<PAGE> 1
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
- ----------- ------------
<C> <S> <C>
COMMON STOCKS - 95.76%*
AEROSPACE - 1.57%*
122,500 McDonnell Douglas Corp.(1)...................................... $ 7,472,500
------------
BANKS - 3.89%*
437,918 First USA, Inc.(1).............................................. 18,556,775
------------
BIOTECHNOLOGY - 1.59%*
1,000,800 Calgene, Inc.**(4).............................................. 7,568,550
------------
DEFENSE ELECTRONICS - 1.64%*
144,200 General Motors Corporation - Class H(2)......................... 7,822,850
------------
ELECTRIC UTILITIES - 3.92%*
535,500 Portland General Corporation.................................... 18,675,563
------------
ELECTRONIC DATABASES - 1.71%*
260,500 MDL Information Systems, Inc.**................................. 8,140,625
------------
ELECTRONIC SECURITY PRODUCTS & SERVICES - 3.61%*
408,720 ADT Ltd.**(2)................................................... 10,218,000
387,900 Ultrak, Inc.**(1)(4)............................................ 6,982,200
------------
17,200,200
------------
ELECTRONIC TESTING EQUIPMENT - 2.44%*
322,000 Tencor Instruments Corp.**...................................... 11,632,250
------------
GIFTWARE - 1.48%*
220,300 Syratech Corporation**.......................................... 7,049,600
------------
HEALTH CARE MANAGEMENT SERVICES - 0.18%*
46,000 Value Health, Inc.**............................................ 851,000
------------
HEALTH MAINTENANCE ORGANIZATIONS - 7.07%*
1,194,500 Healthsource, Inc.**(1)......................................... 24,487,250
26,171 PacifiCare Health Systems, Inc. - Class A**(1).................. 2,162,379
81,770 PacifiCare Health Systems, Inc. - Class B**(1).................. 7,052,662
------------
33,702,291
------------
HOTELS & GAMING - 3.48%*
278,900 ITT Corporation**(2)............................................ 16,420,238
10,000 Studio Plus Hotels, Inc.**...................................... 172,500
------------
16,592,738
------------
</TABLE>
See notes to the financial statements.
1
<PAGE> 2
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
- ----------- ------------
<C> <S> <C>
INDEPENDENT POWER - 0.68%*
156,700 Destec Energy, Inc.**........................................... $ 3,231,937
------------
INSURANCE - 11.58%*
16,100 AVEMCO Corporation.............................................. 376,338
500,800 Allmerica Property & Casualty Companies, Inc.(1)................ 15,650,000
228,500 American States Financial Corp.................................. 7,626,187
153,100 Home Beneficial Corporation - Class B(1)........................ 5,836,938
822,200 Pioneer Financial Services, Inc.(1)............................. 20,657,775
132,200 Zurich Reinsurance Centre Holdings, Inc......................... 5,073,175
------------
55,220,413
------------
MEDICAL DEVICES - 3.74%*
119,700 Target Therapeutics, Inc.**(1).................................. 7,870,275
593,550 Ventritex, Inc.**............................................... 9,941,963
------------
17,812,238
------------
MULTI-INDUSTRY - 7.21%*
859,972 Figgie International, Inc., Class A**(1)........................ 10,427,161
519,600 PHH Corporation(1).............................................. 23,966,550
------------
34,393,711
------------
NATURAL GAS TRANSMISSION & MARKETING - 10.40%*
826,000 ENSERCH Corporation(1).......................................... 16,933,000
1,219,000 NorAm Energy Corporation........................................ 17,827,875
218,800 PanEnergy Corporation(4)........................................ 9,435,750
401,400 TPC Corporation**(1)............................................ 5,368,725
------------
49,565,350
------------
OFFICE SUPPLIES - 3.99%*
933,350 Office Depot, Inc.**(1)(2)...................................... 19,017,006
------------
OILFIELD EQUIPMENT & SERVICES - 0.24%*
20,000 Production Operators Corporation(4)............................. 1,132,500
------------
PHYSICIANS PRACTICE MANAGEMENT - 0.19%*
32,300 InPhyNet Medical Management, Inc.**(1).......................... 904,400
------------
RETAILERS - 2.72%*
200,604 Vons Companies, Inc.**(4)....................................... 12,989,109
------------
</TABLE>
See notes to the financial statements.
