<PAGE> 1
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
- ------ ------------
<C> <S> <C>
COMMON STOCKS -- 120.78%*
AEROSPACE -- 3.42%*
149,300 Northrop Grumman Corporation(1)............................. $ 16,040,419
------------
AGRICULTURAL BIOTECHNOLOGY -- 1.50%*
105,000 Dekalb Genetics Corporation................................. 7,021,875
------------
AUTOMOTIVE EQUIPMENT -- 5.34%*
222,400 Echlin, Inc................................................. 11,662,100
175,000 SPX Corporation**(2)........................................ 13,354,687
------------
25,016,787
------------
BANKS-- 10.29%*
175,300 CoreStates Financial Corp.(1)............................... 15,733,175
273,700 First Commerce Corporation(2)............................... 23,469,775
49,800 Magna Group, Inc.(2)........................................ 2,891,513
83,640 National City Corporation(2)................................ 6,131,857
------------
48,226,320
------------
BROADCASTING -- 9.85%*
204,900 SFX Broadcasting, Inc.**(1)................................. 19,952,138
625,800 Telemundo Group, Inc.**(1)(2)............................... 26,205,375
------------
46,157,513
------------
CEMENT -- 0.39%*
30,200 Medusa Corporation(2)....................................... 1,845,975
------------
COMPUTER HARDWARE -- 6.59%*
590,000 Digital Equipment Corporation**(1)(2)....................... 30,864,375
------------
COMPUTER SERVICES -- 2.35%*
567,500 XLConnect Solutions, Inc.**(2).............................. 11,030,781
------------
CONSUMER FINANCE -- 11.66%*
389,403 Advanta Corporation Class B(2).............................. 8,177,463
207,200 Beneficial Corporation...................................... 25,757,550
648,800 The Money Store, Inc.(2).................................... 20,721,050
------------
54,656,063
------------
ENVIRONMENTAL & INDUSTRIAL SERVICES -- 1.69%*
279,900 Safety-Kleen Corporation.................................... 7,942,163
------------
GIFTWARE -- 0.52%*
73,554 Syratech Corporation**(1)(3)................................ 2,454,865
------------
HEALTH CARE SERVICES -- 0.87%*
224,200 MedCath Incorporated**(1)(2)................................ 4,070,631
------------
HOME BUILDING -- 0.75%*
76,000 Continental Homes Holding Corporation(2).................... 3,534,000
------------
</TABLE>
See notes to the financial statements.
1
<PAGE> 2
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
- ------ ------------
<C> <S> <C>
HOTELS & GAMING -- 11.62%*
38,000 Harveys Casino Resorts(2)................................... $ 1,078,250
571,700 Interstate Hotels Company**(2)(3)........................... 20,867,050
818,600 La Quinta Inns, Inc.(1)(2).................................. 17,190,600
511,300 Showboat, Inc.(2)........................................... 15,307,044
------------
54,442,944
------------
INSURANCE -- 7.61%*
120,800 American Bankers Insurance Group, Inc.(2)................... 7,791,600
923,100 John Alden Financial Corporation(1)......................... 19,904,344
20,000 Mid Ocean Limited(2)........................................ 1,550,000
257,000 USF&G Corporation(2)........................................ 6,408,937
------------
35,654,881
------------
MEDICAL SUPPLIES & DEVICES -- 0.22%*
61,823 Circon Corporation**(1)..................................... 1,031,671
------------
MOVIE THEATERS -- 4.36%*
682,000 Regal Cinemas, Inc.**(1).................................... 20,460,000
------------
NATURAL GAS TRANSMISSION & MARKETING -- 4.31%*
630,702 Williams Companies, Inc.(2)................................. 20,182,464
------------
OFFICE PRODUCTS -- 1.85%*
724,750 BT Office Products International, Inc.**(1)................. 8,651,703
------------
OILFIELD EQUIPMENT & SERVICES -- 4.36%*
52,000 Dresser Industries, Inc.(2)................................. 2,499,250
105,000 EVI, Inc.**(1).............................................. 4,862,813
307,600 Weatherford Enterra, Inc.**(1).............................. 13,053,775
------------
20,415,838
------------
PAPER AND FOREST PRODUCTS -- 2.45%*
475,300 Avenor, Inc................................................. 11,474,488
------------
PLUMBING PRODUCTS -- 1.53%*
151,000 Zurn Industries, Inc.(1)(2)................................. 7,153,625
------------
REAL ESTATE INVESTMENT TRUSTS -- 1.05%
222,700 Oasis Residential, Inc.(2).................................. 4,941,156
------------
SAVINGS & LOANS -- 4.67%*
36,600 CitFed Bancorp, Inc.(1)..................................... 2,058,750
214,600 Coast Federal CVR -- Rights**(1)............................ 3,487,250
422,100 H.F. Ahmanson & Company(2).................................. 15,234,848
100,000 Poughkeepsie Financial Corporation.......................... 1,125,000
------------
21,905,848
------------
</TABLE>
See notes to the financial statements.
