PAGE 1
Prospectus for the T. Rowe Price Short-Term Bond Fund, Inc.,
dated October 1, 1996, should be inserted here.
<PAGE>
Prospectus
T. Rowe Price
Short-Term
Bond Fund
---------------------------------------
To help you achieve your T. Rowe Price A bond fund for
financial goals, T. Rowe Short-Term Bond Fund, Inc. income-oriented
Price offers a wide range October 1, 1996 investors seeking
of stock, bond, and money Prospectus modest share price
market investments, as fluctuation.
well as convenient services
and timely informative [LOGO OF T. RowePrice APPEARS HERE]
reports.
To Open an Account
Investor Services
1-800-638-5660
1-410-547-2308
For Existing Accounts
Shareholder Services
1-800-225-5132
1-410-625-6500
For Yields and Prices
Tele*Access(R)
1-800-638-2587
24 hours, 7 days
Investor Centers
101 East Lombard St.
Baltimore, MD 21202
T. Rowe Price
Financial Center
10090 Red Run Blvd.
Owings Mills, MD 21117
Farragut Square
900 17th Street, N.W.
Washington, D.C. 20006
ARCO Tower
31st Floor
515 South Flower St.
Los Angeles, CA 90071
4200 West Cypress St.
10th Floor
Tampa, FL 33607
Internet Address
http:/www.troweprice.com
PROSSTB 10/1/96
Facts at a Glance
Investment Goal
A high level of income consistent with minimal fluctuation in principal value
and liquidity. As with all mutual funds, there is no guarantee the fund will
achieve its goal.
Strategy
Invests primarily in investment-grade, short- and intermediate-term debt
securities. Dollar-weighted average effective maturity will not exceed three
years.
Risk/Reward
Less share price volatility than can be expected with longer-term bonds,
accompanied by typically lower investment return.
Investor Profile
Investors who seek higher income than money funds or similar investment vehicles
provide and can accept modest share price fluctuation.
Fees and Charges
100% no load. No fees or charges to buy or sell shares or to reinvest dividends;
no 12b-1 marketing fees; free telephone exchange.
Investment Manager
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates,
Inc. ("T. Rowe Price") and its affiliates managed over $87 billion for more than
four million individual and institutional investor accounts as of June 30, 1996.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION, OR ANY STATE SECURITIES AND EXCHANGE COMMISSION, OR ANY
STATE SECURITIES COMMISSION, PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IA A CRIMINAL OFFENSE.
T. Rowe Price
Short-term Bond Fund, Inc.
October 1, 1996
Prospectus
Contents
<TABLE>
<CAPTION>
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1 About the Fund
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<S> <C>
Transaction and Fund Expenses 2
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Financial Highlights 3
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Fund, Market, and Risk
Characteristics 4
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2 About Your Account
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Pricing Shares and Receiving Sale Proceeds 8
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Distributions and Taxes 9
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Transaction Procedures and
Special Requirements 11
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3 More About the Fund
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Organization and Management 13
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Understanding Performance Information 14
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Investment Policies and Practices 15
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4 Investing With T. Rowe Price
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Account Requirements and Transaction Information 22
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Opening a New Account 22
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Purchasing Additional Shares 23
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Exchanging and Redeeming 24
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Shareholder Services 25
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Discount Brokerage 26
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Investment Information 27
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</TABLE>
This prospectus contains information you should know before investing. Please
keep it for future reference. A Statement of Additional Information about the
fund, dated October 1, 1996, has been filed with the Securities and Exchange
Commission and is incorporated by reference in this prospectus. To obtain a free
copy, call 1-800-638-5660.
<PAGE>
1 About the Fund
Transaction and Fund Expenses
These tables should help you understand the kinds of expenses you will bear
directly or indirectly as a fund shareholder.
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Like all T. Rowe Price funds, this fund is 100% no load.
In Table 1 below, "Shareholder Transaction Expenses" shows that you pay no sales
charges. All the money you invest in the fund goes to work for you, subject to
the fees explained below. "Annual Fund Expenses" shows how much it will cost to
operate the fund for a year, based on 1996 fiscal year expenses. These are costs
you pay indirectly, because they are deducted from the fund's total assets
before the daily share price is calculated and before dividends and other
distributions are made. In other words, you will not see these expenses on your
account statement.
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For the fiscal year ended May 31, 1996, fees paid by the fund included the
following: $498,000 to T. Rowe Price Services, Inc. for transfer and dividend
disbursing functions and shareholder services; $400,000 to T. Rowe Price
Retirement Plan Services, Inc. for recordkeeping services for certain retirement
plans; and $120,000 to T. Rowe Price for accounting services.
<TABLE>
<CAPTION>
Shareholder Transaction Expenses Annual Fund Expenses Percentage of Fiscal 1996
Average Net Assets
<S> <C> <C> <C>
Sales charge "load" on purchases None Management fee 0.43%
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Sales charge "load" on reinvested dividends None Marketing fees (12b-1) None
- ---------------------------------------------------------------------------------------------------------------------
Redemption fees None Total other (shareholder 0.29%
servicing, custodial,
auditing, etc.)
- ---------------------------------------------------------------------------------------------------------------------
Exchange fees None
- ---------------------------------------------------------------------------------------------------------------------
Total fund expenses 0.72%
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</TABLE>
Note: A $5 fee is charged for wire redemptions under $5,000, subject to change
without notice, and a $10 fee is charged for small accounts when applicable (see
"Small Account Fee" under "Transaction Procedures and Special Requirements").
- --------------------------------------------------------------------------------
Table 1
The main types of expenses, which all mutual funds may charge against fund
assets, are:
. A management fee: the percent of fund assets paid to the fund's investment
manager. The fund's fee comprises a group fee, 0.33% as of June 30, 1996, and
an individual fund fee of 0.10%.
. "Other" administrative expenses: primarily the servicing of shareholder
accounts, such as providing statements and reports, disbursing dividends, and
providing custodial services.
. Marketing or distribution fees: an annual charge ("12b-1") to existing
shareholders to defray the cost of selling shares to new shareholders. T.
Rowe Price funds do not levy 12b-1 fees.
For further details on fund expenses, please see "Organization and
Management."
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2 T. Rowe Price
<PAGE>
1 About the Fund
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The table at right is just an example; actual expenses can be higher or lower
than those shown.
. Hypothetical example: Assume you invest $1,000, the fund returns 5% annually,
expense ratios remain as listed previously, and you close your account at the
end of the time periods shown. Your expenses would be:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1 year 3 years 5 years 10 years
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$7 $23 $40 $89
- --------------------------------------------------------------------------------
</TABLE>
Table 2
Financial Highlights
The following table provides information about the fund's financial history. It
is based on a single share outstanding throughout each fiscal year. The table
is part of the fund's financial statements which are included in the fund's
annual report and are incorporated by reference into the Statement of Additional
Information. This document is available to shareholders upon request. The
financial statements in the annual report have been audited by Price Waterhouse
LLP, independent accountants, whose unqualified report covers the most recent
five-year period.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Investment Activities Distributions
Net Asset Net Realized
Value Net and Unrealized Total From Net Net Tax
Beginning Investment Gain (Loss) on Investment Investment Realized Return of Total
Year Ended of Period Income Investments Activities Income (Loss) Gain (Loss0 Capital Distributions
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1987 $5.17 $0.40 $ 0.04 $ 0.44 $(0.40) -- -- $(0.40)
1988/a/ 5.21 0.39 (0.13) 0.26 (0.39) -- -- (0.39)
1989 5.08 0.41 (0.20) 0.21 (0.41) -- -- (0.41)
1990 4.88 0.42 0.03 0.45 (0.42) -- -- (0.42)
1991 4.91 0.39 0.06 0.45 (0.39) $(0.03) -- (0.42)
1992/a/ 4.94 0.35 0.11 0.46 (0.35) -- -- (0.35)
1993 5.05 0.33 0.04 0.37 (0.33) -- -- (0.33)
1994 5.09 0.31 (0.09) 0.22 (0.28) -- $(0.03) (0.31)
1994/b/ 5.00 0.07 (0.15) (0.08) (0.07) -- -- (0.07)
1995 4.85 0.29 (0.13) 0.16 (0.29) -- -- (0.29)
1996 4.72 0.29 (0.08) 0.21 (0.28) -- (0.01) (0.29)
<CAPTION>
End of Period
Total Return Ratio of Ratio of Net
Net Asset (Includes Net Expenses to Investment Income Portfolio
Value, End Reinvested Assets Average Net To Average Turnover
Year Ended of Period Dividends) ($ Thousands) Assets Net Assets Rate
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1987 $5.21 8.8% $218,006 0.94% 7.58% 6.8%
1988/a/ 5.08 5.4% 284,237 0.91% 7.85% 203.0%
1989 4.88 4.3% 231,573 0.94% 8.27% 309.1%
1990 4.91 9.4% 209,711 0.95% 8.43% 161.1%
1991 4.94 9.6% 218,634 0.93% 7.90% 980.4%
1992/a/ 5.05 9.7% 396,980 0.88% 7.07% 380.7%
1993 5.09 7.6% 556,330 0.76% 6.59% 68.4%
1994 5.00 4.4% 668,066 0.74% 6.00% 90.8%
1994/b/ 4.85 (1.7)% 601,924 0.79%/b/ 5.56%/b/ 222.8%/b/
1995 4.72 3.4% 493,726 0.79% 6.09% 136.9%
1996 4.64 4.6% 429,498 0.72% 6.15% 118.7%
</TABLE>
/a/ Year ended February 29.