2
<PAGE> 3
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
- ----------- ------------
<C> <S> <C>
SAVINGS & LOANS - 10.90%*
100,000 First Federal Bancshares of Eau Claire, Inc.(1)................. $ 1,862,500
195,000 Great Western Financial Corporation(2).......................... 7,873,125
445,300 Roosevelt Financial Group, Inc.(2).............................. 9,685,275
508,600 Standard Federal Bancorporation................................. 29,498,800
132,800 Standard Financial, Inc......................................... 3,037,800
------------
51,957,500
------------
SPECIALTY CHEMICALS - 2.00%*
161,100 Petrolite Corp.................................................. 9,525,037
------------
TELEPHONY - 6.72%*
669,874 MCI Communications Corporation(1)............................... 23,864,261
216,100 Pacific Telesis Group(4)........................................ 8,157,775
------------
32,022,036
------------
TOYS - 2.81%*
558,653 Mattel, Inc.(4)................................................. 13,407,664
------------
TOTAL COMMON STOCKS (Cost $470,820,160)........................ 456,443,843
------------
STOCK RIGHTS - 0.10%*
21,895 Talbert Medical Management Corporation (Cost $0)................ 468,013
------------
UNIT TRUSTS - 0.40%*
391,100 EnerMark Income Fund(1)(3) (Cost $1,941,834).................... 1,925,171
------------
CONTRACTS (100 SHARES PER CONTRACT)
- -----------------------------------
PUT OPTIONS PURCHASED - 0.00%*
250 Capital One Finance
Expiration June 1997, Exercise Price $30.00 (Cost $22,765)...... 12,500
------------
PAR
VALUE
- -----------
CONVERTIBLE BONDS - 1.85%*
$10,545,000 IVAX Corporation Debentures CLB (Acquired March 1997, Cost
$9,530,960), 6.50%, 11/15/01 (r)................................ 8,805,075
------------
</TABLE>
See notes to the financial statements.
3
<PAGE> 4
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PAR
VALUE VALUE
- ----------- ------------
<C> <S> <C>
CORPORATE BONDS - 3.34%*
$ 1,300,000 Baby Superstore Subordinated Notes CLB, 4.875%, 10/01/00(1)..... $ 1,293,500
14,855,000 REPAP Wisconsin, Inc. Senior Notes CLB, 9.25%, 2/01/02.......... 14,632,175
------------
TOTAL CORPORATE BONDS (Cost $15,908,769)....................... 15,925,675
------------
TOTAL INVESTMENTS (Cost $498,224,488).......................... $483,580,277
============
</TABLE>
- ------------------------------
* Calculated as a percentage of net assets.
** Non-income producing security.
(1) All or a portion of the shares have been committed as collateral for open
short positions.
(2) All or a portion of the shares have been committed as collateral for written
call options.
(3) Foreign security.
(4) All or a portion of the shares have been committed as collateral for the
credit facility.
r - Restricted security.
See notes to the financial statements.
4
<PAGE> 5
THE MERGER FUND
SCHEDULE OF SECURITIES SOLD SHORT
MARCH 31, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
------ ------------
<C> <S> <C>
62,175 Allmerica Financial Corporation................................. $ 2,183,897
42,700 American General Corporation.................................... 1,740,025
510,303 Banc One Corporation............................................ 20,284,544
79,625 The Boeing Company.............................................. 7,853,016
127,000 Boston Scientific Corporation................................... 7,842,250
361,708 British Telecommunications plc ADR.............................. 25,319,560
26,000 Camco International, Inc........................................ 1,144,000
205,500 Checkpoint Systems, Inc......................................... 3,519,188
26,650 Columbia/HCA Healthcare Corporation............................. 896,106
113,752 Conseco, Inc.................................................... 4,052,415
228,262 Duke Power Company.............................................. 10,072,061
535,500 Enron Corporation............................................... 20,349,000
976,417 Enserch Exploration, Inc........................................ 8,665,701
12,250 Extended Stay America, Inc...................................... 180,687
16,100 HCC Insurance Holdings, Inc..................................... 394,450
165,500 HFS, Inc........................................................ 9,743,813
70,200 Houston Industries, Incorporated................................ 1,465,425
322,000 KLA Instruments Corporation..................................... 11,753,000
560,070 Mattel, Inc..................................................... 13,441,680
42,323 MedPartners, Inc................................................ 899,364
119,025 Mercantile Bancorporation, Inc.................................. 6,308,325
26,171 PacifiCare Health Systems, Inc. - Class A....................... 2,162,379
81,770 PacifiCare Health Systems, Inc. - Class B....................... 7,052,662
157,470 SBC Communications, Inc......................................... 8,286,859
285,860 Safeway, Inc.................................................... 13,256,757
333,150 St. Jude Medical Inc............................................ 11,118,881
697,130 Staples, Inc.................................................... 14,029,741
79,300 Texas Utilities Company......................................... 2,716,025
58,700 Tyco International Ltd.......................................... 3,228,500
------------
TOTAL SECURITIES SOLD SHORT (Proceeds $227,770,244)............. $219,960,311
============
</TABLE>
See notes to the financial statements.
