<PAGE> 1
THE MERGER FUND
SCHEDULE OF INVESTMENTS
MARCH 31, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
------ -------------
<S> <C> <C>
COMMON STOCKS -- 95.18%*
AEROSPACE -- 3.31%*
202,800 Sundstrand Corporation(1)(2)................................ $ 14,094,600
------------
APPAREL RETAILERS -- 2.14%*
377,000 Brylane Inc.**.............................................. 9,142,250
------------
BANKS -- 4.86%*
234,700 Bankers Trust Corporation(1)................................ 20,712,275
------------
BROKERAGE/INVESTMENT BANKING -- 1.26%*
172,100 Interstate/Johnson Lane, Inc.(2)............................ 5,388,881
------------
COMPUTER SOFTWARE -- 1.45%*
166,657 BMC Software, Inc.**........................................ 6,176,725
------------
CONSUMER FINANCE -- 0.73%*
346,169 Advanta Corp. -- Class B(2)................................. 3,093,885
------------
EDUCATIONAL & ENTERTAINMENT SOFTWARE -- 2.67%*
393,000 The Learning Company, Inc.**................................ 11,397,000
------------
ELECTRONIC PRODUCTS & DISTRIBUTION -- 3.86%*
307,000 AMP Incorporated(1)......................................... 16,482,062
------------
FOOD RETAILERS -- 2.79%*
360,000 American Stores Company(1)(3)............................... 11,880,000
------------
GAMING EQUIPMENT & SERVICES -- 0.95%*
234,900 Powerhouse Technologies, Inc.**............................. 4,037,344
------------
GIFTWARE -- 0.24%*
73,554 Syratech Corporation(1)(5).................................. 1,029,756
------------
HYDRAULIC COMPONENTS & SYSTEMS -- 2.77%*
205,800 Aeroquip-Vickers, Inc....................................... 11,794,912
------------
INSURANCE -- 11.33%*
107,200 Executive Risk Inc.(2)...................................... 7,611,200
354,762 Guardian Royal Exchange plc(4).............................. 2,097,701
578,200 TIG Holdings, Inc.(2)....................................... 9,431,888
411,000 Transamerica Corporation(1)................................. 29,181,000
------------
48,321,789
------------
INTEGRATED OIL COMPANIES -- 3.80%*
107,700 Atlantic Richfield Company.................................. 7,875,563
13,200 Exxon Corporation........................................... 931,425
84,000 Mobil Corporation(2)........................................ 7,392,000
------------
16,198,988
------------
</TABLE>
See notes to the financial statements.
1
<PAGE> 2
THE MERGER FUND
SCHEDULE OF INVESTMENTS (CONTINUED)
MARCH 31, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
------ -------------
<C> <S> <C>
INTERNET SERVICES -- 9.22%*
158,270 Excite, Inc.**(1)(3)........................................ $ 22,157,800
156,485 GeoCities**(1)(5)........................................... 17,144,888
------------
39,302,688
------------
LEISURE & RECREATIONAL PRODUCTS -- 0.17%*
87,200 The Coleman Company, Inc.**(1).............................. 719,400
------------
LUXURY GOODS -- 1.30%*
69,000 Gucci Group NV -- NYS....................................... 5,554,500
------------
MEDICAL PRODUCTS & DISTRIBUTION -- 2.06%*
360,000 Ballard Medical Products(1)(2).............................. 8,775,000
------------
METALS & MINING -- 1.06%*
173,200 Getchell Gold Corporation**(2).............................. 4,535,675
------------
PAPER & FOREST PRODUCTS -- 3.00%*
190,800 Union Camp Corporation(1)................................... 12,807,450
------------
PHARMACEUTICALS -- 2.04%*
379,000 Astra AB -- Class A -- ADR(1)............................... 8,693,313
------------
REAL ESTATE INVESTMENT TRUSTS -- 1.45%*
188,200 Irvine Apartment Communities, Inc.(1)....................... 6,187,075
------------
SAVINGS & LOANS -- 0.56%*
402,700 Coast Federal Litigation Contingent Payment Rights
Trust**(2)(6)............................................. 2,391,031
------------
SEMICONDUCTORS -- 2.55%*
223,400 Level One Communications, Incorporated**(1)(2).............. 10,862,825
------------
SPECIALTY CHEMICALS -- 2.13%*
247,000 Morton International, Inc.(1)(2)............................ 9,077,250
------------
TELECOMMUNICATIONS -- 15.04%*
300,300 AirTouch Communications, Inc.**............................. 29,016,487
280,600 Frontier Corporation........................................ 14,556,125
40,100 Global Crossing Ltd.**...................................... 1,854,625
104,000 IXC Communications, Inc.**.................................. 4,771,000
510,400 Vanguard Cellular Systems, Inc. -- Class A**(1)............. 13,940,300
------------
64,138,537
------------
TELECOMMUNICATIONS EQUIPMENT -- 8.00%*
260,500 Ascend Communications, Inc.**(1)............................ 21,800,594
335,000 Xylan Corporation**(1)...................................... 12,332,188
------------
34,132,782
------------
TRANSACTION PROCESSING -- 0.22%*
40,000 Paymentech, Inc.**.......................................... 945,000
------------
</TABLE>
See notes to the financial statements.