/b/ For the three months ended May 31, 1994. Fiscal year-end changed
from February 28 to May 31. All ratios are annualized.
- --------------------------------------------------------------------------------
Table 3
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T. Rowe Price 3
<PAGE>
1 About the Fund
Fund, Market, and Risk Characteristics: What to Expect
To help you decide if the fund is appropriate for you, this section takes a
closer look at the fixed income markets in which it invests as well as its
investment program.
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The fund should not represent your complete investment program, nor be used for
short-term trading purposes.
What is the fund's objective?
The fund's objective is a high level of income consistent with minimal
fluctuation in principal value and liquidity.
What is the fund's investment program?
The fund will invest in a diversified portfolio of short- and intermediate-term
corporate, government, and mortgage-backed securities. The fund may also invest
in other types of securities such as bank obligations, collateralized mortgage
obligations (CMOs), foreign securities, hybrids, and futures and options. Under
normal circumstances, at least 65% of total assets will be invested in short-
term bonds. The fund's dollar-weighted average effective maturity will not
exceed three years, and the fund will not purchase any security whose effective
maturity, average life, or tender date, measured from the date of settlement,
exceeds seven years.
- -------------------------
For further details on the fund's investment program and practices, please see
the section entitled "Investment Policies and Practices."
What is the credit quality of the fund's investments?
Securities purchased by the fund will be rated within the four highest credit
categories by at least one established public rating agency (or, if unrated,
must have a T. Rowe Price equivalent). An investment-grade security can range
from the highest rated (AAA) to medium quality (BBB). Securities in the BBB
category may be more susceptible to adverse economic conditions or changing
circumstances, and the securities at the lower end of the BBB category have
certain speculative characteristics. The fund may retain a security that is
downgraded to a noninvestment grade level after purchase.
What are the major differences between this fund, money market funds, and long-
term bond funds?
. Price: Like all bond funds, the fund has a fluctuating share price. Money
market funds are managed to maintain a stable share price.
. Maturity: Short-term bond funds have longer average maturities (from one to
three years) than money market funds (90 days or less). Longer-term bond
funds have the longest average maturities (10 years or more).
. Income: Short-term bond funds typically offer more income than money market
funds and less income than longer-term bond funds.
Is the fund a substitute for a money market fund?
No. Money market funds, which have an average maturity under one year,
ordinarily generate lower income in return for stability of net asset value. The
fund is designed to provide higher income with modest fluctuation of net asset
value. The fund's total return may be higher or lower than a money market fund's
and, as such, it should be viewed as a longer-term investment.
- -------------------------
4 T. Rowe Price
<PAGE>
1 About the Fund
What are the most important influences on the fund's performance?
Performance (total return) is determined by the change in the fund's share price
and income level over a given period. Both components are affected by changes in
interest rates.
The fund's share price will generally move in the opposite direction of interest
rates. For example, as interest rates rise, share price will likely decline.
Rising rates provide the opportunity for the fund's income to increase, but it
is unlikely that the higher income by itself will entirely offset the fall in
price.
The maturity and type of securities in the fund's portfolio determine just how
much the share price rises or falls when rates change. Generally, when rates
fall, long-term securities rise more in price than short-term securities, and
vice versa. Mortgage-backed securities usually follow this pattern, but, because
of prepayments, would not be expected to rise as much in price as Treasury or
corporate bonds.
You will find more information about the types of securities the fund may own
and how they may perform further on in this section and in Section 3.
- -------------------------
The fund's share price will fluctuate; when you sell your shares, you may lose
money.
What are the main risks of investing in the fund?
. Interest rate or market risk: the decline in bond and bond fund prices that
accompanies a rise in the overall level of interest rates. Because short-term
bond funds are less sensitive to interest rate increases or decreases than
longer-term bond funds, they are expected to limit, but not eliminate,
interest rate or market risk.
. Credit risk: the chance that any of the fund's holdings will have its credit
rating downgraded or will default (fail to make scheduled interest or
principal payments), potentially reducing the fund's income level and share
price.
. Currency risk: the possibility that the fund's foreign holdings will be
adversely affected by fluctuations in currency markets.
How does the portfolio manager try to reduce risk?
Consistent with the fund's objective, the portfolio manager actively seeks to
reduce risk and increase total return. Risk management tools include:
. Diversification of assets to reduce the impact of a single holding on the
fund's net asset value.
. Thorough credit research by our own analysts.
. Adjustment of fund duration to try to reduce the negative impact of rising
interest rates or take advantage of the favorable effects of falling rates.
What are derivatives and can the fund invest in them?
The term derivative is used to describe financial instruments whose value is
derived from an underlying security (e.g., a stock or bond) or a market
benchmark (e.g., an interest rate index). Many types of investments representing
a wide range of potential risks and rewards fall under the "derivatives"
umbrella--from conventional instruments such as callable bonds, futures, and
options, to more exotic investments such as stripped mortgage securities and
structured notes. While the term "derivative" has only recently become widely
known among the investing public, derivatives have in fact been employed by
investment managers for many years.
-------------------------
T. Rowe Price 5
<PAGE>
1 About the Fund
The fund will invest in derivatives only if the expected risks and rewards are
consistent with its objective, policies, and overall risk profile as described
in this prospectus. The fund limits its use of derivatives to situations in
which they may enable the fund to accomplish the following: increase yield;
hedge against a decline in principal value; invest in eligible asset classes
with greater efficiency and lower cost than is possible through direct
investment; or adjust the fund's duration.
The fund will not invest in any high-risk, highly leveraged derivative
instrument that is expected to cause the price volatility of the portfolio to be
meaningfully different than that of a three-year investment-grade bond.
- -------------------------
You may want to review some fundamentals that apply to all fixed income
investments.
Is the fund's yield fixed or will it vary?
It will vary. The yield is calculated every day by dividing the fund's net
income per share, expressed at annual rates, by the share price. Since both
income and share price will fluctuate, the fund's yield will also vary.
Is a fund's "yield" the same thing as its "total return"?
Not for bond funds. The total return reported for a fund is the result of
reinvested distributions (income and capital gains) and the change in share
price for a given time period. Income is always a positive contributor to total
return and can enhance a rise in share price or serve as an offset to a drop in
share price.
What is "credit quality" and how does it affect yield?
Credit quality refers to a bond issuer's expected ability to make all required
interest and principal payments in a timely manner. Because highly rated issuers
represent less risk, they can borrow at lower interest rates than less
creditworthy issuers. Therefore, a fund investing in high credit-quality
securities should have a lower yield than an otherwise comparable fund investing
in lower credit-quality securities.
What is meant by a bond fund's "maturity"?
Every bond has a stated maturity date when the issuer must repay the security's
entire principal value to the investor. However, many bonds are "callable,"
meaning their principal can be repaid before their stated maturity dates on (or
after) specified call dates. Bonds are most likely to be called when interest
rates are falling, because the issuer wants to refinance at a lower rate. In
such an environment, a bond's "effective maturity" is calculated using its
nearest call date. For example, the effective maturity of mortgage-backed bonds
is determined by the rate at which homeowners pay down the principal on the
underlying mortgages.
A bond mutual fund has no maturity in the strict sense of the word, but it does
have an average maturity and an average effective maturity. This number is an
average of the stated or effective maturities of the underlying bonds, with each
bond's maturity "weighted" by the percentage of fund assets it represents. Funds
that target effective maturities would use the effective (rather than stated)
maturities of the underlying instruments when computing the average. Targeting
effective maturity provides additional flexibility in portfolio management but,
all else being equal, could result in higher volatility than a fund targeting a
stated maturity or maturity range.
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6 T. Rowe Price
<PAGE>
1 About the Fund
What is meant by a bond fund's "duration"?
Duration is a calculation that seeks to measure the price sensitivity of a bond
or a bond fund to changes in interest rates. It measures bond price sensitivity
to interest rate changes more accurately than maturity because it takes into
account the time value of cash flows generated over the bond's life. Future
interest and principal payments are discounted to reflect their present value
and then are multiplied by the number of years they will be received to produce
a value that is expressed in years, i.e., the duration. Effective duration takes
into account call features and sinking fund payments that may shorten a bond's
life.
Since duration can also be computed for bond funds, you can estimate the effect
of interest rates on a fund's share price. Simply multiply the fund's duration
(available for T. Rowe Price bond funds in our shareholder reports) by an
expected change in interest rates. For example, the price of a bond fund with a
duration of five years would be expected to fall approximately 5% if rates rose
by one percentage point.
How is a bond's price affected by changes in interest rates?
When interest rates rise, a bond's price usually falls, and vice versa.