5
<PAGE> 6
THE MERGER FUND
SCHEDULE OF CALL OPTIONS WRITTEN
MARCH 31, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
CONTRACTS (100 SHARES PER CONTRACT) VALUE
- ----------------------------------- ------------
<C> <S> <C>
2,866 ADT Ltd.
Expiration April 1997, Exercise Price $25.00.................. $ 232,863
1,017 General Motors Corporation -- Class H
Expiration May 1997, Exercise Price $55.00.................... 127,125
Great Western Financial Corporation
1,200 Expiration April 1997, Exercise Price $45.00.................... 45,000
750 Expiration April 1997, Exercise Price $40.00.................... 145,312
------------
190,312
------------
2,789 ITT Corporation
Expiration April 1997, Exercise Price $60.00.................. 209,175
865 Office Depot, Inc.
Expiration April 1997, Exercise Price $22.50.................. 59,469
200 Roosevelt Financial Group, Inc.
Expiration June 1997, Exercise Price $20.00................... 37,500
------------
TOTAL CALL OPTIONS WRITTEN
(Premiums received $1,945,873).................................. $ 856,444
============
</TABLE>
See notes to the financial statements.
6
<PAGE> 7
THE MERGER FUND
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1997 (UNAUDITED)
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (Cost $498,224,488)
See accompanying schedule................................... $483,580,277
Cash........................................................... 7,955,108
Deposit at brokers for short sales............................. 54,282,253
Receivable from brokers for proceeds on securities sold
short....................................................... 226,147,641
Receivable for investments sold................................ 27,584,997
Interest receivable............................................ 519,640
Dividends receivable........................................... 101,436
Other receivables.............................................. 311,447
------------
Total Assets........................................... 800,482,799
LIABILITIES:
Loan payable (Note 10)......................................... $ 35,800,000
Securities sold short, at value (Proceeds of $227,770,244)
See accompanying schedule................................... 219,960,311
Payable for investment securities purchased.................... 27,481,516
Short-term borrowings.......................................... 38,500,000
Call options written, at value (Premiums received $1,945,873)
See accompanying schedule................................... 856,444
Accrued interest payable....................................... 635,958
Investment advisory fee payable................................ 398,649
Distribution fees payable...................................... 76,710
Accrued expenses and other payables............................ 133,880
------------
Total Liabilities...................................... 323,843,468
------------
NET ASSETS....................................................... $476,639,331
============
NET ASSETS consist of:
Accumulated undistributed net investment loss.................. $ (82,808)
Accumulated undistributed net realized gain on investments
sold, securities sold short and option contracts expired or
closed...................................................... 17,790,630
Net unrealized appreciation (depreciation) on:
Investments................................................. (14,633,946)
Short positions............................................. 7,809,933
Call options................................................ 1,089,429
Put options................................................. (10,265)
Paid-in capital................................................ 464,676,358
------------
Total Net Assets....................................... $476,639,331
============
NET ASSET VALUE, offering price and redemption price per share
($476,639,331 / 33,409,410 shares of beneficial interest
outstanding)................................................... $14.27
</TABLE>
See notes to the financial statements.
