FLAG INVESTORS TELEPHONE INCOME FUND INC, 497, 1997-05-07

FLAG INVESTORS TELEPHONE INCOME FUND INC
497, 1997-05-07

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<PAGE>

LOGO
FLAG INVESTORS

TELEPHONE INCOME FUND, INC.
(CLASS A AND CLASS B SHARES)

PROSPECTUS & APPLICATION -- MAY 1, 1997
- -----------------------------------------------------------------------------

THIS MUTUAL FUND (THE "FUND") IS DESIGNED TO PROVIDE CURRENT INCOME AND
LONG-TERM GROWTH OF CAPITAL WITHOUT UNDUE RISK PRIMARILY BY INVESTING IN COMMON
STOCK, SECURITIES CONVERTIBLE THERETO AND DEBT OBLIGATIONS OF COMPANIES IN THE
TELEPHONE INDUSTRY AND IN INCOME-PRODUCING SECURITIES (INCLUDING DEBT
OBLIGATIONS) OF ISSUERS IN THE TELEPHONE OR OTHER INDUSTRIES.

Shares of the Fund are available through your securities dealer or the Fund's
transfer agent. This Prospectus relates to Flag Investors Class A Shares ("Class
A Shares") and Flag Investors 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 May 1, 1997 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.

TABLE OF CONTENTS

Fee Table ................................. 1
Financial Highlights ...................... 2
Investment Program ........................ 5
Investment Restrictions ................... 6
How to Invest in the Fund ................. 7
How to Redeem Shares ...................... 10
Telephone Transactions .................... 11
Dividends and Taxes ....................... 12
Management of the Fund .................... 12
Investment Advisor and Sub-Advisor ........ 13
Distributor ............................... 14
Custodian, Transfer Agent and Accounting
Services ................................. 14
Performance Information ................... 14
General Information ....................... 15
Application ............................... A-1

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.

Flag Investors Funds
P.O. Box 515
Baltimore, Maryland 21203

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

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

- -----------------------------------------------------------------------------
<PAGE>
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
(as a percentage of offering price) ............................................ None None
Maximum Deferred Sales Charge (as a percentage of original purchase price
or redemption proceeds, whichever is lower) .................................... 0.50%* 4.00%**

ANNUAL FUND OPERATING EXPENSES (as a percentage of average daily net assets):
Management Fees ................................................................. 0.66% 0.66%
12b-1 Fees ...................................................................... 0.25% 0.75%
Other Expenses (including a .25% shareholder servicing fee for Class B Shares) .. 0.23% 0.48%***
------- -------
Total Fund Operating Expenses ................................................... 1.14% 1.89%
======= =======
</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 upon
redemption. (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
services provided and expenses incurred in maintaining shareholder accounts,
responding to shareholder inquiries and providing information on their
investments.

<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
EXAMPLE: 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ------------------------------ -------- --------- --------- ----------
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:
Class A Shares ........................................... $56 $80 $105 $177
Class B Shares ........................................... $59 $89 $122 $184*

You would pay the following expenses on the same investment,
assuming no redemption: 1 YEAR 3 YEARS 5 YEARS 10 YEARS
-------- --------- --------- ----------
Class B Shares ........................................ $19 $59 $102 $184*
</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 that institution. The Expenses and Example for the
Class B Shares appearing in the table above have been restated to reflect
current, rather than historical, expenses.

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 Conduct Rules of the National
Association of Securities Dealers, Inc. ("NASD Rules").

1
<PAGE>
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, 1996 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, 1996, which can be obtained
at no charge by calling the Fund at (800) 767-FLAG.

(FOR A CLASS A SHARE OUTSTANDING THROUGHOUT EACH YEAR)(1)
- -----------------------------------------------------------------------------

<TABLE>
<CAPTION>
-------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value at beginning of year ................. $ 14.87 $ 12.30 $ 13.70
---------- ---------- ----------

INCOME FROM INVESTMENT OPERATIONS:
Net investment income ................................ 0.27 0.40 0.41
Net realized and unrealized gain/(loss) on investments 1.67 3.58 (1.27)
---------- ---------- ----------
Total from Investment Operations ..................... 1.94 3.98 (0.86)
---------- ---------- ----------

LESS DISTRIBUTIONS:
Dividends from net investment income and net realized
short-term gains .................................. (0.38) (0.41) (0.44)
Distributions from net realized long-term gains ...... (0.84) (1.00) (0.10)
---------- ---------- ----------
Total distributions .................................. (1.22) (1.41) (0.54)
---------- ---------- ----------
Net asset value at end of year ....................... $ 15.59 $ 14.87 $ 12.30
========== ========== ==========
TOTAL RETURN(4) ........................................ 13.46% 33.44% (6.32)%

RATIOS TO AVERAGE DAILY NET ASSETS:
Expenses ............................................. 1.14% 0.93%(5) 0.92%(5)
Net investment income ................................ 1.74% 2.85%(6) 3.14%(6)

SUPPLEMENTAL DATA:
Net assets at end of year (000) ...................... $505,371 $492,454 $435,805
Portfolio turnover rate .............................. 20% 24% 23%
Average commissions per share ........................ $ 0.07(7) -- --
</TABLE>
- --------------------------------------------------------------------------------
(1) Computed based upon average shares outstanding.
(2) Restated for two-for-one stock split, effected in the form of a stock
dividend to shareholders of record on October 27, 1989.
(3) Investment Company Capital Corp. became Investment Advisor to the Fund on
January 19, 1989.
(4) Total return excludes the effect of sales charge.
(5) Without the waiver of advisory fees, the ratio of expenses to average daily
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.
(6) Without the waiver of advisory fees, the ratio of net investment income to
average daily 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.
(7) Disclosure is required for fiscal years beginning after September 1, 1995.
Represents average commission rate per share charged to the Fund on
purchases and sales of investments during the period.

2
<PAGE>

FINANCIAL HIGHLIGHTS(continued)
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
For the Year Ended December 31,
- -----------------------------------------------------------------------------------------
1993 1992 1991 1990 1989(2)(3) 1988(2) 1987(2)
---------- ---------- ---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
$ 12.20 $ 11.28 $ 9.57 $ 10.98 $ 8.24 $ 7.50 $ 7.84
---------- ---------- ---------- ---------- ---------- ---------- ---------

0.42 0.42 0.45 0.46 0.52 0.46 0.43
1.78 0.93 1.74 (1.29) 3.38 0.97 (0.30)
---------- ---------- ---------- ---------- ---------- ---------- ---------
2.20 1.35 2.19 (0.83) 3.90 1.43 0.13
---------- ---------- ---------- ---------- ---------- ---------- ---------

(0.42) (0.42) (0.46) (0.45) (0.52) (0.46) (0.42)
(0.28) (0.01) (0.02) (0.13) (0.64) (0.23) (0.05)
---------- ---------- ---------- ---------- ---------- ---------- ---------
(0.70) (0.43) (0.48) (0.58) (1.16) (0.69) (0.47)
---------- ---------- ---------- ---------- ---------- ---------- ---------
$ 13.70 $ 12.20 $ 11.28 $ 9.57 $ 10.98 $ 8.24 $ 7.50
========== ========== ========== ========== ========== ========== =========
18.12% 12.35% 23.08% (7.55)% 48.86% 19.90% 1.51%

0.92%(5) 0.92%(5) 0.92%(5) 0.92%(5) 0.93%(5) 0.92% 0.88%
3.12%(6) 3.81%(6) 4.38%(6) 4.54%(6) 4.41%(6) 5.35% 5.37%

$469,163 $307,641 $238,571 $177,963 $162,449 $102,483 $94,650
14% 6% 7% 2% 27% 11% 4%
---------- ---------- ---------- ---------- ---------- ---------- ---------

</TABLE>

3
<PAGE>

FINANCIAL HIGHLIGHTS (CONCLUDED)
- -----------------------------------------------------------------------------

(FOR A CLASS B SHARE OUTSTANDING THROUGHOUT EACH PERIOD)(1)
- -----------------------------------------------------------------------------

<TABLE>
<CAPTION>
For the Period
For the Year January 3, 1995(2)
Ended through
December 31, 1996 December 31, 1995
----------------- -------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value at beginning of period ............... $ 14.83 $12.28
--------- --------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income ................................ 0.19 0.30
Net realized and unrealized gain on investments ...... 1.63 3.56
--------- --------
Total from Investment Operations ..................... 1.82 3.86
--------- --------
LESS DISTRIBUTIONS:
Dividends from net investment income and net realized
short-term gains .................................. (0.30) (0.31)
Distributions from net realized long-term gains ...... (0.84) (1.00)
--------- --------
Total distributions .................................. (1.14) (1.31)
--------- --------
Net asset value at end of period ..................... $ 15.51 $14.83
========= ========
TOTAL RETURN(3) ........................................ 12.60% 32.42%

RATIOS TO AVERAGE DAILY NET ASSETS:
Expenses ............................................. 1.92% 1.70%(4)(5)
Net investment income ................................ 0.95% 2.13%(4)(6)

SUPPLEMENTAL DATA:
Net assets at end of period (000) .................... $17,661 $7,504
Portfolio turnover rate .............................. 20% 24%
Average commissions per share ........................ $ 0.07(7) --
</TABLE>

- ------
(1) Computed based upon average shares outstanding.
(2) Commencement of operations.
(3) Total return excludes the effect of sales charge.
(4) Annualized.
(5) Without the waiver of advisory fees, the ratio of expenses to average daily
net assets would have been 1.74% (annualized) for the period ended December
31, 1995.
(6) Without the waiver of advisory fees, the ratio of net investment income to
average daily net assets would have been 2.09% (annualized) for the period
ended December 31, 1995.
(7) Disclosure is required for fiscal years beginning after September 1, 1995.
Represents average commission rate per share charged to the Fund on
purchases and sales of investments during the period.