- -------------------------
In general, the longer a bond's maturity, the greater the price increase or
decrease in response to a given change in interest rates, as shown in the table
at right.
- --------------------------------------------------------------------------------
How Interest Rates Affect Bond Prices
<TABLE>
<CAPTION>
Bond Maturity Coupon Price per $1,000 of a Bond
if Interest Rates:
Increase Decrease
1% 2% 1% 2%
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------
1 year 5.84% $990 $981 $1,010 $1,019
- --------------------------------------------------------------------------------
5 years 6.56 959 920 1,043 1,089
- --------------------------------------------------------------------------------
10 years 6.80 931 869 1,075 1,157
- --------------------------------------------------------------------------------
30 years 6.98 887 793 1,139 1,310
- --------------------------------------------------------------------------------
</TABLE>
Table 4 Coupons reflect yields on Treasury securities as of July 31, 1996.
The table may not be as representative of price changes for mortgage
securities because of prepayments. This is an illustration and does
not represent expected yields or share price changes of any T. Rowe
Price fund.
How can I decide if the fund is appropriate for me?
Review your own financial objectives, time horizon, and risk tolerance to choose
a fund (or funds) suitable for your particular needs. For example, the fund is
expected to be a good choice for investors seeking more income than provided by
very short-term investments, such as money market funds and CDs, with less
principal risk than longer-term investments. Keep in mind that the share price
of any bond fund will fluctuate. If you are investing primarily for principal
safety and liquidity, you should consider a money market fund.
Is there other information I need to review before making a decision?
Be sure to review "Investment Policies and Practices" in Section 3, which
discusses the following topics: Types of Portfolio Securities (bonds, foreign
securities, asset-backed securities, mortgage-backed securities, hybrid
instruments, private placements, banking industry, and utility industry
concentration); and Types of Management Practices (cash position, borrowing
money
-------------------------
T. Rowe Price 7
<PAGE>
and transferring assets, futures and options, managing foreign exchange risk,
lending of portfolio securities, when-issued securities and forward commitment
contracts, and portfolio turnover).
2 About Your Account
Pricing Shares and Receiving Sale Proceeds
Here are some procedures you should know when investing in a T. Rowe Price fixed
income fund.
- -------------------------
The various ways you can buy, sell, and exchange shares are explained at the end
of this prospectus and on the New Account Form. These procedures may differ for
institutional and employer-sponsored retirement accounts.
How and when shares are priced
Bond and money funds. The share price (also called "net asset value" or NAV per
share) for the fund is calculated at 4 p.m. ET each day the New York Stock
Exchange is open for business. To calculate the NAV, the fund's assets are
valued and totaled, liabilities are subtracted, and the balance, called net
assets, is divided by the number of shares outstanding.
How your purchase, sale, or exchange price is determined
If we receive your request in correct form by 4 p.m. ET, your transaction will
be priced at that day's NAV. If we receive it after 4 p.m., it will be priced at
the next business day's NAV.
We cannot accept orders that request a particular day or price for your
transaction or any other special conditions.
Note: The time at which transactions and shares are priced and the time until
which orders are accepted may be changed in case of an emergency or if the New
York Stock Exchange closes at a time other than 4 p.m. ET.
- -------------------------
When filling out the New Account Form, you may wish to give yourself the widest
range of options for receiving proceeds from a sale.
How you can receive the proceeds from a sale
If your request is received by 4 p.m. ET in correct form, proceeds are usually
sent on the next business day. Proceeds can be sent to you by mail or to your
bank account by ACH transfer or bank wire. Proceeds sent by ACH transfer should
be credited the second day after the sale. ACH (Automated Clearing House) is an
automated method of initiating payments from and receiving payments in your
financial institution account. ACH is a payment system supported by over 20,000
banks, savings banks, and credit unions, which electronically exchanges the
transactions primarily through the Federal Reserve Banks. Proceeds sent by bank
wire should be credited to your account the next business day.
Exception:
- -------------------------
If for some reason we cannot accept your request to sell shares, we will contact
you.
. Under certain circumstances and when deemed to be in the fund's best
interests, your proceeds may not be sent for up to five business days after
receiving your sale or exchange request. If you were exchanging into a bond
or money fund, your new investment would not begin to earn dividends until
the sixth business day.
- -------------------------
8 T. Rowe Price
<PAGE>
2 About Your Account
Useful Information on Distributions and Taxes
- -------------------------
All net investment income and realized capital gains are distributed to
shareholders.
Dividends and Other Distributions
Dividend and capital gain distributions are reinvested in additional fund shares
in your account unless you select another option on your New Account Form. The
advantage of reinvesting distributions arises from compounding; that is, you
receive income dividends and capital gain distributions on a rising number of
shares.
Distributions not reinvested are paid by check or transmitted to your bank
account via ACH. If the Post Office cannot deliver your check, or if your check
remains uncashed for six months, the fund reserves the right to reinvest your
distribution check in your account at the NAV on the business day of the
reinvestment and to reinvest all subsequent distributions in shares of the fund.
Income dividends
. Bond funds declare income dividends daily at 4 p.m. ET to shareholders of
record at that time provided payment has been received on the previous
business day.
. Money funds declare income dividends daily to shareholders of record as of
12:00 noon ET on that day. Wire purchase orders received before 12:00 noon ET
receive the dividend for that day. Other purchase orders receive the dividend
on the next business day after payment has been received.
. Bond and money funds pay dividends on the first business day of each month.
. Bond and money fund shares will earn dividends through the date of
redemption; also, shares redeemed on a Friday or prior to a holiday will
continue to earn dividends until the next business day. Generally, if you
redeem all of your shares at any time during the month, you will also receive
all dividends earned through the date of redemption in the same check. When
you redeem only a portion of your shares, all dividends accrued on those
shares will be reinvested, or paid in cash, on the next dividend payment
date.
Capital gains
. A capital gain or loss is the difference between the purchase and sale price
of a security.
. If the fund has net capital gains for the year (after subtracting any capital
losses), they are usually declared and paid in December to shareholders of
record on a specified date that month. If a second distribution is necessary,
it is usually declared and paid during the first quarter of the following
year.
- -------------------------
You will be sent timely information for your tax filing needs.
Tax Information
You need to be aware of the possible tax consequences when:
. The fund makes a distribution to your account.
. You sell fund shares, including an exchange from one fund to another.
-------------------------
T. Rowe Price 9
<PAGE>
2 About Your Account
Taxes on fund redemptions. When you sell shares in any fund, you may realize a
gain or loss. An exchange from one fund to another is still a sale for tax
purposes.
In January, you will be sent Form 1099-B, indicating the date and amount of
each sale you made in the fund during the prior year. This information will also
be reported to the IRS. For accounts opened new or by exchange in 1983 or later,
we will provide you with the gain or loss on the shares you sold during the
year, based on the "average cost" method. This information is not reported to
the IRS, and you do not have to use it. You may calculate the cost basis using
other methods acceptable to the IRS, such as "specific identification."
To help you maintain accurate records, we send you a confirmation immediately
following each transaction (except for systematic purchases and redemptions) you
make and a year-end statement detailing all your transactions in each fund
account during the year.
- -------------------------
Distributions are taxable whether reinvested in additional shares or received in
cash.
Taxes on fund distributions. The following summary does not apply to retirement
accounts, such as IRAs, which are tax-deferred until you withdraw money from
them.
In January, you will be sent Form 1099-DIV indicating the tax status of any
dividend and capital gain distribution made to you. This information will also
be reported to the IRS. All distributions made by the fund are taxable to you
for the year in which they were paid. The only exception is that distributions
declared during the last three months of the year and paid in January are taxed
as though they were paid by December 31. You will be sent any additional
information you need to determine your taxes on fund distributions, such as the
portion of your dividend, if any, that may be exempt from state income taxes.
Short-term capital gain distributions are taxable as ordinary income and long-
term gain distributions are taxable at the applicable long-term gain rate. The
gain is long- or short-term depending on how long the fund held the securities,
not how long you held shares in the fund. If you realize a loss on the sale or
exchange of fund shares held six months or less, your short-term loss recognized
is reclassified to long-term to the extent of any long-term capital gain
distribution received.
Gains and losses from the sale of foreign currencies and the foreign currency
gain or loss resulting from the sale of a foreign debt security can increase or
decrease the fund's ordinary income dividend. Net foreign currency losses may
result in the fund's dividend being classified as a return of capital.
If the fund pays nonrefundable taxes to foreign governments during the year, the
taxes will reduce the fund's dividends, but will still be included in your
taxable income. However, you may be able to claim an offsetting credit or
deduction on your tax return for your portion of foreign taxes paid by the fund.
Tax effect of buying shares before a capital gain distribution. If you buy
shares shortly before or on the "record date"--the date that establishes you as
the person to receive the upcoming distribution--you will receive, in the form
of a taxable distribution, a portion of the money you just invested. Therefore,
you may also wish to find out the fund's record date before investing. Of
course, the fund's share price may, at any time, reflect undistributed capital
- -------------------------
10 T. Rowe Price
<PAGE>
2 About Your Account
gains or income and unrealized appreciation. When these amounts are eventually
distributed, they are taxable.