2
<PAGE> 3
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
- ------ ------------
<C> <S> <C>
SPECIALTY CHEMICALS -- 1.54%*
86,300 W.R. Grace & Company(2)..................................... $ 7,222,231
------------
TELEPHONY -- 16.29%*
95,800 360 Communications Company **(1)............................ 2,991,983
312,300 ACC Corp.**(1)(2)........................................... 16,629,975
427,300 LCI International, Inc.**................................... 15,677,170
828,927 MCI Communications Corporation(2)........................... 41,031,886
------------
76,331,014
------------
WATER TREATMENT -- 3.70%*
254,500 Culligan Water Technologies, Inc.**(1)...................... 15,158,656
61,602 U.S. Filter Corporation**................................... 2,163,770
------------
17,322,426
------------
TOTAL COMMON STOCKS (Cost $536,047,934)..................... 566,052,056
------------
CONTRACTS (100 SHARES PER CONTRACT)
- ---------------------------------------------------------------------
PUT OPTIONS PURCHASED -- 0.01%*
3,476 Teleport Communications Group, Inc.
Expiration April 1998, Exercise Price $45.00 (Cost
$407,811)................................................. 43,450
------------
PAR VALUE
- ---------------------------------------------------------------------
CONVERTIBLE BONDS -- 1.03%*
$5,486,000 IVAX Corporation Debentures CLB
6.50%, 11/15/01 (Cost $4,664,777)(1)(3)................. 4,813,965
------------
TOTAL INVESTMENTS
(Cost $541,120,522)....................................... $570,909,471
============
</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 the
credit facility.
(3) Fair valued security.
See notes to the financial statements.
3
<PAGE> 4
THE MERGER FUND
SCHEDULE OF SECURITIES SOLD SHORT
MARCH 31, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
- ------ ------------
<C> <S> <C>
70,982 ALLTEL Corporation.......................................... $ 3,102,721
385,030 Banc One Corporation........................................ 24,353,148
95,000 Bowater, Inc. .............................................. 5,359,358
168,920 Camden Property Trust**..................................... 5,004,255
557,560 Compaq Computers Corporation................................ 14,426,865
171,000 D.R. Horton, Inc. .......................................... 3,633,750
397,300 EVI, Inc. .................................................. 18,399,956
20,400 EXEL Limited................................................ 1,581,000
24,600 Fifth Third Bancorp......................................... 2,103,300
284,040 First Union Corporation..................................... 16,119,270
86,300 W.R. Grace & Co.*........................................... 1,628,912
30,000 HUBCO, Inc. ................................................ 1,149,375
52,000 Halliburton Company......................................... 2,609,750
223,000 Laidlaw Environmental Services, Inc. ....................... 836,250
83,600 National City Corporation................................... 6,128,925
459,870 Patriot American Hospitality, Inc.**........................ 12,416,490
204,900 SFX Entertainment, Inc.*.................................... 4,917,600
175,000 SPX Corporation............................................. 13,354,688
72,400 St. Paul Companies, Inc..................................... 6,452,650
46,600 Sealed Air Corporation...................................... 3,052,300
40,500 Sealed Air Corporation Convertible Preferred*(1)............ 2,594,531
26,600 Southdown, Inc. ............................................ 1,853,687
283,819 Teleport Communications Group, Inc. ........................ 16,674,366
48,200 Union Planters Corporation.................................. 2,997,438
497,800 U.S. Filter Corporation..................................... 17,485,225
241,600 U.S. Industries, Inc. ...................................... 7,263,100
417,700 Washington Mutual, Inc. .................................... 15,799,306
630,430 Williams Companies, Inc. ................................... 20,173,760
152,750 Worldcom, Inc. ............................................. 6,577,797
------------
TOTAL SECURITIES SOLD SHORT
(Proceeds $225,495,418) $238,049,773
============
</TABLE>
- ------------------------------
* When-issued security.