7
<PAGE> 8
THE MERGER FUND
STATEMENT OF OPERATIONS
FOR THE FOUR MONTHS ENDED MARCH 31, 1997 (UNAUDITED)
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest...................................................... $ 5,501,567
Dividend income on long positions
(net of foreign withholding taxes of $16,203).............. 1,232,767
-----------
Total investment income.................................... 6,734,334
-----------
EXPENSES:
Investment advisory fee....................................... $ 1,604,448
Distribution fees............................................. 257,748
Transfer agent and shareholder servicing agent fees........... 67,074
Federal and state registration fees........................... 34,364
Professional fees............................................. 59,041
Trustees' fees and expenses................................... 7,846
Custody fees.................................................. 46,352
Administration fee............................................ 72,290
Reports to shareholders....................................... 27,437
Other......................................................... 9,130
-----------
Total Operating Expenses Before Interest Expense and
Dividends on Short Positions............................. 2,185,730
Interest expense.............................................. 3,003,775
Dividends on short positions.................................. 1,193,176
-----------
Total Expenses............................................. 6,382,681
-----------
NET INVESTMENT INCOME........................................... 351,653
-----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on:
Long transactions.......................................... 28,131,287
Short transactions......................................... (9,239,303)
Options contracts expired or closed........................ (1,029,575)
-----------
Total Realized Gain........................................ 17,862,409
Change in unrealized (depreciation) appreciation on:
Investments................................................ (28,672,241)
Short positions............................................ 18,096,353
Call options............................................... 1,559,515
Put options................................................ 203,665
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS................. 9,049,701
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS............ $ 9,401,354
===========
</TABLE>
See notes to the financial statements.
8
<PAGE> 9
THE MERGER FUND
STATEMENT OF CASH FLOWS
FOR THE FOUR MONTHS ENDED MARCH 31, 1997 (UNAUDITED)
<TABLE>
<S> <C> <C>
CASH PROVIDED (USED) BY FINANCING ACTIVITIES:
Sales of Capital Shares...................................... $ 68,975,578
Repurchases of Capital Shares................................ (86,860,980)
-------------
Cash Used for Capital Share Transactions..................... (17,885,402)
Cash Used to Repay Borrowings................................ (122,950,000)
Distributions Paid in Cash*.................................. (3,960,567)
-------------
$(144,795,969)
-------------
CASH (USED) PROVIDED BY OPERATIONS:
Purchases of Portfolio Securities............................ (541,422,045)
Net Sales of Short-Term Investments.......................... 91,244,756
Proceeds from Sales of Portfolio Securities.................. 553,509,889
-------------
103,332,600
-------------
Decrease in Deposit at Brokers and Custodian for Short
Sales...................................................... 47,783,994
Net Investment Income........................................ 351,653
Net Change in Receivables/Payables Related to Operations..... 923,629
-------------
49,062,276 152,391,876
------------- -------------
Net Increase in Cash......................................... 7,595,907
Cash, Beginning of Period.................................... 359,201
-------------
Cash, End of Period.......................................... $ 7,955,108
=============
</TABLE>
- ------------------------------
*Non-cash financing activities include reinvestment of dividends of $39,886,639.
See notes to the financial statements.
9
<PAGE> 10
THE MERGER FUND
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOUR MONTHS
ENDED
MARCH 31, YEAR ENDED
1997 NOV. 30, 1996
------------- -------------
(UNAUDITED)
<S> <C> <C>
Net investment income.......................................... $ 351,653 $ 5,582,632
Net realized gain on investments sold, securities sold short
and option contracts expired or closed....................... 17,862,409 39,120,063
Change in unrealized (depreciation) appreciation of
investments, short positions and call and put options........ (8,812,708) (7,331,567)
------------- -------------
Net increase in net assets resulting from operations........... 9,401,354 37,371,128
Distributions to shareholders from:
Net investment income........................................ (5,757,534) (1,258,321)
Net realized gains........................................... (38,089,672) (13,482,010)
------------- -------------
Total dividends and distributions............................ (43,847,206) (14,740,331)
------------- -------------
Net increase in net assets from capital share transactions
(Note 6)..................................................... 22,001,237 223,370,882
------------- -------------
Net (decrease) increase in net assets.......................... (12,444,615) 246,001,679
NET ASSETS:
Beginning of period............................................ 489,083,946 243,082,267
------------- -------------
End of period (including accumulated undistributed net
investment (loss) income of $(82,808) and $5,323,073,
respectively)................................................ $ 476,639,331 $ 489,083,946
============= =============
</TABLE>
See notes to the financial statements.
10
<PAGE> 11
THE MERGER FUND
FINANCIAL HIGHLIGHTS
Selected per share data is based on a share of beneficial interest outstanding
throughout each period.