4
<PAGE>
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 common stock, securities convertible thereto and debt
obligations of companies in the telephone industry and in income-producing
securities (including debt obligations) of issuers in the telephone or other
industries. 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 that 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 common stock, securities convertible thereto and debt obliga-

<PAGE>

tions of companies in the telephone industry and at least 65% of the Fund's
total assets will be invested in income-producing securities (including debt
obligations) of issuers in the telephone or other industries. The Fund may
purchase American Depositary 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." 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.
Depending on the circumstances, the Fund may temporarily and for defensive
purposes invest up to 100% of its net assets in money market instruments and in
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 (securities rated BBB or higher by S&P or Baa or higher by
Moody's) are generally thought to provide the highest credit quality and the
smallest risk of default. Securities rated BBB by S&P or Baa by Moody's have
speculative characteristics. Up to 10% of the Fund's total assets (measured at
the time of the investment) may be invested 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). Securities that were investment grade 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

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. Securities in the lowest rating
category that the Fund may purchase (secu-

5
<PAGE>

rities 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. 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. The market prices of these securities may
fluctuate more than those of higher rated securities, and may decline
significantly in periods of general economic difficulty, which may follow
periods of rising interest rates. 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. 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 following table 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, 1996,
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.

<PAGE>

S&P
Rating Average
--------- ---------
AAA 1.60%
AA 0.00%
A 0.16%
BBB 0.00%
BB 0.92%
B 0.00%
Unrated 0.00%

INVESTMENTS IN REPURCHASE AGREEMENTS

The Fund may agree to purchase U.S. Government securities from creditworthy
financial institutions, such as banks or broker-dealers, subject to the seller's
agreement to repurchase the securities at an established time and price. Default
by or bankruptcy proceedings with respect to the seller may, however, expose the
Fund to possible loss because of adverse market action or delay in connection
with the disposition of the underlying obligations.

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
Fund's 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.

INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
The Fund's investment program is subject to a number of restrictions that
reflect both self-imposed standards and federal regulatory limitations. The
following investment restrictions are matters of fundamental policy and may not
be changed without shareholder approval. 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); or

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.

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

6
<PAGE>
HOW TO INVEST IN THE FUND
- --------------------------------------------------------------------------------

Class A Shares and Class B Shares may be purchased from the Fund's
distributor (the "Distributor"), through any securities dealer that is
authorized to distribute the Fund's shares ("Participating Dealers") or through
any financial institution that is authorized to service shareholder accounts
("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, 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. (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 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 the Distributor 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 (a "Business Day"). Purchase orders for shares will be

<PAGE>

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 the Distributor or a
Participating Dealer or Shareholder Servicing Agent must be in accordance with
such entity's payment procedures. The Distributor may, in its sole discretion,
refuse to accept any purchase order.

The net asset value per share is determined 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 attributable to that 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.

OFFERING PRICE

Shares may be purchased from the Distributor, Participating Dealers or
Shareholder Servicing Agents at the Offering Price, which for Class A Shares
includes a sales charge that 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 in the following table.

7
<PAGE>

Sales Charge
as Percentage of Dealer
------------------------------ Compensation
Offering Net Amount as Percentage of
Amount of Purchase Price Invested Offering Price
- --------------------------------------------------------------------------------
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*
- --------------------------------------------------------------------------------

* Purchases of $1 million or more may be subject to a contingent deferred sales
charge. (See below.) The Distributor 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
Class A shares of other Flag Investors funds with the same sales charge and
purchases of Class A shares of Flag Investors Short-Intermediate Income Fund,
Inc. (formerly, 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 the Distributor, 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.

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. Class A 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

<PAGE>

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 the
Distributor 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.

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 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 Class
A shares of any other mutual fund in the Flag Investors family of funds with the
same sales charges, or who have redeemed Class A shares of the Intermediate
Funds that 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 the Distributor, Participating Dealers and their respective affiliates.

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 the
Distributor or a Participating Dealer or Shareholder Servicing Agent.

8
<PAGE>

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. 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.

Contingent Deferred Sales Charge
Year Since Purchase (as a percentage of the dollar
Payment was Made amount 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

<PAGE>

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.

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.

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 the
Distributor 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. Shares issued pursuant to this offer will
not be subject to the sales charges described above or any other charge. In
addition, shareholders of Class A shares 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

9
<PAGE>

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 the Distributor 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. Class A 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 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

<PAGE>

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

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. Unless the shareholder elects otherwise, all income dividends and
net capital gains distributions will be reinvested in additional Fund shares of
the same class at net asset value (without a sales charge). Shareholders may
elect to terminate automatic reinvestment by giving written notice to the
Transfer Agent (at its address listed on page 16 of this Prospectus), 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.

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 the Transfer Agent for additional
information.

HOW TO REDEEM SHARES
- --------------------------------------------------------------------------------

Shareholders may redeem all or part of their investment on any Business Day
by transmitting a redemption order through the Distributor, 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) or the close of the New York Stock Exchange,
whichever is earlier, 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 following documents:

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;

10
<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 has the power, under its Articles of Incorporation, to redeem
shareholder accounts amounting to less than $500 upon 60 days' notice.

<PAGE>

Shares will not be redeemed involuntarily as a result of a decline in account
value due to a decline in net asset value alone.

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.

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 $50,000, by
notifying the Transfer Agent by telephone 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 on page 16 of this Prospectus. 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. If these procedures are
employed, 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.")

11
<PAGE>

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.

TAX TREATMENT OF DIVIDENDS AND DISTRIBUTIONS

The following summary of certain federal income tax consequences is based on
current tax laws and regulations, which may be changed by legislative, judicial,
or administrative action. No attempt has been made to present a detailed
explanation of the federal, state or local income tax treatment of the Fund or
the shareholders, and the discussion here is not intended as a substitute for
careful tax planning. Accordingly, shareholders are advised to consult their tax
advisors regarding specific questions as to federal, state and local income
taxes. 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,

<PAGE>

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.

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.

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.

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

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. A majority of the Directors are not affiliated with the Fund's
advisors or the Distributor.

The Fund's Directors and officers are as follows:

Truman T. Semans Chairman Bruce E. Behrens President
Richard T. Hale Director J. Dorsey Brown, III Executive Vice President
Charles W. Cole, Jr. Director Liam D. Burke Executive Vice President
James J. Cunnane Director Hobart C. Buppert, II Vice President
John F. Kroeger Director Lee S. Owen Vice President
Louis E. Levy Director Edward J. Veilleux Vice President
Eugene J. McDonald Director Gary V. Fearnow Vice President
Rebecca W. Rimel Director Scott J. Liotta Vice President
Carl W. Vogt Director and Secretary
Joseph A. Finelli Treasurer
Laurie D. Collidge Assistant Secretary

12
<PAGE>

INVESTMENT ADVISOR AND SUB-ADVISOR
- --------------------------------------------------------------------------------

Investment Company Capital Corp. ("ICC" or the "Advisor") is the Fund's
investment advisor and Alex. Brown Investment Management ("ABIM" or the "Sub-
Advisor") is the Fund's sub-advisor. ICC is also the investment advisor to other
mutual funds in the Flag Investors family of funds and Alex. Brown Cash Reserve
Fund, Inc., which funds had approximately $5.2 billion of net assets as of
December 31, 1996. ABIM is a registered investment advisor with approximately
$5.6 billion under management as of December 31, 1996.

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
the Distributor, provided that compensation to the Distributor 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.

As compensation for providing investment advisory services to the Fund for
the fiscal year ended December 31, 1996, ICC received a fee equal to .66% of the
Fund's average daily net assets and from such fee paid ABIM a sub-advisory fee
equal to .45% of the Fund's average daily net assets. ICC may from time to time
voluntarily waive a portion of its fee to improve performance.

ICC is an indirect subsidiary of Alex. Brown Incorporated. Buppert, Behrens &
Owen, Inc., a company organized and owned by three employees of ABIM, owns a 49%
limited partnership interest and a

<PAGE>

1% general partnership interest in ABIM. The Distributor owns a 1% general
partnership interest in ABIM and Alex. Brown Incorporated owns the remaining 49%
limited partnership interest.

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

PORTFOLIO MANAGERS

Messrs. Bruce E. Behrens, the Fund's President, and Liam D. Burke, an
Executive Vice President of the Fund, share primary responsibility for managing
the Fund's assets. From the Fund's inception through April 30, 1997, Mr. Behrens
shared that responsibility with Hobart C. Buppert, II, who remains a Vice
President of the Fund.

Bruce E. Behrens -- 29 Years' Investment Experience

Mr. Behrens has been a Vice President and a Principal 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 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.

