FLAG INVESTORS TELEPHONE INCOME FUND INC, 497, 1996-04-15

FLAG INVESTORS TELEPHONE INCOME FUND INC
497, 1996-04-15

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<PAGE>

LOGO

FLAG INVESTORS
TELEPHONE INCOME FUND, INC.

(Class A and Class B Shares)

This mutual fund (the "Fund") is designed to provide:

1. A professionally managed portfolio consisting primarily of income-
producing common stock, securities convertible thereto and debt
obligations of companies in the telephone industry; and

2. The objective of current income and long-term growth of capital without
undue risk.

Shares of the Fund are available through Alex. Brown & Sons Incorporated
("Alex. Brown") as well as Participating Dealers and Shareholder Servicing
Agents. This Prospectus relates to Flag Investors Class A Shares ("Class A
Shares") and Class B Shares ("Class B Shares") of the Fund. The separate
classes provide investors with alternatives as to sales load and Fund expenses.
(See "How to Invest in the Fund.")

This Prospectus sets forth basic information that investors should know
about the Fund prior to investing and should be retained for future
reference. A Statement of Additional Information dated April 10, 1996 has been
filed with the Securities and Exchange Commission (the "SEC") and is hereby
incorporated by reference. It is available upon request and without charge by
calling the Fund at (800) 767-FLAG.

- -------------------------------------------------------------------------------

THE FUND'S SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK. THE SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER
GOVERNMENT AGENCY. INVESTMENT IN THE SHARES INVOLVES RISK, INCLUDING POSSIBLE
LOSS OF PRINCIPAL.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.

The date of this Prospectus is April 10, 1996

PROSPECTUS
<PAGE>

FLAG INVESTORS
TELEPHONE INCOME FUND, INC.

(Class A and Class B Shares)

135 East Baltimore Street
Baltimore, Maryland 21202

TABLE OF CONTENTS

------

Page
<S> <C>
1. Fee Table ......................................... 2
2. Financial Highlights .............................. 3
3. Investment Program ................................ 7
4. Investment Restrictions ........................... 10
5. How to Invest in the Fund ......................... 11
6. How to Redeem Shares .............................. 18
7. Telephone Transactions ............................ 19
8. Dividends and Taxes ............................... 21
9. Management of the Fund ............................ 22
10. Investment Advisor and Sub-Advisor ................ 23
11. Distributor ....................................... 25
12. Custodian, Transfer Agent, Accounting Services .... 26
13. Performance Information ........................... 27
14. General Information ............................... 28
</TABLE>

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No person has been authorized to give any information or to make
representations not contained in this Prospectus in connection with any
offering made by this Prospectus and, if given or made, such information
must not be relied upon as having been authorized by the Fund or its
distributor. This Prospectus does not constitute an offering by the Fund or
by its distributor in any jurisdiction in which such offering may not
lawfully be made. Shares may be offered only to residents of those states in
which such shares are eligible for purchase.
- -----------------------------------------------------------------------------

1
<PAGE>

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1. FEE TABLE
...............................................................................

SHAREHOLDER TRANSACTION EXPENSES:

<TABLE>
<CAPTION>
Class A Class B
Shares Shares
Initial Sales Deferred
Charge Sales Charge
Alternative Alternative
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price) ......................... 4.50%* None
Maximum Sales Charge Imposed on Reinvested Dividends ......... None None
Deferred Sales Charge (as a percentage of original purchase
price or redemption proceeds, whichever is lower) ........... 0.50%* 4.00%**
</TABLE>

- -------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES:
(as a percentage of average net assets)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
Management Fees ......................................... .72% .72%
12b-1 Fees .............................................. .25% .75%
Other Expenses (including a .25% shareholder servicing
fee for Class B Shares) ................................ .22% .47%***
------- ---------
Total Fund Operating Expenses ........................... 1.19% 1.94%
======= =========
</TABLE>
- -------------------------------------------------------------------------------

* Purchases of $1 million or more of Class A Shares by persons not otherwise
eligible for sales load waivers are not subject to an initial sales charge,
however, a contingent deferred sales charge of .50% may be imposed on such
purchases. (See "How to Invest in the Fund--Class A Shares.")
** A declining contingent deferred sales charge will be imposed on
redemptions of Class B Shares made within six years of purchase. Class B
Shares will automatically convert to Class A Shares six years after
purchase. (See "How to Invest in the Fund -- Class B Shares.")
*** A portion of the shareholder servicing fee is allocated to member firms
of the National Association of Securities Dealers, Inc. and qualified
banks for continued personal service by such members to investors in
Class B Shares, such as responding to shareholder inquiries, quoting net
asset values, providing current marketing materials and attending to
other shareholder matters.

Example:

<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000
investment, assuming (1) 5% annual return and
(2) redemption at the end of each time period: 1 year 3 years 5 years 10 years
- ------------------------------------------------------------------------------------------------------
Class A Shares ............................... $57 $82 $109 $192
Class B Shares ............................... $60 $93 $130 $206*
- ------------------------------------------------------------------------------------------------------
</TABLE>

* Expenses assume that Class B Shares are converted to Class A Shares at the
end of six years. Therefore, the expense figures assume six years of Class
B expenses and four years of Class A expenses.

2
<PAGE>

You would pay the following expenses on the
same investment, assuming no redemption: ... 1 year 3 years 5 years 10 years
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Class B Shares ............................. $20 $63 $110 $206*
- ---------------------------------------------------------------------------------------------------
</TABLE>

* Expenses assume that Class B Shares are converted to Class A Shares at the
end of six years. Therefore, the expense figures assume six years of Class
B expenses and four years of Class A expenses.

THE EXPENSES AND EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.

The purpose of the foregoing table is to describe the various costs and
expenses that an investor in the Fund will bear directly and indirectly. A
person who purchases shares of either class through a financial institution
may be charged separate fees by the financial institution. (For more complete
descriptions of the various costs and expenses, see "How to Invest in the
Fund", "Investment Advisor and Sub-Advisor" and "Distributor.") The Expenses
and Example appearing in the table above have been restated to reflect current
fees.

The rules of the SEC require that the maximum sales charge be reflected in
the above table. However, certain investors may qualify for reduced sales
charges or no sales charge at all. (See "How to Invest in the Fund--Class A
Shares.") Due to the continuous nature of Rule 12b-1 fees, long-term
shareholders of the Fund may pay more than the equivalent of the maximum
front-end sales charges permitted by the Rules of Fair Practice of the
National Association of Securities Dealers, Inc. ("NASD Rules").

- -------------------------------------------------------------------------------
2. FINANCIAL HIGHLIGHTS

The financial highlights included in the following tables are a part of the
Fund's financial statements for the periods indicated and have been audited by
Coopers & Lybrand L.L.P., independent accountants. The financial statements
and financial highlights for the year ended December 31, 1995 and the report
thereon of Coopers & Lybrand L.L.P. are included in the Statement of
Additional Information. Additional performance information is contained in
the Fund's Annual Report for the fiscal year ended December 31, 1995 which
can be obtained at no charge by calling the Fund at (800) 767-FLAG.

3
<PAGE>

(FOR A CLASS A SHARE OUTSTANDING THROUGHOUT EACH YEAR)*
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
Per Share Operating Performance:
Net asset value at beginning of year $ 12.30 $ 13.70 $ 12.20
---------- ---------- ----------
Income from Investment Operations:
Net investment income 0.40 0.41 0.42
Net realized and unrealized
gain/(loss) on investments 3.58 (1.27) 1.78
---------- ---------- ----------
Total from Investment Operations 3.98 (0.86) 2.20

Less Distributions:
Dividends from net investment income
and short-term gains (0.41) (0.44) (0.42)
Distributions from net realized long-
term gains (1.00) (0.10) (0.28)
---------- ---------- ----------
Total distributions (1.41) (0.54) (0.70)
---------- ---------- ----------
Net asset value at end of year $ 14.87 $ 12.30 $ 13.70
========== ========== ==========
Total Return *** 33.44% (6.32)% 18.12%
Ratios to Average Net Assets:
Expenses 0.93%(2) 0.92%(2) 0.92%(2)
Net investment income 2.85%(3) 3.14%(3) 3.12%(3)
Supplemental Data:
Net assets at end of year (000) $492,454 $435,805 $469,163
Portfolio turnover rate 24% 23% 14%

</TABLE>

4
<PAGE>

<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------------
1992 1991 1990 1989**(1) 1988** 1987** 1986**
---------- ---------- ---------- ---------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value at beginning of year $ 11.28 $ 9.57 $ 10.98 $ 8.24 $ 7.50 $ 7.84 $ 8.02
---------- ---------- ---------- ---------- ---------- --------- ---------
Income from Investment Operations:
Net investment income 0.42 0.45 0.46 0.52 0.46 0.43 0.49
Net realized and unrealized
gain/(loss) on investments 0.93 1.74 (1.29) 3.38 0.97 (0.30) 1.42
---------- ---------- ---------- ---------- ---------- --------- ---------
Total from Investment Operations 1.35 2.19 (0.83) 3.90 1.43 0.13 1.91

Less Distributions:
Dividends from net investment income
and short-term gains (0.42) (0.46) (0.45) (0.52) (0.46) (0.42) (0.54)
Distributions from net realized long-
term gains (0.01) (0.02) (0.13) (0.64) (0.23) (0.05) (1.55)
---------- ---------- ---------- ---------- ---------- --------- ---------
Total Distributions (0.43) (0.48) (0.58) (1.16) (0.69) (0.47) (2.09)
---------- ---------- ---------- ---------- ---------- --------- ---------
Net asset value at end of year $ 12.20 $ 11.28 $ 9.57 $ 10.98 $ 8.24 $ 7.50 $ 7.84
========== ========== ========== ========== ========== ========= =========
Total Return *** 12.35% 23.08% (7.55%) 48.86% 19.90% 1.51% 24.81%
Ratios to Average Net Assets:
Expenses 0.92%(2) 0.92%(2) 0.92%(2) 0.93%(2) 0.92% 0.88% 0.87%
Net investment income 3.81%(3) 4.38%(3) 4.54%(3) 4.41%(3) 5.35% 5.37% 5.58%
Supplemental Data:
Net assets at end of year (000) $ 307,641 $ 238,571 $ 177,963 $ 162,449 $102,483 $94,650 $99,584
Portfolio turnover rate 6% 7% 2% 27% 11% 4% 30%
</TABLE>
- ------
* Computed based upon average shares outstanding.
** Restated for two-for-one stock split, effected in the form of a stock
dividend to shareholders of record on October 27, 1989.
*** Total return represents aggregate total return for the periods indicated
and does not reflect any applicable sales charges.
(1) Investment Company Capital Corp. became Investment Advisor to the Fund on
January 19, 1989.
(2) Without the waiver of advisory fees, the ratio of expenses to average net
assets would have been .99%, .99%, .98%, 1.07%, 1.17%, 1.13% and 1.07%
for the years ended December 31, 1995, 1994, 1993, 1992, 1991, 1990 and
1989, respectively.
(3) Without the waiver of advisory fees, the ratio of net investment income
to average net assets would have been 2.79%, 3.07%, 3.06%, 3.66%, 4.13%,
4.32% and 4.28% for the years ended December 31, 1995, 1994, 1993, 1992,
1991, 1990 and 1989, respectively.

5
<PAGE>

(FOR A CLASS B SHARE OUTSTANDING THROUGHOUT THE PERIOD)*
- -----------------------------------------------------------------------------

<TABLE>
<CAPTION>
For the period from
January 3, 1995**
through
December 31, 1995
-------------------
<S> <C>
Per Share Operating Performance:
Net asset value at beginning of
period $12.28
Income from Investment Operations:
Net investment income 0.30
Net realized and unrealized
gain/(loss) on investments 3.56
-------------------
Total from Investment Operations 3.86
Less distributions:
Dividends from net investment income
and short-term gains (0.31)
Distributions from net realized long-
term gains (1.00)
-------------------
Total Distributions (1.31)
-------------------
Net asset value at end of period $14.83
===================
Total Return *** 32.42%
Ratios to Average Net Assets:
Expenses(2) 1.70%(1)
Net investment income(3) 2.13%(1)
Supplemental Data:
Net assets at end of period (000) $7,504
Portfolio turnover rate 24%
</TABLE>

- ------
* Computed based upon average shares outstanding.
** Commencement of operations.
*** Total return represents aggregate total return for the periods indicated
and does not reflect any applicable sales charges.
(1) Annualized.
(2) Without the waiver of advisory fees, the ratio of expenses to average net
assets would have been 1.74% (annualized) for the period ended December
31, 1995.
(3) Without the waiver of advisory fees, the ratio of net investment income
to average net assets would have been 2.09% (annualized) for the period
ended December 31, 1995.

6
<PAGE>

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3. INVESTMENT PROGRAM
...............................................................................
INVESTMENT OBJECTIVE, POLICIES
AND RISK CONSIDERATIONS

The Fund's investment objective is to seek current income and long-term
growth of capital without undue risk. In seeking this objective, the Fund
invests primarily in income-producing common stock, securities convertible
thereto and debt obligations of companies in the telephone industry and, to a
lesser degree, in other income-producing securities (including debt obligations)
of issuers in other industries and non-income-producing securities of issuers in
the telephone industry. There can be no assurance that the Fund's investment
objective will be met. The Fund's investment objective may be changed only by
the affirmative vote of a majority of the outstanding shares of the Fund.
Concentration in the telephone industry will subject the Fund to the risks
associated with that industry (e.g., regulatory and technological change) and
may result in greater fluctuation in the Fund's net asset value than is
experienced in less concentrated portfolios. In light of the relatively limited
number of telephone companies, the Fund will be non-diversified for purposes of
the Investment Company Act of 1940 (the "Investment Company Act").

The Fund's investment advisors believe that investing in a portfolio of
securities of companies in the telephone industry affords an attractive
opportunity for achieving the Fund's investment objective. The telephone
industry comprises many well capitalized companies which have demonstrated
stable, profitable growth. Significant technological and regulatory changes have
for some time been stimulating new services while certain unit costs are
declining. Extensive changes in telecommunications law, which became effective
on February 29, 1996, are likely to stimulate further rapid changes in the
telephone industry, as well as the telecommunications industry generally. The
new legislation will allow existing telephone companies, both local and
long-distance, to expand into each other's business as well as into other
telecommunications businesses, but will also permit other telecommunications
firms to enter the telephone business. In addition, the legislation enlarges the
scope of permitted affiliations between traditional telephone companies and
other telecommunications companies. The Fund's investment advisors believe that
because the telephone industry is a focal point in the development of the
information age, both for personal and for data communications, it provides new
opportunities for earnings and dividend growth. At the same time, these
developments pose challenges to companies in the telecommunications industry
with attendant risks.

Under normal market conditions at least 65% of the Fund's total assets
will be invested in income-producing common stock, securities convertible
thereto and debt obligations of companies in the telephone industry. The Fund
may purchase American Depository Receipts ("ADRs"), which are U.S. exchange
listed interests in securities of foreign companies. ADRs include American
Depositary Shares and New York Shares and may be "sponsored" or "unsponsored."

7
<PAGE>

Sponsored ADRs are established jointly by a depositary (typically a U.S.
financial institution) and the underlying issuer, whereas unsponsored ADRs may
be established by a depositary without participation by the underlying issuer.
The Fund may invest some portion of its assets in non-income-producing
securities of issuers in the telephone industry and in other income-producing
securities, including money market instruments and other debt obligations, of
issuers in other industries. The circumstances under which the Fund will invest
in such other income-producing securities include, but are not limited to,
occasions when telephone industry securities that satisfy the Fund's criteria of
stability and potential for long-term growth are not available. Depending on the
circumstances, the Fund may temporarily and for defensive purposes invest up to
100% of its net assets in such other income-producing securities.

In general, the Fund will invest in investment grade debt obligations that
are rated, at the time of purchase, BBB or higher by Standard and Poor's Ratings
Group ("S&P") or Baa or higher by Moody's Investors Service, Inc. ("Moody's"),
or, if unrated, determined to be of comparable quality by the Fund's investment
advisors, under criteria approved by the Fund's Board of Directors. Investment
grade securities are generally thought to provide the highest credit quality and
the smallest risk of default, although securities rated BBB by S&P or Baa by
Moody's have speculative characteristics. The value of debt securities changes
as interest rates fluctuate. A decrease in interest rates will generally result
in an increase in the value of the securities while an increase in interest
rates will generally result in a decrease in the value of the securities. Such
changes in the value of portfolio securities will not affect interest income
from these securities but will be reflected in the Fund's net asset value. Up to
10% of the Fund's assets may be invested in lower quality debt oligations
(securities rated BB or lower by S&P or Ba or lower by Moody's). Securities that
were rated BBB/Baa or higher at the time of purchase but are subsequently
downgraded to BB/Ba or lower will be included in the 10% category. In the event
any security owned by the Fund is downgraded, the Fund's investment advisors
will review the situation and take appropriate action, but will not be
automatically required to sell any such security. If such a downgrade causes the
10% limit to be exceeded, the Fund will be precluded from investing further in
debt obligations that are below investment grade. (See "Investments in
Non-Investment Grade Securities" below.)

...............................................................................
INVESTMENTS IN NON-INVESTMENT GRADE SECURITIES

Where deemed appropriate by the Fund's investment advisors, the Fund may
invest up to 10% of its total assets (measured at the time of the investment)
in lower quality debt obligations (securities rated BB or lower by S&P or Ba
or lower by Moody's and unrated securities of comparable quality).

8
<PAGE>

Lower rated debt obligations, also known as "junk bonds," are considered to be
speculative and involve greater risk of default or price changes due to changes
in the issuer's creditworthiness. Yields and market values of these bonds will
fluctuate over time reflecting changing interest rates and the market's
perception of credit quality and the outlook for economic growth. When economic
conditions appear to be deteriorating, lower rated bonds may decline in value,
regardless of prevailing interest rates. Accordingly, adverse economic
developments, including a recession or substantial period of rising interest
rates, may disrupt the high yield bond market, affecting both the value and
liquidity of such bonds. An economic downturn could adversely affect the ability
of issuers of such bonds to make payments of principal and interest to a greater
extent than issuers of higher rated bonds might be affected. Securities in the
lowest rating category that the Fund may purchase (securities rated C by either
S&P or Moody's) may present a particular risk of default, or may be in default
or arrears in the payment of principal and interest. In addition, C rated
securities may be regarded as having extremely poor prospects of ever attaining
any real investment standing. As of the date of this Prospectus, the Fund has
not invested in securities rated CCC or below. The ratings categories of S&P and
Moody's are described more fully in the Appendix to the Statement of Additional
Information.

The table below provides a summary of ratings assigned by S&P to debt
obligations in the Fund's portfolio. These figures are dollar-weighted
averages of month-end portfolio holdings during the fiscal year ended
December 31, 1995, presented as a percentage of total investments. These
percentages are historical and are not necessarily indicative of the quality
of current or future portfolio holdings, which may vary.

S&P
Rating Average
------ -------
A 1.17%
BBB .37%
BB .52%
B .26%
Unrated 0.00%

...............................................................................
INVESTMENTS IN REPURCHASE AGREEMENTS

The Fund may enter into repurchase agreements with domestic banks or
broker-dealers deemed creditworthy under guidelines approved by the Directors.

9
<PAGE>

A repurchase agreement is a short-term investment in which the purchaser (i.e.,
the Fund) acquires ownership of a debt security, and the seller agrees to
repurchase the obligation at a future time and set price, usually not more than
7 days from the date of purchase, thereby determining the yield during the
purchaser's holding period. The value of the underlying securities will be at
least equal at all times to the total amount of the repurchase agreement
obligation, including the interest factor. The underlying securities, which in
the case of the Fund will be U.S. Government securities only, may have
maturities exceeding one year. If the seller defaults on its obligation to
repurchase the underlying instrument, the Fund could experience loss due to
delay in liquidating the collateral and to adverse market action.

...............................................................................
OTHER INVESTMENTS

The Fund has the right to lend portfolio securities to recognized
institutional borrowers on a fully collateralized basis. The Fund may also
write covered call options if each such option is traded on a national
securities exchange (and may purchase calls in related closing transactions).
To date the Fund has not lent portfolio securities. The Fund may also invest
in securities eligible for resale pursuant to Rule 144A under the Securities
Act of 1933, as amended ("Rule 144A Securities") that have been determined to
be liquid by the Advisors under standards approved by the Fund's Board of
Directors, and may invest up to 10% of its net assets in Rule 144A Securities
that are illiquid (see "Investment Restrictions" in the Statement of
Additional Information). Rule 144A Securities may become illiquid if
qualified institutional buyers are not interested in acquiring the
securities.

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4. INVESTMENT RESTRICTIONS

The Fund's investment program is subject to a number of restrictions which
reflect both self-imposed standards and federal and state regulatory
limitations. The investment restrictions recited below are matters of
fundamental policy and may not be changed without the affirmative vote of a
majority of the outstanding shares of the Fund. Accordingly, the Fund will
not:

1) Invest less than 65% of the value of its total assets in the telephone
industry, except as described in this Prospectus (otherwise the Fund will
not concentrate more than 25% of its total assets in securities of issuers
in any industry);

10
<PAGE>

2) Invest in the securities of any single issuer if, as a result, the Fund
would hold more than 10% of the outstanding voting securities of such
issuer; or

3) Borrow money except as a temporary measure for extraordinary or emergency
purposes and then only from banks and in an amount not exceeding 10% of
the value of the total assets of the Fund at the time of such borrowing,
provided that, while borrowings by the Fund equalling 5% or more of the
Fund's total assets are outstanding, the Fund will not purchase securities
for investment.

The Fund is subject to further investment restrictions that are set forth
in the Statement of Additional Information.

