their interest rates lower.
Q DOMESTIC INTEREST RATES WERE SO VOLATILE IN THE FIRST HALF OF 1996. WHAT
CAUSED THE U.S. ENVIRONMENT TO CHANGE AND BECOME SO FAVORABLE DURING THIS
REPORTING PERIOD?
A The economy grew at a moderate rate and inflation remained low over the past
six months. In the first half of 1996, economic activity grew at a pace that
many investors considered to be too robust to keep inflation well contained.
Although interest rates still exhibited some volatility while investors waited
for slower growth to be confirmed, the fluctuations took place within a narrow
range. The slowdown, combined with continued low inflation gave investors
confidence that the Federal Reserve Board would not raise interest rates over
the near-term.
Q IS THAT WHAT ATTRACTED FOREIGN DEMAND?
A The favorable economic climate was an important reason that foreign investors
were drawn to the U.S. fixed-income market. Global liquidity increased
significantly in 1996, due to expansionary monetary policies, particularly in
Europe and Japan. In seeking to invest this excess cash, foreign investors also
were attracted to the high "real" interest rates in the U.S. or the interest
rate received by the investor when inflation is subtracted. These high "real"
interest rates, combined with a strong U.S. dollar, moderate economic growth and
low inflation, made the U.S. an attractive investment environment for
foreigners.
FUND PROFILE
OBJECTIVE: Seeks generous income and capital preservation from a broad spectrum
of bonds.
INCEPTION DATE: September 11, 1935
AVERAGE MATURITY: 12.8 years
AVERAGE QUALITY: A+
NET ASSETS: $516 million
Newspaper Listing: "DivrB2"
<PAGE>
PAGE 4
KEYSTONE DIVERSIFIED BOND FUND (B-2)
Q IN WHAT TYPES OF SECURITIES DID THE FUND INVEST OVER THE PAST SIX MONTHS?
A We emphasized bonds that we thought would perform well in an atmosphere of
moderate economic growth and low inflation. These included corporate bonds,
mortgage-backed securities and collateralized mortgage obligations (CMOs), and
U.S. government securities.
Corporate bonds comprised approximately 49% of net assets and mortgage-backed
securities and CMOs made up approximately 20% of net assets, as of the end of
the reporting period. The portfolio maintained an average rating of A+ as of
February 28, 1997.
Within the high-grade corporate bond sector, we emphasized A-rated and BBB-rated
securities and reduced holdings in AAA-rated and AA-rated bonds. A-rated and
BBB-rated securities provided additional yield, which was appealing in this low
interest rate environment. In fact, in general, lower-rated securities
outperformed higher-rated securities over the past six months. The healthy
economic environment was conducive to higher corporate profits and consequently,
investors felt more comfortable assuming the additional credit risk of
lower-rated securities. This was especially true for high yield bonds.
We concentrated on banks and finance within the high-grade sector. Many positive
events, including mergers and ratings improvements have been taking place in
that sector. Banks and financial service companies have benefited from the
environment of moderate economic growth and low inflation. We believe this
atmosphere has set the stage for the strong and improving credit quality in many
loan portfolios, as well as the high quality of earnings we have witnessed from
many banks. The Fund's investment in banks and finance also served to diversify
the portfolio, since the high yield sector is almost exclusively invested in
industrial bonds.
Q HOW DID YOU STRUCTURE THE PORTFOLIO WITH REGARD TO HIGH YIELD BONDS?
A We realized profits in B-rated high yield bonds and focused on BB-rated
securities. High yield bonds are those that are rated BB and below. BB-rated
bonds represent the highest quality available within the high yield market.
There was heavy demand for these securities over the past six months and they
generated impressive returns. This demand, however, eventually pushed yields so
low relative to higher-rated credits that we believed that some higher-rated
bonds offered better value. As of February 28, 1997, approximately 24.8% of the
Fund was invested in high yield bonds.
Q WHAT OTHER STRATEGIES DID YOU USE IN MANAGING THE PORTFOLIO?
A We continued to seek value worldwide, shifting assets to those market sectors
that we believed provided the best relative opportunity. We increased the Fund's
investment in U.S. government bonds from 9% on August 31, 1996 to 16% on
February 28, 1997. We also decreased the portfolio's holdings in the foreign
sector from 17% to 12% during the same period. The foreign sector had performed
very well, so we realized the gains for the portfolio and shifted assets to the
U.S.
As part of this move, we extended the Fund's average maturity to 12.8 years, as
of February 28, 1997 from 11 years on August 31, 1996. We lengthened average
maturity when we believed that U.S. interest rates had peaked and were about to
fall. This helped the portfolio to keep the highest yields for a longer period
of time.
<PAGE>
PAGE 5
Q HOW ABOUT THE FUND'S POSITION IN MORTGAGE-BACKED SECURITIES AND CMOS?
A Mortgage-backed securities and CMOs provided attractive yield and high credit
quality. The manner in which CMOs are structured also reduced the prepayment
risk to the portfolio. The bonds have performed extremely well. We concentrated
the Fund's CMO investments in securities backed by commercial real estate. This
economic sector has experienced a dramatic turnaround from its downturn in the
early 1990's and is currently in excellent financial condition.
Q WHAT IS YOUR OUTLOOK OVER THE NEXT SIX MONTHS?
A We continue to anticipate a steady interest rate environment, similar to that
of the past few months. We expect the economy to grow at a pace of 1 1/2% to 3%
and for inflation to remain well contained. The economy still exhibits signs of
strength, particularly in the housing and manufacturing sectors and in consumer
confidence. However, consumer borrowing has slowed. This could dampen the rate
of growth, since consumer spending accounts for two-thirds of domestic economic
activity.
We believe that the U.S. economy is in a prolonged moderate growth cycle, with
periodic over-heating and recessionary scares. This leads to a bond market that
should trade in a volatile pattern, but within a generally well-defined range.