Transaction Procedures and Special Requirements
- -------------------------
Following these procedures helps assure timely and accurate transactions.
Purchase Conditions
Nonpayment. If your payment is not received or you pay with a check or ACH
transfer that does not clear, your purchase will be canceled. You will be
responsible for any losses or expenses incurred by the fund or transfer agent,
and the fund can redeem shares you own in this or another identically registered
T. Rowe Price fund as reimbursement. The fund and its agents have the right to
reject or cancel any purchase, exchange, or redemption due to nonpayment.
U.S. dollars. All purchases must be paid for in U.S. dollars; checks must be
drawn on U.S. banks.
Sale (Redemption) Conditions
10-day hold. If you sell shares that you just purchased and paid for by check
or ACH transfer, the fund will process your redemption but will generally delay
sending you the proceeds for up to 10 calendar days to allow the check or
transfer to clear. If your redemption request was sent by mail or mailgram,
proceeds will be mailed no later than the seventh calendar day following receipt
unless the check or ACH transfer has not cleared. If, during the clearing
period, we receive a check drawn against your bond or money market account, it
will be returned marked "uncollected." (The 10-day hold does not apply to the
following: purchases paid for by bank wire; cashier's, certified, or treasurer's
checks; or automatic purchases through your paycheck.)
Telephone, Tele*Access(R), and personal computer transactions. These exchange
and redemption services are established automatically when you sign the New
Account Form unless you check the box which states that you do not want these
services. The fund uses reasonable procedures (including shareholder identity
verification) to confirm that instructions given by telephone are genuine and is
not liable for acting on these instructions. If these procedures are not
followed, it is the opinion of certain regulatory agencies that the fund may be
liable for any losses that may result from acting on the instructions given. A
confirmation is sent promptly after the telephone transaction. All conversations
are recorded.
Redemptions over $250,000. Large sales can adversely affect a portfolio
manager's ability to implement a fund's investment strategy by causing the
premature sale of securities that would otherwise be held. If, in any 90-day
period, you redeem (sell) more than $250,000, or your sale amounts to more than
1% of the fund's net assets, the fund has the right to delay sending your
proceeds for up to five business days after receiving your request, or to pay
the difference between the redemption amount and the lesser of the two
previously mentioned figures with securities from the fund.
-------------------------
T. Rowe Price 11
<PAGE>
2 About Your Account
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T. Rowe Price may bar excessive traders from purchasing shares.
Excessive Trading
Frequent trades, involving either substantial fund assets or a substantial
portion of your account or accounts controlled by you, can disrupt management of
the fund and raise its expenses. We define "excessive trading" as exceeding one
purchase and sale involving the same fund within any 120-day period.
For example, you are in fund A. You can move substantial assets from fund A to
fund B and, within the next 120 days, sell your shares in fund B to return to
fund A or move to fund C.
If you exceed the number of trades described above, you may be barred
indefinitely from further purchases of T. Rowe Price funds.
Three types of transactions are exempt from excessive trading guidelines: 1)
trades solely between money market funds; 2) redemptions that are not part of
exchanges; and 3) systematic purchases or redemptions (see "Shareholder
Services").
Keeping Your Account Open
Due to the relatively high cost to the fund of maintaining small accounts, we
ask you to maintain an account balance of at least $1,000. If your balance is
below $1,000 for three months or longer, we have the right to close your account
after giving you 60 days in which to increase your balance.
Small Account Fee
Because of the disproportionately high costs of servicing accounts with low
balances, a $10 fee, paid to T. Rowe Price Services, the fund's transfer agent,
will automatically be deducted from nonretirement accounts with balances falling
below a minimum level. The valuation of accounts and the deduction are expected
to take place during the last five business days of September. The fee will be
deducted from accounts with balances below $2,000, except for UGMA/UTMA
accounts, for which the limit is $500. The fee will be waived for any investor
whose aggregate T. Rowe Price mutual fund investments total $25,000 or more.
Accounts employing automatic investing (e.g., payroll deduction, automatic
purchase from a bank account, etc.) are also exempt from the charge. The fee
will not apply to IRAs and other retirement plan accounts. (A separate custodial
fee may apply to IRAs and other retirement plan accounts.)
- -------------------------
A signature guarantee is designed to protect you and the
T. Rowe Price funds from fraud by verifying your signature.
Signature Guarantees
You may need to have your signature guaranteed in certain situations, such as:
. Written requests 1) to redeem over $100,000, or 2) to wire redemption
proceeds.
. Remitting redemption proceeds to any person, address, or bank account not on
record.
. Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration (name/ownership) from yours.
. Establishing certain services after the account is opened.
You can obtain a signature guarantee from most banks, savings institutions,
broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot
accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
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12 T. Rowe Price
<PAGE>
3 More About the Fund
3 More About the Fund
Organization and Management
- -------------------------
Shareholders benefit from T. Rowe Price's 59 years of investment management
experience.
How is the fund organized?
The fund was incorporated in Maryland in 1983, and is a "diversified, open-end
investment company," or mutual fund. Mutual funds pool money received from
shareholders and invest it to try to achieve specified objectives.
What is meant by "shares"?
As with all mutual funds, investors purchase shares when they put money in a
fund. These shares are part of a fund's authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles the shareholder to:
. Receive a proportional interest in the fund's income and capital gain
distributions.
. Cast one vote per share on certain fund matters, including the election of
fund directors, changes in fundamental policies, or approval of changes in
the fund's management contract.
Do T. Rowe Price funds have annual shareholder meetings?
The funds are not required to hold annual meetings and, in order to avoid
unnecessary costs to fund shareholders, do not intend to do so except when
certain matters, such as a change in a fund's fundamental policies, are to be
decided. In addition, shareholders representing at least 10% of all eligible
votes may call a special meeting if they wish for the purpose of voting on the
removal of any fund director or trustee. If a meeting is held and you cannot
attend, you can vote by proxy. Before the meeting, the fund will send you proxy
materials that explain the issues to be decided and include a voting card for
you to mail back.
- -------------------------
All decisions regarding the purchase and sale of fund investments are made by
T. Rowe Price--specifically by the fund's portfolio managers.
Who runs the fund?
General Oversight. The fund is governed by a Board of Directors that meets
regularly to review the fund's investments, performance, expenses, and other
business affairs. The Board elects the fund's officers. The policy of the fund
is that the majority of Board members will be independent of T. Rowe Price.
Portfolio Management. The fund has an Investment Advisory Committee composed of
the following members: Edward A. Wiese, Chairman, Robert P. Campbell, Christy M.
DiPietro, and Thomas E. Tewksbury. The committee chairman has day-to-day
responsibility for managing the fund and works with the committee in developing
and executing the fund's investment program. Mr. Wiese has been chairman of the
committee since 1995. He joined T. Rowe Price in 1984 and has been managing
investments since 1985.
Marketing. T. Rowe Price Investment Services, Inc., a wholly owned subsidiary
of T. Rowe Price, distributes (sells) shares of this and all other T. Rowe Price
funds.
Shareholder Services. T. Rowe Price Services, Inc., another wholly owned
subsidiary, acts as the fund's transfer and dividend disbursing agent and
provides shareholder and administrative services. Services for certain types of
retirement plans are provided by T. Rowe Price
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T. Rowe Price 13
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3 More About the Fund
Retirement Plan Services, Inc., also a wholly owned subsidiary. The address for
each is 100 East Pratt St., Baltimore, MD 21202.
How are fund expenses determined?
The management agreement spells out the expenses to be paid by the fund. In
addition to the management fee, the fund pays for the following: shareholder
service expenses; custodial, accounting, legal, and audit fees; costs of
preparing and printing prospectuses and reports sent to shareholders;
registration fees and expenses; proxy and annual meeting expenses (if any); and
director/trustee fees and expenses.
The Management Fee. This fee has two parts--an "individual fund fee" (discussed
under "Transaction and Fund Expenses"), which reflects a fund's particular
investment management costs, and a "group fee." The group fee, which is
designed to reflect the benefits of the shared resources of the T. Rowe Price
investment management complex, is calculated daily based on the combined net
assets of all T. Rowe Price funds (except Equity Index and the Spectrum Funds
and any institutional or private label mutual funds). The group fee schedule
(shown below) is graduated, declining as the asset total rises, so shareholders
benefit from the overall growth in mutual fund assets.
<TABLE>
<S> <C> <C>
0.480% First $1 billion 0.370% Next $1 billion 0.330% Next $10 billion
0.450% Next $1 billion 0.360% Next $2 billion 0.320% Next $10 billion
0.420% Next $1 billion 0.350% Next $2 billion 0.310% Next $16 billion
0.390% Next $1 billion 0.340% Next $5 billion 0.305% Thereafter
</TABLE>
The fund's portion of the group fee is determined by the ratio of its daily net
assets to the daily net assets of all the Price funds described previously.
Based on combined T. Rowe Price funds' assets of approximately $57.1 billion at
June 30, 1996, the group fee was 0.33%.
Understanding Performance Information
- -------------------------
Total return is the most widely used performance measure. Detailed performance
information is included in the fund's annual and semiannual shareholder reports,
and in the quarterly Performance Update, which are all available without charge.