<TABLE>
<CAPTION>
FOUR
MONTHS
ENDED YEAR ENDED NOVEMBER 30,
MARCH 31, ------------------------------------------------------------------
1997 1996 1995 1994 1993 1992
----------- -------- -------- -------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, beginning of period.... $15.41 $14.87 $13.72 $13.70 $12.34 $12.51
Income from investment operations:
Net investment income (loss).......... 0.01(2)(3) 0.20(2)(3) 0.08(2)(3) --(2)(3) (0.07)(2)(3) (0.12)(2)
Net realized and unrealized gain on
investments......................... 0.28 1.24 1.78 1.08 2.10 0.65
-------- -------- -------- -------- ------- -------
Total from investment operations...... 0.29 1.44 1.86 1.08 2.03 0.53
Less distributions:
Dividends from net investment income.. (0.19) (0.08) -- -- -- (0.03)
Distributions from net realized
gains............................... (1.24) (0.82) (0.71) (1.06) (0.67) (0.67)
-------- -------- -------- -------- ------- -------
Total distributions................... (1.43) (0.90) (0.71) (1.06) (0.67) (0.70)
-------- -------- -------- -------- ------- -------
Net Asset Value, end of period.......... $14.27 $15.41 $14.87 $13.72 $13.70 $12.34
======== ======== ======== ======== ======= =======
Total Return............................ 1.96%(5) 10.26% 14.26% 8.41% 17.24% 4.45%
Supplemental Data and Ratios:
Net assets, end of period (000's)..... $476,639 $489,084 $243,082 $170,344 $25,173 $11,611
Ratio of operating expenses to average
net assets.......................... 1.36%(1)(6) 1.36%(1) 1.41%(1) 1.58%(1) 2.19%(1) 2.75%(1)
Ratio of interest expense and
dividends on short positions to
average net assets.................. 2.61%(6) 0.95% 2.42% 1.72% 1.91% 2.28%
Ratio of net investment income (loss)
to average net assets............... 0.22%(6) 1.36% 0.57% (0.03)% (0.57)% (1.42)%
Portfolio turnover rate(4)............ 108.42% 405.99% 418.63% 390.34% 186.00% 231.40%
Average commission rate per share..... $ 0.0319 $ 0.0434
</TABLE>
- ------------------------------
(1) For the four months ended March 31, 1997, and for the years ended November
30, 1996, 1995, 1994, 1993 and 1992, the operating expense ratio excludes
interest expense and dividends on short positions. The ratios including
interest expense and dividends on short positions for the four months ended
March 31, 1997, and for the years ended November 30, 1996, 1995, 1994, 1993
and 1992, were 3.97%, 2.31%, 3.83%, 3.30%, 4.10% and 5.03%, respectively.
(2) Net investment income before interest expense and dividends on short
positions for the four months ended March 31, 1997, and for the years ended
November 30, 1996, 1995, 1994, 1993 and 1992, was $0.14, $0.35, $0.42,
$0.21, $0.17, and $0.07, respectively.
(3) Net investment income (loss) per share represents net investment income for
the respective period divided by the monthly average shares of beneficial
interest outstanding throughout each period.
(4) The numerator for the portfolio turnover rate includes the lesser of
purchases or sales (including both long and short positions). The
denominator includes the average long position throughout the period. The
portfolio turnover rate excluding short positions from the numerator for the
four months ended March 31, 1997, and for the years ended November 30, 1996
and 1995 was 80.79%, 276.99% and 290.48%, respectively.
(5) Not annualized.
(6) Annualized.
See notes to the financial statements.
11
<PAGE> 12
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS
MARCH 31, 1997 (UNAUDITED)
NOTE 1 -- ORGANIZATION
The Merger Fund (the "Fund") is a no-load, open-end, non-diversified
investment company organized as a trust under the laws of the Commonwealth of
Massachusetts on April 12, 1982, and registered under the Investment Company Act
of 1940 (the "1940 Act"), as amended. The Fund was formerly known as the Risk
Portfolio of The Ayco Fund. In January of 1989, the Fund's fundamental policies
were amended to permit the Fund to engage exclusively in merger arbitrage. At
the same time, Westchester Capital Management, Inc. became the Fund's investment
adviser, and the Fund began to do business as The Merger Fund. Merger arbitrage
is a highly specialized investment approach generally designed to profit from
the successful completion of proposed mergers, takeovers, tender offers,
leveraged buyouts, liquidations and other types of corporate reorganizations.
Effective December 1, 1996 the Fund's fiscal year end was changed to September
30 from November 30.
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. These
policies are in conformity with generally accepted accounting principles.