Longer term, we do not see excesses in the economy that could cause embedded
higher inflation. That type of setting should bode well for the fixed-income
markets.
(diamond)
THIS COLUMN IS INTENDED TO ANSWER QUESTIONS ABOUT YOUR FUND.
IF YOU HAVE A QUESTION YOU WOULD LIKE ANSWERED, PLEASE WRITE TO:
EVERGREEN KEYSTONE INVESTMENT SERVICES, INC.
ATTN: SHAREHOLDER COMMUNICATIONS, 22ND FLOOR
200 BERKELEY STREET, BOSTON, MASSACHUSETTS 02116-5034.
<PAGE>
PAGE 6
KEYSTONE DIVERSIFIED BOND FUND (B-2)
Your Fund's
Performance
(Graphics chart appears here an
it plot points are as follows:)
REINVESTED INITIAL
DISTRIBUTIONS INVESTMENT
2/87 10000 10000
2/88 9246.78 10228.5
2/89 8835.48 10801
2/90 8022.8 10896.8
2/91 7462.84 11387.9
2/92 7923.69 13317.6
2/93 8186.32 14972.9
2/94 8270.57 16365
2/95 7418.24 15792.5
2/96 7462,84 17335.4
2/97 7522.3 1870.8
<TABLE>
<CAPTION>
SIX-MONTH PERFORMANCE AS OF FEBRUARY 28, 1997
<S> <C> <C> <C>
Total return* 7.16%
Net asset value 8/31/96 $14.65
2/28/97 $15.18
Dividends $0.51
Capital gains None
</TABLE>
* BEFORE DEDUCTION OF CONTINGENT DEFERRED SALES CHARGE (CDSC)
[CAPTION]
<TABLE>
<CAPTION>
HISTORICAL RECORD AS OF FEBRUARY 28, 1997
<S> <C> <C> <C>
IF YOU IF YOU DID
CUMULATIVE TOTAL RETURN REDEEMED NOT REDEEM
<S> <C> <C> <C>
1-year 4.92% 7.92%
5-year 40.47% 40.47%
10-year 87.08% 87.08%
Average annual total return
1-year 4.92% 7.92%
5-year 7.03% 7.03%
10-year 6.46% 6.46%
</TABLE>
The one year return reflects the deduction of the 3% contingent deferred sales
charge for those investors who sold Fund shares after one calendar year.
Investors who retained their fund investment received the one-year return
reported in the second column of the table.
The investment return and principal value will fluctuate so that your shares,
when redeemed, may be worth more or less than your original cost.
You may exchange shares for another Keystone fund by phone or in writing. You
may also exchange funds through Keystone's Automated Response Line (KARL). The
Fund reserves the right to change or terminate the exchange offer.
<PAGE>
PAGE 7
SCHEDULE OF INVESTMENTS-- FEBRUARY 28, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
INTEREST MATURITY PAR MARKET
RATE DATE VALUE VALUE
<S> <C> <C> <C> <C> <C>
FIXED INCOME (98.2%)
INDUSTRIAL BONDS & NOTES (49.1%)
ADVERTISING & PUBLISHING (0.6%)
K-III Communications Corporation Sr. Notes 8.500% 2006 $ 2,000,000 $ 2,000,000
Lamar Advertising Corporation Notes 9.675 2006 1,250,000 1,306,250
3,306,250
AMUSEMENTS (2.1%)
Casino America, Incorporated Sr. Secd. Notes 12.500 2003 3,500,000 3,587,500
Six Flags Theme Parks, Incorporated
(Eff. Yield 11.12%) (c) Sr. Disc. Notes 0.000 2005 2,250,000 2,227,500
Trump Atlantic City Associates 1st Mtge. Notes 11.250 2006 5,000,000 4,825,000
10,640,000
BROADCASTING (0.5%)
Sinclair Broadcast Group, Incorporated Sr. Notes (Subord.) 10.000 2005 2,500,000 2,612,500
BUILDING MATERIALS (2.4%)
Continental Homes Holding Corporation Sr. Notes 10.000 2006 3,000,000 3,150,000
HMH Properties, Incorporated Sr. Secd. Notes 9.500 2005 5,000,000 5,262,500
Schuller International Group,
Incorporated Sr. Notes 10.875 2004 2,500,000 2,775,000
Webb Corporation Sr. Notes (Subord.) 9.750 2008 1,000,000 1,018,750
12,206,250
CABLE (1.5%)
Comcast Corporation
(Eff. Yield 11.72%) (c) Sr. Disc. Deb. (Subord.) 0.000 2000 3,380,000 2,475,850
Continental Cablevision Sr. Notes 8.625 2003 3,500,000 3,775,695
Fundy Cable Limited Sr. Secd. Second Priority Note 11.000 2005 1,175,000 1,251,375
7,502,920
CAPITAL GOODS (1.8%)
John Deere Capital Corporation Deb. 8.625 2019 8,850,000 9,488,173
CHEMICALS (0.8%)
ISP Holdings Sr. Notes 9.750 2002 2,166,000 2,306,790
Rexene Corporation Sr. Notes 11.750 2004 1,450,000 1,642,125
3,948,915
</TABLE>