- -------------------------------------------------------------------------------
5. HOW TO INVEST IN THE FUND

Class A Shares and Class B Shares may be purchased from Alex. Brown, 135
East Baltimore Street, Baltimore, Maryland 21202, through any securities
dealer which has entered into a dealer agreement with Alex. Brown
("Participating Dealers") or through any financial institution which has
entered into a Shareholder Servicing Agreement with the Fund ("Shareholder
Servicing Agents"). Shares of either class may also be purchased by
completing the Application Form attached to this Prospectus and returning it,
together with payment of the purchase price (including any applicable
front-end sales charge), to the address shown on the Application Form.
Participating Dealers or Shareholder Servicing Agents and their investment
representatives may receive different levels of compensation depending on
which class of shares they sell.

The Class A and Class B alternatives permit an investor to choose the
method of purchasing shares that is more beneficial given the amount of the
purchase, the length of time the investor expects to hold the shares, and
other circumstances. Investors should consider whether, during the
anticipated life of their investment in the Fund, the combination of sales
charge and distribution fee on Class A Shares is more favorable than the
combination of distribution/service fees and contingent deferred sales charge
on Class B Shares. In almost all cases, investors planning to purchase
$100,000 or more of Fund shares will pay lower aggregate charges and expenses
by purchasing Class A Shares. Accordingly, the Fund will not accept purchases
for Class B Shares in excess of $100,000 per account. (See "Fee Table.")

The minimum initial investment in shares of either class is $2,000, except
that the minimum initial investment for shareholders of any other Flag
Investors fund or class is $500 and the minimum initial investment for
participants in the Fund's Automatic Investing Plan is $250. Each subsequent

11
<PAGE>

investment must be at least $100 per class, except that the minimum
subsequent investment under the Fund's Automatic Investing Plan is $250 for
quarterly investments and $100 for monthly investments. (See "Purchases
Through Automatic Investing Plan" below.) There is no minimum investment
requirement for qualified retirement plans (i.e., 401(k) plans or pension and
profit sharing plans). IRA accounts are, however, subject to the $2,000
minimum initial investment requirement. There is no minimum investment
requirement for spousal IRA accounts.

The Fund reserves the right to suspend the sale of shares at any time at the
discretion of Alex. Brown and the Fund's investment advisors. Orders for
purchases of shares are accepted on any day on which the New York Stock Exchange
is open for business ("Business Day"). Purchase orders for shares will be
executed at a per share purchase price equal to the net asset value next
determined after receipt of the purchase order plus any applicable front-end
sales charge (the "Offering Price") on the date such net asset value is
determined (the "Purchase Date"). Purchases made by mail must be accompanied by
payment of the Offering Price. Purchases made through Alex. Brown or a
Participating Dealer or Shareholder Servicing Agent must be in accordance with
such entity's payment procedures. Alex. Brown may, in its sole discretion,
refuse to accept any purchase order.

The net asset value per share is determined once daily as of the close of
the New York Stock Exchange, which is ordinarily 4:00 p.m. (Eastern Time), on
each Business Day. Net asset value per share of a class is calculated by
valuing all assets held by the Fund, deducting all liabilities, including
liabilities attributable to that specific class, and dividing the resulting
amount by the number of then outstanding shares of the class. For this
purpose, portfolio securities are given their market value where feasible. If
a portfolio security is traded on a national exchange or on an automated
dealer quotation system, such as NASDAQ, on the valuation date, the last
quoted sale price is generally used. Options are valued at the last reported
sale price, or if no sales are reported, at the average of the last reported
bid and asked prices. Securities or other assets for which market quotations
are not readily available are valued at their fair value as determined in
good faith under procedures established from time to time and monitored by
the Fund's Board of Directors. Debt obligations with maturities of 60 days or
less are valued at amortized cost, which constitutes fair value as determined
by the Fund's Board of Directors. Because of differences in
distribution/service fees between the classes of shares, the net asset value
per share of the classes differs at times.

12
<PAGE>

...............................................................................
OFFERING PRICE

Shares may be purchased from Alex. Brown, Participating Dealers or
Shareholder Servicing Agents at the Offering Price which for Class A Shares
includes a sales charge which is calculated as a percentage of the Offering
Price and for Class B Shares is net asset value.

...............................................................................
CLASS A SHARES

The sales charge on Class A Shares, which decreases as the amount of
purchase increases, is shown below:

Sales Charge
as % of Dealer
----------------------------- Retention
Offering Net Amount as % of
Amount of Purchase Price Invested Offering Price
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Less than $ 50,000 ..... 4.50% 4.71% 4.00%
$50,000 - $ 99,999 ..... 3.50% 3.63% 3.00%
$100,000 - $249,999 ..... 2.50% 2.56% 2.00%
$250,000 - $499,999 ..... 2.00% 2.04% 1.50%
$500,000 - $999,999 ..... 1.50% 1.52% 1.25%
$1,000,000 and over ..... None* None* None*
- -------------------------------------------------------------------------------
</TABLE>

* Purchases of $1 million or more may be subject to a contingent deferred
sales charge. (See below.) Alex. Brown may make payments to dealers in the
amount of .50% of the Offering Price.

A shareholder who purchases additional Class A Shares may obtain reduced
sales charges, as set forth in the table above, through a right of accumulation.
In addition, an investor may obtain reduced sales charges as set forth above
through a right of accumulation of purchases of Class A Shares and purchases of
shares of other Flag Investors funds with the same sales charge and purchases of
Flag Investors shares of Flag Investors Intermediate-Term Income Fund, Inc. and
Flag Investors Maryland Intermediate Tax Free Income Fund, Inc. (the
"Intermediate Funds"). The applicable sales charge will be determined based on
the total of (a) the shareholder's current purchase plus (b) an amount equal to
the then current net asset value or cost, whichever is higher, of all Class A
Shares and of all Flag Investors shares described above and any Flag Investors
Class D shares held by the shareholder. To obtain the reduced sales charge
through a right of accumulation, the shareholder must provide Alex. Brown,
either directly or through a Participating Dealer or Shareholder Servicing
Agent, as applicable, with sufficient information to verify that the shareholder
has such a right. The Fund may amend or terminate this right of accumulation at
any time as to subsequent purchases.

13
<PAGE>

The term "purchase" refers to an individual purchase by a single
purchaser, or to concurrent purchases, which will be aggregated, by a
purchaser, the purchaser's spouse and their children under the age of 21
years purchasing shares for their own account.

An investor may also obtain the reduced sales charges shown above by
executing a written Letter of Intent which states the investor's intention to
invest at least $50,000 within a 13-month period in Class A Shares. Each
purchase of shares under a Letter of Intent will be made at the Offering
Price applicable at the time of such purchase to the full amount indicated on
the Letter of Intent. A Letter of Intent is not a binding obligation upon the
investor to purchase the full amount indicated. The minimum initial
investment under a Letter of Intent is 5% of the full amount. Shares
purchased with the first 5% of the full amount will be held in escrow (while
remaining registered in the name of the investor) to secure payment of the
higher sales charge applicable to the shares actually purchased if the full
amount indicated is not invested. Such escrowed shares will be involuntarily
redeemed to pay the additional sales charge, if necessary. When the full
amount indicated has been purchased, the escrowed shares will be released. An
investor who wishes to enter into a Letter of Intent in conjunction with an
investment in Class A Shares may do so by completing the appropriate section
of the Application Form attached to this Prospectus.

No sales charge will be payable at the time of purchase on investments of
$1 million or more of Class A Shares. However, a contingent deferred sales
charge may be imposed on such investments in the event of a redemption
within 24 months following the purchase, at the rate of .50% on the lesser of
the value of the shares redeemed or the total cost of such shares. No
contingent deferred sales charge will be imposed on purchases of $3 million
or more of Class A Shares redeemed within 24 months of purchase if the
Participating Dealer and Alex. Brown have entered into an agreement under
which the Participating Dealer agrees to return any payments received on the
sale of such shares. In determining whether a contingent deferred sales
charge is payable, and, if so, the amount of the charge, it is assumed that
shares not subject to such charge are the first redeemed followed by other
shares held for the longest period of time.

Class A Shares may also be purchased through a Systematic Purchase Plan.
An investor who wishes to take advantage of such a plan should contact Alex.
Brown or a Participating Dealer or Shareholder Servicing Agent.

The Fund may sell Class A Shares at net asset value (without sales charge)
to the following: (i) banks, bank trust departments, registered investment
advisory companies, financial planners and broker-dealers purchasing Class A

14
<PAGE>

Shares on behalf of their fiduciary and advisory clients, provided such clients
have paid an account management fee for these services (investors may be charged
a fee if they effect transactions in Fund shares through a broker or agent);
(ii) qualified retirement plans; (iii) participants in a Flag Investors fund
payroll savings plan program; (iv) investors who have redeemed Class A Shares,
or shares of any other mutual fund in the Flag Investors family of funds with
the same sales charges, or who have redeemed shares of the Intermediate Funds
which they had held for at least 24 months prior to redemption, in an amount
that is not more than the total redemption proceeds, provided that the purchase
is within 90 days after the redemption; and (v) current or retired Directors of
the Fund and directors and employees (and their immediate families) of Alex.
Brown, Participating Dealers and their respective affiliates.

...............................................................................
CLASS B SHARES

No sales charge will be payable at the time of purchase of Class B Shares.
However, a contingent deferred sales charge will be imposed on certain Class
B Shares redeemed within six years of purchase. The charge is assessed on an
amount equal to the lesser of the then-current market value of the Class B
Shares redeemed or the total cost of such shares. Accordingly, the contingent
deferred sales charge will not be applied to dollar amounts representing an
increase in the net asset values above the initial purchase price of the
shares being redeemed. In addition, no charge is assessed on redemptions of
Class B Shares derived from reinvestment of dividends or capital gains
distributions.

In determining whether the contingent deferred sales charge is applicable
to a redemption, the calculation is made in the manner that results in the
lowest possible rate. Therefore, it is assumed that the redemption is first
of any Class B Shares in the shareholder's account that represent reinvested
dividends and distributions and second of Class B Shares held the longest
during the six year period. The amount of the contingent deferred sales
charge, if any, will vary depending on the number of years from the time of
payment for the purchase of Class B Shares until the redemption of such
shares (the "holding period"). For purposes of determining this holding
period, all payments during a month are aggregated and deemed to have been
made on the first day of the month. The following table sets forth the rates
of the contingent deferred sales charge.

15
<PAGE>

Contingent Deferred Sales Charge
Year Since Purchase (as a percentage of the dollar amount
Payment was Made subject to charge)
- ------------------------------------------------------------------
First ................. 4.0%
Second ................ 4.0%
Third ................. 3.0%
Fourth ................ 3.0%
Fifth ................. 2.0%
Sixth ................. 1.0%
Thereafter ............ None*
- ------------------------------------------------------------------

* As described more fully below, Class B Shares automatically convert to
Class A Shares six years after the beginning of the calendar month in which
the purchase order is accepted.

Waiver of Contingent Deferred Sales Charge. The contingent deferred sales
charge will be waived on the redemption of Class B Shares (i) following the
death or initial determination of disability (as defined in the Internal
Revenue Code of 1986, as amended) of a shareholder; or (ii) to the extent
that the redemption represents a minimum required distribution from an
individual retirement account or other retirement plan to a shareholder who
has attained the age of 70 1/2. The waiver with respect to (i) above is only
applicable in cases where the shareholder account is registered (a) in the
name of an individual person, (b) as a joint tenancy with rights of
survivorship, (c) as community property or (d) in the name of a minor child
under the Uniform Gifts or Uniform Transfers to Minors Act. A shareholder, or
his or her representative, must notify the Fund's transfer agent (the
"Transfer Agent") prior to the time of redemption if such circumstances exist
and the shareholder is eligible for this waiver. For information on the
imposition and waiver of the contingent deferred sales charge, contact the
Transfer Agent at (800) 553-8080.

Automatic Conversion to Class A Shares. Six years after the beginning of
the calendar month in which the purchase order for Class B Shares is
accepted, such Class B Shares will automatically convert to Class A Shares
and will no longer be subject to the higher distribution and service fees.
Such conversion will be on the basis of the relative net asset values of the
two classes, without the imposition of any sales load, fee or other charge.
The conversion is not a taxable event to the shareholder.

For purposes of conversion to Class A Shares, shares received as dividends
and other distributions paid on Class B Shares in the shareholder's account
will be considered to be held in a separate sub-account. Each time any Class
B Shares in the shareholder's account (other than those in the sub-account)
convert to Class A Shares, an equal pro rata portion of the Class B Shares in
the sub-account will also convert to Class A Shares.

16
<PAGE>

Class B Shares may also be purchased through a Systematic Purchase Plan.
An investor who wishes to take advantage of such a plan should contact Alex.
Brown or a Participating Dealer or Shareholder Servicing Agent.

...............................................................................

PURCHASES BY EXCHANGE

As permitted pursuant to any rule, regulation or order promulgated by the
SEC, shareholders of other Flag Investors funds may exchange their shares of
those funds for an equal dollar amount of Fund shares of the same class that
have the same sales load structure. Except as provided below, shares issued
pursuant to this offer will not be subject to the sales charges described above
or any other charge. Shareholders of the Intermediate Funds may exchange into
Class A Shares upon payment of the difference in sales charges, as applicable,
except that the exchange will be made at net asset value if the shares of such
funds have been held for more than 24 months. Shareholders of Flag Investors
Cash Reserve Prime Class A Shares may exchange into Class A Shares upon payment
of the difference in sales charges, as applicable, or into Class B Shares at net
asset value, subject thereafter to any applicable contingent deferred sales
charge.

When a shareholder acquires Fund shares through an exchange from another
fund in the Flag Investors family of funds, the Fund will combine the period
for which the original shares were held prior to the exchange with the
holding period of the shares acquired in the exchange for purposes of
determining what, if any, contingent deferred sales charge is applicable upon
a redemption of any such shares.

The net asset value of shares purchased and redeemed in an exchange request
received on a Business Day will be determined on the same day, provided that the
exchange request is received prior to 4:00 p.m. (Eastern Time) or the close of
the New York Stock Exchange, whichever is earlier. Exchange requests received
after 4:00 p.m. (Eastern Time) will be effected on the next Business Day.

Shareholders of any mutual fund not affiliated with the Fund, who have
paid a sales charge may exchange shares of such fund for an equal dollar
amount of Class A Shares by submitting to Alex. Brown or a Participating
Dealer the proceeds of the redemption of such shares, together with evidence
of the payment of a sales charge and the source of such proceeds. Shares
issued pursuant to this offer will not be subject to the sales charge
described above or any other charge.

The exchange privilege with respect to other Flag Investors funds may also
be exercised by telephone. (See "Telephone Transactions" below.) The exchange
privilege may be exercised only in those states where the class of shares of

17
<PAGE>

such other funds may legally be sold. Investors should receive and read the
applicable prospectus prior to tendering shares for exchange. The Fund may
modify or terminate this offer of exchange at any time on 60 days' prior written
notice to shareholders.

...............................................................................

PURCHASES THROUGH AUTOMATIC INVESTING PLAN

Shareholders may purchase either Class A Shares or Class B Shares regularly
by means of an Automatic Investing Plan with a pre-authorized check drawn on
their checking accounts. Under this plan, the shareholder may elect to have a
specified amount invested monthly or quarterly in either Class A Shares or Class
B Shares. The amount specified will be withdrawn from the shareholder's checking
account using the pre-authorized check and will be invested in the class of
shares selected by the shareholder at the applicable Offering Price determined
on the date the amount is available for investment. Participation in the
Automatic Investing Plan may be discontinued either by the Fund or the
shareholder upon 30 days' prior written notice to the other party. A shareholder
who wishes to enroll in the Automatic Investing Plan or who wishes to obtain
additional purchase information may do so by completing the appropriate section
of the Application Form attached to this Prospectus.

...............................................................................

PURCHASES THROUGH DIVIDEND REINVESTMENT PLAN

Shareholders may elect to have their distributions (capital gains and/or
dividend income) paid by check or reinvested in additional Fund shares of the
same class. A shareholder who wishes to enroll in the Dividend Reinvestment
Plan should check the appropriate box on the Application Form or call (800)
553-8080 for additional information.

Alternately, shareholders may have their distributions invested in shares of
other funds in the Flag Investors family of funds. Shareholders who are
interested in this option should call (800) 553-8080 for additional information.

Reinvestments of distributions will be effected without a sales charge.

- -------------------------------------------------------------------------------
6. HOW TO REDEEM SHARES

Shareholders may redeem all or part of their investment on any Business
Day by transmitting a redemption order through Alex. Brown, a Participating
Dealer, a Shareholder Servicing Agent or by regular or express mail to the
Transfer Agent. Shareholders may also redeem shares of either class by
telephone (in amounts up to $50,000). (See "Telephone Transactions" below.) A
redemption order is effected at the net asset value per share (reduced by any
applicable contingent deferred sales charge) next determined after receipt of
the order (or, if stock certificates have been issued for the shares to be
redeemed, after the tender of the stock certificates for redemption).
Redemption orders received after 4:00 p.m. (Eastern Time) will be effected at
the net asset value next determined on the following Business Day. Payment
for redeemed shares will be made by check and will be mailed within seven
days after receipt of a duly authorized telephone redemption request or of a
redemption order fully completed and, as applicable, accompanied by the
documents described below:

1) A letter of instructions, specifying the shareholder's account number with
a Participating Dealer, if applicable, and the number of shares or dollar
amount to be redeemed, signed by all owners of the shares in the exact
names in which their account is maintained;

18
<PAGE>

2) For redemptions in excess of $50,000, a guarantee of the signature of each
registered owner by a member of the Federal Deposit Insurance Corporation,
a trust company, broker, dealer, credit union (if authorized under state
law), securities exchange or association, clearing agency or savings
association;

3) If shares are held in certificate form, stock certificates either properly
endorsed or accompanied by a duly executed stock power for shares to be
redeemed; and

4) Any additional documents required for redemption by corporations,
partnerships, trusts or fiduciaries.

Dividends payable up to the date of redemption of shares will be paid on
the next dividend payable date. If all of the shares in a shareholder's
account have been redeemed on a dividend payable date, the dividend will be
remitted by check to the shareholder.

The Fund may suspend the right of redemption or postpone the date upon
which redemptions are effected at times when the New York Stock Exchange is
closed, or under any emergency circumstances as determined by the SEC.

The Fund has the power, under its Articles of Incorporation, to redeem
shareholder accounts amounting to less than $500 (as a result of redemptions)
upon 60 days' notice.

...............................................................................

SYSTEMATIC WITHDRAWAL PLAN

Shareholders who hold Class A Shares or Class B Shares having a value of
$10,000 or more may arrange to have a portion of their shares redeemed
monthly or quarterly under the Fund's Systematic Withdrawal Plan. Such
payments are drawn from income dividends, and to the extent necessary, from
share redemptions (which would be a return of principal and, if reflecting a
gain, would be taxable). If redemptions continue, a shareholder's account may
eventually be exhausted. Because share purchases include a sales charge that
will not be recovered at the time of redemption, a shareholder should not
have a withdrawal plan in effect at the same time he is making recurring
purchases of shares. In addition, Class B Shares may be subject to a
contingent deferred sales charge upon redemption. (See "How to Invest in the
Fund -- Class B Shares.") A shareholder who wishes to participate in the
Fund's Systematic Withdrawal Plan may do so by completing the appropriate
section of the Application Form attached to this Prospectus.

- -------------------------------------------------------------------------------
7. TELEPHONE TRANSACTIONS

Shareholders may exercise the exchange privilege with respect to other
Flag Investors funds, or redeem shares of either class in amounts up to

19
<PAGE>

$50,000, by notifying the Transfer Agent by telephone at (800) 553-8080 on
any Business Day between the hours of 8:30 a.m. and 5:30 p.m. (Eastern Time)
or by regular or express mail at its address listed under "Custodian,
Transfer Agent, Accounting Services." Telephone transaction privileges are
automatic. Shareholders may specifically request that no telephone
redemptions or exchanges be accepted for their accounts. This election may be
made on the Application Form or at any time thereafter by completing and
returning appropriate documentation supplied by the Transfer Agent.

A telephone exchange or redemption placed by 4:00 p.m. (Eastern Time) or
the close of the New York Stock Exchange, whichever is earlier, is effective
that day. Telephone orders placed after 4:00 p.m. (Eastern Time) will be
effected at the net asset value (less any applicable contingent deferred
sales charge on redemptions) as next determined on the following Business
Day.

The Fund and the Transfer Agent will employ reasonable procedures to
confirm that instructions communicated by telephone are genuine. These
procedures include requiring the investor to provide certain personal
identification information at the time an account is opened and prior to
effecting each transaction requested by telephone. In addition, all telephone
transaction requests will be recorded and investors may be required to
provide additional telecopied instructions of such transaction requests. The
Fund or the Transfer Agent may be liable for any losses due to unauthorized
or fraudulent telephone instructions if either of them does not employ these
procedures. If these procedures are followed, neither the Fund nor the
Transfer Agent will be responsible for any loss, liability, cost or expense
for following instructions received by telephone that either of them
reasonably believes to be genuine. During periods of extreme economic or
market changes, shareholders may experience difficulty in effecting telephone
transactions. In such event, requests should be made by regular or express
mail. Shares held in certificate form may not be exchanged or redeemed by
telephone. (See "How to Invest in the Fund -- Purchases by Exchange" and "How
to Redeem Shares.")

20
<PAGE>

- -------------------------------------------------------------------------------
8. DIVIDENDS AND TAXES
...............................................................................