This section should help you understand the terms used to describe fund
performance. You will come across them in shareholder reports you receive from
us, in our newsletter, The Price Report, in Insights articles, in T. Rowe Price
advertisements, and in the media.
Total Return
This tells you how much an investment in a fund has changed in value over a
given time period. It reflects any net increase or decrease in the share price
and assumes that all dividends and capital gains (if any) paid during the period
were reinvested in additional shares. Including reinvested distributions means
that total return numbers include the effect of compounding, i.e., you receive
income and capital gain distributions on a rising number of shares.
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14 T. Rowe Price
<PAGE>
3 More About the Fund
Advertisements for a fund may include cumulative or compound average annual
total return figures, which may be compared with various indices, other
performance measures, or other mutual funds.
Cumulative Total Return
This is the actual rate of return on an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated between the beginning and the end of the period specified.
Average Annual Total Return
This is always hypothetical. Working backward from the actual cumulative return,
it tells you what constant year-by-year return would have produced the actual,
cumulative return. By smoothing out all the variations in annual performance, it
gives you an idea of the investment's annual contribution to your portfolio
provided you held it for the entire period in question.
- -------------------------
You will see frequent references to a fund's yield in our reports, in
advertisements, in media stories, and so on.
Yield
The current or "dividend" yield on a fund or any investment tells you the
relationship between the investment's current level of annual income and its
price on a particular day. The dividend yield reflects the actual income paid to
shareholders for a given period, annualized, and divided by the average price
during the given period. For example, a fund providing $5 of annual income per
share and a price of $50 has a current yield of 10%. Yields can be calculated
for any time period.
The advertised or "SEC" yield is found by determining the net income per share
(as defined by the SEC) earned by a fund during a 30-day base period and
dividing this amount by the per share price on the last day of the base period.
The SEC yield may differ from the dividend yield.
Investment Policies and Practices
This section takes a detailed look at some of the types of securities the fund
may hold in its portfolio and the various kinds of investment practices that may
be used in day-to-day portfolio management. The fund's investment program is
subject to further restrictions and risks described in the Statement of
Additional Information.
Shareholder approval is required to substantively change the fund's objective
and certain investment restrictions noted in the following section as
"fundamental policies." The managers also follow certain "operating policies"
which can be changed without shareholder approval. However, significant changes
are discussed with shareholders in fund reports. The fund adheres to applicable
investment restrictions and policies at the time it makes an investment. A later
change in circumstances will not require the sale of an investment if it was
proper at the time it was made.
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T. Rowe Price 15
<PAGE>
3 More About the Fund
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Fund managers have considerable leeway in choosing investment strategies and
selecting securities they believe will help the fund achieve its objective.
The fund's holdings of certain kinds of investments cannot exceed maximum
percentages of total assets, which are set forth herein. For instance, this fund
is not permitted to invest more than 10% of total assets in hybrid instruments.
While these restrictions provide a useful level of detail about the fund's
investment program, investors should not view them as an accurate gauge of the
potential risk of such investments. For example, in a given period, a 5%
investment in hybrid instruments could have significantly more of an impact on
the fund's share price than its weighting in the portfolio. The net effect of a
particular investment depends on its volatility and the size of its overall
return in relation to the performance of all the fund's other investments.
Changes in the fund's holdings, the fund's performance, and the contribution of
various investments are discussed in the shareholder reports sent to you.
Types of Portfolio Securities
In seeking to meet its investment objective, the fund may invest in any type of
security or instrument (including certain potentially high-risk derivatives)
whose investment characteristics are consistent with the fund's investment
program. The following pages describe the principal types of portfolio
securities and investment management practices of the fund.
Fundamental policy: The fund will not purchase a security if, as a result, with
respect to 75% of its total assets, more than 5% of its total assets would be
invested in securities of a single issuer or more than 10% of the outstanding
voting securities of the issuer would be held by the fund, provided that these
limitations do not apply to the fund's purchase of securities issued or
guaranteed by the U.S. government, its agencies, or instrumentalities.
Bonds. A bond is an interest-bearing security --an IOU --issued by companies or
governmental units. The issuer has a contractual obligation to pay interest at a
stated rate on specific dates and to repay principal (the bond's face value) on
a specified date. An issuer may have the right to redeem or "call" a bond before
maturity, and the investor may have to reinvest the proceeds at lower market
rates.
A bond's annual interest income, set by its coupon rate, is usually fixed for
the life of the bond. Its yield (income as a percent of current price) will
fluctuate to reflect changes in interest rate levels. A bond's price usually
rises when interest rates fall, and vice versa, so its yield stays current.
Bonds may be unsecured (backed by the issuer's general creditworthiness only) or
secured (also backed by specified collateral).
Certain bonds have interest rates that are adjusted periodically, which tend to
minimize fluctuations in their principal value. The maturity of those securities
may be shortened under certain specified conditions.
Bonds may be designated as senior or subordinated obligations. Senior
obligations generally have the first claim on a corporation's earnings and
assets and, in the event of liquidation, are paid before subordinated debt.
Foreign Securities. The fund may invest in foreign securities, including
nondollar-denominated securities traded outside of the U.S. and dollar-
denominated securities of foreign issuers.
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16 T. Rowe Price
<PAGE>
3 More About the Fund
Such investments increase a portfolio's diversification and may enhance return,
but they also involve some special risks such as exposure to potentially adverse
local political and economic developments; nationalization and exchange
controls; potentially lower liquidity and higher volatility; possible problems
arising from accounting, disclosure, settlement, and regulatory practices that
differ from U.S. standards; and the chance that fluctuations in foreign exchange
rates will decrease the investment's value (favorable changes can increase its
value). To the extent the fund invests in developing countries, these risks are
increased.
Operating policy: The fund may invest without limitation in U.S. dollar-
denominated debt securities issued by foreign issuers, foreign branches of U.S.
banks, and U.S. branches of foreign banks. The fund may also invest up to 10% of
its total assets (excluding reserves) in non-U.S. dollar-denominated fixed
income securities principally traded in financial markets outside the United
States.
Asset-Backed Securities. An underlying pool of assets, such as credit card or
automobile trade receivables or corporate loans or bonds, backs these bonds and
provides the interest and principal payments to investors. Credit quality
depends primarily on the quality of the underlying assets and the level of
credit support, if any, provided by the issuer. The underlying assets (i.e.,
loans) are subject to prepayments which can shorten the securities' weighted
average life and may lower their return. The value of these securities also may
change because of actual or perceived changes in the creditworthiness of the
originator, servicing agent, or of the financial institution providing the
credit support. There is no limit on the portion of the fund's investments in
these securities.
- -------------------------
There is no limit on the fund's investment in mortgage-backed securities.
Mortgage-Backed Securities. The fund may invest in a variety of mortgage-backed
securities. Mortgage lenders pool individual home mortgages with similar
characteristics to back a certificate or bond, which is sold to investors such
as the fund. Interest and principal payments generated by the underlying
mortgages are passed through to the investors. The "big three" issuers are the
Government National Mortgage Association (GNMA), the Federal National Mortgage
Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation
(Freddie Mac). GNMA certificates are backed by the full faith and credit of the
U.S. government, while others, such as Fannie Mae and Freddie Mac certificates,
are only supported by the ability to borrow from the U.S. Treasury or supported
only by the credit of the agency. Private mortgage bankers and other
institutions also issue mortgage-backed securities.
Mortgage-backed securities are subject to scheduled and unscheduled principal
payments as homeowners pay down or prepay their mortgages. As these payments are
received, they must be reinvested when interest rates may be higher or lower
than on the original mortgage security. Therefore, these securities are not an
effective means of locking in long-term interest rates. In addition, when
interest rates fall, the pace of mortgage prepayments picks up. These refinanced
mortgages are paid off at face value (par), causing a loss for any investor who
may have purchased the security at a price above par. In such an environment,
this risk limits the potential price appreciation of these securities and can
negatively affect the fund's net asset value. When rates rise, the prices of
mortgage-backed securities can be expected to decline,
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T. Rowe Price 17
<PAGE>
3 More About the Fund
although historically these securities have experienced smaller price
declines than comparable quality bonds. In addition, when rates rise, and
prepayments slow, the effective duration of mortgage-backed securities
extends resulting in increased volatility.
Additional mortgage-backed securities in which the fund may invest include:
. Collateralized Mortgage Obligations (CMOs). CMOs are debt securities that are
fully collateralized by a portfolio of mortgages or mortgage-backed
securities. All interest and principal payments from the underlying mortgages
are passed through to the CMOs in such a way as to create, in most cases,
more definite maturities than is the case with the underlying mortgages. CMOs
may pay fixed or variable rates of interest, and certain CMOs have priority
over others with respect to the receipt of prepayments.