(CONTINUED ON NEXT PAGE)
<PAGE>
PAGE 8
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SCHEDULE OF INVESTMENTS-- FEBRUARY 28, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
INTEREST MATURITY PAR MARKET
RATE DATE VALUE VALUE
<S> <C> <C> <C> <C> <C>
CONSUMER GOODS (2.0%)
Coty, Incorporated Sr. Notes (Subord.) 10.250% 2005 $ 2,500,000 $ 2,750,000
Revlon Worldwide Corporation
(Eff. Yield 12.95%) (c) Sr. Secd. Disc. Notes 0.000 1998 3,500,000 3,281,250
Revlon Worldwide Corporation
(Eff. Yield 10.75%) (b) (c) Sr. Secd. Disc. Notes 0.000 2001 6,840,000 4,486,356
10,517,606
DIVERSIFIED COMPANIES (3.0%)
General Electric Capital Corporation Notes 7.500 2035 6,000,000 6,109,920
Grand Metropolitan Investment
Corporation Sr. Notes 7.450 2035 9,000,000 9,483,480
15,593,400
ENERGY & ELECTRICAL PRODUCTS (1.2%)
Affinity Group Sr. Notes 11.500 2003 2,500,000 2,625,000
Arrow Electronics, Incorporated Sr. Notes 7.000 2007 3,800,000 3,736,968
6,361,968
FINANCE (9.6%)
ABN Amro Bank Subord. Debs. 7.300 2026 3,000,000 2,786,790
Amsouth Bancorporation Subord. Debs. 6.750 2025 10,000,000 9,768,500
APP International Finance Company B. V. Secd. Sr. Notes 11.750 2005 2,000,000 2,205,000
Commercial Credit Group, Incorporated Notes 10.000 2009 5,000,000 6,057,150
First Nationwide Holdings Sr. Notes 12.500 2003 2,500,000 2,825,000
JPM Capital Trust II Deb. 7.950 2027 5,000,000 5,041,750
NB Capital Trust II Notes 7.830 2026 9,000,000 8,965,440
Paine Webber Group, Incorporated Sr. Notes 7.625 2008 10,000,000 10,081,100
Tembec Finance Corporation Sr. Notes 9.875 2005 2,000,000 2,015,000
49,745,730
FOODS (0.6%)
TLC Beatrice International Holdings,
Incorporated Sr. Secd. Notes 11.500 2005 3,000,000 3,210,000
HEALTHCARE (0.7%)
Genesis Health Ventures, Incorporated Sr. Notes (Subord.) 9.250 2006 3,250,000 3,315,000
HOTELS (0.2%)
Wyndham Hotel Corporation Sr. Notes (Subord.) 10.500 2006 1,000,000 1,070,000
</TABLE>
<PAGE>
PAGE 9
SCHEDULE OF INVESTMENTS-- FEBRUARY 28, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
INTEREST MATURITY PAR MARKET
RATE DATE VALUE VALUE
<S> <C> <C> <C> <C> <C>
INSURANCE (7.5%)
Lumbermens Mutual Casualty
Corporation (b) Sr. Notes (Subord.) 9.150% 2026 $ 5,000,000 $ 5,476,500
MBIA, Incorporated Deb. 9.375 2011 15,250,000 18,039,835
Nationwide CSN Trust (b) Sr. Notes 9.875 2025 10,000,000 10,922,600
Reliance Group Holdings, Incorporated Sr. Deb. (Subord.) 9.750 2003 4,000,000 4,220,000
38,658,935
METALS & MINING (0.7%)
Koppers Industries, Incorporated Sr. Notes 8.500 2004 3,500,000 3,430,000
MUNICIPALS (1.0%)
Los Angeles, California (b) Fire Safety Improvements 8.480 2015 4,896,414 5,086,150
Assessment Dist. #1
OIL & OIL SERVICES (4.2%)
Apache Corporation Deb. 7.625 2096 2,500,000 2,461,325
Occidental Petroleum Corporation Sr. Deb. 10.125 2009 5,500,000 6,699,990
Oslo Seismic (b) 1st Prf. Mtg. Notes 8.280 2011 9,809,897 10,050,926
Stena AB Sr. Notes 10.500 2005 2,000,000 2,190,000
21,402,241
RETAIL (0.4%)
Cole National Group, Incorporated Sr. Notes 11.250 2001 2,000,000 2,205,000
TELECOMMUNICATIONS (6.5%)
Adelphia Communications Corporation (b) Sr. Notes 9.875 2007 2,000,000 1,935,000
American Media Operations Corporation Sr. Notes (Subord.) 11.625 2004 4,000,000 4,400,000
Benedek Communications
(Eff. Yield 12.24%) (b) (c) Sr. Disc. Notes (Subord.) 0.000 2006 3,750,000 2,390,625
Cablevision Systems Corporation Sr. Deb. (Subord.) 9.875 2013 1,500,000 1,507,500
Cablevision Systems Corporation Sr. Deb. (Subord.) 10.500 2016 1,500,000 1,575,000
Comcast Corporation Sr. Deb. (Subord.) 10.625 2012 2,500,000 2,812,500
Marcus Cable Operations Limited
Partnership (Eff. Yield 10.91%) (c) Sr. Disc. Notes (Subord.) 0.000 2004 3,000,000 2,505,000
Millicom International Cellular S. A.