2
<PAGE> 3
THE MERGER FUND
SCHEDULE OF INVESTMENTS (CONTINUED)
MARCH 31, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
------ -------------
<C> <S> <C>
TRANSPORTATION -- 0.87%*
97,300 XTRA Corporation............................................ $ 3,727,806
------------
WATER-TREATMENT EQUIPMENT & SERVICES -- 3.35%*
467,000 United States Filter Corporation**.......................... 14,301,875
------------
TOTAL COMMON STOCKS (Cost $400,621,598)..................... 405,902,674
------------
CONTRACTS (100 SHARES PER CONTRACT)
- -----------------------------------
PUT OPTIONS PURCHASED -- 1.94%*
Exxon Corporation
1,241 Expiration April 1999, Exercise Price $85.00(5)........... 1,791,694
Lucent Technologies Inc.
2,148 Expiration April 1999, Exercise Price $135.00(5).......... 5,853,300
Global Crossing Ltd.
1,068 Expiration October 1999, Exercise Price $35.00............ 640,800
------------
TOTAL PUT OPTIONS PURCHASED
(Cost $9,471,544)......................................... 8,285,794
------------
PAR
- ---
CORPORATE BONDS -- 1.93%*
$8,000,000 Republic Engineered Steels, Inc. Notes,
9.875%, 12/15/2001(5)
(Cost $8,090,000)......................................... 8,240,000
------------
TOTAL INVESTMENTS
(Cost $418,183,142)....................................... $422,428,468
============
</TABLE>
- ------------------------------
* Calculated as a percentage of net assets.
** Non-income producing security.
NYS -- New York Shares
(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) All or a portion of the shares have been committed as collateral for short
foreign currency contracts.
(4) Foreign security.
(5) Fair-valued security.
(6) Litigation settlement rights.
See notes to the financial statements.
3
<PAGE> 4
THE MERGER FUND
SCHEDULE OF SECURITIES SOLD SHORT
MARCH 31, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES VALUE
- ------ -------------
<S> <C> <C>
96,805 AT&T Corp. ................................................. $ 7,726,249
28,200 AEGON N.V. -- ADR........................................... 2,534,475
226,850 Albertson's, Inc. .......................................... 12,320,791
164,900 At Home Corporation -- Series A............................. 25,971,750
166,750 BMC Software, Inc. ......................................... 6,180,172
132,500 The Chubb Corporation....................................... 7,759,531
105,100 Global Crossing Ltd. ....................................... 4,860,875
96,000 Intel Corporation........................................... 11,412,000
194,000 International Paper Company................................. 8,184,375
25 Lucent Technologies Inc. ................................... 2,694
343,100 Mattel, Inc. ............................................... 8,534,612
424,200 Placer Dome Inc.(1)......................................... 4,745,738
46,200 Rohm and Haas Company....................................... 1,550,588
49,500 Sunbeam Corporation......................................... 275,344
230,402 Tyco International Ltd. .................................... 16,531,343
33,350 United Technologies Corporation............................. 4,516,841
150,150 Vodafone Group plc -- ADR................................... 28,190,662
66,800 Wachovia Corporation........................................ 5,423,325
105,948 Yahoo! Inc. ................................................ 17,838,994
191,060 Zeneca Group plc -- ADR..................................... 8,991,761
------------
TOTAL SECURITIES SOLD SHORT
(Proceeds $178,184,508) $183,552,120
============
</TABLE>
- ------------------------------
(1) Foreign security.