DIVIDENDS AND DISTRIBUTIONS

The Fund's policy is to distribute to shareholders substantially all of
its taxable net investment income in the form of quarterly dividends. The
Fund will attempt to pay dividends that are consistent in amount with its
taxable net investment company income and reserves the right, with the
approval of the Directors, to pay dividends that constitute a return of
capital which could cause a decrease in a shareholder's tax basis in shares.
The Fund normally will distribute to shareholders any net capital gains on an
annual basis.

Unless the shareholder elects otherwise, all income and capital gains
distributions will be reinvested in additional Fund shares of the same class at
net asset value. Shareholders may elect to terminate automatic reinvestment by
giving written notice to the Transfer Agent (see "Custodian, Transfer Agent,
Accounting Services"), either directly or through any Participating Dealer or
Shareholder Servicing Agent, at least five days before the next date on which
dividends or distributions will be paid.

...............................................................................

TAX TREATMENT OF DIVIDENDS AND DISTRIBUTIONS

The following is only a general summary of certain federal income tax
considerations affecting the Fund and the shareholders. No attempt is made to
present a detailed explanation of the tax treatment of the Fund or the
shareholders, and the discussion here is not intended as a substitute for
careful tax planning.

The following summary is based on current tax laws and regulations, which
may be changed by legislative, judicial, or administrative action. The
Statement of Additional Information sets forth further information concerning
taxes.

The Fund has been and expects to continue to be taxed as a regulated
investment company under Subchapter M of the Internal Revenue Code of 1986,
as amended. As long as the Fund qualifies for this tax treatment, it will be
relieved of federal income tax on amounts distributed to shareholders, but
shareholders, unless otherwise exempt, generally will be subject to income
tax on the amounts so distributed, regardless of whether such distributions
are paid in cash or reinvested in additional shares.

21
<PAGE>

Distributions from the Fund out of net capital gains (the excess of net
long-term capital gains over net short-term capital losses), if any, will be
taxed to shareholders as long-term capital gains regardless of the length of
time a shareholder has held the shares. All other income distributions will
be taxed to shareholders as ordinary income. Corporate shareholders may be
entitled to the dividends received deduction on a portion of dividends
received from the Fund. Shareholders will be advised annually as to the tax
status of all distributions.

The sale, exchange or redemption of shares is a taxable event for the
shareholder.

Ordinarily, shareholders will include all dividends declared by the Fund
in income in the year of payment. However, dividends declared payable to
shareholders of record in December of one year, but paid in January of the
following year, will be deemed for tax purposes to have been received by the
shareholders and paid by the Fund on December 31 of the year in which the
dividends were declared.

The Fund intends to make sufficient distributions of its ordinary income
and capital gain net income prior to the end of each calendar year to avoid
liability for federal excise tax.

Shareholders are advised to consult with their tax advisors concerning the
application of the rules described above to their particular circumstances
and the application of state and local taxes to an investment in the Fund.

- -------------------------------------------------------------------------------
9. MANAGEMENT OF THE FUND

The overall business and affairs of the Fund are managed by its Board of
Directors. The Board approves all significant agreements between the Fund and
persons or companies furnishing services to the Fund, including the Fund's
agreements with its investment advisor, sub-advisor, distributor, custodian
and transfer agent. The day-to-day operations of the Fund are delegated to
the Fund's officers, to the Fund's investment advisor, Investment Company
Capital Corp. ("ICC"), to its sub-advisor, Alex. Brown Investment Management
("ABIM"), and to the Fund's distributor, Alex. Brown. Four Directors and all
of the officers of the Fund are officers or employees of ICC, ABIM or Alex.
Brown. The other Directors of the Fund have no affiliation with ICC, ABIM or
Alex. Brown.

22
<PAGE>

The Fund's Directors and officers are as follows:
<TABLE>

<CAPTION>
<S> <C> <C> <C>
*W. James Price Chairman Bruce E. Behrens President
*Richard T. Hale Director J. Dorsey Brown, III Executive Vice President
*Charles W. Cole, Jr. Director Hobart C. Buppert, II Vice President
James J. Cunnane Director Lee S. Owen Vice President
John F. Kroeger Director Edward J. Veilleux Vice President
Louis E. Levy Director Gary V. Fearnow Vice President
Eugene J. McDonald Director Brian C. Nelson Vice President and
*Rebecca W. Rimel Director Secretary
*Truman T. Semans Director Liam D. Burke Vice President
Carl W. Vogt Director Joseph A. Finelli Treasurer
Harry Woolf Director Laurie D. DePrine Assistant Secretary
</TABLE>

- ------
*Messrs. Price, Hale, Cole and Semans are, and Ms. Rimel may be, Directors
who are "interested persons" of the Fund within the meaning of Section
2(a)(19) under the Investment Company Act.

- -------------------------------------------------------------------------------
10. INVESTMENT ADVISOR AND SUB-ADVISOR

ICC is the Fund's investment advisor and ABIM is the Fund's sub-advisor.
ICC is also the investment advisor to, and Alex. Brown acts as distributor
for other mutual funds in the Flag Investors family of funds and Alex. Brown
Cash Reserve Fund, Inc., which funds had approximately $3.9 billion of net
assets as of December 31, 1995. ABIM is a registered investment advisor with
approximately $4.1 billion under management as of December 31, 1995.

Pursuant to the terms of the Investment Advisory Agreement, ICC supervises
and manages all of the Fund's operations. Under the Investment Advisory and
Sub-Advisory Agreements, ICC delegates to ABIM certain of its duties,
provided that ICC continues to supervise the performance of ABIM and report
thereon to the Fund's Board of Directors. Pursuant to the terms of the
Sub-Advisory Agreement, ABIM is responsible for decisions to buy and sell
securities for the Fund, for broker-dealer selection, and for negotiation of
commission rates under standards established and periodically reviewed by the
Board of Directors. The Board has established procedures under which ABIM may
allocate transactions to Alex. Brown, provided that compensation to Alex.
Brown on each transaction is reasonable and fair compared to the commission,
fee or other remuneration received or to be received by other broker-dealers
in connection with comparable transactions involving similar securities
during a comparable period of time. In addition, consistent with NASD Rules,
and subject to seeking the most favorable price and execution available and
such other policies as the Board may determine, ABIM may consider services in
connection with the sale of shares as a factor in the selection of
broker-dealers to execute portfolio transactions for the Fund.

23
<PAGE>

As compensation for providing investment advisory services, ICC is entitled
to receive a fee from the Fund, calculated daily and payable monthly, at the
annual rate of .85% of the first $100 million of the Fund's average daily net
assets, .75% of the next $100 million of the Fund's average daily net assets,
.70% of the next $100 million of the Fund's average daily net assets, .65% of
the next $200 million of the Fund's average daily net assets, .58% of the next
$500 million of the Fund's average daily net assets, .53% of the next $500
million of the Fund's average daily net assets, and .50% of that portion of the
Fund's average daily net assets in excess of $1.5 billion. ICC may from time to
time voluntarily waive a portion of its fee to improve performance. As
compensation for providing investment sub-advisory services, ABIM is entitled to
receive a fee from ICC, payable from its advisory fee, calculated daily and
payable monthly, at the annual rate of .60% of the first $100 million of the
Fund's average daily net assets, .55% of the next $100 million of the Fund's
average daily net assets, .50% of the next $100 million of the Fund's average
daily net assets, .45% of the next $200 million of the Fund's average daily net
assets, .40% of the next $500 million of the Fund's average daily net assets,
.37% of the next $500 million of the Fund's average daily net assets, and .35%
of that portion of the Fund's average daily net assets in excess of $1.5
billion.

ICC is a wholly-owned subsidiary of Alex. Brown, the Fund's distributor.
Buppert, Behrens & Owen, Inc., a company organized and owned by three
employees of ABIM, owns a 49% limited partnership interest and a 1% general
partnership interest in ABIM. Alex. Brown owns a 1% general partnership
interest in ABIM and Alex. Brown Incorporated owns the remaining 49% limited
partnership interest. The address of both ICC and ABIM is 135 East Baltimore
Street, Baltimore, Maryland 21202.

ICC also serves as the Fund's transfer and dividend disbursing agent and
provides accounting services to the Fund. (See "Custodian, Transfer Agent,
Accounting Services.")

...............................................................................

PORTFOLIO MANAGERS

Messrs. Bruce E. Behrens, the Fund's President, and Hobart C. Buppert, II,
a Vice President of the Fund, have shared primary responsibility for managing
the Fund's assets since inception.

Bruce E. Behrens -- 28 Years Investment Experience

Mr. Behrens has been a Vice President of ABIM since 1981. Prior to joining
ABIM, Mr. Behrens was a Senior Vice President and Principal of Corbyn
Associates from 1978 to 1981 and a Vice President at Investment Counselors of
Maryland from 1972 to 1978. Prior thereto, he was a Security Analyst at
Citibank from 1968 to 1972. Mr. Behrens received his B.A. from Denison

24
<PAGE>

University in 1966 and an M.B.A. from the University of Michigan in 1968. He is
a member and past President of the Baltimore Security Analysts Society and a
member of the Financial Analysts Federation.

Hobart C. Buppert, II -- 24 Years Investment Experience

Mr. Buppert has been a Vice President of ABIM since 1980. Prior to joining
ABIM, Mr. Buppert worked as a Portfolio Manager for T. Rowe Price Associates
from 1976 to 1980 and as a Portfolio Manager and Research Analyst for the
Equitable Trust Company from 1972 to 1976. Mr. Buppert received his B.A and
M.B.A. degrees from Loyola College in 1970 and 1974, respectively. He is a
member of the Baltimore Security Analysts Society and the Financial Analysts
Federation.

- -------------------------------------------------------------------------------
11. DISTRIBUTOR

Alex. Brown acts as distributor of the Class A Shares and the Class B
Shares. Alex. Brown is an investment banking firm which offers a broad range
of investment services to individual, institutional, corporate and municipal
clients. It is a wholly-owned subsidiary of Alex. Brown Incorporated which
has engaged directly and through subsidiaries and affiliates in the
investment business since 1800. Alex. Brown is a member of the New York Stock
Exchange and other leading securities exchanges. Headquartered in Baltimore,
Maryland, Alex. Brown has offices throughout the United States and, through
subsidiaries, maintains offices in London, England, Geneva, Switzerland and
Tokyo, Japan.

The Fund has adopted two separate Distribution Agreements and related
Plans of Distribution, one with respect to the Class A Shares and one with
respect to the Class B Shares (the "Plans") pursuant to Rule 12b-1 under the
Investment Company Act. In addition, the Fund may enter into Shareholder
Servicing Agreements with certain financial institutions, such as banks, to
act as Shareholder Servicing Agents, pursuant to which Alex. Brown will
allocate a portion of its distribution fee as compensation for such financial
institutions' ongoing shareholder services. Such financial institutions may
impose separate fees in connection with these services and investors should
review this Prospectus in conjunction with any such institution's fee
schedule. In addition, financial institutions may be required to register as
dealers pursuant to state securities laws. Amounts allocated to Participating
Dealers and Shareholder Servicing Agents may not exceed amounts payable to
Alex. Brown under the Plans with respect to shares held by or on behalf of
customers of such entities.

25
<PAGE>

As compensation for providing distribution services for the Class A Shares
for the fiscal year ended December 31, 1995, Alex. Brown received a fee equal
to .25% of the average daily net assets of the Class A Shares.

As compensation for providing distribution and shareholder services for
the Class B Shares for the fiscal year ended December 31, 1995, Alex. Brown
received a distribution fee equal to .75% of the Class B Shares' average
daily net assets and a shareholder servicing fee equal to .25% of the Class B
Shares' average daily net assets. The distribution fee is used to compensate
Alex. Brown for its services and expenses in distributing the Class B Shares.
The shareholder servicing fee is used to compensate Alex. Brown,
Participating Dealers and Shareholder Servicing Agents for services provided
and expenses incurred in maintaining shareholder accounts, responding to
shareholder inquiries and providing information on their investments.

Payments under the Plans are made as described above regardless of Alex.
Brown's actual cost of providing distribution services and may be used to pay
Alex. Brown's overhead expenses. If the cost of providing distribution
services to the Fund in connection with the sale of the Class A Shares is
less than .25% of the average daily net assets invested in Class A Shares or
in connection with the sale of the Class B Shares is less than .75% of the
average daily net assets invested in Class B Shares for any period, the
unexpended portion of the distribution fees may be retained as profit by
Alex. Brown. Alex. Brown will from time to time and from its own resources
pay or allow additional discounts or promotional incentives in the form of
cash or other compensation (including merchandise or travel) to Participating
Dealers.

The address of Alex. Brown is 135 East Baltimore Street, Baltimore,
Maryland 21202.

- -------------------------------------------------------------------------------
12. CUSTODIAN, TRANSFER AGENT, ACCOUNTING SERVICES

PNC Bank, National Association ("PNC Bank"), a national banking
association with offices at Airport Business Park, 200 Stevens Drive, Lester,
Pennsylvania 19113, acts as custodian of the Fund's assets. Investment
Company Capital Corp., 135 East Baltimore Street, Baltimore, Maryland 21202
(telephone: (800) 553-8080), is the Fund's transfer and dividend disbursing
agent and provides accounting services to the Fund. As compensation for
providing accounting services to the Fund for the fiscal year ended December
31, 1995, ICC received a fee equal to .02% of the Fund's average daily net
assets. (See the Statement of Additional Information.) ICC also serves as the
Fund's investment advisor.

26
<PAGE>

- -------------------------------------------------------------------------------
13. PERFORMANCE INFORMATION

From time to time, the Fund may advertise its performance, including
comparisons to other mutual funds with similar investment objectives and to
stock or other relevant indices. All such advertisements will show the average
annual total return, net of the Fund's maximum sales charge imposed on Class A
Shares or including the contingent deferred sales charge imposed on Class B
Shares redeemed at the end of the specified period covered by the total return
figure, over one, five and ten year periods or, if such periods have not yet
elapsed, shorter periods corresponding to the life of the Fund. Such total
return quotations will be computed by finding the average annual compounded
rates of return over such periods that would equate an assumed initial
investment of $1,000 to the ending redeemable value, net of the maximum sales
charge and other fees, according to the required standardized calculation. The
standardized calculation is required by the SEC to provide consistency and
comparability in investment company advertising and is not equivalent to a yield
calculation. If the Fund compares its performance to other funds or to relevant
indices, its performance will be stated in the same terms in which such
comparative data and indices are stated, which is normally total return rather
than yield. For these purposes, the performance of the Fund, as well as the
performance of such investment companies or indices, may not reflect sales
charges, which, if reflected, would reduce performance results.

The performance of the Fund may be compared to data prepared by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc. and Morningstar,
Inc., independent services which monitor the performance of mutual funds. The
performance of the Fund may also be compared to the Lehman Brothers Government
Corporate Bond Index, the Consumer Price Index, the return on 90 day U.S.
Treasury bills, the Standard & Poor's 500 Stock Index and the Dow Jones
Industrial Average. The Fund may also use total return performance data as
reported in the following national financial and industry publications that
monitor the performance of mutual funds: Money Magazine, Forbes, Business Week,
Barrons, Investor's Daily, IBC/Donoghue's Money Fund Report and The Wall Street
Journal.

Performance will fluctuate, and any statement of performance should not be
considered as representative of the future performance of the Fund.
Shareholders should remember that performance is generally a function of the
type and quality of instruments held by the Fund, operating expenses and
market conditions. Any fees charged by banks with respect to customer
accounts through which shares may be purchased, although not included in
calculations of performance, will reduce performance results.

27
<PAGE>

Although expenses for Class B Shares may be higher than those for Class A
Shares, the performance of Class B Shares may be higher than the performance
of Class A Shares after giving effect to the impact of the sales charges and
distribution/service fees applicable to each class of shares.

- -------------------------------------------------------------------------------
14. GENERAL INFORMATION
...............................................................................
CAPITAL SHARES

The Fund reorganized as a Maryland corporation on January 19, 1989,
pursuant to an Agreement and Plan of Reorganization and Liquidation approved
by shareholders on December 6, 1988. The Fund is authorized to issue 70
million shares of capital stock, with a par value of $.001 per share. Shares
of the Fund have equal rights with respect to voting. Voting rights are not
cumulative, so the holders of more than 50% of the outstanding shares voting
together for election of Directors may elect all the members of the Board of
Directors of the Fund. In the event of liquidation or dissolution of the
Fund, each share would be entitled to its portion of the Fund's assets after
all debts and expenses have been paid. The fiscal year end of the Fund is
December 31.

The Board of Directors is authorized to establish additional "series" of
shares of capital stock, each of which would evidence interests in a separate
portfolio of securities, and separate classes of each series of the Fund. The
shares offered by this Prospectus have been designated: "Flag Investors
Telephone Income Fund Class A Shares" and "Flag Investors Telephone Income
Fund Class B Shares." The Board has no present intention of establishing any
additional series of the Fund but the Fund does have another class of shares
in addition to the shares offered hereby, "Flag Investors Telephone Income
Fund Class D Shares," which are not currently being offered. Different
classes of the Fund may be offered to certain investors and holders of such
shares may be entitled to certain exchange privileges not offered to Class A
or Class B Shares. All classes of the Fund share a common investment
objective, portfolio of investments and advisory fee, but the classes may
have different distribution/service fees or sales load structures and,
accordingly, performance may differ.

...............................................................................
ANNUAL MEETINGS

The Fund does not expect to hold annual meetings of shareholders, but
special meetings of shareholders may be held under certain circumstances.
Shareholders of the Fund retain the right, under certain circumstances, to
request that a meeting of shareholders be held for the purpose of considering

28
<PAGE>

the removal of a Director from office, and if such a request is made, the Fund
will assist with shareholder communications in connection with the meeting.

...............................................................................
REPORTS

The Fund furnishes shareholders with semi-annual reports containing
information about the Fund and its operations, including a list of
investments held in the Fund's portfolio and financial statements. The annual
financial statements are audited by the Fund's independent accountants,
Coopers & Lybrand L.L.P.

...............................................................................
FUND COUNSEL

Morgan, Lewis & Bockius LLP serves as counsel to the Fund.

...............................................................................
SHAREHOLDER INQUIRIES

Shareholders with inquiries concerning their shares should contact Alex.
Brown at (800) 767-FLAG, the Transfer Agent at (800) 553-8080, or a
Participating Dealer or Shareholder Servicing Agent, as appropriate.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND, INC.
NEW ACCOUNT APPLICATION
- -----------------------------------------------------------------------------

Make check payable to "Flag Investors Telephone Income
Fund, Inc." and mail with this application to:
Alex. Brown & Sons Incorporated/Flag Investors Funds
P.O. Box 419663
Kansas City, MO 64141-6663
Attn: Flag Investors Telephone Income Fund, Inc.

For assistance in completing this application please call: 1-800-553-8080
Monday through Friday, 8:30 a.m. to 5:30 p.m. (Eastern Time)

To open an IRA account, please call 1-800-767-3524 for an IRA information kit.

I wish to purchase the following class of shares of the Fund, in the amount
indicated below. (Please check the applicable box and indicate amount
of purchase.)

/ / Class A Shares (4.5% maximum initial sales charge)
in the amount of $____________________
/ / Class B Shares (4.0% maximum contingent deferred sales charge)
in the amount of $____________________

The minimum initial purchase is $2,000, except that the minimum initial purchase
for shareholders of any other Flag Investors Fund or class is $500 and the
minimum initial purchase for participants in the Fund's Automatic Investing Plan
is $250 per class. Each subsequent purchase requires a $100 minimum per class,
except that the minimum subsequent purchase under the Fund's Automatic Investing
Plan is $250 for quarterly purchases and $100 for monthly purchases. The maximum
investment in Class B Shares is $100,000 per account. The Fund reserves the
right not to accept checks for more than $50,000 that are not certified or bank
checks.

- -----------------------------------------------------------------------------

YOUR ACCOUNT REGISTRATION (PLEASE PRINT)

Existing Account No., if any: _____________________________________

INDIVIDUAL OR JOINT TENANT

- -----------------------------------------------------------------------------
First Name Initial Last Name

- -----------------------------------------------------------------------------
Social Security Number

- -----------------------------------------------------------------------------
Joint Tenant Initial Last Name

CORPORATIONS, TRUSTS, PARTNERSHIPS, ETC.

- -----------------------------------------------------------------
Name of Corporation, Trust or Partnership

- ------------------------------- ------------------------------
Tax ID Number Date of Trust

- -----------------------------------------------------------------
Name of Trustees (If to be included in the Registration)

- -----------------------------------------------------------------
For the Benefit of

GIFTS TO MINORS

- -----------------------------------------------------------------------------
Custodian's Name (only one allowed by law)

- -----------------------------------------------------------------------------
Minor's Name (only one)

- -----------------------------------------------------------------------------
Social Security Number of Minor

under the ____________________ Uniform Gifts to Minors Act
State of Residence

MAILING ADDRESS

- -----------------------------------------------------------------------------
Street

- -----------------------------------------------------------------------------
City State Zip
( )
- -----------------------------------------------------------------------------
Daytime Phone

______________________________________________________________________________
<PAGE>
LETTER OF INTENT - CLASS A SHARES ONLY (OPTIONAL)

[ ] I agree to the Letter of Intent and Escrow Agreement set forth in the
accompanying prospectus. Although I am not obligated to do so, I intend to
invest over a 13-month period in Class A Shares, as shown below, in an
aggregate amount at least equal to:

| | $50,000 | | $100,000 | | $250,000 | | $500,000 | | $1,000,000

________________________________________________________________________________

RIGHT OF ACCUMULATION - CLASS A SHARES ONLY (OPTIONAL)

[ ] I already own shares of the Flag Investors Fund(s) set forth below (except
Class B shares) to be applied for a reduced sales charge. List the Account
numbers of other Flag Investors Funds that you or your immediate family (spouse
and children under 21) already own that qualify for reduced sales charges.