(b) Sr. Notes (Subord.) 13.500 2006 3,750,000 2,531,250
Pricecellular Wireless Corporation
(Eff. Yield 10.52%) (c) Sr. Disc. Notes 0.000 2003 4,025,000 3,642,625
SFX Broadcasting, Incorporated Sr. Notes (Subord.) 10.750 2006 3,500,000 3,780,000
Telewest PLC (Eff. Yield 9.83%) (c) Sr. Disc. Deb. 0.000 2007 5,000,000 3,437,500
Vanguard Cellular Systems, Incorporated Sr. Deb. 9.375 2006 3,000,000 3,045,000
33,562,000
</TABLE>
(CONTINUED ON NEXT PAGE)
<PAGE>
PAGE 10
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SCHEDULE OF INVESTMENTS-- FEBRUARY 28, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
INTEREST MATURITY PAR MARKET
RATE DATE VALUE VALUE
<S> <C> <C> <C> <C> <C>
TRANSPORTATION (0.8%)
Golden State Petroleum Transportation
Corporation (b) 1st Pfd. Mtge. Notes 8.040% 2019 $ 4,000,000 $ 3,958,750
UTILITIES (1.0%)
El Paso Electric Company 1st Mtge. Bonds 9.400 2011 5,000,000 5,381,300
TOTAL INDUSTRIAL BONDS & NOTES (COST-- $247,016,604) 253,203,088
FOREIGN BONDS (U.S. DOLLARS) (3.0%)
Grupo Televisa S.A. (b) Sr. Notes 11.875 2006 1,500,000 1,668,750
Indah Kiat International Finance Company
B. V. Sr. Secd. Notes 12.500 2006 3,000,000 3,360,000
Ispat Mexicana S.A. Sr. Unsecd. Deb. 10.375 2001 4,000,000 4,070,000
Republic of Argentina Deb. 11.375 2017 1,800,000 1,912,500
Transportacion Maritima Mexicana Sr. Notes 10.000 2006 3,500,000 3,473,750
TV Azteca S.A. de C.V. (b) Sr. Notes 10.500 2007 750,000 761,250
TOTAL FOREIGN BONDS (U.S. DOLLARS) (COST-- $13,903,769) 15,246,250
FOREIGN BONDS (NON U.S. DOLLARS) (11.3%)
Canada Government Deb. 8.750 2005 18,400,000 15,646,799
Canadian Dollars
Federal Republic of Germany Deb. 6.500 2003 16,813,000 10,799,169
German Marks
Federal Republic of Germany Deb. 6.875 2005 24,700,000 16,121,434
German Marks
United Kingdom Treasury Govt. Gtd. 7.000 2001 9,670,000 15,796,277
Pound Sterling
TOTAL FOREIGN BONDS (NON U.S. DOLLARS) (COST-- $60,643,814) 58,363,679
COLLATERALIZED MORTGAGE OBLIGATIONS (19.6%)
Asset Securitization Corporation
(Est. Mat. 2011) (a) Series 1996-D3 7.707 2026 3,000,000 3,060,000
Chase Mortgage Finance Corporation
(Est. Mat. 2005) (a) (b) Series 1994-L 7.875 2025 3,015,753 2,937,532
Collateralized Mortgage Investors Trust
(Est. Mat. 1997) (a) Series 6 Class D 8.800 2006 580,957 579,864
Criimi Mae Financial Corporation
(Est. Mat. 2003) (a) Series 1 Class A 7.000 2033 3,237,260 3,107,769
DLJ Mortgage Acceptance Corporation
(Est. Mat. 2007) (a) Series 1997 7.818 2026 8,000,000 7,870,000
FHA Pool #02043143 (Est. Mat. 1999) (a) Blair House Project 9.125 2034 3,374,009 3,648,147
FHA Pool #02043143 (Est. Mat. 1999) (a) Blair House Project 10.250 2034 2,500,587 2,650,661
FHLMC (Est. Mat. 2010) (a) Series G8 Class SB inverse floater 9.600 2023 191,912 157,727
FHLMC Trust (Est. Mat. 2004) (a) Series 47, Class A 5.000 2022 5,000,000 4,398,438
FNMA (Est. Mat. 2004) (a) Series 1993-248, Class SA 3.213 2023 12,510,527 9,081,861
</TABLE>
<PAGE>
PAGE 11
SCHEDULE OF INVESTMENTS-- FEBRUARY 28, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
INTEREST MATURITY PAR MARKET
RATE DATE VALUE VALUE
<S> <C> <C> <C> <C> <C>
COLLATERALIZED MORTGAGE OBLIGATIONS (CONTINUED)
FNMA (Est. Mat. 2004) (a) Series 1993-196, Class SC 5.374% 2008 $ 5,700,000 $ 4,741,688
FNMA Trust (Est. Mat. 2007) (a) Series 1993 038 Class L 5.000 2022 5,000,000 4,185,900
GS Mortgage Securities Corporation
(Est. Mat. 2007) (a) Series 1996-PL 7.410 2027 4,700,000 4,600,859
Marine Midland (Est. Mat. 1997) (a) Series 1991-3 8.000 2024 3,434,960 3,429,592
Merrill Lynch Mortgage Investors,
Incorporated (Est. Mat. 2007) (a) Series 1996-C1 7.420 2026 5,000,000 4,963,281
Merrill Lynch Mortgage Investors,
Incorporated (Est. Mat. 2000) (a) Series 1992 D Class B 8.500 2017 1,407,091 1,463,009
Morgan Stanley, Incorporated
(Est. Mat. 2001) (a) (b) Series 1996 Class A 6.475 2010 4,909,581 4,766,897
Morgan Stanley, Incorporated
(Est. Mat. 2006) (a) (b) Series 1996-WF1 Class B 6.587 2006 2,000,000 1,903,750
Paine Webber Mortgage Acceptance
Corporation IV (Est. Mat. 2006) (a) Series 1993-4 7.500 2023 2,851,796 2,802,660
Residential Asset Securitization Trust
(Est. Mat. 2008) (a) Series 1996-A3 Class A9 7.500 2026 5,000,000 4,767,187
Ryland Acceptance Corporation
(Est. Mat. 2000) (a) Series 88, Class E 7.950 2019 9,778,521 9,818,222
Shearson Lehman, Incorporated
(Est. Mat. 2004) (a) Series V, Class 5 7.500 2019 5,000,000 4,962,500