. Stripped Mortgage Securities. Stripped mortgage securities (a type of
potentially high-risk derivative) are created by separating the interest and
principal payments generated by a pool of mortgage-backed securities or a CMO
to create additional classes of securities. Generally, one class receives
only interest payments (IOs) and one principal payments (POs). Unlike other
mortgage-backed securities and POs, the value of IOs tends to move in the
same direction as interest rates. The fund could use IOs as a hedge against
falling prepayment rates (interest rates are rising) and/or a bear market
environment. POs can be used as a hedge against rising prepayment rates
(interest rates are falling) and/or a bull market environment. IOs and POs
are acutely sensitive to interest rate changes and to the rate of principal
prepayments.
A rapid or unexpected increase in prepayments can severely depress the price
of IOs, while a rapid or unexpected decrease in prepayments could have the
same effect on POs. These securities are very volatile in price and may have
lower liquidity than most other mortgage-backed securities. Certain non-
stripped CMOs may also exhibit these qualities, especially those that pay
variable rates of interest that adjust inversely with and more rapidly than
short-term interest rates. In addition, if interest rates rise rapidly and
prepayment rates slow more than expected, certain CMOs, in addition to losing
value, can exhibit characteristics of longer securities and become more
volatile. There is no guarantee the fund's investment in CMOs, IOs, or POs
will be successful, and the fund's total return could be adversely affected
as a result.
Operating policy: The fund may invest up to 10% of its total assets in
stripped mortgage securities.
- -------------------------
There is no assurance that the fund's investment in hybrids will be successful.
Hybrid Instruments. These instruments (a type of potentially high-risk
derivative) can combine the characteristics of securities, futures, and
options. For example, the principal amount or interest rate of a hybrid could
be tied (positively or negatively) to the price of some commodity, currency,
or securities index or another interest rate (each a "benchmark"). Hybrids
can be used as an efficient means of pursuing a variety of investment goals,
including currency hedging, duration management, and increased total return.
Hybrids may not bear interest or pay dividends. The value of a hybrid or its
interest rate may be a multiple of a benchmark and, as a result, may be
leveraged and move (up or down) more steeply and rapidly than the benchmark.
These benchmarks may be sensitive to economic and political events, such as
com-
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18 T. Rowe Price
<PAGE>
3 More About the Fund
modity shortages and currency devaluations, which cannot be readily foreseen
by the purchaser of a hybrid. Under certain conditions, the redemption value
of a hybrid could be zero. Thus, an investment in a hybrid may entail
significant market risks that are not associated with a similar investment in
a traditional, U.S. dollar-denominated bond that has a fixed principal amount
and pays a fixed rate or floating rate of interest. The purchase of hybrids
also exposes the fund to the credit risk of the issuer of the hybrid. These
risks may cause significant fluctuations in the net asset value of the fund.
Operating policy: The fund may invest up to 10% of its total assets in hybrid
instruments.
Private Placements. These securities are sold directly to a small number of
investors, usually institutions. Unlike public offerings, such securities are
not registered with the SEC. Although certain of these securities may be
readily sold, for example, under Rule 144A, others may be illiquid and their
sale may involve substantial delays and additional costs.
Operating policy: The fund will not invest more than 15% of its net assets in
illiquid securities.
Banking Industry. The fund may, under certain circumstances, invest a
substantial amount of its assets in the banking industry. Investments in the
banking industry may be affected by general economic conditions as well as
exposure to credit losses arising from possible financial difficulties of
borrowers. In addition, the profitability of the banking industry is largely
dependent upon the availability and cost of funds for the purpose of financing
lending operations under prevailing money market conditions. T. Rowe Price
believes that any risk to the fund which might result from concentrating in
the banking industry will be minimized by diversification of the fund's
investments and T. Rowe Price's credit research.
Fundamental policy: The fund will, as a matter of fundamental policy, normally
concentrate 25% or more of its assets in the securities of the banking
industry when the fund's position in issues maturing in one year or less equal
35% or more of the fund's total assets.
Utility Industry Concentration. The fund may, under certain circumstances,
invest a substantial amount of its assets in the utility industry. Investments
in this industry may be affected by environmental conditions, energy
conservation programs, fuel shortages, availability of capital to finance
operations and construction programs, and federal and state legislative and
regulatory actions. T. Rowe Price believes that any risk to the fund which
might result from concentrating in any such industry will be minimized by
diversification of the fund's investments.
Fundamental policy: As a matter of fundamental policy, the fund will, under
certain conditions, invest up to 50% of its assets in any one of the following
industries: gas utility, gas transmission utility, electric utility, telephone
utility, and petroleum.
Types of Management Practices
- -------------------------
Cash reserves provide flexibility and serve as a short-term defense during
periods of unusual market volatility.
Cash Position. The fund will hold a certain portion of its assets in U.S. and
foreign dollar-denominated money market securities, including repurchase
agreements, in the two highest rating categories, maturing in one year or
less. For temporary, defensive purposes, the fund may invest without
limitation in such securities. This reserve position provides flexibility in
meeting redemptions, expenses, and the timing of new investments and serves as
a short-term defense during periods of unusual market volatility.
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T. Rowe Price 19
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3 More About the Fund
Borrowing Money and Transferring Assets. The fund can borrow money from banks
as a temporary measure for emergency purposes, to facilitate redemption
requests, or for other purposes consistent with the fund's investment
objective and program. Such borrowings may be collateralized with fund assets,
subject to restrictions.
Fundamental policy: Borrowings may not exceed 33 1/3% of total fund assets.
Operating policies: The fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33 1/3% of the fund's
total assets. The fund may not purchase additional securities when borrowings
exceed 5% of total assets.
- -------------------------
Futures are used to manage risk; options give the investor the option to buy or
sell an asset at a predetermined price in the future.
Futures and Options. Futures (a type of potentially high-risk derivative) are
often used to manage or hedge risk because they enable the investor to buy or
sell an asset in the future at an agreed upon price. Options (another type of
potentially high-risk derivative) give the investor the right, but not the
obligation, to buy or sell an asset at a predetermined price in the future.
The fund may buy and sell futures and options contracts for any number of
reasons, including: to manage its exposure to changes in interest rates, bond
prices, and foreign currencies; as an efficient means of adjusting its overall
exposure to certain markets; in an effort to enhance income; to protect the
value of portfolio securities; and to adjust the portfolio's duration. The
fund may purchase, sell, or write call and put options on securities,
financial indices, and foreign currencies.
Futures contracts and options may not always be successful hedges; their
prices can be highly volatile. Using them could lower the fund's total return,
and the potential loss from the use of futures can exceed the fund's initial
investment in such contracts.
Operating policies: Futures: Initial margin deposits and premiums on options
used for non-hedging purposes will not equal more than 5% of the fund's net
asset value. Options on securities: The total market value of securities
against which the fund has written call or put options may not exceed 25% of
its total assets. The fund will not commit more than 5% of its total assets to
premiums when purchasing call or put options.
Managing Foreign Exchange Risk. Investors in foreign securities may "hedge"
their exposure to potentially unfavorable currency changes by purchasing a
contract to exchange one currency for another on some future date at a
specified exchange rate. In certain circumstances, a "proxy currency" may be
substituted for the currency in which the investment is denominated, a
strategy known as "proxy hedging." The fund may also use these contracts to
create a synthetic bond--issued by a U.S. company, for example, but with the
dollar component transformed into a foreign currency. Although foreign
currency transactions will be used primarily to protect the fund's foreign
securities from adverse currency movements relative to the dollar, they
involve the risk that anticipated currency movements will not occur and the
fund's total return could be reduced.
Operating policy: The fund will not commit more than 10% of its total assets
to forward currency contracts.
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20 T. Rowe Price
<PAGE>
3 More About the Fund
Lending of Portfolio Securities. Like other mutual funds, the fund may lend
securities to broker-dealers, other institutions, or other persons to earn
additional income. The principal risk is the potential insolvency of the
broker-dealer or other borrower. In this event, the fund could experience
delays in recovering its securities and possibly capital losses.
Fundamental policy: The value of loaned securities may not exceed 33 1/3%
of total fund assets.
When-Issued Securities and Forward Commitment Contracts. The fund may purchase
securities on a when-issued or delayed delivery basis or may purchase or sell
securities on a forward commitment basis. There is no limit on the fund's
investment in these securities. The price of these securities is fixed at the
time of the commitment to buy, but delivery and payment can take place a month
or more later. During the interim period, the market value of the securities
can fluctuate, and no interest accrues to the purchaser. At the time of
delivery, the value of the securities may be more or less than the purchase or
sale price. To the extent the fund remains fully or almost fully invested (in
securities with a remaining maturity of more than one year) at the same time
it purchases these securities, there will be greater fluctuations in the
fund's net asset value than if the fund did not purchase them.
Portfolio Turnover. Although the fund will not generally trade for short-term
profits, circumstances may warrant a sale without regard to the length of time
a security was held. A high turnover rate may increase transaction costs and
result in additional taxable gains. The fund's portfolio turnover rates for
the fiscal years ended May 31, 1996 and May 31, 1995, were 118.7%, and 136.9%,
respectively. The fund's annualized portfolio turnover rate for the three-
month fiscal year ended May 31, 1994, was 222.8%. The fund's portfolio
turnover rate for the fiscal year ended February 28, 1994, was 90.8%. The
fund's higher turnover rate for the three months ended May 31, 1994, compared
with the year ended February 28, 1994, was the result of portfolio sales to
meet increased redemptions and a restructuring of the portfolio in light of
changes in the market for fixed income securities.