Liam D. Burke -- 8 Years' Investment Experience

Mr. Burke joined ABIM in 1994 with primary responsibility as a
telecommunications analyst for the Fund. Prior to joining ABIM, Mr. Burke worked
as a telecommunications industry analyst at a regional broker-dealer, Ferris,
Baker, Watts, Inc., from 1992 to 1994 and as managing director of Frey & Co., a
Baltimore-based private investment bank, from 1989 to 1992. Mr. Burke began his
professional career at AT&T and spent eight years in positions that included
operations, regional staff management and national account sales. He is a
graduate of Georgetown University and received his MBA from The George
Washington University.

13
<PAGE>

DISTRIBUTOR
- --------------------------------------------------------------------------------

Alex. Brown & Sons Incorporated ("Alex. Brown" or the "Distributor") acts as
distributor of the Fund's shares. Alex. Brown is an investment banking firm
that 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 agreements with certain
financial institutions, such as banks, to provide shareholder services, pursuant
to which Alex. Brown will allocate up to all of its distribution fee as
compensation for such 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.

As compensation for providing distribution services for the Class A Shares
for the fiscal year ended

<PAGE>

December 31, 1996, 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, 1996, 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 is less than the payments received, the unexpended portion 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.

CUSTODIAN, TRANSFER AGENT AND ACCOUNTING SERVICES
- --------------------------------------------------------------------------------

Investment Company Capital Corp. 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, 1996, ICC received a fee equal to .02% of the Fund's average daily net
assets. (See the Statement of Additional Information.) PNC Bank, National
Association, a national banking association, acts as custodian of the Fund's
assets.

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, the Fund's performance will be stated in the same terms in which such
comparative data and indices are stated, which is

14
<PAGE>

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 that 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. 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 Fund shares may be purchased, although not
included in calculations of performance, will reduce performance results.

GENERAL INFORMATION
- --------------------------------------------------------------------------------
CAPITAL SHARES

The Fund is an open-end non-diversified management investment company. The
Fund reorganized as a Maryland corporation on January 19, 1989 and 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

<PAGE>

the Fund share a common investment objective, portfolio of investments and
advisory fee, but to the extent the classes have different distribution/service
fees or sales load structures, performance may differ.

ANNUAL MEETINGS

Unless required under applicable Maryland law, the Fund does not expect to
hold annual meetings of shareholders. Shareholders of the Fund retain the right,
under certain circumstances, to request that a meeting of shareholders be held
for the purpose of considering 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.

SHAREHOLDER INQUIRIES

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

FLAG INVESTORS TELEPHONE INCOME FUND, INC.
NEW ACCOUNT APPLICATION
- -----------------------------------------------------------------------------------------------------------------------------------
Make check payable to "Flag Investors Telephone Income FOR ASSISTANCE IN COMPLETING THIS APPLICATION PLEASE CALL: 1-800-553-8080
Fund, Inc." and mail with this Application to: MONDAY THROUGH FRIDAY, 8:30 A.M. TO 5:30 P.M. (EASTERN TIME).
Alex. Brown & Sons Incorporated/Flag Investors Funds
P.O. Box 419663 TO OPEN AN IRA ACCOUNT, PLEASE CALL 1-800-767-3524 FOR AN IRA INFORMATION
Kansas City, MO 64141-6663 KIT.
Attn: Flag Investors Telephone Income Fund, Inc.
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 FOR EACH CLASS OF SHARES 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. 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 GIFTS TO MINORS

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

- ----------------------------------------------------------------- -----------------------------------------------------------
Social Security Number Minor's Name (only one)

- ----------------------------------------------------------------- -----------------------------------------------------------
Joint Tenant Initial Last Name Social Security Number of Minor

under the__________________Uniform Gifts to Minors Act
State of Residence

CORPORATIONS, TRUSTS, PARTNERSHIPS, ETC. MAILING ADDRESS

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

- ------------------------------- ---------------------- -----------------------------------------------------------
Tax ID Number Date of Trust City State Zip
( )
- ----------------------------------------------------------------- -----------------------------------------------------------
Name of Trustees (If to be included in the Registration) Daytime Phone

- -----------------------------------------------------------------
For the Benefit of
--------------------------------------------------
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
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
<S> <C>
-------------------------------------------------------
RIGHT OF ACCUMULATION -- CLASS A SHARES ONLY (OPTIONAL)
-------------------------------------------------------
List the Account numbers of other Flag Investors Funds (except Class B shares) that you or your immediate family already own that
qualify for reduced sales charges.
Fund Name Account No. Owner's Name Relationship

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

- -----------------------------------------------------------------------------------------------------------------------------------
--------------------
DISTRIBUTION OPTIONS
--------------------
Please check the appropriate boxes. If none of the options are selected, all distributions will be reinvested in additional shares
of the same class of the Fund at no sales charge.
INCOME DIVIDENDS CAPITAL GAINS
[ ] Reinvested in additional shares [ ] Reinvested in additional shares
[ ] Paid in Cash [ ] Paid in Cash
Call (800) 553-8080 for information about reinvesting your dividends in other funds in the Flag Investors Family of Funds.

A-1
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
<S> <C>
-----------------------------------
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)
-----------------------------
PLEASE ATTACH A VOIDED CHECK.
-----------------------------

- ------------------------------------------------------- ----------------------------------------------------------------------
Bank Name Depositor's Signature Date

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

-----------------------------------------
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
<S> <C>
------------------------------------
SIGNATURE AND TAXPAYER CERTIFICATION
------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
[The Following Text Appears in a Box]
THE FUND MAY BE REQUIRED TO WITHHOLD AND REMIT TO THE U.S. TREASURY 31% OF ANY TAXABLE DIVIDENDS, CAPITAL GAINS DISTRIBUTIONS AND
REDEMPTION PROCEEDS PAID TO ANY INDIVIDUAL OR CERTAIN OTHER NON-CORPORATE SHAREHOLDERS WHO FAIL TO PROVIDE THE INFORMATION AND/OR
CERTIFICATIONS REQUIRED BELOW. THIS BACKUP WITHHOLDING IS NOT AN ADDITIONAL TAX, AND ANY AMOUNTS WITHHELD MAY BE CREDITED AGAINST
THE SHAREHOLDER'S ULTIMATE U.S. TAX LIABILITY.
BY SIGNING THIS APPLICATION, I HEREBY CERTIFY UNDER PENALTIES OF PERJURY THAT THE INFORMATION ON THIS APPLICATION IS COMPLETE AND
CORRECT AND THAT AS REQUIRED BY FEDERAL LAW: (PLEASE CHECK APPLICABLE BOXES)
[ ] U.S. CITIZEN/TAXPAYER:
[ ] I CERTIFY THAT (1) THE NUMBER SHOWN ABOVE ON THIS FORM IS THE CORRECT SOCIAL SECURITY NUMBER OR TAX ID NUMBER AND (2) I AM
NOT SUBJECT TO ANY BACKUP WITHHOLDING EITHER BECAUSE (A) I AM EXEMPT FROM BACKUP WITHHOLDING, OR (B) I HAVE NOT BEEN
NOTIFIED BY THE INTERNAL REVENUE SERVICE ("IRS") THAT I AM SUBJECT TO BACKUP WITHHOLDING AS A RESULT OF A FAILURE TO REPORT
ALL INTEREST OR DIVIDENDS, OR (C) THE IRS HAS NOTIFIED ME THAT I AM NO LONGER SUBJECT TO BACKUP WITHHOLDING.
[ ] IF NO TAX ID NUMBER OR SOCIAL SECURITY NUMBER HAS BEEN PROVIDED ABOVE, I HAVE APPLIED, OR INTEND TO APPLY, TO THE IRS OR
THE SOCIAL SECURITY ADMINISTRATION FOR A TAX ID NUMBER OR A SOCIAL SECURITY NUMBER, AND I UNDERSTAND THAT IF I DO NOT
PROVIDE EITHER NUMBER TO THE TRANSFER AGENT WITHIN 60 DAYS OF THE DATE OF THIS APPLICATION OR IF I FAIL TO FURNISH MY
CORRECT SOCIAL SECURITY NUMBER OR TAX ID NUMBER, I MAY BE SUBJECT TO A PENALTY AND A 31% BACKUP WITHHOLDING ON DISTRIBUTIONS
AND REDEMPTION PROCEEDS. (PLEASE PROVIDE EITHER NUMBER ON IRS FORM W-9. YOU MAY REQUEST SUCH FORM BY CALLING THE TRANSFER
AGENT AT 800-553-8080).
[ ] NON-U.S. CITIZEN/TAXPAYER: INDICATED COUNTRY OF RESIDENCE FOR TAX PURPOSES: _______________________________________________
UNDER PENALTIES OF PERJURY, I CERTIFY THAT I AM NOT A U.S. CITIZEN OR RESIDENT AND I AM AN EXEMPT FOREIGN PERSON AS DEFINED
BY THE INTERNAL REVENUE SERVICE.
[End of Box]
- -----------------------------------------------------------------------------------------------------------------------------------
I have received a copy of the Fund's prospectus dated May 1, 1997. 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.
- -----------------------------------------------------------------------------------------------------------------------------------
[The Following Text Appears in a Box]
THE INTERNAL REVENUE SERVICE DOES NOT REQUIRE YOUR CONSENT TO ANY PROVISION OF THIS DOCUMENT OTHER THAN THE CERTIFICATIONS REQUIRED
TO AVOID BACKUP WITHHOLDING.
[End of Box]
- -----------------------------------------------------------------------------------------------------------------------------------