Volvo Car Finance Grantor Trust
(Eff. Yield 6.62%) (Est. Mat. 1996)
(a) (b) (c) Series 1993-2 Class A 0.000 1997 105,455 105,291
Zale Funding Trust (Est. Mat. 1999) (a) Series 1994-1 Class A2 7.325 2003 11,000,000 11,120,312
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (COST-- $101,184,049) 101,123,147
ASSET-BACKED SECURITIES (0.7%) (COST-- $3,983,750)
Cargill Lease Receivables Trust Series 1996-A Class A2 6.430 2005 4,000,000 3,950,625
UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (14.5%)
FHLMC Global Note 6.700 2007 5,575,000 5,531,459
United States Treasury Bonds 6.500 2026 8,300,000 7,918,698
United States Treasury Bonds 7.875 2021 26,250,000 29,047,200
United States Treasury Notes 6.250 2002 8,250,000 8,194,560
United States Treasury Notes 6.500 2006 5,215,000 5,174,271
United States Treasury Strip
(Eff. Yield 8.71%) (c) 0.000 2021 106,250,000 18,893,375
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C>
TOTAL UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (COST-- $74,586,905) 74,759,563
</TABLE>
(CONTINUED ON NEXT PAGE)
<PAGE>
PAGE 12
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SCHEDULE OF INVESTMENTS-- FEBRUARY 28, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
MARKET
VALUE
<S> <C> <C> <C> <C> <C>
TOTAL FIXED INCOME (COST-- $501,318,891) $506,646,352
SHARES
COMMON STOCK (0.0%) (COST-- $2)
PM Holdings Corporation (d) 1,618 2
<CAPTION>
INTEREST MATURITY MATURITY
RATE DATE VALUE
<S> <C> <C> <C> <C> <C>
REPURCHASE AGREEMENT (4.1%) (COST-- $21,273,000)
Keystone Joint Repurchase Agreement
(Investments in repurchase agreements,
in a joint trading account, purchased
2/28/97) (e) 5.413% 3/3/97 $21,282,596 21,273,000
TOTAL INVESTMENTS (COST-- $522,591,893) 527,919,354
OTHER ASSETS AND LIABLITIES-- NET (-2.3%) (12,029,923)
NET ASSETS (100%) $515,889,431
</TABLE>
(a) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected prepayment rates. Changes in interest rates
can cause the estimated maturity to differ from the listed date.
(b) 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.
(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 agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at February 28, 1997.
Legend of Portfolio Abbreviations:
FHA-- Federal Housing Administration
FHLMC-- Federal Home Loan Mortgage Corporation
FNMA-- Federal National Mortgage Association
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
NET UNREALIZED
EXCHANGE U.S. VALUE AT IN EXCHANGE APPRECIATION/
DATE FEBRUARY 28, 1997 FOR U.S. $ DEPRECIATION
<S> <C> <C> <C> <C> <C>
Forward Foreign Currency Exchange Contracts
to Sell
Contracts to Deliver
04/28/97 9,670,000 British Pounds $15,739,470 $15,709,205 $(30,265)
05/09/97 47,299,000 German Marks 28,173,804 28,878,360 704,556
05/27/97 21,649,440 Canadian Dollars 15,931,920 15,998,699 66,779
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 13
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
FEBRUARY 28, YEAR ENDED AUGUST 31,
1997 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net asset value beginning of period $14.65 $15.09 $15.28 $17.06 $16.44 $15.37
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.47 0.95 1.06 1.06 1.28 1.33
Net realized and unrealized gain (loss) on investments and foreign
currency related transactions 0.57 (0.35) 0.11 (1.62) 0.70 1.14
Total from investment operations 1.04 0.60 1.17 (0.56) 1.98 2.47
LESS DISTRIBUTIONS FROM:
Net investment income (0.51) (0.96) (1.06) (1.22) (1.28) (1.33)
In excess of net investment income 0 0 (0.22) 0 (0.08) (0.07)
Tax basis return of capital 0 (0.08) (0.08) 0 0 0
Total distributions (0.51) (1.04) (1.36) (1.22) (1.36) (1.40)
NET ASSET VALUE END OF PERIOD $15.18 $14.65 $15.09 $15.28 $17.06 $16.44
TOTAL RETURN (A) 7.16% 4.03% 8.13% (3.53%) 12.73% 16.88%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Total expenses 1.88%(b)(c) 1.84%(b) 1.81% 1.75% 1.89% 1.99%
Net investment income 6.26%(c) 6.42% 7.05% 6.48% 7.73% 8.29%
Portfolio turnover rate 66% 246% 178% 200% 133% 117%
Net assets end of period (thousands) $515,889 $559,792 $734,837 $814,245 $1,004,393 $902,339
</TABLE>
(a) Excluding applicable sales charges.
(b) Ratio of expenses to average net assets includes indirectly paid expenses.
Excluding indirectly paid expenses, the expense ratios would have been 1.87%
(annualized) for the six months ended February 28, 1997 and 1.83% for the
year ended August 31, 1996.