-------------------------
T. Rowe Price 21
<PAGE>
4 Investing With T. Rowe Price
Account Requirements and Transaction Information
- -------------------------
Always verify your transactions by carefully reviewing the confirmation we send
you. Please report any discrepancies to Shareholder Services promptly.
Tax Identification Number
We must have your correct Social Security or corporate tax
identification number on a signed New Account Form or W-9
Form. Otherwise, federal law requires the funds to withhold a
percentage (currently 31%) of your dividends, capital gain
distributions, and redemptions, and may subject you to an IRS
fine. If this information is not received within 60 days after
your account is established, your account may be redeemed,
priced at the NAV on the date of redemption.
- -------------------------
T. Rowe Price
Trust Company
1-800-492-7670
1-410-625-6585
Employer-Sponsored Retirement Plans and Institutional Accounts
Transaction procedures in the following sections may not apply
to employer-sponsored retirement plans and institutional
accounts. For procedures regarding employer-sponsored
retirement plans, please call T. Rowe Price Trust Company or
consult your plan administrator. For institutional account
procedures, please call your designated account manager or
service representative.
Opening a New Account: $2,500 minimum initial investment;
$1,000 for retirement plans or gifts or transfers to minors
(UGMA/UTMA) accounts
- -------------------------
Regular Mail
T. Rowe Price
Account Services
P.O. Box 17300
Baltimore, MD
21298-9353
Account Registration
If you own other T. Rowe Price funds, be sure to register any
new account just like your existing accounts so you can
exchange among them easily. (The name and account type would
have to be identical.)
By Mail
Please make your check payable to T. Rowe Price Funds
(otherwise it will be returned) and send your check together
with the New Account Form to the address at left. We do not
accept third party checks, except for IRA Rollover checks that
are properly endorsed, to open new accounts.
- -------------------------
Mailgram, Express,
Registered, or Certified Mail
T. Rowe Price
Account Services
10090 Red Run Blvd.
Owings Mills, MD 21117
- -------------------------
22 T. Rowe Price
<PAGE>
4 Investing With T. Rowe Price
By Wire
. Call Investor Services for an account number and give the following wire
address to your bank:
Morgan Guaranty Trust Co. of New York
ABA# 021000238
T. Rowe Price [fund name]
AC-00153938
account name(s) and account number
. Complete a New Account Form and mail it to one of the appropriate addresses
listed on the previous page.
Note: No services will be established and IRS penalty withholding may occur
until a signed New Account Form is received. Also, retirement plans cannot be
opened by wire.
By Exchange
Call Shareholder Services or use Tele*Access or your personal computer (see
"Automated Services" under "Shareholder Services"). The new account will have
the same registration as the account from which you are exchanging. Services
for the new account may be carried over by telephone request if preauthorized
on the existing account. (See explanation of "Excessive Trading" under
"Transaction Procedures.")
In Person
Drop off your New Account Form at any location listed on the cover and obtain
a receipt.
Purchasing Additional Shares: $100 minimum purchase; $50 minimum for
retirement plans, Automatic Asset Builder, and gifts or transfers to minors
(UGMA/UTMA) accounts
By ACH Transfer
Use Tele*Access, your personal computer, or call Investor Services if you have
established electronic transfers using the ACH network.
By Wire
Call Shareholder Services or use the wire address in "Opening a New Account."
- -------------------------
Regular Mail
T. Rowe Price Funds
Account Services
P.O. Box 89000
Baltimore, MD
21289-1500
(For mailgrams,
express, registered,
or certified mail, see
previous section.)
By Mail
. Make your check payable to T. Rowe Price Funds (otherwise it may be
returned).
. Mail the check to us at the address shown at left with either a fund
reinvestment slip or a note indicating the fund you want to buy and your fund
account number.
. Remember to provide your account number and the fund name on your check.
By Automatic Asset Builder
Fill out the Automatic Asset Builder section on the New Account or Shareholder
Services Form.
-------------------------
T. Rowe Price 23
<PAGE>
4 Investing With T. Rowe Price
Exchanging and Redeeming Shares
By Phone
Call Shareholder Services. If you find our phones busy during unusually
volatile markets, please consider placing your order by your personal
computer, Tele*Access (if you have previously authorized telephone services),
mailgram, or express mail. For exchange policies, please see "Transaction
Procedures and Special Requirements--Excessive Trading."
Redemption proceeds can be mailed to your account address, sent by ACH
transfer, or wired to your bank (provided your bank information is already on
file). For charges, see "Electronic Transfers--By Wire" under "Shareholder
Services."
- -------------------------
For Mailgram, Express, Registered, or Certified mail, see addresses under
"Opening a New Account."
By Mail
For each account involved, provide the account name, number, fund name, and
exchange or redemption amount. For exchanges, be sure to indicate any fund you
are exchanging out of and the fund or funds you are exchanging into. Please
mail to the appropriate address below or as indicated at left. T. Rowe Price
requires the signatures of all owners exactly as registered, and possibly a
signature guarantee (see "Transaction Procedures and Special Requirements--
Signature Guarantees").
Regular Mail
For nonretirement and For employer-sponsored
IRA accounts: retirement accounts:
T. Rowe Price Account Services T. Rowe Price Trust Company
P.O. Box 89000 P.O. Box 89000
Baltimore, MD 21289-0220 Baltimore, MD 21289-0300
Redemptions from employer-sponsored retirement accounts must be in writing;
please call T. Rowe Price Trust Company or your plan administrator for
instructions. IRA distributions may be requested in writing or by telephone;
please call Shareholder Services to obtain an IRA Distribution Form or an IRA
Shareholder Services Form to authorize the telephone redemption service.
Rights Reserved by the Fund
The fund and its agents reserve the right to waive or lower investment
minimums; to accept initial purchases by telephone or mailgram; to refuse any
purchase order; to cancel or rescind any purchase or exchange (for example, if
an account has been restricted due to excessive trading or fraud) upon notice
to the shareholder within five business days of the trade or if the written
confirmation has not been received by the shareholder, whichever is sooner; to
freeze any account and suspend account services when notice has been received
of a dispute between the registered or beneficial account owners or there is
reason to believe a fraudulent transaction may occur; to otherwise modify the
conditions of purchase and any services at any time; or to act on instructions
believed to be genuine.
- -------------------------
24 T. Rowe Price
<PAGE>
4 Investing With T. Rowe Price
Shareholder Services
- -------------------------
Shareholder Services
1-800-225-5132
1-410-625-6500
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically and others you must authorize on the New Account Form.
By signing up for services on the New Account Form rather than later on, you
avoid having to complete a separate form and obtain a signature guarantee.
This section reviews some of the principal services currently offered. Our
Services Guide contains detailed descriptions of these and other services.
If you are a new T. Rowe Price investor, you will receive a Services Guide
with our Welcome Kit.
- -------------------------
Investor Services
1-800-638-5660
1-410-547-2308
Note: Corporate and other entity accounts require an original or certified
resolution to establish services and to redeem by mail. For more information,
call Investor Services.
Retirement Plans
We offer a wide range of plans for individuals and institutions, including
large and small businesses: IRAs, SEP-IRAs, Keoghs (profit sharing and money
purchase pension), 401(k), and 403(b)(7). For information on IRAs, call
Investor Services. For information on all other retirement plans, please call
our Trust Company at 1-800-492-7670.
Exchange Service
You can move money from one account to an existing identically registered
account, or open a new identically registered account. Remember, exchanges are
purchases and sales for tax purposes. (Exchanges into a state tax-free fund
are limited to investors living in states where the funds are registered.)
Some of the T. Rowe Price funds may impose a redemption fee of .50% to 2%,
payable to such funds, on shares held for less than one year, or in some
funds, six months.
Automated Services
- -------------------------
Tele*Access
1-800-638-2587
Tele*Access. 24-hour service via a toll-free number provides information on
fund yields and prices, dividends, account balances, and your latest
transaction, as well as the ability to request prospectuses, account and tax
forms, duplicate statements, and checks, and to initiate purchase, redemption,
and exchange orders in your accounts (see "Electronic Transfers" below).
Personal Computer Access. 24-hour service via a dial-up modem provides the
same information as Tele*Access, but on a personal computer. Please call
Investor Services to order.
Telephone and Walk-In Services
Buy, sell, or exchange shares by calling one of our service representatives or
by visiting one of our investor center locations whose addresses are listed on
the cover.
Electronic Transfers
By ACH. With no charges to pay, you can initiate a purchase or redemption for
as little as $100 or as much as $100,000 between your bank account and fund
account using the ACH network. Enter instructions via Tele*Access or your
personal computer, or call Shareholder Services.
-------------------------
T. Rowe Price 25
<PAGE>
4 Investing With T. Rowe Price
By Wire. Electronic transfers can also be conducted via bank wire. There is
currently a $5 fee for wire redemptions under $5,000, and your bank may charge
for incoming or outgoing wire transfers regardless of size.