Fund Name Account No. Owner's Name Relationship
--------- ----------- ------------ ------------
________________________________________________________________________________

________________________________________________________________________________

<PAGE>
DISTRIBUTION OPTIONS

Please check the appropriate boxes. If none of the options is selected, all
distributions will be reinvested in additional shares of the same class of
the Fund at no sales charge.

Income Dividends

[ ] Reinvested in additional shares
[ ] Paid in Cash

Capital Gains

[ ] Reinvested in additional shares
[ ] Paid in Cash

Call (800) 553-8080 for information about reinvesting your dividends in other
funds in the Flag Investors Family of Funds.

- -----------------------------------------------------------------------------
AUTOMATIC INVESTING PLAN (OPTIONAL)

[ ] I authorize you as Agent for the Automatic Investing Plan to
automatically invest $_______ in Class A Shares or $_______ in Class B Shares
for me, on a monthly or quarterly basis, on or about the 20th of each month
or if quarterly, the 20th of January, April, July and October, and to draw a
bank draft in payment of the investment against my checking account. (Bank
drafts may be drawn on commercial banks only.)

Minimum Initial Investment: $250 per class
Subsequent Investments (check one):

[ ] Monthly ($100 minimum per class)
[ ] Quarterly ($250 minimum per class)

- -----------------------------------------------------------------------------
Bank Name

- -----------------------------------------------------------------------------
Existing Flag Investors Fund Account No., if any

Please attach a voided check.

- -----------------------------------------------------------------------------
Depositor's Signature Date

- -----------------------------------------------------------------------------
Depositor's Signature Date
(if joint acct., both must sign)
- -----------------------------------------------------------------------------
SYSTEMATIC WITHDRAWAL PLAN (OPTIONAL)

[ ] Beginning the month of _______, 19__ please send me checks on a
monthly or quarterly basis, as indicated below, in the amount of (complete as
applicable) $______ from Class A Shares and/or $______ from Class B Shares
that I own, payable to the account registration address as shown above.
(Participation requires minimum account value of $10,000 per class.)

Frequency (check one):

[ ] Monthly
[ ] Quarterly (January, April, July and October)
______________________________________________________________________________

TELEPHONE TRANSACTIONS

I understand that I will automatically have telephone redemption privileges
(for amounts up to $50,000) and telephone exchange privileges (with respect
to other Flag Investors Funds) unless I mark one or both of the boxes below:

No, I/We do not want

[ ] Telephone redemption privileges
[ ] Telephone exchange privileges

Redemptions effected by telephone will be mailed to the address of record. If
you would prefer redemptions mailed to a pre-designated bank account, please
provide the following information:

Bank: ___________________________ Bank Account No: ___________________

Address: ___________________________ Bank Account Name: ___________________

_______________________________________________________________________________

<PAGE>
SIGNATURE AND TAXPAYER CERTIFICATION

I have received a copy of the Fund's prospectus dated April 10, 1996. Unless the
box below is checked, I certify under penalties of perjury, (1) that the
number shown on this form is my correct taxpayer identification number and
(2) that I am not subject to backup withholding as a result of a failure to
report all interest or dividends, or the Internal Revenue Service has
notified me that I am no longer subject to backup withholding. [ ] Check here
if you are subject to backup withholding.
If a non-resident alien, please indicate country of residence:

- -----------------------------------------------------------------------------

I acknowledge that the telephone redemption and exchange privileges are
automatic and will be effected as described in the Fund's current prospectus
(see "Telephone Transactions"). I also acknowledge that I may bear the risk
of loss in the event of fraudulent use of such privileges. If I do not want
telephone redemption or exchange privileges, I have so indicated on this
Application.

- -----------------------------------------------------------------------------
Signature Date

- -----------------------------------------------------------------------------
Signature (if joint acct., both must sign) Date

- -----------------------------------------------------------------------------

For Dealer Use Only

Dealer's Name: ___________________ Dealer Code: _________________________

Dealer's Address: ___________________ Branch Code: _________________________

____________________

Representative: ____________________ Rep. No. _________________________

<PAGE>

Flag Investors Telephone Income Fund, Inc.
P.O. Box 515
Baltimore, MD 21203

- ----------------
BULK RATE
U.S. POSTAGE
PAID
PERMIT NO. 2139
BALTO., MD
- ----------------

<PAGE>

STATEMENT OF ADDITIONAL INFORMATION

--------------------------------------------

FLAG INVESTORS TELEPHONE INCOME FUND, INC.
(Class A and Class B Shares)

135 E. Baltimore Street
Baltimore, Maryland 21202

--------------------------------------------

THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A
PROSPECTUS. IT SHOULD BE READ IN CONJUNCTION WITH A
PROSPECTUS, WHICH MAY BE OBTAINED FROM ANY
PARTICIPATING DEALER OR SHAREHOLDER SERVICING AGENT
OR BY WRITING OR CALLING ALEX. BROWN & SONS
INCORPORATED, 135 EAST BALTIMORE ST., BALTIMORE,
MARYLAND 21202, (800) 767-FLAG.

Statement of Additional Information Dated: April 10, 1996

Relating to the Prospectus Dated: April 10, 1996

<PAGE>

TABLE OF CONTENTS

Page
----
1. General Information and History......................... 1

2. Investment Objective and Policies....................... 2

3. Valuation of Shares and Redemption...................... 7

4. Federal Tax Treatment of Dividends and Distributions.... 8

5. Management of the Fund.................................. 11

6. Investment Advisory and Other Services.................. 16

7. Distribution of Fund Shares............................. 17

8. Brokerage............................................... 21

9. Capital Stock........................................... 22

10. Semi-Annual Reports..................................... 23

11. Custodian, Transfer Agent, Accounting Services.......... 23

12. Independent Accountants................................. 24

13. Performance Information................................. 24

14. Control Persons and Principal Holders of Securities..... 26

15. Financial Statements ................................... 26

Appendix................................................ A-1

<PAGE>

1. GENERAL INFORMATION AND HISTORY

Flag Investors Telephone Income Fund, Inc. (the "Fund") is an
open-end management investment company that was originally designed to provide
both convenience and professional investment management to shareholders of the
former American Telephone and Telegraph Company ("AT&T") after AT&T's
divestiture and reorganization in January 1984.

Under the rules and regulations of the Securities and Exchange
Commission (the "SEC"), all mutual funds are required to furnish prospective
investors with certain information concerning the activities of the company
being considered for investment. The Fund currently offers two classes of
shares: Flag Investors Telephone Income Fund Class A Shares and Flag Investors
Telephone Income Fund Class B Shares. As used herein, the "Fund" refers to Flag
Investors Telephone Income Fund, Inc. and specific references to either class of
the Fund's shares will be made using the name of such class. Important
information concerning the Fund is included in the Fund's Prospectus which may
be obtained without charge from Alex. Brown & Sons Incorporated ("Alex. Brown"),
135 East Baltimore Street, Baltimore, Maryland 21202 (telephone (800) 767-FLAG)
or from Participating Dealers that offer shares of the respective classes of the
Fund ("Shares") to prospective investors. Prospectuses may also be obtained from
Shareholder Servicing Agents. Some of the information required to be in this
Statement of Additional Information is also included in the Fund's current
Prospectus. To avoid unnecessary repetition, references are made to related
sections of the Prospectus. In addition, the Prospectus and this Statement of
Additional Information omit certain information about the Fund and its business
that is contained in the Registration Statement respecting the Fund and its
Shares filed with the SEC. Copies of the Registration Statement as filed,
including such omitted items, may be obtained from the SEC by paying the charges
prescribed under its rules and regulations.

The Fund was organized as a Maryland corporation on October
18, 1983. Shares of the Fund were sold by Alex. Brown and other broker-dealers
in an offering that commenced on December 7, 1983. On January 18, 1984, the Fund
effected a tax-free exchange of five of its Shares for each share of AT&T common
stock that had previously been transmitted to the Fund by exchanging
shareholders. The Fund collected the distributed shares of the regional
telephone companies created by AT&T's divestiture and undertook an investment
program consistent with the Fund's investment objectives. (See Prospectus -
"Investment Program"). On May 20, 1985, the Fund reorganized as a Massachusetts
business trust and on January 19, 1989, it reorganized as a Maryland corporation
pursuant to an Agreement and Plan of Reorganization and Liquidation approved by
shareholders on December 6, 1988.

For the period from April 6, 1993 through November 18, 1994,
the Fund offered another class of shares: Flag Investors Telephone Income Fund
Class D Shares, which were known at the time as Flag Investors Telephone Income
Fund Class B Shares and were reclassified as Flag Investors Telephone Income
Fund Class D Shares on November 18, 1994. Shares of that class are not currently
being offered although shares remain outstanding. The Fund commenced offering
the Flag Investors Telephone Income Fund Class B Shares on January 3, 1995.

Under a license agreement dated January 19, 1989 between the
Fund and Alex. Brown Incorporated, Alex. Brown Incorporated licenses to the Fund
the "Flag Investors" name and logo but retains rights to that name and logo,
including the right to permit other investment companies to use them.

-1-
<PAGE>

2. INVESTMENT OBJECTIVE AND POLICIES

The Fund's investment objective is to seek current income and
long-term growth of capital without undue risk. In seeking this objective, the
Fund invests primarily in income-producing common stock, securities convertible
thereto and debt obligations of companies in the telephone industry. The Fund's
investment advisor, Investment Company Capital Corp. ("ICC") and sub-advisor,
Alex. Brown Investment Management ("ABIM"), collectively, (the "Advisors")
believe that investing in a portfolio of securities of companies in the
telephone industry affords an attractive opportunity for achieving this
investment objective. There can be no assurance, however, that the Fund's
investment objective will be achieved. The Fund was rated the number-one equity
income fund by Lipper Analytical Services, Inc. for the ten-year period ended
December 31, 1995. Morningstar Mutual Fund Advisory Services assigned the Fund a
four star rating as of December 31, 1995.

The Fund may also invest under certain circumstances,
described in the Prospectus, in income-producing securities (including debt
obligations) of issuers in other industries and non-income-producing securities
of issuers in the telephone industry, and may enter into repurchase agreements,
may loan portfolio securities, and may write covered call options. In general,
the Fund will invest in investment grade debt obligations that are rated, at the
time of purchase, BBB or higher by Standard & Poor's Ratings Group ("S&P") or
Baa or higher by Moody's Investors Service, Inc. ("Moody's"). Up to 10% of the
Fund's assets may be invested in lower quality debt obligations (securities
rated BB or lower by S&P or Ba or lower by Moody's). (See "Below Investment
Grade Securities" below.) The ratings categories of S&P and Moody's are
described more fully in Appendix A.

Below Investment Grade Securities

The Fund may purchase debt obligations that carry ratings
lower than those assigned to investment grade bonds by Moody's or S&P, or that
are unrated if such bonds, in the Advisors' judgment, meet the quality criteria
established by the Board of Directors. These bonds are generally known as "junk
bonds." These securities may trade at substantial discounts from their face
values. Accordingly, if the Fund is successful in meeting its objectives,
investors may receive a total return consisting not only of income dividends
but, to a lesser extent, capital gain distributions. Appendix A to this
Statement of Additional Information sets forth a description of the S&P and
Moody's rating categories, which indicate the rating agency's opinion as to the
probability of timely payment of interest and principal. These ratings range in
descending order of quality from AAA to D (though the Fund will not purchase
securities rated, at the time of purchase below C), in the case of S&P, and from
Aaa to C, in the case of Moody's. Generally, securities which are rated lower
than BBB by S&P or Baa by Moody's are described as below investment grade.
Securities rated lower than investment grade may be of a predominantly
speculative character and their future cannot be considered well-assured. The
issuer's ability to make timely payments of principal and interest may be
subject to material contingencies. Securities in the lowest rating categories
may be unable to make timely interest or principal payments and may be in
default and in arrears in interest and principal payments.

The following summarizes the Moody's and S&P definitions for
speculative grade debt obligations in which the Fund may invest. Bonds which are
rated Ba by Moody's are judged to have speculative elements; their future cannot
be considered well-assured; and protection of interest and principal payments
may be very moderate, and thereby not well safeguarded during both good and bad
times over the future. Uncertainty of position characterizes bonds in this
class. Bonds rated B generally lack characteristics of the desirable investment
and the assurance of interest and principal payments or of maintenance of other
terms of the contract over any long period of time may be small. Caa rated bonds

-2-
<PAGE>

are of poor standing and may be in default or may have elements of danger with
respect to principal or interest. Bonds rated Ca represent obligations which are
speculative in a high degree and are often in default or have other marked
shortcomings. Bonds rated C are the lowest rated class of bonds and can be
regarded as having extremely poor prospects of ever attaining any real
investment standing. In the case of S&P, BB rated bonds have less near-term
vulnerability to default than other speculative issues but face major ongoing
uncertainties or exposure to adverse business, financial, or economic conditions
which could lead to inadequate capacity to meet timely interest and principal
payments. The BB rating category is also used for debt subordinated to senior
debt that is assigned an actual or implied BBB- rating. B rated bonds have a
greater vulnerability to default than BB rated bonds but currently have the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB or BB-
rating. CCC rated bonds have a currently identifiable vulnerability to default
and are dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, they are not likely to have
the capacity to pay interest and repay principal. The CCC rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied B or B- rating. The rating CC typically is applied to debt subordinated
to senior debt that is assigned an actual or implied CCC rating. The rating C
typically is applied to debt subordinated to senior debt which is assigned an
actual or implied CCC- debt rating. The C rating may be used to cover a
situation where a bankruptcy petition has been filed, but debt service payments
are continued. The rating CI is reserved for income bonds on which no interest
is being paid.

Ratings of S&P and Moody's represent their opinions of the
quality of bonds and other debt securities they undertake to rate at the time of
issuance. However, these ratings are not absolute standards of quality and may
not reflect changes in an issuer's creditworthiness. Accordingly, the Advisors
do not rely exclusively on ratings issued by S&P or Moody's in selecting
portfolio securities but supplement such ratings with independent and ongoing
review of credit quality. In addition, the total return the Fund may earn from
investments in high yield securities will be significantly affected not only by
credit quality but by fluctuations in the markets in which such securities are
traded. Accordingly, selection and supervision by the Advisors of investments in
lower rated securities involves continuous analysis of individual issuers,
general business conditions, activities in the high yield bond market and other
factors. The analysis of issuers may include, among other things, historic and
current financial conditions, strength of management, responsiveness to business
conditions, credit standing and current and anticipated results of operations.
Analysis of general business conditions and other factors may include
anticipated changes in economic activity in interest rates, the availability of
new investment opportunities and the economic outlook for specific industries.

Investing in higher yield, lower rated bonds entails
substantially greater risk than investing in investment grade bonds, including
not only credit risk, but potentially greater market volatility and lower
liquidity. Yields and market values of high yield bonds will fluctuate over
time, reflecting not only changing interest rates but the bond market's
perception of credit quality and the outlook for economic growth. When economic
conditions appear to be deteriorating, lower rated bonds may decline in value
due to heightened concern over credit quality, regardless of prevailing interest
rates. In adverse economic conditions, the liquidity of the secondary market for
junk bonds may be significantly reduced. In addition, adverse economic
developments could disrupt the high yield market, affecting both price and
liquidity, and could also affect the ability of issuers to repay principal and
interest, thereby leading to a default rate higher than has been the case
historically. Even under normal conditions, the market for junk bonds may be
less liquid than the market for investment grade corporate bonds. There are

-3-
<PAGE>

fewer securities dealers in the high yield market and purchasers of high yield
bonds are concentrated among a smaller group of securities dealers and
institutional investors. In periods of reduced market liquidity, the market for
junk bonds may become more volatile and there may be significant disparities in
the prices quoted for high yield securities by various dealers. Under conditions
of increased volatility and reduced liquidity, it would become more difficult
for the Fund to value its portfolio securities accurately because there might be
less reliable, objective data available.

Finally, prices for high yield bonds may be affected by
legislative and regulatory developments. For example, from time to time,
Congress has considered legislation to restrict or eliminate the corporate tax
deduction for interest payments or to regulate corporate restructurings such as
takeovers, mergers or leveraged buyouts. Such legislation may significantly
depress the prices of outstanding high yield bonds.

Repurchase Agreements

The Fund may enter into repurchase agreements with domestic
banks or broker-dealers deemed to be creditworthy by ICC and ABIM, under
guidelines approved by the Board of Directors. A repurchase agreement is a
short-term investment in which the purchaser (i.e., the Fund) acquires ownership
of a debt security and the seller agrees to repurchase the obligation at a
future time and set price, usually not more than seven days from the date of
purchase, thereby determining the yield during the purchaser's holding period.
The value of underlying securities will be at least equal at all times to the
total amount of the repurchase obligation, including the interest factor. The
Fund makes payment for such securities only upon physical delivery or evidence
of book entry transfer to the account of a custodian, sub-custodian, or bank
acting as agent. The underlying securities, which in the case of the Fund are
securities of the U.S. Government only, may have maturity dates exceeding one
year. The Fund does not bear the risk of a decline in value of the underlying
securities unless the seller defaults under its repurchase obligation. In the
event of a bankruptcy or other default of a seller of a repurchase agreement,
the Fund could experience both delays in liquidating the underlying securities
and loss including: (a) possible decline in the value of the underlying security
during the period during which the Fund seeks to enforce its rights thereto, (b)
possible subnormal levels of income and lack of access to income during this
period, and (c) expenses of enforcing its rights.

Lending of Portfolio Securities

The Fund may lend portfolio securities to Board-approved
brokers or dealers in corporate or government securities, banks or other
recognized institutional borrowers of securities, provided that the borrower
maintains cash or equivalent collateral or a letter of credit in the Fund's
favor of not less than 100% of the market value of the securities loaned by
marking to market daily. While the portfolio securities are on loan, the Fund
receives from the borrower an amount equal to any dividend or interest paid on
such securities. The Fund may invest the cash collateral to generate additional
income or it may by agreement with the borrower receive interest income from the
borrower. Either the Fund or the borrower may terminate the loan at any time.
The Fund may pay reasonable administrative and custodial fees in connection with
a loan and may agree to pay a portion of interest generated on the Fund's
investment of the cash or equivalent collateral to the borrower or placing
broker. The Fund has no current intention of lending more than 5% of its
portfolio securities.

-4-
<PAGE>

Covered Call Options

In an attempt to earn additional income, and as a means of
protecting the Fund's assets against market declines, the Fund may, to a limited
extent, write covered call option contracts on certain of its securities and
purchase call options for the purpose of terminating its outstanding obligations
with respect to securities upon which call option contracts have been written.

When the Fund writes a call option on securities which it
owns, it gives the purchaser of the option the right to buy the securities at
the price specified in the option (the "Exercise Price") at any time prior to
the expiration of the option. In the strategy to be employed by the Fund, the
Exercise Price, plus the option premium paid by the purchaser, is almost always
greater than the market price of the underlying security at the time the option
is written. If any option is exercised, the Fund will realize the long-term or
short-term gain or loss from the sale of the underlying security and the
proceeds of the sale will be increased by the net premium originally received.
By writing a covered option, the Fund may forego, in exchange for the net
premium, the opportunity to profit from an increase in value of the underlying
security above the Exercise Price. Thus, options will be written when ICC and
ABIM believe the security should be held for the long term but expects no
appreciation or only moderate appreciation within the option period. The Fund
also may write covered options on securities that have a current value above the
original purchase price but which, if then sold, would not normally qualify for
a long-term capital gains treatment. Such activities will normally take place
during periods when market volatility is expected to be high.

Only call options which are traded on a national securities
exchange will be written. Call options are issued by the Options Clearing
Corporation, which also serves as the clearing house for transactions with
respect to options. The price of a call option is paid to the writer without
refund on expiration or exercise, and no portion of the price is retained by The
Options Clearing Corporation or the exchanges listed above. Writers and
purchasers of options pay the transaction costs, which may include commissions
charged or incurred in connection with such option transactions.

The Fund may write options contracts on its securities up to
an amount not in excess of 20% of the value of its net assets at the time such
options are written. The Fund will not sell the securities against which options
have been written (uncover the options) until after the option period has
expired, the option has been exercised or a closing purchase has been executed.

Call options may be purchased by the Fund, but only to
terminate an obligation as a writer of a call option. This is accomplished by
making a closing purchase transaction, that is, the purchase of a call option on
the same security with the same Exercise Price and expiration date as specified
in the call option which had been written previously. A closing purchase
transaction with respect to calls traded on a national securities exchange has
the effect of extinguishing the obligation of a writer. Although the cost to the
Fund of such a transaction may be greater than the net premium received by the
Fund upon writing the original option, the Directors believe that it is
appropriate for the Fund to have the ability to make closing purchase
transactions in order to prevent its portfolio securities from being purchased
pursuant to the exercise of a call. ICC and ABIM may also permit the call option
to be exercised. A profit or loss from a closing purchase transaction will be
realized depending on whether the amount paid to purchase a call to close a
position is less or more than the amount received from writing the call. A
profit or loss from an option exercised will be realized depending upon whether

-5-
<PAGE>

the cost of the stock sold through the exercise, minus the premium received on
the option, is less or more than the proceeds of the exercise.