** Real Estate Investment Trusts.
(1) Fair valued security.
See notes to the financial statements.
4
<PAGE> 5
THE MERGER FUND
SCHEDULE OF OPTIONS WRITTEN
MARCH 31, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
CONTRACTS (100 SHARES PER CONTRACT) VALUE
----------------------------------- -----------
<C> <S> <C>
CALL OPTIONS
American Bankers Insurance Group, Inc.
420 Expiration April 1998, Exercise Price $60.00................ $ 189,000
Beneficial Corporation
1,782 Expiration April 1998, Exercise Price $110.00............... 2,851,200
290 Expiration April 1998, Exercise Price $115.00(1)............ 348,000
Dekalb Genetics Corporation
250 Expiration April 1998, Exercise Price $55.00................ 315,625
800 Expiration April 1998, Exercise Price $60.00................ 640,000
Echlin, Inc.
470 Expiration June 1998, Exercise Price $50.00(1).............. 202,687
1,754 Expiration May 1998, Exercise Price $50.00(1)............... 613,900
LCI International, Inc.
3,100 Expiration June 1998, Exercise Price $35.00................. 1,546,897
90 Expiration June 1998, Exercise Price $40.00................. 146,250
MCI Communications Corporation
7,061 Expiration April 1998, Exercise Price $45.00(1)............. 3,486,369
Northrop Grumman Corporation
1,493 Expiration April 1998, Exercise Price $100.00............... 1,186,546
PUT OPTIONS
Teleport Communications Group, Inc.
2,843 Expiration April 1998, Exercise Price $55.00(1)............. 53,306
STRUCTURED PUT OPTION PACKAGES
Patriot American Hospitality, Inc.(1)
Expiration February 1999, Exercise Price $34.19, $27.97,
2,731 $26.42.................................................... 1,365,500
U.S. Filter Corporation(1)
1,393 Expiration May 1998, Exercise Price $35.00, $32.00.......... 192,234
Western Resources, Inc.(1)
2,804 Expiration September 1998, Exercise Price $34.90, $29.09.... 16,824
Worldcom, Inc(1)
1,228 Expiration September 1998, Exercise Price $41.00, $29.00.... 121,572
-----------
TOTAL OPTIONS WRITTEN
(Premiums received $12,564,932)............................. $13,275,910
===========
</TABLE>
- ------------------------------
(1) Fair valued security.
5
<PAGE> 6
THE MERGER FUND
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1998 (UNAUDITED)
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (Cost $541,120,522)
See accompanying schedule.............................. $570,909,471
Cash...................................................... 2,489,300
Deposit at brokers for short sales........................ 67,313,271
Receivable from brokers for proceeds on securities sold
short.................................................. 204,245,001
Receivable for investments sold........................... 48,923,020
Receivable for Fund shares sold........................... 130,601
Receivable for options written............................ 1,753,724
Interest receivable....................................... 134,712
Dividends receivable...................................... 358,024
Other receivables......................................... 310,500
------------
Total Assets...................................... 896,567,624
LIABILITIES:
Loan payable (Note 10).................................... $129,750,000
Securities sold short, at value (Proceeds of $225,495,418)
See accompanying schedule.............................. 238,049,773
Payable for investment securities purchased............... 44,991,465
Options written, at value (Premiums received $12,564,932)
See accompanying schedule.............................. 13,275,910
Payable for Fund shares repurchased....................... 297,591
Accrued interest payable.................................. 561,803
Investment advisory fee payable........................... 388,011
Distribution fees payable................................. 74,723
Dividends payable on short positions...................... 308,191
Accrued expenses and other payables....................... 191,330
------------
Total Liabilities................................. 427,888,797
------------
NET ASSETS.................................................. $468,678,827
============
NET ASSETS consist of:
Accumulated undistributed net investment income........... $ 830,115
Accumulated undistributed net realized gain on investments
sold, securities sold short and option contracts
expired or closed...................................... (1,824,036)
Net unrealized appreciation (depreciation) on:
Investments............................................ 29,791,427
Short positions........................................ (12,554,355)
Written options........................................ (710,978)
Paid-in capital........................................... 453,146,654
------------
Total Net Assets.................................. $468,678,827
============
NET ASSET VALUE, offering price and redemption price per
share ($468,678,827 / 32,829,873 shares of beneficial
interest outstanding)..................................... $14.28
</TABLE>
See notes to the financial statements.