See notes to the financial statements.
4
<PAGE> 5
THE MERGER FUND
SCHEDULE OF OPTIONS WRITTEN
MARCH 31, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
CONTRACTS (100 SHARES PER CONTRACT) VALUE
- ----------------------------------- ----------
<S> <C> <C>
CALL OPTIONS
Atlantic Richfield Company
1,077 Expiration April 1999, Exercise Price $70.00.............. $ 430,800
Frontier Corporation
2,210 Expiration April 1999, Exercise Price $50.00(1)........... 593,938
Gucci Group NV -- NYS
690 Expiration April 1999, Exercise Price $75.00(1)........... 439,875
PUT OPTIONS
Global Crossing Ltd.
651 Expiration October 1999, Exercise Price $55.00............ 1,082,287
----------
TOTAL OPTIONS WRITTEN
(Premiums received $2,638,553).............................. $2,546,900
==========
</TABLE>
- ------------------------------
(1) Fair-valued security.
See notes to the financial statements.
5
<PAGE> 6
THE MERGER FUND
STATEMENT OF ASSETS AND LIABILITIES
MARCH 31, 1999 (UNAUDITED)
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (Cost $418,183,142)................. $422,428,468
Cash...................................................... 10,034,412
Deposit at brokers for short sales........................ 28,529,177
Receivable from brokers for proceeds on securities sold
short.................................................. 170,114,893
Receivable for investments sold........................... 23,039,808
Receivable for fund shares issued......................... 436,197
Receivable for forward currency exchange contracts........ 16,647
Dividends and interest receivable......................... 592,538
Other receivables......................................... 203,066
------------
Total Assets...................................... 655,395,206
------------
LIABILITIES:
Loan payable (Note 10).................................... $ 18,350,000
Securities sold short, at value (Proceeds of
$178,184,508).......................................... 183,552,120
Payable for investment securities purchased............... 22,042,335
Options written, at value (Premiums received $2,638,553)
See accompanying schedule.............................. 2,546,900
Payable for fund shares redeemed.......................... 1,381,145
Accrued interest payable.................................. 400,815
Investment advisory fee payable........................... 337,155
Distribution fees payable................................. 25,399
Dividends payable on short positions...................... 105,639
Accrued expenses and other payables....................... 202,606
------------
Total Liabilities................................. 228,944,114
------------
NET ASSETS.................................................. $426,451,092
============
NET ASSETS Consist Of:
Accumulated undistributed net investment income........... $ 397,114
Accumulated undistributed net realized gain on investments
sold, forward currency exchange contracts, securities
sold short and option contracts expired or closed...... 498,375
Net unrealized appreciation (depreciation) on:
Investments and foreign currency related items......... 4,245,326
Short positions........................................ (5,367,612)
Written options........................................ 91,653
Forward currency exchange contracts.................... 16,647
Paid-in capital........................................... 426,569,589
------------
Total Net Assets.................................. $426,451,092
============
Net Asset Value, offering price and redemption price per
share ($426,451,092/30,333,548 shares of beneficial
interest outstanding)..................................... $14.06
======
</TABLE>
See notes to the financial statements.
6
<PAGE> 7
THE MERGER FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED)
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest.................................................. $ 3,814,923
Dividend income on long positions
(net of foreign withholding taxes of $540)............. 2,557,819
------------
Total investment income................................ 6,372,742
------------
EXPENSES:
Investment advisory fee................................... $ 1,869,516
Distribution fees......................................... 284,659
Transfer agent and shareholder servicing agent fees....... 76,916
Federal and state registration fees....................... 18,995
Professional fees......................................... 66,479
Trustees' fees and expenses............................... 13,135
Custody fees.............................................. 51,492
Administration fee........................................ 86,219
Reports to shareholders................................... 46,902
Other..................................................... 13,386
------------
Total operating expenses before interest expense and
dividends on short positions......................... 2,527,699
Interest expense.......................................... 1,736,903
Dividends on short positions (net of foreign withholding
taxes of $3,182)....................................... 561,790
------------
Total expenses......................................... 4,826,392
------------
NET INVESTMENT INCOME....................................... 1,546,350
------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on:
Long transactions and foreign currency related items... 24,619,057
Short transactions..................................... (6,000,475)
Option contracts expired or closed..................... (13,676,079)
Forward currency exchange contracts.................... (1,498,497)
------------
Net realized gain...................................... 3,444,006
Change in unrealized appreciation (depreciation) on:
Investments and foreign currency related items......... 60,155,039
Short positions........................................ (30,107,998)
Written options........................................ 113,878
Forward currency exchange contracts.................... 1,076,196
------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............. 34,681,121
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 36,227,471
============
</TABLE>
See notes to the financial statements.