- ---------------------------------------------------- -------------------------------------------------------------------------
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.: ________________________________________________________

A-2
</TABLE>

<PAGE>

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

Investment Advisor
INVESTMENT COMPANY CAPITAL CORP.
One South Street
Baltimore, Maryland 21202

Sub-Advisor Distributor
ALEX. BROWN INVESTMENT MANAGEMENT ALEX. BROWN & SONS INCORPORATED
One South Street One South Street
Baltimore, Maryland 21202 Baltimore, Maryland 21202
1-800-767-FLAG

Transfer Agent Independent Accountants
INVESTMENT COMPANY CAPITAL CORP. COOPERS & LYBRAND L.L.P.
One South Street 2400 Eleven Penn Center
Baltimore, Maryland 21202 Philadelphia, Pennsylvania 19103
1-800-553-8080

Custodian Fund Counsel
PNC BANK, NATIONAL ASSOCIATION MORGAN, LEWIS & BOCKIUS LLP
Airport Business Park 2000 One Logan Square
200 Stevens Drive Philadelphia, Pennsylvania 19103
Lester, Pennsylvania 19113

<PAGE>

STATEMENT OF ADDITIONAL INFORMATION

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

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

One South 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, ONE SOUTH STREET, BALTIMORE, MARYLAND
21202, (800) 767-FLAG.

Statement of Additional Information Dated: May 1, 1997

Relating to the Prospectus Dated: May 1, 1997

TABLE OF CONTENTS
<S> <C> <C>
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............................................................. 18

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

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

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

11. Custodian, Transfer Agent and 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
</TABLE>

<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 the Fund's distributor (the "Distributor")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 for 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 the Distributor 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.
<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 common stock, securities convertible thereto and debt
obligations of companies in the telephone industry and in income-producing
securities (including debt obligations) of issuers in the telephone or other
industries. The Fund's investment advisor (the "Advisor") and sub-advisor (the
"Sub-Advisor"), 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.

Depending on the circumstances, the Fund may temporarily and
for defensive purposes, invest up to 100% of its net assets in money market
instruments and in other income-producing securities. The Fund may also 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

-2-
<PAGE>

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 that 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.

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,

-3-
<PAGE>

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
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 the Advisors, 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.

-4-
<PAGE>

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.

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 that 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 the
Advisors believe the security should be held for the long term but expect 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 that 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.

-5-
<PAGE>

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 that 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. The Advisors 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
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
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 outstanding shares. The percentage limitations contained in these
restrictions apply at the time of purchase of securities. Accordingly, the Fund
will not:

1. 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 equaling 5% or more
of the Fund's total assets are outstanding, the Fund will not purchase
securities for investment;

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

3. Purchase or sell commodities or commodities contracts;

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);

-6-
<PAGE>

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 investment restriction may be changed by a vote
of the majority of the Board of Directors. The Fund will not:

1. Invest in shares of any other investment company registered
under the Investment Company Act of 1940, except as permitted by federal law.

3. VALUATION OF SHARES AND REDEMPTION

Valuation of Shares

The net asset value per Share is determined daily as of the
close of the New York Stock Exchange, which is ordinarily 4:00 p.m. (Eastern
Time) each day on which the New York Stock Exchange is open for business (a
"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.

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
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 in the
Prospectus under "How to Invest in the Fund," 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.

-7-

<PAGE>
4. FEDERAL TAX TREATMENT OF DIVIDENDS AND DISTRIBUTIONS

The following discussion of certain 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 federal
income 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 intends to be, taxed as a
regulated investment company ("RIC") under Subchapter M of the Code. 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 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 that the
Fund controls and that 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.

-8-
<PAGE>

Under Subchapter M, the Fund is exempt from federal income tax
on its net investment income and capital gains that 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 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. 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. In the unlikely event the Fund elects to retain
its net capital gains, it is expected that the Fund 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 that 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). This
loss disallowance rule will apply to Shares received through the reinvestment of
dividends during the 61-day period.

-9-
<PAGE>

Investors purchasing Shares 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) 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 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. In certain circumstances the Fund may be
required to liquidate portfolio investments in order to make sufficient
distributions to avoid excise tax liability.

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 advisors as to the consequences of these and other state and
local tax rules affecting investment in the Fund.

-10-

<PAGE>

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 One South Street, Baltimore, Maryland 21202.

*TRUMAN T. SEMANS, Chairman (10/27/27)
Managing Director, Alex. Brown & Sons Incorporated; Director,
Investment Company Capital Corp. (registered investment advisor);
Formerly, Vice Chairman, Alex. Brown Incorporated.

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

*RICHARD T. HALE, Director (7/17/45)
Managing Director, Alex. Brown & Sons Incorporated; Director and
President, Investment Company Capital Corp. (registered investment
advisor); Chartered Financial Analyst.

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
(registered investment company).

JOHN F. KROEGER, Director (8/11/24)
37 Pippins Way, Morristown, New Jersey 07960. Director/Trustee, AIM
Funds (registered investment companies); 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); Director, Central

-11-

<PAGE>

Carolina Bank & Trust (banking), Key Funds (registered investment
companies), and AMBAC Treasurers Trust (registered investment company).

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. 20004-2604. Senior Partner, Fulbright & Jaworski L.L.P. (law);
Director, Yellow Corporation (trucking); Formerly, Chairman and Member,
National Transportation Safety Board; Director, National Railroad
Passenger Corporation (Amtrak) and Member, Aviation System Capacity
Advisory Committee (Federal Aviation Administration).

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. (investments), 1987-Present.

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 (registered investment advisor).

LIAM D. BURKE, Executive 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.

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. (investments), 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. (investments), 1987-Present.

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

-12-

<PAGE>

GARY V. FEARNOW, Vice President (12/6/44)
Managing Director, Alex. Brown & Sons Incorporated and Manager, Private
Client Marketing, Alex. Brown & Sons Incorporated.

SCOTT J. LIOTTA, Vice President and Secretary (3/18/65)+
Manager, Fund Administration, Alex. Brown & Sons Incorporated, July
1996-Present; Formerly, Manager and Foreign Markets Specialist, Putnam
Investments Inc. (registered investment companies), April 1994-July
1996; Supervisor, Brown Brothers Harriman & Co. (domestic and global
custody), August 1991-April 1994.

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

LAURIE D. COLLIDGE, Assistant Secretary (1/1/66)
Asset Management Department, Alex. Brown & Sons Incorporated.

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

* Messrs. Semans, Cole and Hale are directors who are "interested persons,"
as defined in the 1940 Act.
+ Mr. Liotta is Mr. Cole's son-in-law.

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 the Distributor or its affiliates. There are currently
twelve funds in the Flag Investors/ISI Funds and Alex. Brown Cash Reserve Fund,
Inc. fund complex (the "Fund Complex"). Mr. Cole serves as Chairman of one fund
and as a Director of seven other funds in the Fund Complex. Mr. Hale serves as
Chairman of three funds, 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 Chairman of
five funds and as a Director of five other funds in the Fund Complex. Messrs.
Cunnane, Kroeger, Levy and McDonald serve as Directors of each fund in the Fund
Complex. Ms. Rimel serves as a Director of ten funds in the Fund Complex. Mr.
Vogt serves as a Director of nine 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 Executive Vice President of three funds in the Fund Complex.
Mr. Buppert serves as President of one fund and Vice President of two funds in
the Fund Complex and Mr. Owen serves as President of one fund and Vice President
of two funds in the Fund Complex. Mr. Fearnow serves as Vice President of ten
funds in the Fund Complex. Mr. Veilleux serves as Executive Vice President of
one fund and as Vice President of eleven funds in the Fund Complex. Mr. Burke
serves as Executive Vice President of one fund in the Fund Complex. Mr. Liotta
serves as Vice President and Secretary, Mr. Finelli serves as Treasurer and Ms.
Collidge serves as Assistant Secretary 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, the Distributor 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.

-13-

<PAGE>

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 the Distributor 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") 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 each
fund in the Fund Complex 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, 1996, Non-Interested Directors' fees attributable
to the assets of the Fund totaled $36,330.