Investment Restrictions

The Fund's investment program is subject to a number of
investment restrictions which reflect self-imposed standards as well as federal
and state regulatory limitations. The investment restrictions recited below are
in addition to those described in the Fund's Prospectus, and are matters of
fundamental policy and may not be changed without the affirmative vote of a
majority of the outstanding Shares. The percentage limitations contained in
these restrictions apply at the time of purchase of securities. Accordingly, the
Fund will not:

1. Invest in real estate or mortgages on real estate;

2. Purchase or sell commodities or commodities contracts;

3. Borrow in order to increase income; however, the Fund may
borrow on a temporary basis amounts up to 10% of its assets to facilitate
redemption requests which might otherwise require untimely disposition of
portfolio securities. The Fund will not purchase additional securities when
borrowings exceed 5% of its total assets;

4. Act as an underwriter of securities within the meaning of
the U.S. federal securities laws except insofar as it might be deemed to be
an underwriter upon disposition of certain portfolio securities acquired within
the limitation on purchases of restricted securities;

5. Issue senior securities;

6. Make loans, except that the Fund may purchase or hold debt
instruments in accordance with its investment objectives and policies, and may
loan portfolio securities and enter into repurchase agreements as described in
this Registration Statement;

7. Effect short sales of securities;

8. Purchase securities on margin (but the Fund may obtain such
short-term credits as may be necessary for the clearance of transactions);

9. Purchase participations or other interests in oil, gas or
other mineral exploration or development programs; or

10. Invest more than 10% of the value of its net assets in
illiquid securities (as defined under federal and state securities laws),
including repurchase agreements with remaining maturities in excess of seven
days.

The following are investment restrictions that may be changed
by a vote of the majority of the Board of Directors. The Fund will not:

1. Purchase any securities of unseasoned issuers which have
been in operation directly or through predecessors for less than three years;

2. Invest in shares of any other investment company registered
under the Investment Company Act of 1940, other than in connection with a
merger, consolidation, reorganization or acquisition of assets;

-6-
<PAGE>

3. Purchase or retain the securities of any issuer if to the
knowledge of the Fund any officer or Director of the Fund or its investment
advisor owns beneficially more than .5% of the outstanding securities of such
issuer and together they own beneficially more than 5% of the securities of such
issuer;

4. Invest in companies for the purpose of exercising
management or control;

5. Invest in puts or calls or any combination thereof, except
that the Fund may write covered call options and may enter into related closing
transactions in accordance with its investment objectives and policies; or

6. Invest in warrants if as a result more than 2% of the value
of the Fund's net assets would be invested in warrants which are not listed on a
recognized stock exchange, or more than 5% of the Fund's net assets would be
invested in warrants regardless of whether listed on such exchange.

7. Invest in real estate limited partnerships or oil, gas or
mineral leases.

3. VALUATION OF SHARES AND REDEMPTION

Valuation of Shares

The net asset value per Share is determined once daily as of
4:00 p.m. (Eastern Time) each day on which the New York Stock Exchange is open
for business ("Business Day"). The New York Stock Exchange is open for business
on all weekdays except for the following holidays: New Year's Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day.

For the purpose of determining the price at which Shares are
redeemed, the net asset value per Share is calculated by valuing all securities
held by the Fund, deducting the Fund's actual and accrued liabilities (including
liability for dividends declared), and dividing the resulting amount by the
number of outstanding Shares. To determine the net asset value per Share of
either class, the net asset value calculated as described above will be further
adjusted to reflect the pro rata portion of income and expenses attributable to
that class. For this purpose, portfolio securities will be given their market
value where feasible. If a portfolio security is traded on a national securities
exchange or on an automated dealer quotation system, such as NASDAQ, on the
valuation date, the last quoted sale price will generally be used. Options are
valued at the last reported sale price, or if no sales are reported at the
average of the last reported bid and asked prices. Securities or other assets
for which market quotations are not readily available are valued by appraisal at
their fair value so determined in good faith by ICC and ABIM under procedures
established and monitored by the Board of Directors. Short-term obligations with
maturities of 60 days or less will be valued at amortized cost, which
constitutes fair value as determined by the Directors.

Redemption

The Fund may suspend the right of redemption or postpone the
date of payment during any period when (a) trading on the New York Stock
Exchange is restricted by applicable rules and regulations of the SEC; (b) the
New York Stock Exchange is closed for other than customary weekend and holiday

-7-
<PAGE>

closings; (c) the SEC has by order permitted such suspension; or (d) an
emergency exists as determined by the SEC so that valuation of the net assets of
the Fund is not reasonably practicable.

Under normal circumstances, the Fund will redeem Shares by
check as described in the Prospectus. However, if the Board of Directors
determines that it would be in the best interests of the remaining shareholders
of the Fund to make payment of the redemption price in whole or in part by a
distribution in kind of readily marketable securities from the portfolio of the
Fund in lieu of cash, in conformity with applicable rules of the SEC, the Fund
will make such distributions in kind. If Shares are redeemed in kind, the
redeeming shareholder will incur brokerage costs in later converting the assets
into cash. The method of valuing portfolio securities is described under
"Valuation of Shares," and such valuation will be made as of the same time the
redemption price is determined. The Fund, however, has elected to be governed by
Rule 18f-1 under the Investment Company Act of 1940, as amended (the "1940 Act")
pursuant to which the Fund is obligated to redeem Shares solely in cash up to
the lesser of $250,000 or 1% of the net asset value of the Fund during any
90-day period for any one shareholder.

4. FEDERAL TAX TREATMENT OF DIVIDENDS AND DISTRIBUTIONS

The following discussion of federal income tax consequences is
based on the Internal Revenue Code of 1986, as amended (the "Code") and the
regulations issued thereunder as in effect on the date of this Statement of
Additional Information. New legislation, as well as administrative changes or
court decisions, may significantly change the conclusions expressed herein, and
may have a retroactive effect with respect to the transactions contemplated
herein.

The following is only a summary of certain additional tax
considerations generally affecting the Fund and its shareholders that are not
described in the Fund's Prospectus. No attempt is made to present a detailed
explanation of the tax treatment of the Fund or its shareholders, and the
discussion here and in the Fund's Prospectus is not intended as a substitute for
careful tax planning.

Qualification as a Regulated Investment Company

The Fund has elected to be, and has been, taxed as a regulated
investment company ("RIC") under Subchapter M of the Code. However, in order to
qualify as a RIC for any taxable year, the Fund must generally derive at least
90% of its gross income from dividends, interest, certain payments with respect
to securities loans, and gains from the sale or other disposition of stock,
securities, or foreign currencies and other income (including, but not limited
to gains from options, futures or forward contracts) derived with respect to its
business of investing in stocks, securities or currencies (the "Income
Requirement"). In addition, the Fund generally must derive less than 30% of its
gross income from gains on the sale or other disposition of certain investments
held for less than three months, including stock or securities (as defined in
Section 2(a)(36) of the 1940 Act); foreign currencies (or options, futures, or
forward contracts on foreign currencies) that are not directly related to the
Fund's principal business of investing in stock or securities (or options and
futures with respect to stocks or securities); and options, futures or forward
contracts (other than options, futures,or forward contracts on foreign
currencies) (the "Short-Short Gain Test").

To the extent that the Fund is able and chooses to identify
and designate offsetting positions (e.g., options that the Fund has written and
the securities covered by such options) as "hedges," increases and decreases
in the value of such positions will be netted for the purposes of determining
whether the Short-Short Gain Test has been satisfied. The Short-Short Gain

-8-
<PAGE>

Test will not prevent the Fund from disposing of investments at a loss, since
the recognition of a loss before the expiration of the three-month holding
period is disregarded.

In addition, at the close of each quarter of the Fund's
taxable year, at least 50% of the value of its total assets must consist of cash
and cash items, U.S. government securities, securities of other RICs, and
securities of other issuers (as to which the Fund has not invested more than 5%
of the value of its total assets in securities of any such issuer and as to
which the Fund does not hold more than 10% of the outstanding voting securities
of any such issuer), and no more than 25% of the value of its total assets may
be invested in the securities of any one issuer (other than U.S. government
securities and securities of other RICs), or in two or more issuers which the
Fund controls and which are engaged in the same, similar or related trades or
businesses (the "Asset Diversification Test"). The Fund will not lose its status
as a RIC if it fails to meet the Asset Diversification Test solely as a result
of a fluctuation in value of portfolio assets not attributable to a purchase.
The Fund may curtail its investments in certain securities where the application
thereto of the Asset Diversification Test is uncertain.

Under Subchapter M, the Fund is exempt from federal income tax
on its net investment income and capital gains which it distributes to
shareholders, provided that it distributes at least 90% of its investment
company taxable income (net investment income and the excess of net short term
capital gains over net long term capital losses) for the year (the "Distribution
Requirement") and complies with the other requirements of the Code described
above. The Distribution Requirement for any year may be waived if a RIC
establishes to the satisfaction of the Internal Revenue Service that it is
unable to satisfy the Distribution Requirement by reason of distributions
previously made for the purpose of avoiding liability for federal excise tax.

Although the Fund intends to distribute substantially all of
its net investment income and capital gains for any taxable year, the Fund will
be subject to federal income taxation to the extent any such income or gains are
not distributed.

If for any taxable year, the Fund does not qualify as a
regulated investment company, all of its taxable income will be subject to tax
at regular corporate income tax rates without any deduction for distributions to
shareholders, and all such distributions generally will be taxable to
shareholders as ordinary dividends to the extent of the Fund's current and
accumulated earnings and profits. Such distributions generally will be eligible
for the 70% dividends received deduction for corporate shareholders.

Fund Distributions

Distributions of investment company taxable income will be
taxable to shareholders as ordinary income, regardless of whether such
distributions are paid in cash or are reinvested in additional Shares. The Fund
anticipates that it will distribute substantially all of its investment company
taxable income for each taxable year.

The Fund may either retain or distribute to shareholders its
excess of net long-term capital gains over net short-term capital losses ("net
capital gain") for each taxable year. However, the Fund expects to distribute
substantially all of its net capital gains each year. If such gains are
distributed as a capital gains distribution, they are taxable to shareholders as
long-term capital gains, regardless of the length of time the shareholder has
held the Shares, whether or not such gains were recognized by the Fund prior to
the date on which a shareholder acquired Fund Shares and whether or not the
distribution was paid in cash or reinvested in Shares. Conversely, if the Fund
elects to retain its net capital gains, it will be taxed thereon (except to the

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<PAGE>

extent of any available capital loss carryovers) at the applicable corporate
capital gains tax rate. In this event, it is expected that the Fund also will
elect to have shareholders treated as having received a distribution of such
gains, with the result that shareholders will be required to report such gains
on their returns as long-term capital gains, will receive a tax credit for their
allocable share of capital gains tax paid by the Fund on the gains, and will
increase the tax basis for their Shares by an amount equal to 65% of such gains.

Generally, gain or loss on the sale or exchange of a Share
will be a capital gain or loss which will be long-term if the Share has been
held for more than one year and otherwise will be short-term. However, a
shareholder who realizes a loss on the sale, exchange or redemption of a Share
held for six months or less and has previously received a capital gains
distribution with respect to the Share (or has included in income any
undistributed net capital gains of the Fund with respect to such Share) must
treat the loss as a long-term capital loss to the extent of the amount of the
prior capital gains distribution (or any undistributed net capital gains of the
Fund with respect to such Share which have been included in the shareholder's
income). In addition, any loss realized on a sale or other disposition of Shares
will be disallowed to the extent an investor repurchases (or enters into a
contract or option to repurchase) Shares within a period of 61 days (beginning
30 days before and ending 30 days after the disposition of the Shares).
Investors should particularly note that this loss disallowance rule will apply
to Shares received through the reinvestment of dividends during the 61-day
period.

Investors should be careful to consider the tax implications
of purchasing Shares just prior to the ex-dividend date of any ordinary income
dividend or capital gains distribution. Those purchasing just prior to an
ordinary income dividend or capital gains distribution will be taxable on the
entire amount of the dividend or distribution received, even though the net
asset value per Share on the date of such purchase may have reflected the amount
of such forthcoming dividend or distribution.

In the case of corporate shareholders, Fund distributions
(other than capital gains distributions) generally qualify for the 70% dividends
received deduction to the extent of the gross amount of certain qualifying
dividends received by the Fund for the year. Generally, a dividend will be
treated as a qualifying dividend if it has been received from a domestic
corporation. For purposes of the alternative minimum tax and the environmental
tax, corporate shareholders generally will be required to take the full amount
of any dividend received from the Fund into account in determining their
adjusted current earnings for purposes of computing "alternative minimum taxable
income."

The Fund will be required in certain cases to withhold and
remit to the United States Treasury 31% of distributions payable to any
shareholder who (1) has provided either an incorrect taxpayer identification
number or no number at all, (2) is subject to backup withholding by the Service
for failure to properly report the receipt of interest or dividend income, or
(3) who has failed to certify to the Fund that such shareholder is not subject
to backup withholding.

The Fund will provide a statement annually to shareholders as
to the federal income tax status of distributions paid (or deemed to be paid) by
the Fund during the year.

Federal Excise Tax; Miscellaneous Considerations

The Code imposes a nondeductible 4% federal excise tax on RICs
that do not distribute in each calendar year an amount equal to 98% of their
ordinary income for the calendar year plus 98% of their capital gain net income
(the excess of long and short-term capital gain over long and short-term capital
loss) for the one-year period ending on October 31 of such calendar year. The

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<PAGE>

excise tax is imposed on the undistributed part of this required distribution.
In addition, the balance of such income must be distributed during the next
calendar year to avoid liability for the excise tax in that year. For the
foregoing purposes, an investment company is treated as having distributed any
amount on which it is subject to income tax for any taxable year ending in such
calendar year.

The Fund intends to make sufficient distributions of its
ordinary income and capital gain net income prior to the end of each calendar
year to avoid liability for excise tax. However, investors should note that in
certain circumstances the Fund may be required to liquidate portfolio
investments in order to make sufficient distributions to avoid excise tax
liability, and in addition, that the liquidation of investments in such
circumstances may affect the ability of the Fund to satisfy the Short-Short Gain
Test.

Rules of state and local taxation of dividend and capital
gains distributions from regulated investment companies often differ from the
rules for federal income taxation described above. Shareholders are urged to
consult their tax advisers as to the consequences of these and other state and
local tax rules affecting investment in the Fund.

5. MANAGEMENT OF THE FUND

Directors and Officers

The Directors and executive officers of the Fund, their
respective dates of birth and their principal occupations during the last five
years are set forth below. Unless otherwise indicated, the address of each
Director and executive officer is 135 East Baltimore Street, Baltimore, Maryland
21202.

*W. JAMES PRICE, Chairman and Director (10/6/24)
6885 North Ocean Boulevard, Apartment #306, Ocean Ridge, Florida
33435-3342. Director, Boca Research, Inc. (computer peripherals);
Managing Director Emeritus, Alex. Brown & Sons Incorporated; Formerly,
Director, CSX Corporation (transportation), and PHH Corporation
(business services).

*CHARLES W. COLE, JR., Director (11/11/35)
Vice Chairman, Alex. Brown Capital Advisory & Trust Company (registered
investment advisor); Director, Provident Bankshares Corporation and
Provident Bank of Maryland; Formerly, President, Chief Executive
Officer, Chief Administrative Officer and Director, First Maryland
Bancorp, The First National Bank of Maryland and First Omni Bank;
Formerly, Director, York Bank and Trust Company.

JAMES J. CUNNANE, Director (3/11/38)
CBC Capital, 264 Carlyle Lake Drive, St. Louis, Missouri 63141.
Managing Director, CBC Capital (merchant banking), 1993-Present;
Formerly, Senior Vice President and Chief Financial Officer, General
Dynamics Corporation (defense), 1989-1993 and Director, The Arch Fund
(mutual fund).

*RICHARD T. HALE, Director (7/17/45)
Managing Director, Alex. Brown & Sons Incorporated; Chartered
Financial Analyst.

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<PAGE>

JOHN F. KROEGER, Director (8/11/24)
P.O. Box 464, 24875 Swan Road-Martingham, St. Michaels, Maryland 21663.
Director/Trustee, AIM Funds; Formerly, Consultant, Wendell & Stockel
Associates, Inc. (consulting firm) and General Manager, Shell Oil
Company.

LOUIS E. LEVY, Director (11/16/32)
26 Farmstead Road, Short Hills, New Jersey 07078. Director,
Kimberly-Clark Corporation (personal consumer products) and Household
International (banking and finance); Chairman of the Quality Control
Inquiry Committee, American Institute of Certified Public Accountants;
Formerly, Trustee, Merrill Lynch Funds for Institutions, 1991-1993;
Adjunct Professor, Columbia University-Graduate School of Business,
1991-1992; Partner, KPMG Peat Marwick, retired 1990.

EUGENE J. MCDONALD, Director (7/14/32)
Duke Management Company, Erwin Square, Suite 1000, 2200 West Main
Street, Durham, North Carolina 27705. President, Duke Management
Company (investments); Executive Vice President, Duke University
(education, research and health care).

*TRUMAN T. SEMANS, Director (10/27/27)
Managing Director, Alex. Brown & Sons Incorporated; Formerly, Vice
Chairman, Alex. Brown Incorporated.

*REBECCA W. RIMEL, Director (4/10/51)
The Pew Charitable Trusts, One Commerce Square, 2005 Market Street,
Suite 1700, Philadelphia, PA 19103-7017; President and Chief Executive
Officer, The Pew Charitable Trusts; Director and Executive Vice
President, The Glenmede Trust Company; Formerly, Executive Director,
The Pew Charitable Trusts.

CARL W. VOGT, Director (4/20/36)
Fulbright & Jaworski L.L.P., 801 Pennsylvania Avenue, N.W., Washington,
D.C. 2004-2604. Senior Partner, Fulbright & Jaworski L.L.P. (law);
Formerly, Chairman, National Transportation Safety Board; Director,
National Railroad Passenger Corporation (Amtrak) and Member, Aviation
System Capacity Advisory Committee (Federal Aviation Administration).

HARRY WOOLF, Director (8/12/23)
Institute for Advanced Study, South Olden Lane, Princeton, New Jersey
08540. Professor-at-Large Emeritus, Institute for Advanced Study;
Director, ATL and Spacelabs Medical Corp. (medical equipment) and
Family Health International (non-profit research and education);
Trustee, Reed College (education); Director, Research America
(non-profit medical research); Formerly, Trustee, Rockefeller
Foundation and Director, Merrill Lynch Cluster C Funds (mutual funds).

BRUCE E. BEHRENS, President (4/20/44)
Vice President and Portfolio Manager, Alex. Brown Investment Management
(registered investment advisor); Vice President and Treasurer, Buppert,
Behrens & Owen, Inc.

J. DORSEY BROWN, III, Executive Vice President (8/26/39)
Managing Director, Alex. Brown & Sons Incorporated; Currently, Chief
Executive Officer and Formerly, General Partner, Alex. Brown Investment
Management.

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<PAGE>

HOBART C. BUPPERT, II, Vice President (8/1/46)
Vice President and Portfolio Manager, Alex. Brown Investment Management
(registered investment advisor) 1984-Present; President, Buppert,
Behrens & Owen, Inc., 1987-Present.

LEE S. OWEN, Vice President (10/27/47)
Vice President and Portfolio Manager, Alex. Brown Investment Management
(registered investment advisor); Vice President and Secretary, Buppert,
Behrens & Owen, Inc.

EDWARD J. VEILLEUX, Vice President (8/26/43)
Principal, Alex. Brown & Sons Incorporated; President, Investment
Company Capital Corp. (registered investment advisor); Vice President,
Armata Financial Corp. (registered broker-dealer).

GARY V. FEARNOW, Vice President (12/6/44)
Managing Director, Alex. Brown & Sons Incorporated; Manager, Special
Products Department, Alex. Brown & Sons Incorporated.

BRIAN C. NELSON, Vice President and Secretary (7/31/59)
Vice President, Alex. Brown & Sons Incorporated, Investment Company
Capital Corp. (registered investment advisor) and Armata Financial
Corp. (registered broker-dealer); Assistant Secretary, The Glenmede
Fund, Inc. and The Glenmede Portfolios (registered investment
companies).

LIAM D. BURKE, Vice President (12/27/55)
Telecommunications Analyst, Alex. Brown Investment Management, October
1994-Present; Formerly, Telecommunications Analyst, Ferris, Baker
Watts, Inc. (brokerage firm), May 1992-October 1994 and Managing
Director, Frey and Co. (investment banking), October 1989-May 1992.

JOSEPH A. FINELLI, Treasurer (1/24/57)
Vice President, Alex. Brown & Sons Incorporated, September
1995-Present; Treasurer, The Glenmede Fund, Inc. and The Glenmede
Portfolios (registered investment companies), December 1995-Present;
Formerly, Vice President and Treasurer, The Delaware Group of Funds
(registered investment companies) and Vice President, Delaware
Management Company, Inc., 1980-August 1995.

LAURIE D. DePRINE, Assistant Secretary (1/1/66)
Asset Management Department, Alex. Brown & Sons Incorporated,
1991-Present; Formerly, Student, 1989-1991.

- -------------------

* Messrs. Price, Cole, Hale and Semans are, and Ms. Rimel may be,
directors who are "interested persons," as defined in the 1940 Act.