(c) Annualized.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 14
KEYSTONE DIVERSIFIED BOND FUND (B-2)
STATEMENT OF ASSETS AND LIABILITIES
FEBRUARY 28, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
<S> <C>
ASSETS (NOTE 2)
Investments at market value
(identified cost-- $522,591,893) $527,919,354
Cash 252,138
Receivable for:
Interest 9,001,787
Investments sold 6,911,100
Fund shares sold 138,395
Net unrealized appreciation on forward
foreign currency exchange contracts 771,335
Prepaid expenses and other assets 129,496
Total assets 545,123,605
LIABILITIES (NOTES 2, 4 AND 5)
Payable for:
Investments purchased 17,716,561
Reverse repurchase agreement 8,065,541
Fund shares redeemed 1,233,158
Distributions to shareholders 1,267,451
Distribution fees payable 873,190
Net unrealized depreciation on forward
foreign currency exchange contracts 30,265
Due to related parties 12,701
Other accrued expenses 35,307
Total liabilities 29,234,174
NET ASSETS $515,889,431
NET ASSETS REPRESENTED BY
Paid-in capital $672,745,544
Accumulated distributions in excess of net
investment income (2,715,199)
Accumulated net realized loss on investments
and foreign currency related transactions (160,079,290)
Net unrealized appreciation on investments
and foreign currency related transactions 5,938,376
Total net assets $515,889,431
NET ASSET VALUE PER SHARE (NOTE 2)
Net asset value of $515,889,431433,981,190
outstanding shares of beneficial interest $ 15.18
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
STATEMENT OF OPERATIONS
SIX MONTHS ENDED FEBRUARY 28, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME
Interest (Net of foreign
witholding tax of $4,459) $22,107,450
EXPENSES (NOTES 4, 5 AND 6)
Distribution Plan expenses $ 2,713,986
Management fee 1,490,237
Transfer agent fees 655,739
Custodian fees 137,423
Accounting, auditing and legal
fees 32,503
Trustees' fees and expenses 14,090
Other 63,312
Total expenses 5,107,290
Less: Indirectly paid expenses (32,096)
Net expenses 5,075,194
NET INVESTMENT INCOME 17,032,256
NET REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS AND FOREIGN
CURRENCY RELATED TRANSACTIONS
(NOTE 3)
Net realized gain on:
Investments 6,618,743
Foreign currency related
transactions 3,210,524
Net realized gain on investments
and foreign currency related
transactions 9,829,267
Net change in unrealized
appreciation on:
Investments 10,642,469
Foreign currency related
transactions 1,037,384
Net change in unrealized
appreciation on investments and
foreign currency related
transactions 11,679,853
Net realized and unrealized gain
on investments and foreign
currency related transactions 21,509,120
Net increase in net assets
resulting from operations $38,541,376
</TABLE>
<PAGE>
PAGE 15
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
FEBRUARY 28, 1997 AUGUST 31, 1996
<S> <C> <C>
<CAPTION>
(UNAUDITED)
<S> <C> <C>
OPERATIONS:
Net investment income $ 17,032,256 $ 42,141,831
Net realized gain on investments and foreign currency related transactions 9,829,267 323,307
Net change in unrealized appreciation (depreciation) on investments and foreign
currency related transactions 11,679,853 (14,654,381)
Net increase in net assets resulting from operations 38,541,376 27,810,757
DISTRIBUTIONS TO SHAREHOLDERS FROM (NOTE 1)
Net investment income (18,300,501) (42,020,420)
Tax basis return of capital 0 (2,935,918)
Total distributions to shareholders (18,300,501) (44,956,338)
NET INCREASE (DECREASE) IN CAPITAL SHARE TRANSACTIONS (NOTE 2)
Proceeds from shares sold 21,569,041 89,671,653
Payments for shares redeemed (95,796,787) (273,136,100)
Net asset value of shares issued in reinvestment of dividends and distributions 10,084,364 25,564,686
Total decrease from capital share transactions (64,143,382) (157,899,761)
Total decrease in net assets (43,902,507) (175,045,342)
NET ASSETS:
Beginning of period 559,791,938 734,837,280
End of period [Including accumulated distributions in excess of net investment
income as follows: 1997-- ($2,715,199) and 1996-- ($1,446,954)] (Note 1) $ 515,889,431 $ 559,791,938
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 16
KEYSTONE DIVERSIFIED TERM BOND FUND (B-2)
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. SIGNIFCANT ACCOUNTING POLICIES
Keystone Diversified Bond Fund (B-2) (the "Fund") is a Pennsylvania common law
trust for which Keystone Investment Management Company ("Keystone") is the
Investment Adviser and Manager. Keystone was formerly a wholly-owned subsidiary
of Keystone Investments, Inc. ("KII") and is currently a subsidiary of First
Union Keystone, Inc. First Union Keystone, Inc. is a wholly-owned subsidiary of
First Union National Bank of North Carolina which in turn is a wholly-owned
subsidiary of First Union Corporation ("First Union"). The Fund is registered
under the Investment Company Act of 1940, as amended (the "1940 Act"), as a
diversified, open-end investment company. The Fund's investment objective is to
provide maximum income without undue risk of principal.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles, which
require management to make estimates and assumptions that affect amounts
reported herein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial to the net assets of the Fund.
A. VALUATION OF SECURITIES
U.S. Government obligations held by the Fund are valued at the mean between the
over-the-counter bid and asked prices as furnished by an independent pricing
service. Listed corporate bonds, other fixed income securities, mortgage and
other asset-backed securities, and other related securities are valued at prices
provided by an independent pricing service. In determining value for normal
institutional-size transactions, the pricing service uses methods based on
market transactions for comparable securities and various relationships between
securities which are generally recognized by institutional traders. Securities
for which valuations are not available from an independent pricing service
(including restricted securities) are valued at fair value as determined in good
faith according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. REPURCHASE AGREEMENTS
Pursuant to an exemptive order issued by the Securities and Exchange Commission,
the Fund, along with certain other Keystone funds, may transfer uninvested cash
balances into a joint trading account. These balances are invested in one or
more repurchase agreements that are fully collateralized by U.S. Treasury and/or
Federal Agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the collateral
daily and will require the seller to provide additional collateral in the event
the market value of the securities pledged falls below the carrying value of the
repurchase agreement.
C. REVERSE REPURCHASE AGREEMENTS
The Fund enters into reverse repurchase agreements with qualified third-party
broker-dealers. Interest on the value of reverse repurchase agreements is based
upon competitive market rates at the time of issuance. At the time the Fund
enters into a reverse repurchase agreement, it will establish and maintain a
segregated account with its custodian containing liquid assets having a value
not less than the repurchase price (including accrued interest). If the
counterparty to the transaction is rendered insolvent, the ultimate realization
of the securities to be repurchased by the Fund may be delayed or limited.