A. Investment Valuation
Investments in securities and commodities (including options) are valued at
the last sales price on the securities or commodities exchange on which such
financial instruments are primarily traded. Securities not listed on an exchange
or securities for which there were no transactions are valued at the average of
the current bid and asked prices. Securities for which there are no such
valuations are valued at fair value as determined in good faith by management
under the supervision of the Board of Trustees. The investment adviser reserves
the right to value securities, including options, at prices other than last-sale
prices or the average of current bid and asked prices when such prices are
believed unrepresentative of fair market value as determined in good faith by
the adviser. Investments in United States government securities (other than
short-term securities) are valued at the average of the quoted bid and asked
prices in the over-the-counter market. Short term investments are carried at
amortized cost, which approximates market value.
B. Transactions with Brokers for Short Sales
Cash and liquid securities in the amount of $250,437,846 have been
committed as collateral for open short investment positions and are on deposit
in segregated accounts with brokers and the custodian. The Fund's receivable
from brokers for proceeds on securities sold short and deposit at brokers for
short sales are with three major securities dealers. The Fund does not require
the brokers to maintain collateral in support of the receivable from broker for
proceeds on securities sold short.
C. Federal Income Taxes
No provision for federal income taxes has been made since the Fund has
complied to date with the provisions of the Internal Revenue Code available to
regulated investment companies and intends to
12
<PAGE> 13
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997 (UNAUDITED)
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
continue to so comply in future years and to distribute investment company net
taxable income and net capital gains to shareholders.
D. Written Option Accounting
The Fund writes covered call options to hedge portfolio investments. When
the Fund sells an option, an amount equal to the premium received by the Fund is
included in the Statement of Assets and Liabilities as an asset and an
equivalent liability. The amount of the liability is subsequently
marked-to-market to reflect the current value of the option written. Option
contracts are valued at the last sales price reported on the date of valuation.
If no sale is reported, the option contract written is valued at the average of
the current bid and asked price reported on the day of valuation. When an option
expires on its stipulated expiration date or the Fund enters into a closing
purchase transaction, the Fund realizes a gain or loss if the cost of the
closing purchase transaction differs from the premium received when the option
was sold without regard to any unrealized gain or loss on the underlying
security, and the liability related to such option is eliminated. When an option
is exercised, the Fund realizes a gain or loss from the sale of the underlying
security, and the proceeds from such sale are increased by the premium
originally received.
E. Purchased Option Accounting
The Fund purchases put options to hedge portfolio investments. Premiums
paid for option contracts purchased are included in the Statement of Assets and
Liabilities as an asset. Option contracts are valued at the last sales price
reported on the date of valuation. If no sale is reported, the option contract
purchased is valued at the average of the current bid and asked price reported
on the day of valuation. When option contracts expire or are closed, realized
gains or losses are recognized without regard to any unrealized gains or losses
on the underlying securities.
F. Distributions to Shareholders
Dividends from net investment income and net realized capital gains, if
any, are declared and paid annually.
G. Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
H. Foreign Securities
Investing in securities of foreign companies and foreign governments
involves special risks and considerations not typically associated with
investing in U.S. companies and the U.S. government. These risks include
revaluation of currencies and future adverse political and economic
developments.
13
<PAGE> 14
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997 (UNAUDITED)
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Moreover, securities of many foreign companies and foreign governments and their
markets may be less liquid and their prices more volatile than those of
securities of comparable U.S. companies and the U.S. government.
I. Foreign Currency Translations
The books and records of the Fund are maintained in U.S. dollars. Foreign
currency transactions are translated into U.S. dollars on the following basis:
(i) market value of investment securities, assets and liabilities at the daily
rates of exchange, and (ii) purchases and sales of investment securities,
dividend and interest income and certain expenses at the rates of exchange
prevailing on the respective dates of such transactions. For financial reporting
purposes, the Fund does not isolate changes in the exchange rate of investment
securities from the fluctuations arising from changes in the market prices of
securities. However, for federal income tax purposes the Fund does isolate and
treat as ordinary income the effect of changes in foreign exchange rates on
realized gain or loss from the sale of investment securities and payables and
receivables arising from trade date and settlement date differences.
J. Restricted Security
The Fund owns a certain investment security which is unregistered and thus
restricted as to resale. This security is valued by the Fund after giving due
consideration to pertinent factors including recent private sales, market
conditions and the issuer's financial performance. Where future disposition of
this security requires registration under the Securities Act of 1933 the Fund
has the right to include its security in such registration, generally without
cost to the Fund. The Fund has no right to require registration of unregistered
securities.