Directors and officers of the Fund are also directors and
officers of some or all of the other investment companies managed, administered,
advised or distributed by Alex. Brown or its affiliates. There are currently 12
funds in the Flag Investors/ISI Funds and Alex. Brown Cash Reserve Fund, Inc.
fund complex (the "Fund Complex"). Mr. Price serves as a Director of seven funds
in the Fund Complex. Mr. Cole serves as a Director of four funds in the Fund
Complex. Mr. Hale serves as President and Director of one fund and as a Director
of each of the other funds in the Fund Complex. Mr. Semans serves as a Director

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<PAGE>

of eight funds in the Fund Complex. Messrs. Cunnane, Kroeger, Levy, McDonald and
Woolf serve as Directors of each fund in the Fund Complex. Ms. Rimel serves as a
Director of six funds in the Fund Complex. Mr. Vogt serves as a Director of five
funds in the Fund Complex. Mr. Behrens serves as President of one fund and Vice
President of two funds in the Fund Complex. Mr. Brown serves as President of one
fund and Executive Vice President of two funds in the Fund Complex. Mr. Buppert
serves as Executive Vice President of one fund and Vice President of two funds
in the Fund Complex and Mr. Owen serves as President of one fund, Executive Vice
President of one fund and Vice President of one fund in the Fund Complex. Mr.
Fearnow serves as Vice President of 10 funds in the Fund Complex. Mr. Veilleux
serves as Executive Vice President of one fund and as Vice President of 11 funds
in the Fund Complex. Mr. Burke serves as Vice President of one fund in the Fund
Complex. Mr. Nelson serves as Vice President and Secretary, Mr. Finelli serves
as Treasurer and Ms. DePrine serves as Assistant Secretary, respectively, of
each of the funds in the Fund Complex.

Some of the Directors of the Fund are customers of, and have
had normal brokerage transactions with, Alex. Brown in the ordinary course of
business. All such transactions were made on substantially the same terms as
those prevailing at the time for comparable transactions with unrelated persons.
Additional transactions may be expected to take place in the future.

Officers of the Fund receive no direct remuneration in such
capacity from the Fund. Officers and Directors of the Fund who are officers or
directors of Alex. Brown or Alex. Brown Incorporated may be considered to have
received remuneration indirectly. As compensation for his or her services as
director, each Director who is not an "interested person" of the Fund (as
defined in the 1940 Act) (a "Non-Interested Director") and Ms. Rimel, receives
an aggregate annual fee (plus reimbursement for reasonable out-of-pocket
expenses incurred in connection with his or her attendance at board and
committee meetings) from all Flag Investors/ISI Funds and Alex. Brown Cash
Reserve Fund, Inc., for which he or she serves. In addition, the Chairman of the
Fund Complex's Audit Committee receives an aggregate annual fee from the Fund
Complex. Payment of such fees and expenses is allocated among all such funds
described above in direct proportion to their relative net assets. For the
fiscal year ended December 31, 1995, Non-Interested Directors' fees attributable
to the assets of the Fund totalled $29,209.

COMPENSATION TABLE
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Total Compensation From the Fund
Aggregate Compensation From the Fund and Fund Complex Paid to Directors
in the Fiscal Year Ended in the Fiscal Year Ended
Name of Person, Position+ December 31, 1995 December 31, 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
*W. James Price, Chairman $0 $0

*Robert S. Killebrew, Jr., Director
and Vice President** $0 $0

*Truman T. Semans, Director $0 $0

James J. Cunnane, Director $4,402(1) $39,000 for service on 13
Boards(2) in the Fund Complex

N. Bruce Hannay, Director*** $4,402(1) $39,000 for service on 13
Boards(2) in the Fund Complex

John F. Kroeger, Director $5,000 $44,425 for service on 13
Boards(2) in the Fund Complex
</TABLE>

-14-
<PAGE>

<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Total Compensation From the Fund
Aggregate Compensation From the Fund and Fund Complex Paid to Directors
in the Fiscal Year Ended in the Fiscal Year Ended
Name of Person, Position+ December 31, 1995 December 31, 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Louis E. Levy, Director $4,402 $39,000 for service on 13
Boards(2) in the Fund Complex

Eugene J. McDonald, Director $4,402(1) $39,000 for service on 13
Boards(2) in the Fund Complex

Harry Woolf, Director $4,402(1) $39,000 for service on 13
Boards(2) in the Fund Complex
</TABLE>

- ------------
+ Messrs. Hale, Cole and Vogt and Ms. Rimel were elected to the Board at a
special meeting of Directors held on April 10, 1996.
* A Director who is an "interested person" as defined in the Investment
Company Act.
** Resigned, effective April 10, 1996.
*** Retired, effective January 31, 1996.
(1) Of amounts paid to Messrs. Cunnane, Hannay, McDonald and Woolf, all of
such amounts has been deferred pursuant to a deferred compensation plan,
except Mr. Hannay who deferred $3,197.
(2) One of these funds ceased operations on May 17, 1995.

The Fund Complex has adopted a Retirement Plan (the "Retirement
Plan") for Directors who are not employees of the Fund, the Fund's Advisor or
their respective affiliates (the "Participants"). After completion of six years
of service, each Participant will be entitled to receive an annual retirement
benefit equal to a percentage of the fee earned by the Participant in his or her
last year of service. Upon retirement, each Participant will receive annually
10% of such fee for each year that he or she served after completion of the
first five years, up to a maximum annual benefit of 50% of the fee earned by the
Participant in his or her last year of service. The fee will be paid quarterly,
for life, by each Fund for which he or she served. The Retirement Plan is
unfunded and unvested. Messrs. Kroeger and Woolf have qualified but have not yet
received benefits. The Fund has two Participants, a Director who retired
effective December 31, 1994, and a Director who retired effective January 31,
1996 who have qualified for the Retirement Plan and each of whom will be paid a
quarterly fee of $4,875 by the Fund Complex for the rest of his life. Such fee
is allocated to each fund in the Fund Complex based upon the relative net assets
of such fund to the Fund Complex.

Beginning in December, 1994, any Director who receives fees from
the Fund is permitted to defer a minimum of 50%, or up to all, of his or her
annual compensation pursuant to a Deferred Compensation Plan. Messrs. Cunnane,
Hannay, Kroeger, Levy, McDonald, Vogt and Woolf, and Ms. Rimel have each
executed a Deferred Compensation Agreement. Currently, the deferring Directors
may select various Flag and Alex. Brown Funds in which all or part of their
deferral account shall be deemed to be invested. Distributions from the
deferring Directors deferral accounts will be paid in cash, in generally equal
quarterly installments over a period of five years.

Code of Ethics

The Board of Directors of the Fund has adopted a Code of Ethics
pursuant to Rule 17j-1 under the Investment Company Act. The Code of Ethics
significantly restricts the personal investing activities of all employees of
ICC and the directors and officers of Alex. Brown. As described below, the Code
of Ethics imposes additional, more onerous, restrictions on the Fund's
investment personnel, including the portfolio managers and employees who execute
or help execute a portfolio manager's decisions or who obtain contemporaneous
information regarding the purchase or sale of a security by the Fund.

The Code of Ethics requires that all employees of ICC, any
director or officer of Alex. Brown, and all Directors, preclear personal
securities investments (with certain exceptions, such as non-volitional
purchases or purchases which are part of an automatic dividend reinvestment
plan). The preclearance requirement and associated procedures are designed to
identify any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to investment personnel
include a ban on acquiring any securities in an initial public offering, a
prohibition from profiting on short-term trading in securities and preclearance
of the acquisition of securities in private placements. Furthermore, the Code of
Ethics provides for trading "blackout periods" that prohibit trading by
investment personnel and certain other employees within periods of trading by
the Fund in the same security.

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<PAGE>

6. INVESTMENT ADVISORY AND OTHER SERVICES

On April 10, 1996, the shareholders of the Fund approved an
Investment Advisory Agreement between the Fund and ICC and a Sub-Advisory
Agreement among the Fund, ICC and ABIM, both of which contracts are described in
greater detail below. ICC, the investment advisor, is a wholly owned subsidiary
of Alex Brown, the Fund's distributor. ICC is also the investment advisor to
Flag Investors Value Builder Fund, Inc. and Flag Investors Equity Partners Fund,
Inc. (for which funds ABIM serves as the sub-advisor), Alex. Brown Cash Reserve
Fund, Inc., Flag Investors International Fund, Inc., Flag Investors Emerging
Growth Fund, Inc., Flag Investors Intermediate-Term Income Fund, Inc., Flag
Investors Maryland Intermediate Tax Free Income Fund, Inc., and Flag Investors
Real Estate Securities Fund, Inc., which are also distributed by Alex. Brown.
Prior to January 19, 1989, ABIM served as the Fund's investment advisor pursuant
to investment advisory agreements dated May 16, 1985 and September 17, 1987.
Buppert, Behrens & Owens, Inc., a company organized and owned by three employees
of ABIM, owns a 49% limited partnership interest and a 1% general partnership
interest in ABIM. Alex. Brown holds a 1% general partnership interest in ABIM
and Alex. Brown Incorporated owns the remaining 49% limited partnership
interest. ABIM is a registered investment advisor and has under management as of
December 31, 1995 approximately $4.1 billion, including the assets of the Fund
and the assets of ABIM's other clients.

Under the Investment Advisory Agreement, ICC obtains and
evaluates economic, statistical and financial information to formulate and
implement investment policies for the Fund. ICC has delegated this
responsibility to ABIM. Any investment program undertaken by ICC or ABIM will at
all times be subject to policies and control of the Fund's Board of Directors.
ICC will provide the Fund with office space for managing its affairs, with the
services of required executive personnel and with certain clerical and
bookkeeping services and facilities. These services are provided by ICC without
reimbursement by the Fund for any costs. Neither ICC nor ABIM shall be liable to
the Fund or its shareholders for any act or omission by ICC or ABIM or any
losses sustained by the Fund or its shareholders except in the case of willful
misfeasance, bad faith, gross negligence, or reckless disregard of duty. The
services of ICC and ABIM to the Fund are not exclusive and ICC and ABIM are free
to render similar services to others.

As compensation for its services, ICC is entitled to receive a
fee from the Fund, calculated daily and paid monthly, at the annual rate of .85%
of the first $100 million of the Fund's average daily net assets, .75% of the
next $100 million of the Fund's average daily net assets, .70% of the next $100
million of the Fund's average daily net assets, .65% of the next $200 million of
the Fund's average daily net assets, .58% of the next $500 million of the Fund's
average daily net assets, .53% of the next $500 million of the Fund's average
daily net assets and .50% of that portion of the Fund's average daily net assets
exceeding $1.5 billion. As compensation for its services, ABIM is entitled to
receive a fee from ICC, payable from its advisory fee, calculated daily and paid
monthly, at the annual rate of .60% of the first $100 million of the Fund's
average daily net assets, .55% of the next $100 million of the Fund's average
daily net assets, .50% of the next $100 million of the Fund's average daily net
assets, .45% of the next $200 million of the Fund's average daily net assets,
.40% of the next $500 million of the Fund's average daily net assets, .37% of
the next $500 million of the Fund's average daily net assets, and .35% of that
portion of the Fund's average daily net assets exceeding $1.5 billion.

ICC has agreed to reduce its aggregate fees on a monthly basis
for any fiscal year to the extent required so that the amount of the ordinary
expenses of the Fund (excluding brokerage commissions, interest, taxes and
extraordinary expenses such as legal claims, liabilities, litigation costs and
indemnification related thereto) paid or incurred by the Fund for such fiscal
year does not exceed the expense limitations applicable to the Fund imposed by

-16-
<PAGE>

the securities laws or regulations of the states in which the Fund's Shares are
registered or qualified for sale as such limitations may be raised or lowered
from time to time. Currently, the most restrictive of such expense limitations
requires ICC to reduce its fees to the extent required so that ordinary expenses
of the Fund (excluding brokerage commissions, interest, taxes, and extraordinary
expenses such as legal claims, liabilities, litigation costs and indemnification
related thereto) do not exceed 2.5% of the first $30 million of the Fund's
average daily net assets, 2.0% of the next $70 million of the Fund's average
daily net assets and 1.5% of the Fund's average daily net assets in excess of
$100 million. In addition, if required to do so by any applicable state
securities laws or regulations, ICC will reimburse the Fund to the extent
required to prevent the expense limitations of any state law or regulation from
being exceeded. ABIM has agreed to reduce its aggregate fees for any fiscal year
in an amount proportionate to the amount by which ICC's fees may be reduced as
described above.

Each of the Investment Advisory Agreement and the Sub-Advisory
Agreement has an initial term of two years and will continue in effect from year
to year thereafter if such continuance is specifically approved at least
annually by the Fund's Board of Directors, including a majority of the
Non-Interested Directors who have no direct or indirect financial interest in
such agreements, by votes cast in person at a meeting called for such purpose,
and by a vote of a majority of the outstanding Shares. The Fund or ICC may
terminate the Investment Advisory Agreement on sixty days' written notice
without penalty. The Investment Advisory Agreement will terminate automatically
in the event of assignment. The Sub-Advisory Agreement has similar termination
provisions. Prior to April 10, 1996, ICC served as the Fund's investment advisor
and ABIM served as the Fund's sub-advisor pursuant to agreements approved by
shareholders on December 6, 1988. For the fiscal years ended December 31, 1995,
December 31, 1994 and December 31, 1993, the Fund paid ICC fees (net of fee
waivers) of $2,297,474, $2,244,515 and $1,892,883, respectively, and ICC paid
ABIM from the fees it received, fees in the amount of $1,541,505, $1,533,375 and
$1,289,934, respectively. Absent such fee waivers, the Class A Shares' Total
Operating Expenses would have been .99%, .99% and .98%, respectively, of its
average net assets. Absent fee waivers for the fiscal period from January 3,
1995 (commencement of operation) through December 31, 1995, the Class B Shares'
Total Operating Expenses would have been 1.74% of its average net assets. Absent
fee waivers, for the years ended December 31, 1995 and December 31, 1994 and for
the period from April 6, 1993 through December 31, 1993, the Class D Shares'
Total Operating Expenses would have been 1.34%, 1.34% and 1.31%, respectively,
of its average net assets. Such voluntary fee waivers were discontinued on
October 6, 1995.

ICC also serves as the Fund's transfer and dividend disbursing
agent and provides accounting services to the Fund. See "Custodian, Transfer
Agent, Accounting Services."

7. DISTRIBUTION OF FUND SHARES

The Distribution Agreements provide that Alex. Brown has the
exclusive right to distribute the related class of Flag Investors Telephone
Income Fund Shares either directly or through other broker-dealers and further
provide that Alex. Brown will: (a) solicit and receive orders for the purchase
of Shares, (b) accept or reject such orders on behalf of the Fund in accordance
with the Fund's currently effective prospectus and transmit such orders as are
accepted to the Fund's transfer agent as promptly as possible, (c) receive
requests for redemptions and transmit such redemption requests to the Fund's
transfer agent as promptly as possible, and (d) respond to inquiries from
shareholders concerning the status of their accounts and the operations of the
Fund. Alex. Brown has not undertaken to sell any specific number of Shares. The
Distribution Agreements further provide that, in connection with the
distribution of Shares, Alex. Brown will be responsible for all of the
promotional expenses. The services provided by Alex. Brown to the Fund are not

-17-
<PAGE>

exclusive, and Alex. Brown is free to provide similar services to others. Alex.
Brown shall not be liable to the Fund or its shareholders for any act or
omission by Alex. Brown or any losses sustained by the Fund or its shareholders
except in the case of willful misfeasance, bad faith, gross negligence or
reckless disregard of duty.

Alex. Brown and certain broker-dealers ("Participating Dealers")
have entered into Sub-Distribution Agreements under which such broker-dealers
have agreed to process investor purchase and redemption orders and respond to
inquiries from Fund shareholders concerning the status of their accounts and the
operations of the Fund.

As compensation for providing distribution services as described
above, the Fund will pay Alex. Brown for the Flag Investors Class A Shares, an
annual fee, paid monthly equal to .25% of the average daily net assets of the
Class A Shares. As compensation for providing distribution services as described
above for the Flag Investors Class B Shares, the Fund will pay Alex. Brown, an
annual fee, paid monthly, equal to .75% of the average daily net assets of the
Class B Shares. With respect to the Class A Shares, Alex. Brown expects to
allocate most of its annual distribution fee to its investment representatives
and up to all of its fee to Participating Dealers. With respect to the Class B
Shares, Alex. Brown expects to retain the entire distribution fee as
reimbursement for front-end payments to its investment representatives and to
Participating Dealers.

As compensation for providing distribution services for the Class
A Shares in the fiscal years ended December 31, 1995, December 31, 1994 and
December 31, 1993, Alex. Brown received from the Fund aggregate commissions and
fees in the amount of $1,153,795, $1,155,931 and $973,525, respectively. For the
same periods, Alex. Brown paid from the fees it received $448,990, $470,275 and
$259,204 to its investment representatives as compensation and $691,339,
$652,516 and $485,886 to Participating Dealers as compensation. In addition, in
the fiscal year ended December 31, 1995, Alex. Brown incurred expenses on the
Class A Shares of $0 for advertising and $34,499 for printing and mailing
prospectuses to prospective investors. As compensation for providing
distribution services for the Class B Shares for the period from January 3, 1995
(commencement of operations) through December 31, 1995, Alex. Brown received
from the Fund aggregate 12b-1 fees in the amount of $35,130 and from such
amounts paid $0 for advertising and $3,833 for printing and mailing
prospectuses to prospective investors.

In addition, with respect to the Class B Shares, the Fund will
pay Alex. Brown a shareholder servicing fee at an annual rate of .25% of the
average daily net assets of the Class B Shares. (See the Prospectus.) Alex.
Brown expects to allocate most of its shareholder servicing fee to its
investment representatives or to Participating Dealers. For the period from
January 3, 1995 through December 31, 1995, such fees totalled $8,879.75 and
Alex. Brown paid from such amounts $2,356 to its investment representatives and
$6,398 to Participating Dealers.

For the period April 6, 1993 through November 18, 1994 the Fund
offered the Flag Investors Telephone Income Fund Class D Shares of the Fund
(which were known at such time as the Flag Investors Telephone Income Fund Class
B Shares.) Some Class D Shares remain outstanding. As compensation for providing
distribution services for the Class D Shares for the fiscal years ended December
31, 1995 and for the period from April 6, 1993 through December 31, 1993, Alex.
Brown received from the Fund aggregate commissions and fees in the amount of
$189,406, $185,856 and $39,490 and paid from such fees it received $29,730,
$6,785 and $0 to its investment representatives as compensation and $103,634,

-18-
<PAGE>

$20,377 and $0 to Participating Dealers as compensation. In the fiscal year
ended December 31, 1995, Alex. Brown incurred no expenses on the Class D Shares.

Pursuant to Rule 12b-1 under the 1940 Act, which provides that
investment companies may pay distribution expenses, directly or indirectly, only
pursuant to a plan adopted by the investment company's board of directors and
approved by its shareholders, the Fund has adopted a Plan of Distribution for
each of its classes of Shares (the "Plans"). Under the Plans, the Fund pays a
fee to Alex. Brown for distribution and other shareholder servicing assistance
as set forth in the Distribution Agreements, and Alex. Brown is authorized to
make payments out of its fees to its investment representatives and to
participating broker-dealers. Each Distribution Agreement has an initial term of
two years. The Distribution Agreements and the Plans encompassed therein will
remain in effect from year to year as specifically approved (a) at least
annually by the Fund's Board of Directors and (b) by the affirmative vote of a
majority of the Non-Interested Directors, by votes cast in person at a meeting
called for such purpose. The Distribution Agreements including the Plans and
forms of Sub-Distribution Agreements, were most recently approved by the Fund's
Board of Directors, including a majority of the Non-Interested Directors, on
September 26, 1995.

In approving the Plans, the Directors concluded, in the exercise
of reasonable business judgment, that there was a reasonable likelihood that the
Plans would benefit the Fund and its shareholders. The Plans will be renewed
only if the Directors make a similar determination in each subsequent year. The
Plans may not be amended to increase materially the fee to be paid pursuant to
the Distribution Agreements without the approval of the shareholders of the
Fund. The Plans may be terminated at any time and the Distribution Agreements
may be terminated at any time upon sixty days' notice, in either case without
penalty, by the vote of a majority of the Fund's Non-Interested Directors or by
a vote of a majority of the outstanding class of Shares (as defined under
"Capital Stock"). Any Sub-Distribution Agreement may be terminated in the same
manner at any time. The Distribution Agreements and any Sub-Distribution
Agreements shall automatically terminate in the event of assignment.

During the continuance of the Plans, the Fund's Board of
Directors will be provided for their review, at least quarterly, a written
report concerning the payments made under the Plans to Alex. Brown pursuant to
the Distribution Agreements and to broker-dealers pursuant to Sub-Distribution
Agreements. Such reports shall be made by the persons authorized to make such
payments. In addition, during the continuance of the Plans, the selection and
nomination of the Fund's Non-Interested Directors shall be committed to the
discretion of the Non-Interested Directors then in office.

In addition, the Fund may enter into Shareholder Servicing
Agreements with certain financial institutions, such as banks, to act as
Shareholder Servicing Agents, pursuant to which Alex. Brown will allocate a
portion of its distribution fee as compensation for such financial institutions'
ongoing shareholder services. Although banking laws and regulations prohibit
banks from distributing shares of open-end investment companies such as the
Fund, according to interpretations by various bank regulatory authorities,
financial institutions are not prohibited from acting in other capacities for
investment companies, such as the shareholder servicing capacities described
above. Should future legislative, judicial or administrative action prohibit or
restrict the activities of the Shareholder Servicing Agents in connection with
the Shareholder Servicing Agreements, the Fund may be required to alter
materially or discontinue its arrangements with the Shareholder Servicing
Agents. Such financial institutions may impose separate fees in connection with
these services and investors should review the Prospectus and this Statement of
Additional Information in conjunction with any such institution's fee schedule.
In addition, state securities laws on this issue may differ from the

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<PAGE>

interpretations of federal law expressed herein, and banks and financial
institutions may be required to register as dealers pursuant to state law.