D. FOREIGN CURRENCY
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into United States dollars as
follows:
<PAGE>
PAGE 17
market value of investments, assets and liabilities at the daily rate of
exchange; purchases and sales of investments, income and expenses at the rate of
exchange prevailing on the respective dates of such transactions. Net unrealized
foreign exchange gain (loss) resulting from changes in foreign currency exchange
rates is a component of net unrealized appreciation (depreciation) on
investments and foreign currency transactions. Net realized foreign currency
gains and losses resulting from changes in exchange rates include foreign
currency gains and losses between trade date and settlement date on investment
securities transactions, foreign currency transactions and the difference
between the amounts of interest and dividends recorded on the books of the Fund
and the amount actually received. The portion of foreign currency gains and
losses related to fluctuations in exchange rates between the initial purchase
trade date and subsequent sale trade date is included in realized gain (loss) on
foreign currency transactions.
E. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to settle portfolio purchases and sales of securities denominated in
a foreign currency and to hedge certain foreign currency assets or liabilities.
Forward contracts are recorded at the forward rate and marked-to-market daily.
Realized gains and losses arising from such transactions are included in net
realized gain (loss) on foreign currency related transactions. The Fund bears
the risk of an unfavorable change in the foreign currency exchange rate
underlying the forward contract and is subject to the credit risk that the other
party will not fulfill their obligations under the contract. Forward contracts
involve elements of market risk in excess of the amount reflected in the
statement of assets and liabilities.
F. SECURITY TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes
amortization of discounts. Dividend income is recorded on the ex-dividend date.
G. FEDERAL INCOME TAXES
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income taxes is required.
H. DISTRIBUTIONS
The Fund distributes net investment income monthly and net capital gains, if
any, at least annually. Distributions to shareholders are recorded at the close
of business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. These differences are primarily due to differing
treatment for paydown gains (losses) and foreign currency transactions for
income tax purposes that have been recognized for financial statement purposes.
<PAGE>
PAGE 18
KEYSTONE DIVERSIFIED BOND FUND (B-2)
2. CAPITAL SHARE TRANSACTIONS
The Fund's Restatement of 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:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED
02/28/97 08/31/96
<S> <C> <C>
Shares sold 1,421,638 5,954,123
Shares redeemed (6,329,063) (18,152,163)
Shares issued in reinvestment
of dividends and
distributions 667,510 1,709,087
Net decrease (4,239,915) (10,488,953)
</TABLE>
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) were as follows for the six months ended February 28,
1997:
<TABLE>
<CAPTION>
COST OF PROCEEDS
PURCHASES FROM SALES
<S> <C> <C>
Non-U.S. Government $193,849,887 $277,042,706
U.S. Government 158,025,905 136,623,036
</TABLE>
As of August 31, 1996, the Fund had a capital loss carryover for federal
income tax purposes of approximately $169,901,000 which expires as follows:
$38,243,000-- 1998; $85,002,000-- 1999; $26,644,000-- 2003 and
$20,012,000-- 2004.
The average daily balance of reverse repurchase agreements outstanding during
the six months ended February 28, 1997 was $6,534,838 at a weighted average
interest rate of 4.60%. The maximum amount of borrowing during the six months
ended February 28, 1997 was $16,852,313 (including accrued interest).
4. DISTRIBUTION PLANS
The Fund bears some of the costs of selling its shares under a Distribution Plan
(the "Plan") adopted pursuant to Rule 12b-1 under the 1940 Act. Under the Plan,
the Fund pays its principal underwriter amounts which are calculated and paid
monthly.
On December 11, 1996, the Fund entered into a principal underwriting agreement
with Evergreen Keystone Distributor, Inc. (formerly, Evergreen Funds
Distributor, Inc.) ("EKD"), a wholly-owned subsidiary of The BISYS Group Inc.
Prior to December 11, 1996, Evergreen Keystone Investment Services, Inc.
(formerly, Keystone Investment Distributors Company) ("EKIS"), a wholly-owned
subsidiary of Keystone, served as the Fund's principal underwriter.
Under the Plan, the Fund pays a distribution fee which may not exceed 1.00% of
the Fund's average daily net assets. Of that amount, 0.75% is used to pay
distribution expenses and 0.25% may be used to pay service fees.
Contingent deferred sales charges paid by redeeming shareholders are paid to
EKD or its predecessor.
The Plan may be terminated at any time by vote of the Independent Trustees or
by vote of a majority of the outstanding voting shares of the Fund. However,
after the termination of the Plan, and at the discretion of the Independent
Trustees, payments to EKIS and/or EKD may continue as compensation for services
which had been earned while the Plan was in effect.
EKD intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof would be within permitted limits.
At February 28, 1997 total unpaid distribution costs were $16,840,396.
5. INVESTMENT MANAGEMENT AGREEMENT AND OTHER AFFILIATED TRANSACTIONS
Under an investment advisory agreement dated December 11, 1996, Keystone serves
as the Investment Adviser and Manager to the Fund. Keystone provides the Fund
with investment advisory and management services. In return, Keystone is paid a
management fee computed at an annual rate of 2.00% of the Fund's gross
investment income plus an amount determined by applying percentage rates
starting at 0.50% and
<PAGE>
PAGE 19
declining as net assets increase to 0.25% per annum, to the average daily net
asset value of the Fund.
Prior to December 11, 1996, Keystone Management, Inc. ("KMI"), a wholly-owned
subsidiary of Keystone, served as Investment Manager to the Fund and provided
investment management and administrative services. Under an investment advisory
agreement between KMI and Keystone, Keystone served as the Investment Adviser
and provided investment advisory and management services to the Fund. In return
for its services, Keystone received an annual fee equal to 85% of the management
fee received by KMI.
During the six months ended February 28, 1997, the Fund paid or accrued
$11,834 to Keystone for certain accounting services. The Fund paid or accrued
$655,739 to Evergreen Keystone Service Company (formerly, Keystone Investor
Resource Center, Inc.), a wholly-owned subsidiary of Keystone, for services
rendered as the Fund's transfer and dividend disbursing agent.