6
<PAGE> 7
THE MERGER FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 31, 1998 (UNAUDITED)
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest.................................................. $ 4,928,459
Dividend income on long positions
(net of foreign withholding taxes of $37,580).......... 2,921,627
-----------
Total investment income................................ 7,850,086
-----------
EXPENSES:
Investment advisory fee................................... $ 2,283,035
Distribution fees......................................... 353,080
Transfer agent and shareholder servicing agent fees....... 91,268
Federal and state registration fees....................... 27,373
Professional fees......................................... 80,984
Trustees' fees and expenses............................... 11,467
Custody fees.............................................. 62,176
Administration fee........................................ 94,517
Reports to shareholders................................... 65,602
Other..................................................... 16,505
------------
Total operating expenses before interest expense and
dividends on short positions......................... 3,086,007
Interest expense.......................................... 1,941,872
Dividends on short positions.............................. 1,769,603
-----------
Total expenses......................................... 6,797,482
-----------
NET INVESTMENT INCOME....................................... 1,052,604
-----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on:
Long transactions...................................... 15,418,475
Short transactions..................................... (5,883,063)
Option contracts expired or closed..................... (7,279,207)
Forward currency exchange contracts.................... (319,363)
------------
Total realized gain.................................... 1,936,842
Change in unrealized (depreciation) appreciation on:
Investments............................................ 13,926,729
Short positions........................................ (130,653)
Written options........................................ (1,033,816)
Forward currency exchange contracts.................... 28,880
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............. 14,727,982
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $15,780,586
===========
</TABLE>
See notes to the financial statements.
7
<PAGE> 8
THE MERGER FUND
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 1998 (UNAUDITED)
<TABLE>
<S> <C> <C>
CASH PROVIDED (USED) BY FINANCING ACTIVITIES:
Sales of Capital Shares..................................... $ 95,021,126
Repurchases of Capital Shares............................... (86,558,983)
---------------
Cash Provided by Capital Share Transactions................. 8,462,143
Cash Provided by Borrowings................................. 125,391,146
Distributions Paid in Cash*................................. (1,550,787)
---------------
$ 132,302,502
-------------
CASH (USED) PROVIDED BY OPERATIONS:
Purchases of Investments.................................... (1,403,403,131)
Proceeds from Sales of Investments.......................... 1,293,837,299
---------------
(109,565,832)
---------------
Increase in Deposit at Brokers and Custodian for Short
Sales..................................................... (21,436,294)
Net Investment Income....................................... 1,052,604
Net Change in Receivables/Payables Related to Operations.... 136,320
---------------
(20,247,370) (129,813,202)
--------------- -------------
Net Increase in Cash........................................ 2,489,300
Cash, Beginning of Period................................... 0
-------------
Cash, End of Period......................................... $ 2,489,300
=============
</TABLE>
- ------------------------------
*Non-cash financing activities include reinvestment of dividends of $43,453,261.
See notes to the financial statements.
8
<PAGE> 9
THE MERGER FUND
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS ENDED TEN MONTHS ENDED
MARCH 31, 1998 SEPTEMBER 30, 1997
---------------------- ------------------
(UNAUDITED)
<S> <C> <C>
Net investment income................................ $ 1,052,604 $ 507,738
Net realized gain on investments sold, forward
currency exchange contracts, securities sold short
and option contracts expired or closed............. 1,936,842 41,019,184
Change in unrealized (depreciation) appreciation of
investments, forward currency exchange contracts,
short positions and call and put options........... 12,791,140 667,095
------------ ------------
Net increase in net assets resulting from
operations......................................... 15,780,586 42,194,017
------------ ------------
Distributions to shareholders from:
Net investment income.............................. (813,613) (5,757,534)
Net realized gains................................. (44,190,435) (38,089,672)
------------ ------------
Total dividends and distributions.................. (45,004,048) (43,847,206)
------------ ------------
Net increase (decrease) in net assets from capital
share transactions (Note 6)........................ 51,915,404 (41,443,872)
------------ ------------
Net increase (decrease) in net assets................ 22,691,942 (43,097,061)
NET ASSETS:
Beginning of period.................................. 445,986,885 489,083,946
------------ ------------
End of period (including accumulated undistributed
net investment income of $830,115 and $589,493,
respectively)...................................... $468,678,827 $445,986,885
============ ============
</TABLE>
See notes to the financial statements.