Under the Plans, amounts allocated to Participating Dealers and
Shareholder Servicing Agents may not exceed amounts payable to Alex. Brown under
the Plans. Payments under the Plan are made as described above regardless of
Alex. Brown's actual cost of providing distribution services and may be used to
pay Alex. Brown's overhead expenses. If the cost of providing distribution
services to the Fund in connection with the sale of the Class A Shares is less
than .25% of the Class A Shares' average daily net assets for any period or in
connection with the sale of the Class B Shares is less than .75% of the Class B
Shares' average daily net assets for any period, the unexpended portion of the
distribution fee may be retained by Alex. Brown. The Plans do not provide for
any charges to the Fund for excess amounts expended by Alex. Brown and, if
either Plan is terminated in accordance with its terms, the obligation of the
Fund to make payments to Alex. Brown pursuant to the Plan will cease and the
Fund will not be required to make any payments past the date the related
Distribution Agreement terminates.

In the fiscal years ended December 31, 1995, December 31, 1994
and December 31, 1993, Alex. Brown received sales commissions on the Class A
Shares of $146,261, $812,666 and $1,867,533 and from such amounts retained
$73,667, $260,734 and $706,570 for each such year, respectively. In the period
from January 3, 1995 (commencement of operations) through December 31, 1995,
Alex. Brown received contingent deferred sales loads on the Class B Shares of
$78,146 and retained all of this amount.

Except as described elsewhere, the Fund pays or causes to be paid
all continuing expenses of the Fund, including, without limitation: investment
advisory and distribution fees; the charges and expenses of any registrar, any
custodian or depository appointed by the Fund for the safekeeping of cash,
portfolio securities and other property, and any transfer, dividend or
accounting agent or agents appointed by the Fund; brokers' commissions
chargeable to the Fund in connection with portfolio securities transactions to
which the Fund is a party; all taxes, including securities issuance and transfer
taxes, and fees payable by the Fund to Federal, state or other governmental
agencies; the costs and expenses of engraving or printing of certificates
representing Shares; all costs and expenses in connection with the registration
and maintenance of registration of the Fund and its Shares with the SEC and
various states and other jurisdictions (including filing fees, legal fees and
disbursements of counsel); the costs and expenses of printing, including
typesetting and distributing prospectuses and statements of additional
information of the Fund and supplements thereto to the Fund's shareholders; all
expenses of shareholders' and Directors' meetings and of preparing, printing and
mailing proxy statements and reports to shareholders; fees and travel expenses
of Directors and Director members of any advisory board or committee; all
expenses incident to the payment of any dividend, distribution, withdrawal or
redemption, whether in Shares or in cash; charges and expenses of any outside
service used for pricing of the Shares; fees and expenses of legal counsel,
including counsel to the Non-Interested Directors, and of independent certified
public accountants, in connection with any matter relating to the Fund;
membership dues of industry associations; interest payable on Fund borrowings;
postage; insurance premiums on property or personnel (including Officers and
Directors) of the Fund which inure to its benefit; extraordinary expenses
(including, but not limited to, legal claims and liabilities and litigation
costs and any indemnification related thereto); and all other charges and costs
of the Fund's operation unless otherwise explicitly assumed by Alex.
Brown, ICC or ABIM.

The address of Alex. Brown is 135 East Baltimore Street,
Baltimore, Maryland 21202.

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<PAGE>

8. BROKERAGE

ABIM is responsible for decisions to buy and sell securities for
the Fund, for the broker-dealer selection and for negotiation of commission
rates, subject to the supervision of ICC. Purchases and sales of securities on a
securities exchange are effected through broker-dealers who charge a commission
for their services. Brokerage commissions are subject to negotiation between
ABIM and the broker-dealers. ABIM may direct purchase and sale orders to any
broker-dealer, including, to the extent and in the manner permitted by
applicable law, Alex. Brown.

In over-the-counter transactions, orders are placed directly with
a principal market maker and such purchases normally include a mark up over the
bid to the broker-dealer based on the spread between the bid and asked price for
the security. Purchases from underwriters of portfolio securities include a
commission or concession paid by the issuer to the underwriter. On occasion,
certain money market instruments may be purchased directly from an issuer
without payment of a commission or concession. The Fund will not deal with Alex.
Brown in any transaction in which Alex. Brown acts as a principal; that is, an
order will not be placed with Alex. Brown if execution of the trade involves
Alex. Brown serving as a principal with respect to any part of the Fund's order,
nor will the Fund buy or sell over-the-counter securities with Alex. Brown
acting as market maker.

If Alex. Brown is participating in an underwriting or selling
group, the Fund may not buy portfolio securities from the group except in
accordance with rules of the SEC. The Fund believes that the limitation will not
affect its ability to carry out its present investment objective.

ABIM's primary consideration in effecting securities transactions
is to obtain best price and execution of orders on an overall basis. As
described below, however, ABIM may, in its discretion, effect transactions with
dealers that furnish statistical, research or other information or services
which are deemed by ABIM to be beneficial to the Fund's investment program.
Certain research services furnished by broker-dealers may be useful to ABIM with
clients other than the Fund. Similarly, any research services received by ABIM
through placement of portfolio transactions of other clients may be of value to
ABIM in fulfilling its obligations to the Fund. No specific value can be
determined for research and statistical services furnished without cost to ABIM
by a broker-dealer. ABIM is of the opinion that because the material must be
analyzed and reviewed by its staff, its receipt does not tend to reduce
expenses, but may be beneficial in supplementing ABIM's research and analysis.
Therefore, it may tend to benefit the Fund by improving ABIM's investment
advice. ABIM's policy is to pay a broker-dealer higher commissions for
particular transactions than might be charged if a different broker-dealer had
been chosen when, in ABIM's opinion, this policy furthers the overall objective
of obtaining best price and execution. Subject to periodic review by the Fund's
Board of Directors, ABIM is also authorized to pay broker-dealers other than
Alex. Brown higher commissions on brokerage transactions for the Fund in order
to secure research and investment services described above. The allocation of
orders among broker-dealers and the commission rates paid by the Fund will be
reviewed periodically by the Board.

Subject to the above considerations, the Board of Directors has
authorized the Fund to effect portfolio transactions, on an agency basis,
through Alex. Brown. At the time of such authorization the Board adopted certain
policies and procedures incorporating the standards of Rule 17e-1 under the 1940
Act which requires that the commissions paid Alex. Brown must be "reasonable and
fair compared to the commission, fee or other remuneration received or to be
received by other brokers in connection with comparable transactions involving
similar securities during a comparable period of time." Rule 17e-1 also contains
requirements for the review of such transactions by the Board of Directors and
requires ICC and ABIM to furnish reports and to maintain records in connection
with such reviews. The Distribution Agreement between Alex. Brown and the Fund
does not provide for any reduction in the distribution fee to be received by

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<PAGE>

Alex. Brown from the Fund as a result of profits resulting from brokerage
commissions on transactions of the Fund effected through Alex. Brown.

ABIM manages other investment accounts. It is possible that, at
times, identical securities will be acceptable for the Fund and one or more of
such other accounts; however, the position of each account in the securities of
the same issuer may vary and the length of time that each account may choose to
hold its investment in such securities may likewise vary. The timing and amount
of purchase by each account will also be determined by its cash position. If the
purchase or sale of securities consistent with the investment policies of the
Fund or one or more of these accounts is considered at or about the same time,
transactions in such securities will be allocated among the accounts in a manner
deemed equitable by ABIM. ABIM may combine such transactions, in accordance with
applicable laws and regulations, in order to obtain the best net price and most
favorable execution. Such simultaneous transactions, however, could adversely
affect the ability of the Fund to obtain or dispose of the full amount of a
security which it seeks to purchase or sell.

During the fiscal years ended December 31, 1995, December 31,
1994 and December 31, 1993, Alex. Brown directed $288,166,553, $208,696,174 and
$119,892,648, respectively, of transactions to broker-dealers and paid
$386,539, $254,895 and $257,703, respectively, to broker-dealers in related
commissions because of research services provided. In the fiscal years ended
December 31, 1995, December 31, 1994 and December 31, 1993, the Fund paid Alex.
Brown brokerage commissions in the aggregate amount of $0, $7,000 and
$5,600, which represented 0%, 2.7% and 2.2% of the Fund's aggregate brokerage
commissions for the respective periods and which were paid on transactions that
represented 0%, 1.8% and 2.3% of the aggregate dollar amount of transactions
that incurred commissions paid by the Fund during the respective periods. The
Fund is required to identify any securities of its "regular brokers or dealers"
(as such term is defined in the Investment Company Act) which the Fund has
acquired during its most recent fiscal year. As of December 31, 1995, the Fund
held a 5.70% repurchase agreement issued by Goldman Sachs & Co. valued at
$2,493,000. Goldman Sachs & Co. is a "regular broker or dealer" of the Fund.

9. CAPITAL STOCK

Under the Fund's Articles of Incorporation, the Fund has 70
million authorized Shares of common stock, with a par value of $.001 per share.
The Board of Directors may increase or decrease the number of authorized Shares
without shareholder approval. On October 11, 1989, the Fund declared a two for
one stock dividend payable to shareholders of record on October 27, 1989.

The Fund's Articles of Incorporation provide for the
establishment of separate series and separate classes of Shares by the Directors
at any time. The Fund currently has one Series and the Board has designated
three classes of Shares: Flag Investors Telephone Income Fund Class A Shares,
Flag Investors Telephone Income Fund Class B Shares and Flag Investors Telephone
Income Fund Class D Shares. The Flag Investors Telephone Income Fund Class D
Shares are not currently being offered. In the event separate series are
established, all Shares of the Fund, regardless of series or class, would have
equal rights with respect to voting, except that with respect to any matter
affecting the rights of the holders of a particular series or class, the holders
of each series or class would vote separately. In general, each such series
would be managed separately and shareholders of each series would have an
undivided interest in the net assets of that series. For tax purposes, the
series would be treated as separate entities. Generally, each class of Shares
issued by a particular series would be identical to every other class and

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<PAGE>

expenses of the Fund (other than 12b-1 fees) are prorated between all classes
of a series based upon the relative net assets of each class. Any matters
affecting any class exclusively would be voted on by the holders of such class.

Shareholders of the Fund do not have cumulative voting rights,
and therefore the holders of more than 50% of the outstanding Shares voting
together for election of Directors may elect all the members of the Board of
Directors of the Fund. In such event, the remaining holders cannot elect any
members of the Board of Directors of the Fund. There are no preemptive,
conversion or exchange rights applicable to any of the Shares. The issued and
outstanding Shares are fully paid and non-assessable. In the event of
liquidation or dissolution of the Fund, each Share is entitled to its portion of
the Fund's assets (or the assets allocated to a separate series of shares if
there is more than one series) after all debts and expenses have been paid.

As used in this Statement of Additional Information, the term
"majority of the outstanding shares" means the vote of the lesser of (i) 67% or
more of the shares present at a meeting, if the holders of more than 50% of the
outstanding shares are present or represented by proxy, or (ii) more than 50% of
the outstanding shares.

10. SEMI-ANNUAL REPORTS

11. CUSTODIAN, TRANSFER AGENT, ACCOUNTING SERVICES

PNC Bank, National Association ("PNC Bank"), Airport Business
Park, 200 Stevens Drive, Lester, Pennsylvania 19113, has been retained to act as
custodian of the Fund's investments. PNC Bank receives such compensation from
the Fund for its services as Custodian as may be agreed to from time to time by
PNC Bank and the Fund. Investment Company Capital Corp., 135 East Baltimore
Street, Baltimore, Maryland 21202, has been retained to act as transfer and
dividend disbursing agent. As compensation for providing these services, the
Fund pays ICC up to $10.12 per account per year, plus reimbursement for
out-of-pocket expenses incurred in connection therewith. For the fiscal year
ended December 31, 1995, such fees totalled $550,000.

ICC also provides certain accounting services to the Fund under a
Master Services Agreement effective January 1, 1994, between the Fund and ICC.
As compensation for these services, ICC receives an annual fee, calculated daily
and paid monthly as shown below.

Average Net Assets Incremental Accounting Services Fee
------------------ -----------------------------------
$ 0 - $ 10,000,000 $13,000(fixed fee)
$ 10,000,000 - $ 20,000,000 .100%
$ 20,000,000 - $ 30,000,000 .080%
$ 30,000,000 - $ 40,000,000 .060%
$ 40,000,000 - $ 50,000,000 .050%
$ 50,000,000 - $ 60,000,000 .040%
$ 60,000,000 - $ 70,000,000 .030%
$ 70,000,000 - $ 100,000,000 .020%
$100,000,000 - $ 500,000,000 .015%
$500,000,000 - $1,000,000,000 .005%
over $1,000,000,000 .001%

-23-
<PAGE>

In addition, the Fund will reimburse ICC for the following
out-of-pocket expenses incurred in connection with ICC's provision of accounting
services under the Master Services Agreement: express delivery services,
independent pricing and storage.

As compensation for providing accounting services for the
fiscal year ended December 31, 1995, ICC received fees of $113,878.

ICC also serves as the Fund's investment advisor.

12. INDEPENDENT ACCOUNTANTS

The annual financial statements of the Fund are audited by Coopers &
Lybrand L.L.P. whose report thereon appears elsewhere herein, and have been
included herein in reliance upon the report of such firm of accountants given on
their authority as experts in accounting and auditing. Coopers & Lybrand L.L.P.
has offices at 2400 Eleven Penn Center, Philadelphia, Pennsylvania 19103.

13. PERFORMANCE INFORMATION

For purposes of quoting and comparing the performance of the Fund to
that of other open-end diversified management investment companies and to stock
or other relevant indices in advertisements or in certain reports to
shareholders, performance will be stated in terms of total return rather than in
terms of yield. The total return quotations, under the rules of the SEC, must be
calculated according to the following formula:

n
P(l + T) = ERV

Where: P = a hypothetical initial payment of $1,000

T = average annual total return

n = number of years (1, 5 or 10)

ERV = ending redeemable value at the end of the 1, 5,
or 10 year periods (or fractional portion thereof) of a
hypothetical $1,000 payment made at the beginning of the
1, 5 or 10 year periods.

Under the foregoing formula, the time periods used in advertising
will be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication, and will
cover one, five, and ten year periods or a shorter period dating from the
effectiveness of the Fund's registration statement or the date the Fund (or a
class or series) commenced operations (provided such date is subsequent to the
date the registration statement became effective). In calculating the ending
redeemable value, the maximum sales load (for the Class A Shares 4.5% and for

-24-
<PAGE>

the Class B Shares, 4.0% for the one year period, 2.0% for the five year period
and no sales charge thereafter) is deducted from the initial $1,000 payment and
all dividends and distributions by the Fund are assumed to have been reinvested
at net asset value as described in the prospectus on the reinvestment dates
during the period. "T" in the formula above is calculated by finding the average
annual compounded rate of return over the period that would equate an assumed
initial payment of $1,000 to the ending redeemable value. Any sales loads that
might in the future be made applicable at the time to reinvestments would be
included as would any recurring account charges that might be imposed by the
Fund.

The Fund may also from time to time include in such advertising total return
figures that are not calculated according to the formula set forth above in
order to compare more accurately the Fund's performance with other measures of
investment return. For example, in comparing the Fund's total return with data
published by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc.
or Morningstar Inc., or with the performance of the Lehman Brothers Government
Corporate Bond Index, the Consumer Price Index, the return on 90 day U.S.
Treasury bills, the Standard and Poor's 500 Stock Index or the Dow Industrial
Average, the Fund calculates its aggregate and average annual total return for
the specified periods of time by assuming the investment of $10,000 in Shares
and assuming the reinvestment of each dividend or other distribution at net
asset value on the reinvestment date. For this alternative computation, the Fund
assumes that the $10,000 invested in Shares is net of all sales charges (as
distinguished from the computation required by the SEC where the $1,000 payment
is reduced by sales charges before being invested in Shares). The Fund will,
however, disclose the maximum sales charges and will also disclose that the
performance data do not reflect sales charges and that inclusion of sales
charges would reduce the performance quoted. Such alternative total return
information will be given no greater prominence in such advertising than the
information prescribed under SEC rules, and all advertisements containing
performance data will include a legend disclosing that such performance data
represent past performance and that the investment return and principal value of
an investment will fluctuate so that an investor's shares, when redeemed, may be
worth more or less than their original cost.

Calculated according to the SEC rules, for the one year period
ended December 31, 1995, the ending redeemable value of a hypothetical $1,000
payment for the Class A Shares was $1,274 resulting in an annual total return
for such class equal to 27.43%. For the five year period ended December 31,
1995, the ending redeemable value of a hypothetical $1,000 payment for the Class
A Shares was $1,950, resulting in an average annual total return for such class
of 14.29%. For the ten year period ended December 31, 1995, the ending
redeemable value of a hypothetical $1,000 payment for the Class A Shares was
$4,076, resulting in an average annual total return for such shares equal to
15.09%.

Calculated according to the SEC rules for the period from January
3, 1995 (commencement of operations) through December 31, 1995, the ending
redeemable value of a hypothetical $1,000 payment for the Flag Investors Class B
Shares was $1,271, resulting in an aggregate total return for such shares equal
to 27.12%.

Calculated according to SEC rules for the one year period ended
December 31, 1995, the ending redeemable value of a hypothetical $1,000 payment
for the Class D Shares was $1,296, resulting in an annual total return for such
shares equal to 29.58%. For the period from April 6, 1993 (commencement of
operations of such class) to the end of the Fund's fiscal year on December 31,
1995, the ending redeemable value of a hypothetical $1,000 payment for the Class
D Shares was $1,314, resulting in an average annual total return for such shares
equal to 10.47%.

-25-
<PAGE>

Calculated according to the alternative computation, which assumes
no sales charges and reinvestment of all distributions, for the one year period
ended December 31, 1995, the ending redeemable value of a hypothetical $10,000
investment in Class A Shares was $13,344, resulting in an annual total return
equal to 33.44%. For the five-year period ended December 31, 1995, the ending
redeemable value of a hypothetical $10,000 investment in Class A Shares was
$20,417, resulting in a total return equal to 104.17% and an average annual
total return equal to 15.34%. For the ten year period ended December 31, 1995,
the ending redeemable value of a hypothetical $10,000 investment in Class A
Shares was $42,681 resulting in a total return equal to 326.81% and an average
annual total return equal to 15.62%.

Calculated according to the alternative computation for the period
from January 3, 1995 (commencement of operations) through December 31, 1995, the
ending redeemable value of a hypothetical $10,000 investment in Class B Shares
was $13,242, resulting in an aggregate return equal to 32.42%.

Calculated according to the alternative computation for the one
year period ended December 31, 1995, the ending redeemable value of a
hypothetical $10,000 investment in Class D Shares was $13,291, resulting in an
average total return equal to 32.91%. For the period from April 6, 1993
(commencement of operations of such class) to December 31, 1995, the ending
redeemable value of a hypothetical $10,000 investment in Flag Investors Class D
Shares was $13,475, resulting in a total return equal to 34.75% and an average
annual total return for such shares equal to 11.49%.

The Fund's annual portfolio turnover rate (the lesser of the value
of the purchases or sales for the year divided by the average monthly market
value of the portfolio during the year, excluding U.S. Government and short-term
securities) may vary from year to year, as well as within a year, depending on
market conditions. The Fund's portfolio turnover rates in fiscal years 1995 and
1994 were 24% and 23%, respectively.

14. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

As of January 11, 1996, to Fund management's knowledge, the
following persons held beneficially or of record 5% or more of the Fund's
outstanding shares:

Alex. Brown & Sons Incorporated, 135 East Baltimore Street,
Baltimore, Maryland 21202 owned of record 28.56% of the Fund's outstanding Class
A Shares, 22.24% of the Fund's outstanding Class B Shares and 18.75% of the
Fund's outstanding Class D Shares. As of such date, Alex. Brown owned
beneficially less than 1% of such shares.

As of January 11, 1996, the Directors and officers as a group owned
less than 1% of the Fund's total outstanding shares.

15. FINANCIAL STATEMENTS

See next page.