K. Other
Investment and shareholder transactions are recorded no later than the
first business day after the trade date. Realized gains and losses from security
transactions are recorded on the identified cost basis. Dividend income and
distributions to shareholders are recorded on the ex-dividend date. Interest is
accounted for on the accrual basis. Investment income includes $3,846,145 of
interest earned on receivables from brokers for proceeds on securities sold
short and deposits. Generally accepted accounting principles require that
permanent financial reporting and tax differences be reclassified to capital
stock.
NOTE 3 -- AGREEMENTS
The Fund's investment adviser is Westchester Capital Management, Inc. (the
"Adviser") pursuant to an investment advisory agreement dated January 31, 1989.
Under the terms of this agreement, the Adviser is entitled to receive a fee,
calculated daily and payable monthly, at the annual rate of 1.00% of the Fund's
average daily net assets.
14
<PAGE> 15
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997 (UNAUDITED)
NOTE 3 -- AGREEMENTS (CONTINUED)
Firstar Trust Company, a subsidiary of Firstar Corporation, a publicly held
bank holding company, serves as custodian, transfer agent, administrator and
accounting services agent for the Fund.
Distribution services are performed pursuant to distribution contracts with
Mercer Allied Company, L.P. ("Mercer"), the Fund's principal underwriter, and
other broker-dealers.
NOTE 4 -- SHORT POSITIONS
The Fund may sell securities short for hedging purposes. For financial
statement purposes, an amount equal to the settlement amount is included in the
Statement of Assets and Liabilities as an asset and an equivalent liability. The
amount of the liability is subsequently marked-to-market to reflect the current
value of the short position. Subsequent fluctuations in the market prices of
securities sold, but not yet purchased, may require purchasing the securities at
prices which may differ from the market value reflected on the Statement of
Assets and Liabilities. The Fund is liable for any dividends payable on
securities while those securities are in a short position. As collateral for its
short positions, the Fund is required under the 1940 Act to maintain segregated
assets consisting of cash, cash equivalents or liquid securities. These
segregated assets are required to be adjusted daily to reflect changes in the
value of the securities sold short.
NOTE 5 -- RELATED PARTY TRANSACTIONS
William H. Bohnett, Esq., a partner of Fulbright & Jaworski L.L.P., serves
as a Trustee and Assistant Secretary of the Fund. Fulbright & Jaworski L.L.P.
furnishes legal services to the Fund. For the four months ended March 31, 1997,
the Fund paid $47,580 for such services.
Certain officers of the Fund are also officers of the Adviser.
NOTE 6 -- SHARES OF BENEFICIAL INTEREST
The Trustees have the authority to issue an unlimited amount of shares of
beneficial interest without par value.
Changes in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
FOUR MONTHS ENDED YEAR ENDED
MARCH 31, 1997 NOVEMBER 30, 1996
------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ----------- -------------
<S> <C> <C> <C> <C>
Sold........................... 4,821,181 $ 68,975,578 28,042,908 $ 412,955,551
Issued as reinvestment of
dividends.................... 2,826,835 39,886,639 901,799 12,721,008
Redeemed....................... (5,980,757) (86,860,980) (13,551,329) (202,305,677)
---------- ------------ ----------- -------------
Net increase................... 1,667,259 $ 22,001,237 15,393,378 $ 223,370,882
========== ============ =========== =============
</TABLE>
Effective June 1, 1996, The Merger Fund was closed to new investors.
15
<PAGE> 16
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997 (UNAUDITED)
NOTE 7 -- INVESTMENT TRANSACTIONS
Purchases and sales of securities for the four months ended March 31, 1997
(excluding short-term investments and options) aggregated $407,086,877 and
$426,072,464, respectively.
At March 31, 1997, gross unrealized appreciation and depreciation of
investments for federal income tax purposes were:
<TABLE>
<S> <C>
Appreciation............................................................ $ 12,820,949
(Depreciation).......................................................... (28,426,626)
------------
Net unrealized depreciation on investments.............................. $(15,605,677)
============
</TABLE>
At March 31, 1997, the cost of investments for federal income tax purposes
was $499,185,954.