The following table shows aggregate compensation payable to
each of the Fund's Directors by the Fund and the Fund Complex, respectively, and
pension or retirement benefits accrued as part of Fund expenses in the fiscal
year ended December 31, 1996.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
COMPENSATION TABLE

Name of Person, Position Aggregate Compensation Pension or Retirement Total Compensation
From the Fund Payable to Benefits Accrued As From the Fund
Directors for the Part of Fund Expenses and Fund Complex
Fiscal Year Ended Payable to Directors
December 31, 1996 for the Fiscal Year
Ended December 31, 1996

- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
W. James Price, Chairman (1, 2) $0 $0 $0

Charles W. Cole, Jr., Director (1, 3) $0 $0 $0

Richard T. Hale, Director (1, 3) $0 $0 $0

Truman T. Semans, Director (1, 4) $0 $0 $0

James J. Cunnane, Director $3,813 (5) (6) $39,000 for service on 12
Boards in the Fund Complex

N. Bruce Hannay, Director (7) $320 (5) (6) $3,321 for service on 12
Boards in the Fund Complex

John F. Kroeger, Director $4,790 (5) (6) $49,000 for service on 12
Boards in the Fund Complex

Louis E. Levy, Director $3,813 (5) (6) $39,000 for service on 12
Boards in the Fund Complex

Eugene J. McDonald, Director $3,813 (5) (6) $39,000 for service on 12
Boards in the Fund Complex

Rebecca W. Rimel, Director (3) $3,441 (5) (6) $39,000 for service on 6 (8)
Boards in the Fund Complex

Carl W. Vogt, Director (3) $4,576 (5) (6) $39,000 for service on 5 (8)
Boards in the Fund Complex

Harry Woolf, Director (2) $3,813 (5) (6) $39,000 for service on 12
Boards in the Fund Complex
</TABLE>
- -------------------

-14-
<PAGE>

(1) A Director who is an "interested person" as defined in the 1940 Act.
(2) Retired, effective December 31, 1996.
(3) Messrs. Hale, Cole and Vogt and Ms. Rimel were elected to the Board at a
special meeting of Directors held on April 10, 1996.
(4) Mr. Semans was elected Chairman of the Board, effective January 1, 1997.
(5) Of amounts payable to Messrs. Cunnane, Hannay, Kroeger, Levy, McDonald,
Vogt and Woolf, and to Ms. Rimel, $3,813, $0, $0, $0, $3,813, $4,576,
$3,813 and $3,441, respectively, was deferred pursuant to a deferred
compensation plan.
(6) The Fund Complex has adopted a Retirement Plan for eligible Directors, as
described below. The actuarially computed pension expense for the Fund for
the year ended December 31, 1996 was approximately $19,997.
(7) Retired, effective January 31, 1996 and is now deceased.
(8) Ms. Rimel and Mr. Vogt receive proportionately higher compensation from
each fund for which they serve as a Director.

The Fund Complex has adopted a Retirement Plan (the "Retirement
Plan") for Directors who are not employees of the Fund, the Advisors 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 serves. The Retirement Plan is
unfunded and unvested. Mr. Kroeger has qualified but has not received benefits.
The Fund has two Participants, a Director who retired effective December 31,
1994, and a Director who retired effective December 31, 1996, who have qualified
for the Retirement Plan by serving thirteen and fourteen years, respectively, as
Directors in the Fund Complex and each of whom will be paid a quarterly fee of
$4,875 by the Fund Complex for the rest of his life. Another participant, who
retired on January 31, 1996 and died on June 2, 1996, was paid fees of $8,090 by
the Fund Complex under the Retirement Plan in the fiscal year ended December 31,
1996. Such fees are allocated to each fund in the Fund Complex based upon the
relative net assets of such fund to the Fund Complex.

Set forth in the table below are the estimated annual benefits
payable to a Participant upon retirement assuming various years of service and
payment of a percentage of the fee earned by such Participant in his or her last
year of service, as described above. The approximate credited years of service
at December 31, 1996 are as follows: for Mr. Cunnane, 2 years; for Mr. Kroeger,
14 years; for Mr. Levy, 2 years; for Mr. McDonald, 4 years; for Ms. Rimel, 1
year; and for Mr. Vogt, 1 year.
<TABLE>
<CAPTION>
Years of Service Estimated Annual Benefits Payable By Fund Complex Upon Retirement

Chairman of Audit Committee Other Participants
<C> <C> <C>
6 years $4,900 $3,900
7 years $9,800 $7,800
8 years $14,700 $11,700
9 years $19,600 $15,600
10 years or more $24,500 $19,500
</TABLE>
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, Kroeger, Levy, McDonald and
Vogt and Ms. Rimel have each executed a Deferred Compensation Agreement.
Currently, the deferring Directors may select various Flag Investors and Alex.
Brown Funds in which all or part of their deferral account shall be deemed to be
invested. Distributions from

-15-

<PAGE>

the deferring Directors' deferral accounts will be paid in cash, in generally
equal quarterly installments over a period of ten years.

Code of Ethics

The Board of Directors of the Fund has adopted a Code of Ethics
pursuant to Rule 17j-1 under the 1940 Act. The Code of Ethics applies to the
personal investing activities of all the directors and officers of the Fund, as
well as to designated officers, directors and employees of the Advisors and the
Distributor. As described below, the Code of Ethics imposes additional
restrictions on the Advisors' 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 covered employees of the
Advisors, certain directors or officers of the Distributor, and all Fund
Directors who are "interested persons" preclear personal securities investments
(with certain exceptions, such as non-volitional purchases or purchases that 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 special 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. Officers, directors and employees of the Advisors and the Distributor
may comply with codes instituted by those entities so long as they contain
similar requirements and restrictions.

6. INVESTMENT ADVISORY AND OTHER SERVICES

On April 10, 1996, the shareholders of the Fund approved an
Investment Advisory Agreement between the Fund and Investment Company Capital
Corp. ("ICC" or the "Advisor") and a Sub-Advisory Agreement among the Fund, ICC
and Alex. Brown Investment Management ("ABIM" or the "Sub-Advisor"), both of
which contracts are described in greater detail below. ICC, is a wholly-owned
subsidiary of Alex. Brown Financial Corporation and an indirect subsidiary of
Alex. Brown Incorporated. ICC also serves as the investment advisor and ABIM
serves as the sub-advisor to other funds in the Flag Investors family of funds.
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. The Distributor holds a 1% general partnership interest in
ABIM and Alex. Brown Incorporated owns the remaining 49% limited partnership
interest.

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.
-16-

<PAGE>

As compensation for its services, ICC is entitled to receive a
fee from the Fund, calculated daily and paid monthly, at the following annual
rates based upon the Fund's average daily net assets: 0.85% of the first $100
million, 0.75% of the next $100 million, 0.70% of the next $100 million, 0.65%
of the next $200 million, 0.58% of the next $500 million, 0.53% of the next $500
million and 0.50% of that portion exceeding $1.5 billion. Prior to April 11,
1995, the annual rates based upon the Fund's average daily net assets were:
0.65% of the first $100 million, 0.55% of the next $100 million, 0.50% of the
next $100 million and 0.45% of that portion in excess of $300 million. 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
following annual rates based upon the Fund's average daily net assets: 0.60% of
the first $100 million, 0.55% of the next $100 million, 0.50% of the next $100
million, 0.45% of the next $200 million, 0.40% of the next $500 million, 0.37%
of the next $500 million and 0.35% of that portion in excess of $1.5 billion.

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.

Advisory fees paid by the Fund to ICC and sub-advisory fees paid
by ICC to ABIM for the last three fiscal years were as follows:

Year Ended December 31,
-----------------------------------------------------
Fees Paid to: 1996 1995 1994

ICC $ 3,562,609 $ 2,297,474* $ 2,244,515*
ABIM $ 2,430,407 $ 1,541,505 $ 1,533,375

--------------
* Net of fee waivers. Absent such fee waivers for the fiscal years ended
December 31, 1995 and December 31, 1994, the Class A Shares' Total
Operating Expenses would have been .99% and .99%, respectively, of its
average daily net assets. Absent fee waivers for the period from January
3, 1995 (commencement of operations) through December 31, 1995, the Class
B Shares' Total Operating Expenses would have been 1.74% of its average
daily net assets. Absent fee waivers, for the years ended December 31,
1995 and December 31, 1994, the Class D Shares' Total Operating Expenses
would have been 1.34% and 1.34%, respectively, of its average daily 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 and Accounting Services."

-17-
<PAGE>

7. DISTRIBUTION OF FUND SHARES

The Distribution Agreements provide that Alex. Brown and Sons
Incorporated ("Alex. Brown" or the "Distributor") 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 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.

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.

-18-

<PAGE>

As compensation for providing distribution and shareholder
services to the Fund for the last three fiscal years, Alex. Brown received
fees in the following amounts:

Year Ended December 31
- -------------------------------------------------------------------------------
Class 1996 1995 1994
- ----- ---- ---- ----
Class A 12b-1 Fee $1,251,568 $1,153,794 $1,155,931
Class B 12b-1 Fee $98,828 $26,347* --
Class B Shareholder $32,943 $8,783* --
Servicing Fee
Class D 12b-1 Fee ** $176,582 $189,406 $185,856
Total Fees $1,559,921 $1,378,330 $1,341,787

* For the period from January 3, 1995 (commencement of operations) through
December 31, 1995.
** For the period from April 6, 1993 through November 18, 1994, the Fund
offered the Flag Investors Telephone Income Fund Class D Shares (which
were known at such time as the Flag Investors Telephone Income Fund Class
B Shares.) Some Class D Shares remain outstanding.

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 thereafter 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 30, 1996.

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

-19-

<PAGE>

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.

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 return for payments received
pursuant to the Plans in the fiscal years ended December 31, 1996, December 31,
1995 and December 31, 1994, Alex. Brown paid the distribution related expenses
of the related classes including one or more of the following: printing and
mailing of prospectuses to other than current shareholders; compensation to
dealers and sales personnel; and interest, carrying, or other financing charges.