-26-
<PAGE>

<TABLE>
<CAPTION>
Statement of Net Assets December 31, 1995

<S> <C>
Shares/
Par Market Value
(000) (Note A)
- ---------------------------------------------------------------------------------------------------------------------------
TELEPHONE INDUSTRY: 83.0%
Common Stock: 80.7%
220,408 AirTouch Communications Inc.* $ 6,226,526
659,224 AT&T Corp. 42,684,754
394,000 Ameritech Corp. 23,246,000
400,000 BCE Inc. 13,800,000
262,008 Bell Atlantic Corp. 17,521,785
330,964 BellSouth Corp. 14,396,934
366,428 BlackBox Corp.* 6,000,259
320,500 BroadBand Technologies* 5,208,125
115,000 Cellstar Corp.* 2,990,000
625,800 Cincinnati Bell Inc. 21,746,550
150,000 Compania Telefonica National de Espana ADS 6,281,250
200,000 DSC Communications Corp.* 7,375,000
1,122,400 Frontier Corp. 33,672,000
214,700 General Instrument Corp. 5,018,612
887,320 GTE Corp. 39,042,080
210,000 MFS Communications* 11,182,500
420,000 Motorola Inc. 23,940,000
150,000 Octel Communications Corp.* 4,837,500
156,000 Orbital Sciences Corp.* 1,989,000
900,408 Pacific Telesis Group 30,276,219
325,000 QUALCOMM Inc.* 13,975,000
859,106 SBC Communications Inc. 49,398,595
690,000 Southern New England Telecommunications Corp. 27,427,500
500,000 Telefonos de Mexico SA ADS 15,937,500
124,000 Vodafone Group PLC ADR 4,371,000
- ---------------------------------------------------------------------------------------------------------------------------
Total Common Stock (Cost $282,175,040) 428,544,689
- ---------------------------------------------------------------------------------------------------------------------------
Convertible Preferred Stock: 2.1%
207,800 LCI International Inc., 5% Cvt Pfd 11,117,300
- ---------------------------------------------------------------------------------------------------------------------------
Total Convertible Preferred Stock (Cost $6,138,548) 11,117,300
- ---------------------------------------------------------------------------------------------------------------------------
Corporate Bonds: 0.2%
$1,000 Orbital Sciences Corp., 6.75%, 3/1/03 1,065,000
- ---------------------------------------------------------------------------------------------------------------------------
Total Corporate Bonds (Cost $1,259,443) 1,065,000
- ---------------------------------------------------------------------------------------------------------------------------
Total Telephone Industry (Cost $289,573,031) 440,726,989

<PAGE>

NON-TELEPHONE INDUSTRY: 16.0%
Common Stock: 11.1%

626,900 Alexander Haagen Properties $ 7,679,525
242,956 Conseco Inc. 15,215,119
179,600 DeBartolo Realty Corporation 2,334,800
109,000 General Growth Properties 2,261,750
145,000 Meditrust SBI 5,056,875
200,000 Nationwide Health Properties Inc. 8,400,000
200,000 Philip Morris Cos., Inc. 18,100,000
- ---------------------------------------------------------------------------------------------------------------------------
Total Common Stock (Cost $35,502,588) 59,048,069
- ---------------------------------------------------------------------------------------------------------------------------

Convertible Preferred Stock: 3.6%
246,000 American Express, 6.25% Cvt Pfd 13,653,000
100,000 Conseco Inc., 6.5% Series D Cvt Pfd 5,300,000
- ---------------------------------------------------------------------------------------------------------------------------
Total Convertible Preferred Stock (Cost $14,295,500) 18,953,000
- ---------------------------------------------------------------------------------------------------------------------------

Corporate Bonds: 1.3%
$5,000 HMH Properties, 9.50%, 5/15/05 5,125,000
2,000 Philip Morris Cos., Inc., Deb., 8.75%, 12/1/96 2,057,500
- ---------------------------------------------------------------------------------------------------------------------------
Total Corporate Bonds (Cost $6,903,103) 7,182,500
- ---------------------------------------------------------------------------------------------------------------------------
Total Non-Telephone Industry (Cost $56,701,191) 85,183,569

REPURCHASE AGREEMENT: 0.5%
$2,493 Goldman Sachs & Co., 5.70%
Dated 12/29/95, to be repurchased on 1/2/96, collateralized by
U.S. Treasury Notes with a market value of $2,543,435.
(Cost $2,493,000) 2,493,000
- ---------------------------------------------------------------------------------------------------------------------------

<PAGE>

Total Investments in Securities: 99.5%
(Cost $348,767,222)** $528,403,558
Other Assets in Excess of Liabilities, Net: 0.5% 2,871,367
- ---------------------------------------------------------------------------------------------------------------------------
Net Assets: 100.0% $531,274,925

- ---------------------------------------------------------------------------------------------------------------------------
Net Asset Value Per:
Class A Share
($492,453,558 / 33,120,036 shares outstanding) $14.87(1)
Class B Share
($7,504,388 / 505,908 shares outstanding) $14.83(2)
Class D Share
($31,316,979 / 2,105,445 shares outstanding) $14.87(3)
Maximum Offering Price Per:
Class A Share
($14.87 / .955) $15.57
Class B Share $14.83
</TABLE>

* Non-income producing security.
** Aggregate cost for federal tax purposes was $345,969,173.
1 Redemption value is $14.87.
2 Redemption value is $14.24 following 4.00% maximum contingent deferred sales
charge.
3 Redemption value is $14.72 following 1.00% maximum contingent
deferred sales charge.
See accompanying Notes to Financial Statements.

STATEMENT OF OPERATIONS For the Year Ended December 31, 1995

INVESTMENT INCOME (NOTE A):

Dividends $ 16,903,886
Interest 2,093,131
Other income 19,502
Less:Foreign taxes withheld (242,692)
Total income 18,773,827

EXPENSES:
Investment advisory fee (Note B) 2,584,817
Distribution fees (Note B) 1,378,330
Transfer agent fees (Note B) 550,000
Printing and postage 144,435
Accounting fee (Note B) 113,878
Legal 59,397
Custodian fee 56,745
Registration fees 51,428
Directors' fees 26,712
Audit 25,999
Miscellaneous 24,527
Insurance 18,230
Total expenses 5,034,498
Less:Fees waived (Note B) (287,343)
Net expenses 4,747,155
Net investment income 14,026,672

REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain from security transactions 35,372,071*
Change in unrealized appreciation of investments 93,655,306
Net gain on investments 129,027,377

NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $143,054,049

- ------------------------------------------------------------------------------
*Net realized gain for federal tax purposes was $36,106,029.
See accompanying Notes to Financial Statements.
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------------
1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE/(DECREASE) IN NET ASSETS:
Operations:
Net investment income $ 14,026,672 $ 15,367,428
Net gain from security transactions 35,372,071 4,980,639
Change in unrealized appreciation/(depreciation)
of investments 93,655,306 (52,606,757)
Net increase/(decrease) in net assets resulting from operations 143,054,049 (32,258,690)

DIVIDENDS TO SHAREHOLDERS FROM:
Net investment income:
Class A Shares (13,188,618) (14,498,099)
Class B Shares (71,352) --
Class D Shares (766,702) (869,329)
Net realized short-term gains:
Class A Shares (594,281) (1,380,369)
Class B Shares (6,947) --
Class D Shares (39,689) (207,441)
Net realized long-term gains:
Class A Shares (31,183,490) (3,302,412)
Class B Shares (411,017) --
Class D Shares (2,033,414) (243,429)
Total distributions (48,295,510) (20,501,079)

CAPITAL SHARE TRANSACTIONS (NOTE C):
Proceeds from sale of shares 35,420,420 74,463,764
Value of shares issued in reinvestment of dividends 40,313,196 14,926,479
Cost of shares repurchased (106,718,217) (61,773,728)
Increase/(decrease) in net assets derived from
capital share transactions (30,984,601) 27,616,515
Total increase/(decrease) in net assets 63,773,938 (25,143,254)

NET ASSETS:
Beginning of year 467,500,987 492,644,241
End of year $ 531,274,925 $467,500,987
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Financial Statements.

FINANCIAL HIGHLIGHTS -- CLASS A SHARES
(For a share outstanding throughout each year)*
<TABLE>
<CAPTION>
For the Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value at beginning of year $ 12.30 $ 13.70 $ 12.20 $ 11.28 $ 9.57

Income from Investment Operations:
Net investment income 0.40 0.41 0.42 0.42 0.45
Net realized and unrealized gain/(loss)
on investments 3.58 (1.27) 1.78 0.93 1.74
Total from Investment Operations 3.98 (0.86) 2.20 1.35 2.19

Less Distributions:
Dividends from net investment income
and short-term gains (0.41) (0.44) (0.42) (0.42) (0.46)
Distributions from net realized
long-term gains (1.00) (0.10) (0.28) (0.01) (0.02)
Total distributions (1.41) (0.54) (0.70) (0.43) (0.48)
Net asset value at end of year $ 14.87 $ 12.30 $ 13.70 $ 12.20 $ 11.28

Total Return 33.44% (6.32)% 18.12% 12.35% 23.08%

Ratios to Average Net Assets:
Expenses(1) 0.93% 0.92% 0.92% 0.92% 0.92%
Net investment income(2) 2.85% 3.14% 3.12% 3.81% 4.38%

Supplemental Data:
Net assets at end of year (000) $492,454 $435,805 $469,163 $307,641 $238,571
Portfolio turnover rate 24% 23% 14% 6% 7%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Computed based upon average shares outstanding.
1 Without the waiver of advisory fees (Note B), the ratio of expenses to
average net assets would have been 0.99%, 0.99%, 0.98%, 1.07% and 1.17% for
the years ended December 31, 1995, 1994, 1993, 1992 and 1991, respectively.
2 Without the waiver of advisory fees (Note B), the ratio of net investment
income to average net assets would have been 2.79%, 3.07%, 3.06%, 3.66% and
4.13% for the years ended December 31, 1995, 1994, 1993, 1992 and 1991,
respectively.
See accompanying Notes to Financial Statements.
<PAGE>

FINANCIAL HIGHLIGHTS -- CLASS B SHARES
(For a share outstanding throughout the period)*
<TABLE>
<CAPTION>
For the Period
January 3, 1995**
through
December 31, 1995
<S> <C>
Per Share Operating Performance:
Net asset value at beginning of period $12.28

Income from Investment Operations:
Net investment income 0.30
Net realized and unrealized gain/(loss) on investments 3.56
Total from Investment Operations 3.86

Less Distributions:
Dividends from net investment income and short-term gains (0.31)
Distribution from net realized long-term gains (1.00)
Total distributions (1.31)
Net asset value at end of period $14.83

Total Return 32.42%

Ratios to Average Net Assets:
Expenses(2) 1.70%(1)
Net investment income(3) 2.13%(1)

Supplemental Data:
Net assets at end of period (000) $7,504
Portfolio turnover rate 24%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>

* Computed based upon average shares outstanding.
**Commencement of operations.
1 Annualized.
2 Without the waiver of advisory fees (Note B), the ratio of
expenses to average net assets would have been 1.74% (annualized) for the
period ended December 31, 1995.
3 Without the waiver of advisory fees (Note B), the ratio of net investment
income to average net assets would have been 2.09% (annualized) for the
period ended December 31, 1995.

<PAGE>

FINANCIAL HIGHLIGHTS -- CLASS D SHARES
(For a share outstanding throughout each period)*

For the Period
For the Year Ended April 6, 1993**
December 31 through
1995 1994 December 31, 1993
<S> <C> <C> <C>
Per Share Operating Performance:
Net asset value at beginning of period $ 12.30 $ 13.67 $ 13.21

Income from Investment Operations:
Net investment income 0.34 0.37 0.25
Net realized and unrealized gain/(loss) on investments 3.58 (1.20) 0.80
Total from Investment Operations 3.92 (0.83) 1.05

Less Distributions:
Dividends from net investment income and short-term gains (0.35) (0.42) (0.31)
Distribution in excess of net investment income -- (0.02) --
Distribution from net realized long-term gains (1.00) (0.10) (0.28)
Total distributions (1.35) (0.54) (0.59)

Net asset value at end of period $ 14.87 $ 12.30 $ 13.67

Total Return 32.91% (6.13)% 8.01%

Ratios to Average Net Assets:
Expenses(2) 1.28% 1.27% 1.27%(1)
Net investment income(3) 2.50% 2.81% 2.73%(1)

Supplemental Data:
Net assets at end of period (000) $31,317 $31,696 $23,481
Portfolio turnover rate 24% 23% 14%
- ---------------------------------------------------------------------------------------------------------------------------

</TABLE>

* Computed based upon average shares outstanding.
**Commencement of operations.
1 Annualized.
2 Without the waiver of advisory fees (Note B), the ratio of expenses to
average net assets would have been 1.34%, 1.34% and 1.31% for the years
ended December 31, 1995, 1994 and the period ended December 31, 1993.
3 Without the waiver of advisory fees (Note B), the ratio of net
investment income to average net assets would have been 2.44%, 2.74%
and 1.98% for the years ended December 31, 1995, 1994 and the period ended
December 31, 1993.
See accompanying Notes to Financial Statements.

Notes to Financial Statements
<PAGE>

A. Significant Accounting Policies - Flag Investors Telephone Income Fund, Inc.
("the Fund") is organized as a Maryland corporation and commenced operations on
January 18, 1984 (the exchange date) when investors received five shares of the
Fund in a tax-free exchange for each share of American Telephone & Telegraph
Company (AT&T), with rights to the divested Regional Bell Operating Companies
attached. The Fund is registered under the Investment Company Act of 1940, as
amended, as an open-end, management investment company. On April 6, 1993, the
Fund began offering Class D Shares (formerly Class B Shares). The Class A and
Class D Shares each have different sales loads and distribution fees. Beginning
November 18, 1994, Class D Shares were no longer available for sale; however,
existing shareholders may reinvest their dividends. On January 3, 1995, the Fund
began offering Class B Shares. Class B Shares have no initial sales charge but
are subject to a contingent deferred sales charge on certain shares redeemed
within six years of purchase.

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.
Significant accounting policies are as follows:

Security Valuation - Portfolio securities that are listed on a National
Securities Exchange are valued on the basis of their last price or, in the
absence of recorded sales, at the average of readily available closing bid
and asked prices. Unlisted securities held by the Fund are valued at the
average of the quoted bid and asked prices in the over-the-counter market.
Short-term obligations with maturities of 60 days or less are valued at
amortized cost.

Repurchase Agreements - The Fund may agree to purchase money market
instruments subject to the seller's agreement to repurchase them at an
agreed upon date and price. The seller, under a tri-party repurchase
agreement, will be required on a daily basis to maintain the value of the
securities subject to the agreement at not less than the repurchase price.
The agreement is conditioned upon the collateral being deposited under the
Federal Reserve book-entry system.

Federal Income Taxes - No provision is made for federal income taxes as it
is the Fund's intention to continue to qualify as a regulated investment
company and to continue to make requisite distributions to the shareholders
that will be sufficient to relieve it from all or substantially all federal
income and excise taxes. The Fund's policy is to distribute to shareholders
substantially all of its taxable net investment income and net realized
capital gains.

Distributions are determined in accordance with income tax regulations,
which may differ from generally accepted accounting principles. Accordingly,
periodic reclassifications are made within the Fund's capital accounts to
reflect income and capital gains available for distribution under income tax
regulations.

Other - Security transactions are accounted for on the trade date and the
cost of investments sold is determined by use of the specific identification
method for both financial reporting and income tax purposes. Cost for
financial reporting purposes includes the value of the securities received
in the exchange. For income tax purposes, the tax cost is the basis of the
AT&T shares in the hands of the exchanging AT&T shareholders at the date of
exchange. Interest income is recorded on an accrual basis; dividend income
is recorded on the ex-dividend date.
<PAGE>

B. Investment Advisory Fees, Transactions with Affiliates and Other Fees -
Investment Company Capital Corp. ("ICC"), a subsidiary of Alex. Brown &Sons
Incorporated ("Alex. Brown"), is the Fund's investment advisor and Alex. Brown
Investment Management ("ABIM") is the Fund's sub-advisor. As compensation for
its advisory services, ICC receives from the Fund an annual fee, calculated
daily and paid monthly, at the annual rate of 0.65% of the first $100 million of
the Fund's average daily net assets; 0.55% of the Fund's average daily net
assets in excess of $100 million but not exceeding $200 million; 0.50% of the
Fund's average daily net assets in excess of $200 million but not exceeding $300
million; and 0.45% of the Fund's average daily net assets in excess of $300
million.

As compensation for its sub-advisory services, ABIMreceives a fee from ICC,
payable from its advisory fee, calculated daily and paid monthly, at an
annual rate of 0.40% of the first $100 million of the Fund's average daily
net assets; 0.35% of the Fund's average daily net assets in excess of $100
million but not exceeding $200 million; 0.30% of the Fund's average daily
net assets in excess of $200 million but not exceeding $300 million; and
0.25% of the Fund's average daily net assets over $300 million.

Through October 6, 1995, ICC had agreed to reduce its aggregate fees so that
ordinary expenses of the Fund for any fiscal year did not exceed 0.92% of
average daily net assets of Class A Shares, 1.67% of Class B Shares and
1.27% of Class D Shares.For the period January 1, 1995 through October 6,
1995, ICC voluntarily waived $287,343 in fees.
Effective October 7, 1995, ICC is no longer waiving fees.

As compensation for its transfer agent services, ICC receives from the Fund
a per account fee, calculated and paid monthly. ICC received $550,000 for
transfer agent services for the year ended December 31, 1995.

As compensation for its accounting services, ICC receives from the Fund an
annual fee, calculated daily and paid monthly, based upon the Fund's average
daily net assets. ICC received $113,878 for accounting services for the year
ended December 31, 1995.

As compensation for providing distribution services, Alex. Brown receives
from the Fund an annual fee, calculated daily and paid monthly, at an annual
rate equal to 0.25% of the Fund's average daily net assets of Class A
Shares, 1.00% (includes 0.25% shareholder servicing fee) of the average
daily net assets of Class B Shares and 0.60% of the average daily net assets
of Class D Shares. For the year ended December 31, 1995, distribution fees
aggregated $1,378,330 of which $1,153,794, $35,130 and $189,406 were
attributable to Class A Shares, Class B Shares and Class D Shares,
respectively. Alex. Brown received no commissions on security transactions
from the Fund for the year ended December 31, 1995.

Flag Investors/ISI Fund complex has adopted a retirement plan for eligible
Directors. The actuarially computed pension expense for the year ended
December 31, 1995 was approximately $15,000.
<PAGE>

C. Capital Share Transactions - The Fund is authorized to issue up to 70 million
shares of capital stock (60 million Class A Shares, 5 million Class B Shares, 3
million Class D Shares and 2 million undesignated), par value $.001 per share,
all of which are designated as common stock. Transactions in shares of the Fund
were as follows:

Class A Shares
For the Year Ended
December 31,
1995 1994
Shares sold 2,145,785 4,615,066
Shares issued to share-
holders on reinvest-
ment of dividends 2,674,624 1,088,372
Shares redeemed (7,132,553) (4,517,710)
Net increase/(decrease)
in shares
outstanding (2,312,144) 1,185,728
Proceeds from sale
of shares $ 28,720,184 $ 60,821,115
Value of reinvested
dividends 37,305,866 13,849,565
Cost of shares
redeemed (97,427,131) (58,534,367)
Net increase/(decrease)
from capital share
transactions $(31,401,081) $ 16,136,313

Class B Shares
For the
Period
January 3, 1995*
through
December 31, 1995
Shares sold 489,011
Shares issued to shareholders
on reinvestment
of dividends 32,826
Shares redeemed (15,929)
Net increase in shares
outstanding 505,908
Proceeds from sale
of shares $6,700,236
Value of reinvested
dividends 458,760
Cost of shares redeemed (229,177)
Net increase from
capital share
transactions $6,929,819

- ------------------------------------------------------------------------------
*Commencement of operations.

<PAGE>

Class D Shares
For the Year Ended
December 31,
1995 1994
Shares sold -- 1,028,832
Shares issued to share-
holders on reinvest-
ment of dividends 183,832 84,910
Shares redeemed (655,092) (254,327)
Net increase/(decrease)
in shares
outstanding (471,260) 859,415
Proceeds from sale
of shares $ -- $13,642,649
Value of reinvested
dividends 2,548,570 1,076,914
Cost of shares
redeemed (9,061,909) (3,239,361)
Net increase/(decrease)
from capital share
transactions $(6,513,339) $11,480,202

D. Investment Transactions - Purchases and sales of investment securities,
other than short-term obligations and U.S. government securities,
aggregated $114,577,349 and $176,205,901, respectively, for the year ended
December 31, 1995. There were no purchases or sales of U.S. Government
obligations.

At December 31, 1995, net unrealized appreciation for all securities in
which there is an excess of value over tax cost was $182,434,385 of
which $194,645,463 related to appreciated securities and $12,211,078
related to depreciated securities.

E. Net Assets - At December 31, 1995, net assets consisted of:

Paid-in capital:
Flag Investors Class A Shares $314,341,690
Flag Investors Class B Shares 6,929,820
Flag Investors Class D Shares 28,926,870
Undistributed net realized gain
from security transactions 1,440,208
Unrealized appreciation of
investments 179,636,337

$531,274,925
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and Directors of Flag
Investors Telephone Income Fund, Inc.

We have audited the accompanying statement of net assets of Flag Investors
Telephone Income Fund, Inc. as of December 31, 1995 and the related statement of
operations for the year then ended, the statement of changes in net assets for
each of the two years in the period then ended and the financial highlights for
each of the respective periods presented. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of investments owned as of
December 31, 1995 by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Flag
Investors Telephone Income Fund, Inc. as of December 31, 1995, the results of
its operations for the year then ended, the changes in its net assets and its
financial highlights for each of the respective periods in conformity with
generally accepted accounting principles.

COOPERS & LYBRAND L.L.P.

Philadelphia, Pennsylvania
January 26, 1996
<PAGE>

APPENDIX A

CORPORATE BOND RATINGS

Standard & Poor's Bond Ratings

AAA -- The highest rating assigned by Standard & Poor's. Capacity
to pay interest and repay principal is extremely strong.

AA -- Very strong capacity to pay interest and repay principal
and differs from the higher rated issues only in small degree.

A -- Strong capacity to pay interest and repay principal although
it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.

BBB -- Regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.

BB, B, CCC, CC and C -- Regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least degree of speculation and C the highest degree
of speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major exposures
to adverse conditions.

CI -- Reserved for income bonds on which no interest is being
paid.

D -- In payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.

Moody's Bond Ratings

Aaa -- Bonds that are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a large or
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.

Aa -- Bonds that are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the Aaa bonds because
margins of protection may not be as large as in the case of Aaa securities, or
the fluctuation of protective elements may be of greater amplitude or there may
be other elements present which make the long-term risks appear somewhat larger
than in Aaa securities.

A-1
<PAGE>

A -- Bonds that are rated A possess many favorable investment
attributes and are to be considered upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present that suggest a susceptibility to impairment some time in the
future.

Baa -- Bonds that are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.

Ba -- Bonds that are rated Ba are judged to have speculative
elements; their future cannot be considered as well-assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.

B -- Bonds that are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time may be
small.

Caa -- Bonds that are rated Caa are of poor standing. Such issues
may be in default or there may be present elements of danger with respect to
principal or interest.

Ca -- Bonds that are rated Ca represent obligations that are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.

C -- Bonds that are rated C are the lowest rated class of bonds,
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.

A-2