NOTE 8 -- OPTION CONTRACTS WRITTEN
The premium amount and the number of option contracts written during the
four months ended March 31, 1997, were as follows:
<TABLE>
<CAPTION>
PREMIUM NUMBER OF
AMOUNT CONTRACTS
----------- ---------
<S> <C> <C>
Options outstanding at November 30, 1996..................... $ 3,834,076 16,523
Options written.............................................. 7,196,845 34,636
Options closed............................................... (2,442,350) (10,698)
Options exercised............................................ (4,914,189) (21,659)
Options expired.............................................. (1,728,509) (9,115)
----------- --------
Options outstanding at March 31, 1997........................ $ 1,945,873 9,687
=========== ========
</TABLE>
NOTE 9 -- DISTRIBUTION PLAN
The Fund has adopted a Plan of Distribution (the "Plan") dated July 1,
1993, as amended, pursuant to Rule 12b-1 under the Investment Company Act of
1940. Under the Plan, the Fund will compensate its principal underwriter,
Mercer, and any other broker-dealers with whom Mercer or the Fund has entered
into a contract to distribute Fund shares ("Dealers"). Under the Plan, the
amount of compensation paid in any one year shall not exceed 0.25% of the
average daily net assets of the Fund, payable as a service fee to Mercer and
Dealers for providing personal service and maintenance of shareholder accounts.
For the four months ended March 31, 1997, the Fund incurred $257,748 pursuant to
the Plan.
The Plan will remain in effect from year to year provided such continuance
is approved at least annually by a vote either of a majority of the Trustees,
including a majority of the non-interested Trustees, or a majority of the Fund's
outstanding shares.
16
<PAGE> 17
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1997 (UNAUDITED)
NOTE 10 -- CREDIT FACILITY
Custodial Trust Company has made available to the Fund a $230 million
credit facility pursuant to a Loan and Security Agreement ("Agreement") dated
March 18, 1992 (subsequently amended) for the purpose of purchasing portfolio
securities. The Agreement can be terminated by either the Fund or Custodial
Trust Company with three months' prior notice. Outstanding principal amounts
under the credit facility bear interest at a rate per annum of 0.50% plus the
Broker Call Rate quoted by Bear Stearns Securities Corp. at its office in New
York on credit extended up to $25 million on any given day and the Broker Call
Rate plus 0.25% for the amount of the loan which exceeds $25 million (weighted
average rate of 6.55% during the four months ended March 31, 1997). Advances are
collateralized by securities owned by the Fund and held separately in a special
custody account pursuant to a Special Custody Agreement dated March 31, 1994.
During the four months ended March 31, 1997, the Fund had an outstanding average
daily balance of $136,534,959. The maximum amount outstanding during the four
months ended March 31, 1997, was $208,000,000. Interest expense amounted to
$3,003,775 for the four months ended March 31, 1997. At March 31, 1997, the Fund
had a loan payable balance of $35,800,000, and the securities collateralizing
the Agreement amounted to $72,199,884.
The Fund had short-term borrowings at March 31, 1997, in the amount of
$38,500,000 from Firstar Corporation. The short-term borrowings were repaid
within seven days.
Pursuant to the 1940 Act, the Fund is required to satisfy asset coverage
requirements on its outstanding borrowings. At March 31, 1997, the Fund
satisfied all asset coverage requirements of the 1940 Act.
END TO NOTES TO THE FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Effective October 31, 1995, Grant Thornton L.L.P. was terminated as the
Fund's independent accountants. For the years ended November 30, 1991
through November 30, 1994, Grant Thornton L.L.P. expressed an unqualified
opinion on the Fund's financial statements. There were no disagreements
between Fund management and Grant Thornton L.L.P. prior to their
termination. The Board of Trustees approved the termination of Grant
Thornton L.L.P. and the appointment of Price Waterhouse LLP as the Fund's
independent accountants.
- --------------------------------------------------------------------------------
17
<PAGE> 18
INVESTMENT ADVISER
Westchester Capital Management, Inc.
100 Summit Lake Drive
Valhalla, NY 10595
(914) 741-5600
ADMINISTRATOR, TRANSFER AGENT, DIVIDEND
PAYING AGENT, SHAREHOLDER
SERVICING AGENT & CUSTODIAN
Firstar Trust Company
P.O. Box 701
Milwaukee, WI 53201-0701
(800) 343-8959
TRUSTEES
Frederick W. Green
William H. Bohnett
Michael J. Downey
James P. Logan III
Frank A. McDermott, Jr.
EXECUTIVE OFFICERS
Frederick W. Green, President
Bonnie L. Smith, Vice President, Treasurer
and Secretary
COUNSEL
Fulbright & Jaworski L.L.P.
666 Fifth Avenue
New York, NY 10103
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
100 East Wisconsin Avenue
Milwaukee, WI 53202
[THE MERGER FUND LOGO]
SEMI-ANNUAL REPORT
MARCH 31, 1997