In the fiscal years ended December 31, 1996, December 31, 1995
and December 31, 1994, Alex. Brown received sales commissions on the Class A
Shares of $717,441, $146,261 and $812,666 and from such amounts retained
$255,062, $73,667 and $260,734 for each such year, respectively. In the fiscal
year ended December 31, 1996 and the period from January 3, 1995 through
December 31, 1995, Alex. Brown received contingent deferred sales loads on the
Class B Shares of $377,125 and $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,

-20-

<PAGE>

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 that 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.

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, 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 that 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.

-21-

<PAGE>

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
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 that it seeks to purchase or sell.

During the fiscal years ended December 31, 1996, December 31,
1995 and December 31, 1994, Alex. Brown directed $191,851,754, $288,166,553 and
$208,696,174, respectively, of transactions to broker-dealers and paid $396,046,
$386,539 and $254,895, respectively, to broker-dealers in related commissions
because of research services provided. In the fiscal years ended December 31,
1996, December 31, 1995 and December 31, 1994, the Fund paid Alex. Brown
brokerage commissions in the aggregate amount of $7,000, $0 and $7,000, which
represented 1.9%, 0.0% and 2.7% of the Fund's aggregate brokerage commissions
for the periods and which were paid on transactions that represented 2.9%, 0.0%
and 1.8%, respectively, 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) that the Fund has acquired during
its most recent fiscal year. As of December 31, 1996, the Fund held a 6.0%
repurchase agreement issued by Goldman Sachs & Co. valued at $5,410,000. 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 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

-22-

<PAGE>

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 expenses of the Fund (other than 12b-1 fees and any applicable
services fees) are prorated between all classes of a series based upon the
relative net assets of each class. Any matters affecting any class exclusively
will 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

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.

11. CUSTODIAN, TRANSFER AGENT AND ACCOUNTING SERVICES

PNC Bank, National Association ("PNC Bank") 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. 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, 1996, such fees totalled $623,604.

ICC also provides certain accounting services to the Fund under a
Master Services Agreement 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 Annual Accounting 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%

-23-
<PAGE>

$ 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%

In addition, the Fund reimburses ICC for certain out-of-pocket
expenses incurred in connection with ICC's provision of accounting services
under the Master Services Agreement.

As compensation for providing accounting services to the Fund
for the fiscal year ended December 31, 1996, ICC received fees of $117,160.

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.

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 later commencement of operations of the series or class). In calculating the
ending redeemable value for the Class A Shares, the maximum sales load (4.5%) is
deducted from the initial $1,000 payment and all dividends and distributions by

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<PAGE>

the Fund are assumed to have been reinvested at net asset value as described in
the Prospectus on the reinvestment dates during the period. In calculating the
performance of the Class B Shares, the applicable contingent deferred sales
charge (4.0% for the one-year period, 2.0% for the five-year period and no
sales charge thereafter) is deducted from the ending redeemable value 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.

Calculated according to SEC rules, the ending redeemable value and
average annual total return of a hypothetical $1,000 payment for the periods
ended December 31, 1996 were as follows:
<TABLE>
<CAPTION>
One-Year Period Ended Five-Year Period Ended Ten-Year Period Ended
December 31, 1996 December 31, 1996 December 31, 1996
------------------- ------------------- -------------------
Ending Average Ending Average Ending Average
Redeemable Annual Total Redeemable Annual Total Redeemable Annual Total
Class Value Return Value Return Value Return
- ----- ----- ------ ----- ------ ----- ------
<S> <C> <C> <C> <C> <C>
Class A $1,083.50 8.35% 1,798.78$ 12.46% 3,708.39$ 14.00%
January 18, 1984+
Class B $1,095.74 9.57% N/A N/A N/A N/A
January 3, 1995+
Class D $1,105.74 10.57% N/A N/A N/A N/A
April 6, 1993+

[BROKEN TABLE]

Inception Through
December 31, 1996
------------------
Ending Average
Redeemable Annual Total
Value Return
----- ------
Class A * *
January 18, 1984+
Class B $1,450.99 20.52%
January 3, 1995+
Class D $1,490.03 11.21%
April 6, 1993+

</TABLE>

+ Inception Date.
* Not required since more than ten years have elapsed since inception.

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. 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.

-25-
<PAGE>

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 rate in fiscal year 1996 was
20% and in fiscal year 1995 was 24%.

Morningstar Mutual Fund Advisory Service ("Morningstar") assigned
the Fund their "5" Best in Category rating among the ten funds in the
communications funds category for the three-year period ended March 31, 1997. As
of March 31, 1997, Morningstar assigned the Fund a weighted overall
risk-adjusted rating of four stars based on the three-, five- and ten-year
ratings (see explanation below). As of March 31, 1997, the Fund's ratings for
separate periods within its investment category of domestic equity funds, were
two stars among 1,919 funds for three years, three stars among 1,076 funds for
five years and five stars among 601 funds for ten years.

The Morningstar risk-adjusted rating is expressed on a scale of 1
to 5 stars. The star rating is neither a predictive measure nor a "buy/sell"
recommendation. It is a purely descriptive representation of how well a fund has
balanced risk and return in the past. If the fund scores in the top 10% of its
investment category, it receives 5 stars (Highest); if it falls in the next
22.5%, it receives 4 stars (Above Average); if it falls in the middle 35%, it
receives 3 stars (Neutral or Average); if it falls in the next 22.5%, it
receives two stars (Below Average); and if it falls in the bottom 10%, it
receives 1 star (Lowest). The star ratings are recalculated monthly. The Fund's
overall risk-adjusted star rating is a weighted average of the Fund's three-,
five-, and 10-year histories, relative to other funds in its broad investment
category (i.e, equity). The three time periods are combined as a weighted
average. The 10-year rating accounts for 50% of the overall rating, the
five-year figure for 30%, and the three-year period 20%.

14. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

To Fund management's knowledge, the following persons held
beneficially or of record 5% or more of the Fund's outstanding shares, as of
April 15, 1997:

Alex. Brown & Sons Incorporated 26.2%*
One South Street
Baltimore, Maryland

----------
* As of such date, Alex. Brown owned beneficially less
than 1% of such Shares.

As of April 15, 1997, 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>

ALEX BROWN TELEPHONE INCOME FUND

FLAG INVESTORS TELEPHONE INCOME FUND
- --------------------------------------------------------------------------------
Statement of Net Assets December 31, 1996

Market Value
Shares Security (Note 1)
- ------------------------------------------------------------------------------

TELEPHONE INDUSTRY--90.3%

Common Stock--90.3%
220,408 AirTouch Communications Inc.* $ 5,565,302
600,000 America Online, Inc. 19,950,000
394,000 Ameritech Corporation 23,886,250
224,224 AT&T Corporation 9,753,744
370,000 BCE Inc. 17,667,500
497,608 Bell Atlantic Corporation 32,220,118
223,464 BellSouth Corporation 9,022,359
366,428 BlackBox Corporation* 15,115,155
290,000 BroadBand Technologies Inc.* 4,277,500
115,000 CellStar Corporation* 2,070,000
595,800 Cincinnati Bell Inc. 36,716,175
200,000 DSC Communications Corporation* 3,575,000
25,000 Excel Communications Inc.* 525,000
1,022,400 Frontier Corporation 23,131,800
214,700 General Instrument Corporation* 4,642,888
823,320 GTE Corporation 37,461,060
496,841 LCI International Inc. 10,682,081
181,235 Lucent Technologies Inc. 8,382,119
440,000 MFS Communications Co. Inc.* 23,980,000
405,000 Mobile Telecommunication 3,442,500
340,000 Motorola Inc. 20,867,500
200,000 NEXTEL Communications Inc.--Class A* 2,612,500
250,000 Octel Communications Corporation* 4,375,000
435,347 Orbital Sciences Corporation* 7,509,736
1,373,808 Pacific Telesis Group 50,487,444
130,000 Preferred Networks Inc.* 845,000
140,000 QUALCOMM Inc.* 5,582,500
969,106 SBC Communications Inc. 50,151,235
690,000 Southern New England
Telecommunications Corporation 26,823,750
128,000 Telefonica de Espana SA ADR 8,864,000
500,000 Telefonos de Mexico SA ADR--Series L 16,500,000
148,000 U.S. Robotics Corporation* 10,656,000
------------

Total Common Stock
(Cost $327,639,322) 497,341,216
------------

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- ------------------------------------------------------------------------------
Statement of Net Assets (concluded) December 31, 1996

Shares/ Market Value
Par (000) Security (Note 1)
- ------------------------------------------------------------------------------

NON-TELEPHONE INDUSTRY--8.5%

Common Stock--7.6%
626,900 Alexander Haagen Properties, Inc. $ 9,246,775
367,774 Conseco Inc. 23,445,593
67,700 Meditrust Corporation 2,708,000
100,000 Nationwide Health Properties, Inc. 2,425,000
122,128 Simon DeBartolo Group, Inc. 3,785,968
------------
Total Common Stock
(Cost $18,040,909) 41,611,336
------------
Corporate Bond--0.9%
$ 5,000 HMH Properties, 9.5%, 5/15/05
(Cost $4,910,351) 5,225,000
------------

Total Non-Telephone Industry
(Cost $22,951,260) 46,836,336
------------

REPURCHASE AGREEMENT--1.0%
5,410 Goldman Sachs & Co., 6.00%
Dated 12/31/96, to be repurchased on
1/2/97, collateralized by U.S. Treasury
Notes with a market value of $5,518,672.
(Cost $5,410,000) 5,410,000
------------
Total Investments in Securities--99.8%
(Cost $356,000,582)** 549,587,552
------------
Other Assets in Excess of Liabilities, Net--0.2% 1,016,790
------------
Net Assets--100.0% $550,604,342
============

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- --------------------------------------------------------------------------------
Net Asset Value Per:
Class A Share
($505,371,023 / 32,421,696 shares outstanding) $15.59(dagger)
=======
Class B Share
($17,660,516 / 1,138,610 shares outstanding) $15.51(double daggers)
=======
Class D Share
($27,572,803 / 1,768,618 shares outstanding) $15.59(triple daggers)
=======
Maximum Offering Price Per:
Class A Share
($15.59 / .955) $16.32
=======
Class B Share $15.51
=======
Class D Share
($15.59 / .985) $15.83
=======

- ---------------
* Non-income producing security.