7
<PAGE> 8
THE MERGER FUND
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED)
<TABLE>
<S> <C> <C>
CASH PROVIDED (USED) BY FINANCING ACTIVITIES:
Sales of Capital Shares..................................... $ 135,363,835
Repurchase of Capital Shares................................ (169,299,639)
---------------
Cash Provided by Capital Share Transactions................. (33,935,804)
Cash Provided by Borrowings................................. (92,317,593)
Distributions Paid in Cash*................................. (2,232,939)
---------------
$(128,486,336)
-------------
CASH (USED) PROVIDED BY OPERATIONS:
Purchases of Investments.................................... (1,276,094,669)
Net Proceeds from Short-Term Investments.................... 0
Proceeds from Sales of Investments.......................... 1,423,923,763
---------------
147,829,094
---------------
Decrease in Deposit at Brokers and Custodian for Short
Sales..................................................... (11,045,208)
Net Investment Income....................................... 1,546,350
Net Change in Receivables/Payables Related to Operations.... 190,512
---------------
(9,308,346) 138,520,748
--------------- -------------
Net Increase in Cash........................................ 10,034,412
Cash, Beginning of Year..................................... 0
-------------
Cash, End of Year........................................... $ 10,034,412
=============
</TABLE>
- ------------------------------
*Non-cash financing activities include reinvestment of dividends of $28,405,479.
See notes to the financial statements.
8
<PAGE> 9
THE MERGER FUND
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS ENDED FISCAL YEAR ENDED
MARCH 31, 1999 SEPTEMBER 30, 1998
---------------- ------------------
(UNAUDITED)
<S> <C> <C>
Net investment income..................................... $ 1,546,350 $ 6,433,162
Net realized gain on investments sold, forward currency
exchange contracts, securities sold short and option
contracts expired or closed............................. 3,444,006 32,750,166
Change in unrealized appreciation (depreciation) of
investments, forward currency exchange contracts, short
positions and written options........................... 31,237,115 (35,986,058)
------------ ------------
Net increase in net assets resulting from operations...... 36,227,471 3,197,270
------------ ------------
Distributions to shareholders from:
Net investment income................................... (5,109,498) (813,613)
Net realized gains...................................... (25,528,920) (44,190,435)
------------ ------------
Total dividends and distributions....................... (30,638,418) (45,004,048)
------------ ------------
Net increase (decrease) in net assets from capital share
transactions (Note 6)................................... (5,530,325) 22,212,257
------------ ------------
Net increase (decrease) in net assets..................... 58,728 (19,594,521)
NET ASSETS:
Beginning of period....................................... 426,392,364 445,986,885
------------ ------------
End of period (including accumulated undistributed net
investment income of $397,114 and $5,458,760,
respectively)........................................... $426,451,092 $426,392,364
============ ============
</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 YEAR TEN MONTHS
ENDED ENDED ENDED
MARCH 31, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1997
----------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Net Asset Value, beginning of
period........................ $13.90 $15.35 $15.41
Income from investment
operations:
Net investment income......... 0.06(2)(3) 0.20(2)(3) 0.02(2)(3)
Net realized and unrealized
gain on investments......... 1.42 (0.05) 1.35
-------- -------- --------
Total from investment
operations.................. 1.48 0.15 1.37
Less distributions:
Dividends from net investment
income...................... (0.22) (0.03) (0.19)
Distributions from net
realized gains.............. (1.10) (1.57) (1.24)
-------- -------- --------
Total distributions........... (1.32) (1.60) (1.43)
-------- -------- --------
Net Asset Value, end of
period........................ $14.06 $13.90 $15.35
======== ======== ========
Total Return.................... 11.04%(5) 0.82% 9.68%(5)
Supplemental Data and Ratios:
Net assets, end of period
(000's)..................... $426,451 $426,392 $445,987
Ratio of operating expenses to
average net assets.......... 1.35%(1)(6) 1.33%(1) 1.36%(1)(6)
Ratio of interest expense and
dividends on short positions
to average net assets....... 1.23%(6) 1.93% 2.93%(6)
Ratio of net investment income
(loss) to average net
assets...................... 0.83%(6) 1.36% 0.13%(6)
Portfolio turnover rate....... 171.54% 355.38% 271.24%
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED NOVEMBER 30,
---------------------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Net Asset Value, beginning of
period........................ $14.87 $13.72 $13.70
Income from investment