Officers of the Fund and affiliated Trustees receive no compensation directly
from the Fund.
6. EXPENSE OFFSET ARRANGEMENT
The Fund has entered into an expense offset arrangement with its custodian. For
the six months ended February 28, 1997, the Fund incurred total custody fees of
$137,423 and received a credit of $32,096 pursuant to this expense offset
arrangement, resulting in a net custody expense of $105,327. The assets
deposited with the custodian under this expense offset arrangement could have
been invested in income-producing assets.
7. SUBSEQUENT DISTRIBUTION TO SHAREHOLDERS
A distribution from net investment income of $0.080 was declared payable by
March 6, 1997 to shareholders of record on February 25, 1997. These distribution
are not reflected in the accompanying financial statements.
<PAGE>
PAGE 20
KEYSTONE DIVERSIFIED TERM BOND FUND (B-2)
ADDITIONAL INFORMATION
(UNAUDITED)
Shareholders of the Fund considered and acted upon the proposals listed below at
a special meeting of shareholders held Monday, December 9, 1996. In addition,
below each proposal are the results of that vote.
1. TO ELECT THE FOLLOWING TRUSTEES:
<TABLE>
<CAPTION>
AFFIRMATIVE WITHHELD
<S> <C> <C>
Frederick Amling 24,637,539 595,375
Laurence B. Ashkin 24,635,973 596,941
Charles A. Austin III 24,639,103 593,812
Foster Bam 24,634,864 598,051
George S. Bissell 24,624,879 608,036
Edwin D. Campbell 24,638,566 594,349
Charles F. Chapin 24,637,540 595,375
K. Dun Gifford 24,640,440 592,475
James S. Howell 24,631,987 600,928
Leroy Keith, Jr. 24,635,000 597,915
F. Ray Keyser, Jr. 24,636,653 596,262
Gerald M. McDonell 24,630,133 602,782
Thomas L. McVerry 24,636,774 596,141
William Walt Pettit 24,629,098 603,817
David M. Richardson 24,640,492 592,423
Russell A. Salton, III M.D. 24,632,527 600,388
Michael S. Scofield 24,631,011 601,903
Richard J. Shima 24,639,258 593,657
Andrew J. Simons 24,623,011 609,904
</TABLE>
2. TO APPROVE AN INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT BETWEEN THE FUND
AND KEYSTONE INVESTMENT MANAGEMENT COMPANY:
<TABLE>
<S> <C>
Affirmative 23,977,890
Against 368,163
Abstain 886,862
</TABLE>
<PAGE>
PAGE 21
Glossary of
Mutual Fund Terms
MUTUAL FUND-- A company which combines the investment money of many people
whose fnancial goals are similar, and invests that money in a variety of
securities. A mutual fund allows the smaller investor the benefts of
diversifcation, professional management and constant supervision usually
available only to large investors.
PORTFOLIO MANAGER-- An investment professional who is responsible for managing
a portfolio's assets prudently and making appropriate investment decisions, such
as which securities to buy, hold and sell, based on the investment objectives of
the portfolio.
STOCK-- Equity or ownership interest in a corporation, which represents a
claim on the corporation's assets and earnings.
BOND-- Security issued by a government or corporation to those from whom it
has borrowed money. A bond usually promises to pay interest income to the
bondholder at regular intervals and to repay the entire amount borrowed at
maturity date.
CONVERTIBLE SECURITY-- A corporate security (usually preferred stock or bonds)
that is exchangeable for a set number of another security type (usually common
stocks) at a pre-stated price.
MONEY MARKET FUND-- A mutual fund whose assets are invested in a diversifed
portfolio of short-term securities, including commercial paper, bankers'
acceptances, certifcates of deposit and other short-term instruments. The fund
pays income which can fluctuate daily. Liquidity and safety of principal are
primary objectives.
NET ASSET VALUE (NAV) PER SHARE-- The value of one share of a mutual fund. The
NAV per share is determined by subtracting a fund's total liabilities from its
total assets, and dividing that amount by the number of fund shares outstanding.
DIVIDEND-- A per share distribution of the income earned from the fund's
portfolio holdings. When a dividend distribution is made, the fund's net asset
value drops by the amount of the distribution because the distribution is no
longer considered part of the fund's assets.
CAPITAL GAIN-- The proft from the sale of securities, less any losses. Capital
gains are paid to fund shareholders on a per share basis. When a capital gain
distribution is made, the fund's net asset value drops by the amount of the
distribution because the distribution is no longer considered part of the fund's
assets.
YIELD-- The annualized rate of income as measured against the current net
asset value of fund shares.
TOTAL RETURN-- The change in value of a fund investment over a specifed period
of time, taking into account the change in a fund's market price and the
reinvestment of all fund distributions.
SHORT-TERM-- An investment with a maturity of one year or less.
LONG-TERM-- An investment with a maturity of greater than one year.
AVERAGE MATURITY-- The average number of days until the notes, drafts,
acceptances, bonds or other debt instruments in a portfolio become due and
payable.
OFFERING PRICE-- The offering price of a share of a mutual fund is the price
at which the share is sold to the public.
<PAGE>
(This page left blank intentionally)
<PAGE>
(This page left blank intentionally)
<PAGE>
KEYSTONE
FUND FAMILY
(diamond)
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 Inc.
Precious Metals Holdings, Inc.
Tax Free Fund
Liquid Trust
(Evergreen Keystone
logo appears here)
Evergreen Keystone Distributor, Inc.
230 Park Avenue
New York, New York 10169
KEYSTONE
(photo of Lighthouse
apears here)
DIVERSIFIED
BOND FUND (B-2)
(Evergreen Keystone
logo appears here)
SEMI-ANNUAL REPORT
FEBRUARY 28, 1997