** Aggregate cost for federal tax purposes was $352,513,493.

(dagger) Redemption value is $15.59.

(double daggers) Redemption value is $14.89 following 4.00% maximum contingent
deferred sales charge.

(triple daggers) Redemption value is $15.43 following 1.00% maximum contingent
deferred sales charge.

See Notes to Financial Statements.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- -------------------------------------------------------------------------------
Statement of Operations

For the
Year Ended
Dec. 31,
- ------------------------------------------------------------------------------
1996
Investment Income (Note 1):
Dividends $14,802,988
Interest 971,287
Less: Foreign taxes withheld (148,592)
-----------
Total income 15,625,683
-----------
Expenses:
Investment advisory fee (Note 2) 3,562,609
Distribution fee (Note 2) 1,559,921
Transfer agent fee (Note 2) 623,604
Printing and postage 191,642
Accounting fee (Note 2) 117,160
Legal 105,286
Custodian fees 67,181
Miscellaneous 55,576
Audit 49,511
Director's fees 36,330
Insurance 17,258
Registration fees 16,940
-----------
Total expenses 6,403,018
-----------
Net investment income 9,222,665
-----------

Realized and unrealized gain on investments:
Net realized gain from security transactions 44,618,521
Change in unrealized appreciation or
depreciation of investments 13,950,633
-----------
Net gain on investments 58,569,154
-----------

Net increase in net assets resulting from operations $67,791,819
===========

See Notes to Financial Statements.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- --------------------------------------------------------------------------------
Statement of Changes in Net Assets

For the Year Ended Dec. 31,
- --------------------------------------------------------------------------------
1996 1995
Increase in Net Assets:
Operations:
Net investment income $ 9,222,665 $ 14,026,672
Net realized gain from security transactions 44,618,521 35,372,071
Change in unrealized appreciation or
depreciation of investments 13,950,633 93,655,306
------------ ------------
Net increase in net assets resulting
from operations 67,791,819 143,054,049
------------ ------------
Distributions to Shareholders from:
Net investment income:
Class A Shares (8,654,688) (13,188,618)
Class B Shares (157,647) (71,352)
Class D Shares (410,330) (766,702)
Net realized short-term gains:
Class A Shares (3,437,642) (594,281)
Class B Shares (118,740) (6,947)
Class D Shares (187,069) (39,689)
Net realized long-term gains:
Class A Shares (26,060,648) (31,183,490)
Class B Shares (896,656) (411,017)
Class D Shares (1,420,532) (2,033,414)
------------ ------------
Total distributions (41,343,952) (48,295,510)
------------ ------------
Capital Share Transactions (Note 3):
Proceeds from sale of shares 36,388,229 35,420,420
Value of shares issued in reinvestment
of dividends 33,751,356 40,313,196
Cost of shares repurchased (77,258,035) (106,718,217)
------------ ------------
Decrease in net assets derived from
capital share transactions (7,118,450) (30,984,601)
------------ ------------
Total increase in net assets 19,329,417 63,773,938

Net Assets:
Beginning of year 531,274,925 467,500,987
------------ ------------
End of year $550,604,342 $ 531,274,925
------------ ------------

See Notes to Financial Statements.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- -------------------------------------------------------------------------------
Financial Highlights -- Class A Shares
(For a share outstanding throughout each year)(1)

For the Year Ended
Dec. 31, For the Year Ended Dec. 31,
- ------------------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
<S> <C>
Per Share Operating Performance:
Net asset value at beginning of year $ 14.87 $ 12.30 $ 13.70 $ 12.20 $ 11.28
------- ------- ------- ------- -------
Income from Investment Operations:
Net investment income 0.27 0.40 0.41 0.42 0.42
Net realized and unrealized gain/(loss)
on investments 1.67 3.58 (1.27) 1.78 0.93
------- ------- ------- ------- -------
Total from Investment Operations 1.94 3.98 (0.86) 2.20 1.35
------- ------- ------- ------- -------
Less Distributions:
Distributions from net investment income
and net realized short-term gains (0.38) (0.41) (0.44) (0.42) (0.42)
Distributions from net realized
long-term gains (0.84) (1.00) (0.10) (0.28) (0.01)
------- ------- ------- ------- -------
Total distributions (1.22) (1.41) (0.54) (0.70) (0.43)
------- ------- ------- ------- -------
Net asset value at end of year $ 15.59 $ 14.87 $ 12.30 $ 13.70 $ 12.20
======= ======= ======= ======= =======
Total Return(2) 13.46% 33.44% (6.32)% 18.12% 12.35%
Ratios to Average Daily Net Assets:
Expenses(3) 1.14% 0.93% 0.92% 0.92% 0.92%
Net investment income(4) 1.74% 2.85% 3.14% 3.12% 3.81%
Supplemental Data:
Net assets at end of year (000) $505,371 $492,454 $435,805 $469,163 $307,641
Portfolio turnover rate 20% 24% 23% 14% 6%
Average commissions per share $ 0.07(5) -- -- -- --

</TABLE>
- -----------------
(1) Computed based upon average shares outstanding.
(2) Total return excludes the effect of sales charge.
(3) Without the waiver of advisory fees (Note 2), the ratio of expenses to
average daily net assets would have been 0.99%, 0.99%, 0.98% and 1.07% for
the years ended December 31, 1995, 1994, 1993 and 1992, respectively.
(4) Without the waiver of advisory fees (Note 2), the ratio of net investment
income to average daily net assets would have been 2.79%, 3.07%, 3.06% and
3.66% for the years ended December 31, 1995, 1994, 1993 and 1992,
respectively.
(5) Disclosure is required for fiscal years beginning after September 1, 1995.
Represents average commission rate per share charged to the Fund on
purchases and sales of investments during the period.

See Notes to Financial Statements.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- --------------------------------------------------------------------------------
Financial Highlights -- Class B Shares
(For a share outstanding throughout each period)(1)
For the Period
For the Year Jan. 3, 1995(2)
Ended through
Dec. 31, Dec. 31,
- --------------------------------------------------------------------------------
1996 1995
Per Share Operating Performance:
Net asset value at beginning of period $ 14.83 $12.28
------- ------
Income from Investment Operations:
Net investment income 0.19 0.30
Net realized and unrealized gain
on investments 1.63 3.56
------- ------
Total from Investment Operations 1.82 3.86
------- ------
Less Distributions:
Distributions from net investment
income and net realized
short-term gains (0.30) (0.31)
Distributions from net realized
long-term gains (0.84) (1.00)
------- ------
Total distributions (1.14) (1.31)
------- ------
Net asset value at end of period $ 15.51 $14.83
======= ======
Total Return(3) 12.60% 32.42%
Ratios to Average Daily Net Assets:
Expenses(4) 1.92% 1.70%(6)
Net investment income(5) 0.95% 2.13%(6)
Supplemental Data:
Net assets at end of period (000) $17,661 $7,504
Portfolio turnover rate 20% 24%
Average commissions per share $ 0.07(7) --
- -----------------
(1) Computed based upon average shares outstanding.

(2) Commencement of operations.

(3) Total return excludes the effect of sales charge.

(4) Without the waiver of advisory fees (Note 2), the ratio of expenses to
average daily net assets would have been 1.74% (annualized) for the period
ended December 31, 1995.

(5) Without the waiver of advisory fees (Note 2), the ratio of net investment
income to average daily net assets would have been 2.09% (annualized) for
the period ended December 31, 1995.

(6) Annualized.

(7) Disclosure is required for fiscal years beginning after September 1, 1995.
Represents average commission rate per share charged to the Fund on
purchases and sales of investments during the period.