9
<PAGE> 10
THE MERGER FUND
FINANCIAL HIGHLIGHTS
Selected per share data is based on a share of beneficial interest outstanding
throughout each period.
<TABLE>
<CAPTION>
SIX MONTHS TEN MONTHS
ENDED ENDED YEAR ENDED NOVEMBER 30,
MARCH 31, SEPTEMBER 30, ----------------------------------------------------
1998 1997 1996 1995 1994 1993
----------- ------------- -------- -------- -------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, beginning of
period............................. $15.35 $15.41 $14.87 $13.72 $13.70 $12.34
Income from investment operations:
Net investment income (loss)....... 0.03(2)(3) 0.02(2)(3) 0.20(2)(3) 0.08(2)(3) --(2)(3) (0.07)(2)(3)
Net realized and unrealized gain on
investments...................... 0.50 1.35 1.24 1.78 1.08 2.10
-------- -------- -------- -------- -------- -------
Total from investment operations... 0.53 1.37 1.44 1.86 1.08 2.03
Less distributions:
Dividends from net investment
income........................... (0.03) (0.19) (0.08) -- -- --
Distributions from net realized
gains............................ (1.57) (1.24) (0.82) (0.71) (1.06) (0.67)
-------- -------- -------- -------- -------- -------
Total distributions................ (1.60) (1.43) (0.90) (0.71) (1.06) (0.67)
-------- -------- -------- -------- -------- -------
Net Asset Value, end of period....... $14.28 $15.35 $15.41 $14.87 $13.72 $13.70
======== ======== ======== ======== ======== =======
Total Return......................... 3.58%(5) 9.68%(5) 10.26% 14.26% 8.41% 17.24%
Supplemental Data and Ratios:
Net assets, end of period
(000's).......................... $468,679 $445,987 $489,084 $243,082 $170,344 $25,173
Ratio of operating expenses to
average net assets............... 1.35%(1)(6) 1.36%(1)(6) 1.36%(1) 1.41%(1) 1.58%(1) 2.19%(1)
Ratio of interest expense and
dividends on short positions to
average net assets............... 1.62%(6) 2.93%(6) 0.95% 2.42% 1.72% 1.91%
Ratio of net investment income
(loss) to average net assets..... 0.46%(6) 0.13%(6) 1.36% 0.57% (0.03)% (0.57)%
Portfolio turnover rate............ 173.29% 271.24% 276.99% 290.48% 390.34%(4) 186.00%(4)
Average commission rate per share.. $ 0.0418 $ 0.0373 $ 0.0434
</TABLE>
- ------------------------------
(1) For the six months ended March 31, 1998, the ten months ended September 30,
1997, and for the years ended November 30, 1996, 1995, 1994 and 1993, the
operating expense ratio excludes interest expense and dividends on short
positions. The ratios including interest expense and dividends on short
positions for the six months ended March 31, 1998, the ten months ended
September 30, 1997, and for the years ended November 30, 1996, 1995, 1994
and 1993, were 2.98%, 4.29%, 2.31%, 3.83%, 3.30% and 4.10%, respectively.
(2) Net investment income before interest expense and dividends on short
positions for the six months ended March 31, 1998, the ten months ended
September 30, 1997, and for the years ended November 30, 1996, 1995, 1994
and 1993, was $0.16, $0.38, $0.35, $0.42, $0.21 and $0.17, respectively.
(3) Net investment income (loss) per share represents net investment income for
the respective year divided by the monthly average shares of beneficial
interest outstanding throughout each year.
(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 year.
(5) Not annualized.
(6) Annualized.
See notes to the financial statements.
10
<PAGE> 11
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS
MARCH 31, 1998 (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. At March 31, 1998 such
securities represent 4.9% of investments, at value. 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 $245,361,163 have been
committed as collateral for open short investment positions and are on deposit
in segregated accounts with the brokers and 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 the 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 applicable to
regulated investment companies and intends to
11
<PAGE> 12
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998 (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. Additionally, the Fund
intends to make all required distributions to avoid federal excise tax.
D. Written Option Accounting
The Fund writes covered call options to hedge portfolio investments.
Uncovered put options can also be written by the Fund as part of a merger
arbitrage strategy involving a pending corporate reorganization. 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. By writing an option, the Fund
may become obligated during the term of the option to deliver or purchase the
securities underlying the option at the exercise price if the option is
exercised. 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 premium originally received decreases the cost
basis of the security (or increases the proceeds on a sale of the security), and
the Fund realizes a gain or loss from the sale of the underlying security.