operations:
Net investment income......... 0.20(2)(3) 0.08(2)(3) --(2)(3)
Net realized and unrealized
gain on investments......... 1.24 1.78 1.08
-------- -------- --------
Total from investment
operations.................. 1.44 1.86 1.08
Less distributions:
Dividends from net investment
income...................... (0.08) -- --
Distributions from net
realized gains.............. (0.82) (0.71) (1.06)
-------- -------- --------
Total distributions........... (0.90) (0.71) (1.06)
-------- -------- --------
Net Asset Value, end of
period........................ $15.41 $14.87 $13.72
======== ======== ========
Total Return.................... 10.26% 14.26% 8.41%
Supplemental Data and Ratios:
Net assets, end of period
(000's)..................... $489,084 $243,082 $170,344
Ratio of operating expenses to
average net assets.......... 1.36%(1) 1.41%(1) 1.58%(1)
Ratio of interest expense and
dividends on short positions
to average net assets....... 0.95% 2.42% 1.72%
Ratio of net investment income
(loss) to average net
assets...................... 1.36% 0.57% (0.03)%
Portfolio turnover rate....... 276.99% 290.48% 390.34%(4)
</TABLE>
- ------------------------------
(1) For the six months ended March 31, 1999, the year ended September 30, 1998,
the ten months ended September 30, 1997, and for the years ended November
30, 1996, 1995, and 1994, 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,
1999, the year ended September 30, 1998, the ten months ended September 30,
1997, and for the years ended November 30, 1996, 1995, and 1994, were 2.58%,
3.26%, 4.29%, 2.31%, 3.83% and 3.30%, respectively.
(2) Net investment income before interest expense and dividends on short
positions for the six months ended March 31, 1999, the year ended September
30, 1998, the ten months ended September 30, 1997, and for the years ended
November 30, 1996, 1995, and 1994 was $0.14, $0.49, $0.38, $0.35, $0.42, and
$0.21, respectively.
(3) Net investment income 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, 1999 (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, 1999 such long
securities represent 8.1% of investments, at value, while such written options
represent 40.6% of options written, 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 $183,899,925 have been
committed as collateral for open short investment positions and specifically
identfied in the Fund's records. 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, 1999 (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 (sells) 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 writes (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. Income and capital gain distributions are
determined in accordance with income tax regulations which may differ from
generally accepted accounting principles. These differences are due primarily to
wash loss and straddle loss deferrals and unrealized gains or losses on Section
1256 contracts, which are realized, for tax purposes, at September 30, 1998. The
Fund also utilized earnings and profits distributed to shareholders on
redemption of shares as part of the dividends paid deduction.
12
<PAGE> 13
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999 (UNAUDITED)
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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. 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
13
<PAGE> 14
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999 (UNAUDITED)
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
accrual basis. Investment income includes $3,483,978 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 in the capital accounts.
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 Mutual Fund Services, LLC, a subsidiary of Firstar Corporation, a
publicly held bank holding company, serves as transfer agent, administrator and
accounting services agent for the Fund. Firstar Bank Milwaukee, N.A. serves as
custodian 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 assets
consisting of cash, cash equivalents or liquid securities. These 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, 1999
the Fund paid $43,310 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, 1999 (UNAUDITED)
NOTE 6 -- SHARES OF BENEFICIAL INTEREST (CONTINUED)
Changes in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
MARCH 31, 1999 SEPTEMBER 30, 1998
----------------------------- -----------------------------
SHARES AMOUNT SHARES AMOUNT
------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Sold........................ 9,746,153 $ 135,363,835 14,330,739 $ 208,258,666
Issued as reinvestment of
dividends................. 2,104,109 28,405,478 3,071,709 43,453,261
Redeemed.................... (12,184,305) (169,299,639) (15,780,835) (229,499,670)
----------- ------------- ----------- -------------
Net increase (decrease)..... (334,043) $ (5,530,326) 1,621,613 $ 22,212,257
=========== ============= =========== =============
</TABLE>
Effective June 1, 1996, through October 13, 1998, The Merger Fund was
closed to new investors.