See Notes to Financial Statements.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND

<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Financial Highlights -- Class D Shares
(For a share outstanding throughout each period)(1)
For the Period
Apr. 6, 1993(2)
through
For the Year Ended Dec. 31, Dec. 31,
- --------------------------------------------------------------------------------------
<S> <C>
1996 1995 1994 1993
Per Share Operating Performance:
Net asset value at beginning of period $ 14.87 $ 12.30 $ 13.67 $ 13.21
------- ------- ------- -------
Income from Investment Operations:
Net investment income 0.22 0.34 0.37 0.25
Net realized and unrealized gain/(loss)
on investments 1.67 3.58 (1.20) 0.80
------- ------- ------- -------
Total from Investment Operations 1.89 3.92 (0.83) 1.05
------- ------- ------- -------
Less Distributions:
Distributions from net investment
income and net realized
short-term gains (0.33) (0.35) (0.42) (0.31)
Distributions in excess of net
investment income -- -- (0.02) --
Distributions from net realized
long-term gains (0.84) (1.00) (0.10) (0.28)
------- ------- ------- -------
Total distributions (1.17) (1.35) (0.54) (0.59)
------- ------- ------- -------
Net asset value at end of period $ 15.59 $ 14.87 $ 12.30 $ 13.67
======= ======= ======= =======

Total Return(3) 13.00% 32.91% (6.13)% 8.01%
Ratios to Average Daily Net Assets:
Expenses(4) 1.49% 1.28% 1.27% 1.27%(6)
Net investment income(5) 1.40% 2.50% 2.81% 2.73%(6)
Supplemental Data:
Net assets at end of period (000) $27,573 $31,317 $31,696 $23,481
Portfolio turnover rate 20% 24% 23% 14%
Average commissions per share $ 0.07(7) -- -- --

</TABLE>

- ----------------
(1) Computed based upon average shares outstanding.

(2) Commencement of operations.

(3) Total return excludes the effect of sales charge.

(4) Without the waiver of advisory fees (Note 2), the ratio of expenses to
average daily 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,
respectively.

(5) Without the waiver of advisory fees (Note 2), the ratio of net investment
income to average daily 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, respectively.

(6) Annualized.

See Notes to Financial Statements.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- -------------------------------------------------------------------------------
Notes to Financial Statements

NOTE 1--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 Bell regional 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.
The Class A and Class D Shares each have different sales charges and
distribution fees. As of 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, which 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:

A. Security Valuation--Portfolio securities that are primarily traded on a
recognized U.S. securities exchange are valued on the basis of their
last sale price. In the event that there are no sales or the security is
not listed, it is valued at the average between the last reported bid
and asked prices or at the fair value as determined by the Investment
Advisor under procedures established and monitored by the Board of
Directors. Short-term obligations with maturities of 60 days or less are
valued at amortized cost.

B. Repurchase Agreements--The Fund may agree to enter into tri-party
repurchase agreements. Securities held as collateral for tri-party
repurchase agreements are maintained by the broker's custodial bank in a
segregated account until maturity of the repurchase agreement. The
agreement ensures that the market value of the collateral, including
accrued interest thereon, is sufficient in the event of default. If the
counterparty defaults and the value of the collateral declines or if the

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- -------------------------------------------------------------------------------

NOTE 1--concluded

counterparty enters into an insolvency proceeding, realization of the
collateral by the Fund may be delayed or limited.

C. Federal Income Tax -- 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 make requisite distributions to 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, if any.

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 gains available for distribution
under income tax regulations.

D. 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.

NOTE 2--Investment Advisory Fees, Transactions with Affiliates and Other Fees

Investment Company Capital Corp. ("ICC"), a subsidiary of Alex. Brown
Financial Corp., 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 following annual rates based upon the Fund's average daily net
assets: 0.85% of the first $100 million, 0.75% of the next $100 million, 0.70%
of the next $100 million, 0.65% of the next $200 million, 0.58% of the next $500
million, 0.53% of the next $500 million and 0.50% of that portion in excess of
$1.5 billion. Prior to April 11, 1996, the annual rates based upon the Fund's
average daily net assets were: 0.65% of the first $100 million, 0.55% of the
next $100 million, 0.50% of the next $100 million and 0.45% of that portion in
excess of $300 million.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- --------------------------------------------------------------------------------
Notes to Financial Statements (continued)

NOTE 2--concluded

As compensation for its sub-advisory services, ABIM receives a fee from
ICC, payable from its advisory fee, calculated daily and paid monthly, at the
following annual rates based upon the Fund's average daily net assets: 0.60% of
the first $100 million, 0.55% of the next $100 million, 0.50% of the next $100
million, 0.45% of the next $200 million, 0.40% of the next $500 million, 0.37%
of the next $500 million and 0.35% of that portion in excess of $1.5 billion.

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 $117,160 for accounting services for the year
ended December 31, 1996.

As compensation for its transfer agent services, ICC receives from the Fund
a per account fee, calculated and paid monthly. ICC received $623,604 for
transfer agent services for the year ended December 31, 1996.

As compensation for providing distribution services, Alex. Brown & Sons
Incorporated ("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, 1996,
distribution fees aggregated $1,559,921 of which $1,251,568, $131,771 and
$176,582 were attributable to Class A Shares, Class B Shares and Class D Shares,
respectively. Alex. Brown received $7,000 of commissions on security
transactions from the Fund for the year ended December 31, 1996.

The Fund complex of which the Fund is a part has adopted a retirement plan
for eligible Directors. The actuarially computed pension expense allocated to
the Fund for the period January 1, 1996 through December 31, 1996 was
approximately $19,997, and the accrued liability was approximately $68,940.

NOTE 3--Capital Share Transactions

The Fund is authorized to issue up to 70 million shares of $.001 par value
capital stock (60 million Class A Shares, 5 million Class B Shares, 3 million
Class D Shares and 2 million undesignated). Transactions in shares of the Fund
are listed on the following pages.

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- --------------------------------------------------------------------------------
NOTE 3--continued

Class A Shares
-------------------------------
For the For the
Year Ended Year Ended
Dec. 31, 1996 Dec. 31, 1995
-------------- --------------
Shares sold 1,730,953 2,145,785
Shares issued to shareholders on
reinvestment of dividends 2,022,300 2,674,624
Shares redeemed (4,451,593) (7,132,553)
-------------- --------------
Net decrease in shares outstanding (698,340) (2,312,144)
============== ==============
Proceeds from sale of shares $ 26,738,906 $ 28,720,184
Value of reinvested dividends 30,812,547 37,305,866
Cost of shares redeemed (69,090,064) (97,427,131)
-------------- --------------
Net decrease from capital share transactions $(11,538,611) $(31,401,081)
============== ==============

Class B Shares
-------------------------------
For the Period
For the Jan. 3, 1995*
Year Ended through
Dec. 31, 1996 Dec. 31, 1995
-------------- --------------
Shares sold 628,129 489,011
Shares issued to shareholders on
reinvestment of dividends 73,229 32,826
Shares redeemed (68,656) (15,929)
-------------- --------------
Net increase in shares outstanding 632,702 505,908
============== ==============
Proceeds from sale of shares $ 9,649,323 $6,700,236
Value of reinvested dividends 1,109,830 458,760
Cost of shares redeemed (1,071,919) (229,177)
-------------- --------------
Net increase from capital share transactions $ 9,687,234 $6,929,819
============== ==============

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

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- -------------------------------------------------------------------------------
Notes to Financial Statements (concluded)

NOTE 3--concluded

Class D Shares
-------------------------------
For the For the
Year Ended Year Ended
Dec. 31, 1996 Dec. 31, 1995
-------------- --------------
Shares sold -- --
Shares issued to shareholders on
reinvestment of dividends 120,074 183,832
Shares redeemed (456,901) (655,092)
-------------- --------------
Net decrease in shares outstanding (336,827) (471,260)
============== ==============
Proceeds from sale of shares $ -- $ --
Value of reinvested dividends 1,828,979 2,548,570
Cost of shares redeemed (7,096,052) (9,061,909)
-------------- --------------
Net decrease from capital share transactions $(5,267,073) $(6,513,339)
============== ==============

NOTE 4--Investment Transactions

Purchases and sales of investment securities, other than short-term and
U.S. government obligations, aggregated $105,864,301 and $146,174,704,
respectively, for the year ended December 31, 1996. There were no purchases or
sales of U.S. government obligations for the period.

On December 31, 1996, net unrealized appreciation for all securities in
which there was an excess of value over tax cost was $197,074,059, of which
$210,460,413 related to appreciated securities and $13,386,354 related to
depreciated securities.

NOTE 5--Net Assets

On December 31, 1996, net assets consisted of:

Paid-in capital:
Class A Shares $302,803,079
Class B Shares 16,617,054
Class D Shares 23,659,797
Accumulated net realized gain from securities transactions 13,937,442
Unrealized appreciation of investments 193,586,970
------------
$550,604,342
============

<PAGE>

FLAG INVESTORS TELEPHONE INCOME FUND
- --------------------------------------------------------------------------------

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, 1996 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, 1996 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, 1996, 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
February 4, 1997

<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 -- Judged to be of the best quality. Carries the smallest
degree of investment risk and 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.

Aa -- Judged to be of high quality by all standards. Together
with the Aaa group, comprise what are generally known as high grade bonds. 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 -- Possess many favorable investment attributes and 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.

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Baa -- Considered as medium grade obligations, that is, 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. Lack
outstanding investment characteristics and in fact have speculative
characteristics as well.

Ba -- Judged to have speculative elements; 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 -- 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 -- Of poor standing. May be in default or there may be
present elements of danger with respect to principal or interest.

Ca -- Represent obligations that are speculative in a high
degree. Often in default or have other marked shortcomings.

C -- The lowest rated class of bonds. Can be regarded as having
extremely poor prospects of ever attaining any real investment standing.

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