E. Purchased Option Accounting
The Fund purchases put options to hedge portfolio investments. Call options
may be purchased only for the purpose of closing out previously written covered
call options. 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
12
<PAGE> 13
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998 (UNAUDITED)
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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. 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. When-Issued Securities
The Fund may sell securities on a when-issued or delayed delivery basis.
Although the payment and interest terms of these securities are established at
the time the Fund enters into the agreement, these securities may be delivered
for cash proceeds at a future date. The Fund records sales of when-issued
securities and reflects the values of such securities in determining net asset
value in the same manner as other open short sale positions. The Fund segregates
and maintains at all times cash, cash equivalents, or other liquid securities in
an amount at least equal to the market value for when-issued securities.
K. Other
Investment and shareholder transactions are recorded on 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 $4,753,460 of interest earned on receivables
from brokers for proceeds on securities sold short and deposits. Other income
consists of cash settlements of class action lawsuits on securities held by the
Fund. Generally accepted accounting principles require that permanent financial
reporting and tax differences be reclassified in the capital accounts.
13
<PAGE> 14
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998 (UNAUDITED)
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.
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 six months ended March 31, 1998
the Fund paid $33,541 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.
14
<PAGE> 15
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998 (UNAUDITED)
NOTE 6 -- SHARES OF BENEFICIAL INTEREST (CONTINUED)
Changes in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED TEN MONTHS ENDED
MARCH 31, 1998 SEPTEMBER 30, 1997
--------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Sold......................... 6,560,091 $ 95,021,126 8,129,829 $ 117,907,516
Issued as reinvestment of
dividends.................. 3,071,709 43,453,261 2,826,841 39,886,639
Redeemed..................... (5,847,905) (86,558,983) (13,652,842) (199,238,027)
----------- ------------- ----------- -------------
Net increase (decrease)...... 3,783,895 $ 51,915,404 (2,696,172) $ (41,443,872)
=========== ============= =========== =============
</TABLE>
Effective June 1, 1996, The Merger Fund was closed to new investors.
NOTE 7 -- INVESTMENT TRANSACTIONS
Purchases and sales of securities for the six months ended March 31, 1998
(excluding short-term investments, options and short positions) aggregated
$1,018,518,451 and $901,246,555, respectively.
At March 31, 1998, gross unrealized appreciation and depreciation of
investments for federal income tax purposes were:
<TABLE>
<S> <C>
Appreciation................................................ $40,150,403
(Depreciation).............................................. (13,450,667)
-----------
Net unrealized appreciation on investments.................. $26,699,736
===========
</TABLE>
At March 31, 1998, the cost of investments for federal income tax purposes
was $544,209,735. The primary difference between the cost amount for book
purposes and tax purposes is due to deferred wash sale losses.
NOTE 8 -- OPTION CONTRACTS WRITTEN
The premium amount and the number of option contracts written during the
six months ended March 31, 1998, were as follows:
<TABLE>
<CAPTION>
PREMIUM NUMBER OF
AMOUNT CONTRACTS
------------ ---------
<S> <C> <C>
Options outstanding at September 30, 1997................... $ 2,294,272 17,002
Options written............................................. 37,812,266 109,928
Options closed.............................................. (17,191,985) (71,378)
Options exercised........................................... (10,105,152) (24,560)
Options expired............................................. (244,469) (2,483)
------------ -------
Options outstanding at March 31, 1998....................... $ 12,564,932 28,509
============ =======
</TABLE>
15
<PAGE> 16
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998 (UNAUDITED)
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 1940 Act. 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 six months ended March
31, 1998, the Fund incurred $353,080 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.
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. For the period October 1, 1997 to
December 31, 1997, the interest rate on the outstanding principal amount was the
Federal Funds Rate plus 0.625%. The interest rate changed on January 1, 1998 to
the Federal Funds Rate plus 1.00% (weighted average rate of 6.38% during the six
months ended March 31, 1998). 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 six months ended March 31,
1998, the Fund had an outstanding average daily balance of $61,126,126. The
maximum amount outstanding during the six months ended March 31, 1998, was
$130,100,000. Interest expense amounted to $1,941,872 for the six months ended
March 31, 1998. At March 31, 1998, the Fund had a loan payable balance of
$129,750,000 and the securities collateralizing the Agreement amounted to
$266,515,606.
16
<PAGE> 17
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
LOGO
SEMI-ANNUAL REPORT
MARCH 31, 1998