NOTE 7 -- INVESTMENT TRANSACTIONS
Purchases and sales of securities for the six months ended March 31, 1999
(excluding short-term investments, options and short positions) aggregated
$731,444,572 and $869,489,125, respectively.
At March 31, 1999, gross unrealized appreciation and depreciation of
investments for federal income tax purposes were:
<TABLE>
<S> <C>
Appreciation................................................ $ 22,383,951
(Depreciation).............................................. (19,802,416)
------------
Net unrealized appreciation on investments.................. $ 2,581,535
============
</TABLE>
At March 31, 1999, the cost of investments for federal income tax purposes
was $419,846,933.
NOTE 8 -- OPTION CONTRACTS WRITTEN
The premium amount and the number of option contracts written during the
six months ended March 31, 1999, were as follows:
<TABLE>
<CAPTION>
PREMIUM NUMBER OF
AMOUNT CONTRACTS
------------ ---------
<S> <C> <C>
Options outstanding at September 30, 1998.................. $ 1,632,021 10,359
Options written............................................ 10,454,780 20,921
Options closed............................................. (4,029,385) (11,323)
Options exercised.......................................... (4,146,240) (11,373)
Options expired............................................ (1,272,623) (3,956)
------------ -------
Options outstanding at March 31, 1999...................... $ 2,638,553 4,628
============ =======
</TABLE>
15
<PAGE> 16
THE MERGER FUND
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999 (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 such
compensation paid in any one year shall not exceed 0.25% annually of the average
daily net assets of the Fund, which may be payable as a service fee for
providing record keeping, subaccounting, subtransfer agency and/or shareholder
liaison services. For the six months ended March 31, 1999, the Fund incurred
$284,659 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, 1998 to
March 31, 1999, the interest rate on the outstanding principal amount was the
Federal Funds Rate plus 1.00% (weighted average rate of 5.90% during the six
months ended March 31, 1999). 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,
1999, the Fund had an outstanding average daily balance of $68,858,670. The
maximum amount outstanding during the six months ended March 31, 1999, was
$124,390,000. Interest expense amounted to $2,052,482 for the six months ended
March 31, 1999. At March 31, 1999, the Fund had a loan payable balance of
$18,350,000 and the securities collateralizing the Agreement amounted to
$68,121,785.
NOTE 11 -- FORWARD CURRENCY EXCHANGE CONTRACTS
At March 31, 1999, the Fund had entered into "position hedge" forward
currency exchange contracts that obligate the Fund to deliver and receive
currencies at specified future dates. The net unrealized appreciation of $16,648
is included in the net unrealized appreciation (depreciation) section of the
accompanying financial statements. The terms of the open contracts are as
follows:
<TABLE>
<CAPTION>
CURRENCY TO U.S. $ VALUE AT CURRENCY TO U.S. $ VALUE AT
SETTLEMENT DATE BE DELIVERED MARCH 31, 1999 BE RECEIVED MARCH 31, 1999
- --------------- ------------ --------------- ----------- ---------------
<C> <S> <C> <C> <C>
5/14/99 1,271,000 British Pounds 2,050,507 2,067,155 U.S. Dollars 2,067,155
--------- ---------
</TABLE>
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, AND SHAREHOLDER
SERVICING AGENT
Firstar Mutual Fund Services, LLC
615 East Michigan Street
P.O. Box 701
Milwaukee, WI 53201-0701
(800) 343-8959
CUSTODIAN
Firstar Bank Milwaukee, N.A.
P.O. Box 701
Milwaukee, WI 53201-0701
(800) 343-8959
TRUSTEES [THE MERGER FUND LOGO]
Frederick W. Green
William H. Bohnett
Michael J. Downey
James P. Logan III
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
SEMI-ANNUAL REPORT
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP MARCH 31, 1999
100 East Wisconsin Avenue
Milwaukee, WI 53202