Checkwriting (not available for equity funds, or the High Yield Fund or
Emerging Markets Bond Fund)
You may write an unlimited number of free checks on any money market fund, and
most bond funds, with a minimum of $500 per check. Keep in mind, however, that
a check results in a redemption; a check written on a bond fund will create a
taxable event which you and we must report to the IRS.
Automatic Investing ($50 minimum)
You can invest automatically in several different ways, including:
Automatic Asset Builder. You instruct us to move $50 or more from your bank
account, or you can instruct your employer to send all or a portion of your
paycheck to the fund or funds you designate.
Note: If you are moving money from your bank account, and if the date you
select for your transactions falls on a Sunday or a Monday which is a holiday,
your order will be priced on the second business day following this date.
Automatic Exchange. You can set up systematic investments from one fund
account into another, such as from a money fund into a stock fund.
Discount Brokerage
- -------------------------
Discount Brokerage is a division of T. Rowe Price Investment Services, Inc.,
Member NASD/SIPC.
This additional service gives you the opportunity to easily consolidate all of
your investments with one company. Through our discount brokerage, you can buy
and sell individual securities--stocks, bonds, options, and others--at
considerable commission savings. We also provide a wide range of services,
including:
Automated telephone and on-line services. You can enter trades, access quotes,
and review account information 24 hours a day, seven days a week. Any trades
executed through these programs save you an additional 10% on commissions.
- -------------------------
To open an account:
1-800-638-5660
Note: Discount applies to our current commission schedule, subject to our $35
minimum commission.
Investor information. A variety of informative reports, such as our Brokerage
Insights series, S&P Market Month Newsletter, and optional stock reports can
help you better evaluate economic trends and investment opportunities.
- -------------------------
For existing discount brokerage investors: 1-800-225-7720
Dividend Reinvestment Service. Virtually all stocks held in customer accounts
are eligible for this service--free of charge.
- -------------------------
26 T. Rowe Price
<PAGE>
4 Investing With T. Rowe Price
Investment Information
To help shareholders monitor their current investments and make decisions that
accurately reflect their financial goals, T. Rowe Price offers a wide variety
of information in addition to account statements.
Shareholder Reports. Fund managers' reviews of their strategies and results.
If several members of a household own the same fund, only one fund report is
mailed to that address. To receive additional copies, please call Shareholder
Services or write to us at 100 East Pratt Street, Baltimore, Maryland 21202.
The T. Rowe Price Report. A quarterly investment newsletter discussing markets
and financial strategies.
Performance Update. Quarterly review of all T. Rowe Price fund results.
Insights. Educational reports on investment strategies and financial markets.
Investment Guides. Asset Mix Worksheet, College Planning Kit, Personal
Strategy Planner, Retirees Financial Guide, and Retirement Planning Kit.
-------------------------
T. Rowe Price 27
PAGE 2
The Statement of Additional Information for the T. Rowe Price
Short-Term Bond Fund, Inc., dated October 1, 1996, should be
inserted here.
PAGE 1
STATEMENT OF ADDITIONAL INFORMATION
T. ROWE PRICE CORPORATE INCOME FUND, INC.
T. ROWE PRICE GNMA FUND
T. ROWE PRICE HIGH YIELD FUND, INC.
T. ROWE PRICE NEW INCOME FUND, INC.
T. ROWE PRICE PERSONAL STRATEGY FUNDS, INC.
Personal Strategy Balanced Fund
Personal Strategy Growth Fund
Personal Strategy Income Fund
T. ROWE PRICE PRIME RESERVE FUND, INC.
T. ROWE PRICE SHORT-TERM BOND FUND, INC.
T. ROWE PRICE SHORT-TERM U.S. GOVERNMENT FUND, INC.
T. ROWE PRICE U.S. TREASURY FUNDS, INC.
U.S. Treasury Intermediate Fund
U.S. Treasury Long-Term Fund
U.S. Treasury Money Fund
(collectively the "Funds" and individually the "Fund")
This Statement of Additional Information is not a prospectus
but should be read in conjunction with the appropriate Fund's
prospectus dated October 1, 1996 which may be obtained from
T. Rowe Price Investment Services, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202.
If you would like a prospectus for a Fund of which you are
not a shareholder, please call 1-800-638-5660. A prospectus with
more complete information, including management fees and expenses
will be sent to you. Please read it carefully.
The date of this Statement of Additional Information is
October 1, 1996.
SAI-INCOME 10/1/96
PAGE 2
TABLE OF CONTENTS
Page Page
Asset-Backed Securities . . Lending of Portfolio
Capital Stock . . . . . . . Securities . . . . . . .
Code of Ethics . . . . . . Management of Fund . . .
Custodian . . . . . . . . . Mortgage-Related
Description of the Fund . . Securities . . . . . . .
Distributor for Fund . . . Net Asset Value Per
Dividends and Distributions Share . . . . . . . . .
Federal and State . . . . . . . Options
Registration of Shares . . Portfolio Transactions .
Foreign Currency . Pricing of Securities
Transactions . . . . . . . Principal Holders of
Foreign Futures and Options Securities . . . . . . .
Futures Contracts . . . . . Ratings of Commercial
Hybrid Instruments . . . . Paper . . . . . . . . .
Independent Accountants . . Ratings of Corporate
Illiquid or Restricted. . . . . . Debt Securities
Securities . . . . . . . . Repurchase Agreements . .
Investment Management . . . . Risk Factors
Services . . . . . . . . . Tax Status . . . . . . .
Investment Objectives Taxation of Foreign
and Policies
Shareholders . . . . . . .
Investment Performance . . Warrants . . . . . . . .
Investment Program . . . . When-Issued Securities and
Investment Restrictions . . Forward Commitment
Legal Counsel . . . . . . . Contracts . . . . . . .
Yield Information
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of each
Fund's investment objectives and policies discussed in each
Fund's prospectus. The Funds will not make a material change in
their investment objectives without obtaining shareholder
approval. Unless otherwise specified, the investment programs
and restrictions of the Funds are not fundamental policies. Each
Fund's operating policies are subject to change by each Board of
Directors/Trustees without shareholder approval. However,
shareholders will be notified of a material change in an
operating policy. Each Fund's fundamental policies may not be
changed without the approval of at least a majority of the
outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the
holders of 50% or more of the shares are represented.
Throughout this Statement of Additional Information, "the
Fund" is intended to refer to each Fund listed on the cover page,
unless otherwise indicated.
RISK FACTORS
All Funds
Debt Obligations
Yields on short, intermediate, and long-term securities are
dependent on a variety of factors, including the general
conditions of the money and bond markets, the size of a
particular offering, the maturity of the obligation, and the
credit quality and rating of the issue. Debt securities with
longer maturities tend to have higher yields and are generally
subject to potentially greater capital appreciation and
depreciation than obligations with shorter
PAGE 3
maturities and lower yields. The market prices of debt
securities usually vary, depending upon available yields. An
increase in interest rates will generally reduce the value of
portfolio debt securities, and a decline in interest rates will
generally increase the value of portfolio debt securities. The
ability of the Fund to achieve its investment objective is also
dependent on the continuing ability of the issuers of the debt
securities in which the Fund invests to meet their obligations
for the payment of interest and principal when due. Although the
Fund seeks to reduce risk by portfolio diversification, credit
analysis, and attention to trends in the economy, industries and
financial markets, such efforts will not eliminate all risk.
There can, of course, be no assurance that the Fund will achieve
its investment objective.
After purchase by the Fund, a debt security may cease to be
rated or its rating may be reduced below the minimum required for
purchase by the Fund. For the Prime Reserve and U.S. Treasury
Money Funds, the procedures set forth in Rule 2a-7, under the
Investment Company Act of 1940, may require the prompt sale of
any such security. For the other Funds, neither event will
require a sale of such security by the Fund. However, T. Rowe
Price will consider such event in its determination of whether
the Fund should continue to hold the security. To the extent
that the ratings given by Moody's or S&P may change as a result
of changes in such organizations or their rating systems, the
Fund will attempt to use comparable ratings as standards for
investments in accordance with the investment policies contained
in the prospectus. When purchasing unrated securities, T. Rowe
Price, under the supervision of the Fund's Board of Directors,
determines whether the unrated security is of a qualify
comparable to that which the Fund is allowed to purchase.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions
of the risks associated with the investments and practices
described therein as they apply to the Fund.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Because of its investment policy, the Fund may or may not be
suitable or appropriate for all investors. The Fund is not a
money market fund and is not an appropriate investment for those
whose primary objective is principal stability. The value of the
portfolio securities of the Fund will fluctuate based upon market
conditions. Although the Fund seeks to reduce risk by investing
in a diversified portfolio, such diversification does not
eliminate all risk. There can, of course, be no assurance that
the Fund will achieve its investment objective.
PAGE 4
Prime Reserve and U.S. Treasury Money Funds
There can be no assurance that the Funds will achieve their
investment objectives or be able to maintain their net asset
value per share at $1.00. The price of the Fund is not
guaranteed or insured by the U.S. Government and its yield is not
fixed. An increase in interest rates could reduce the value of
the Fund's portfolio investments, and a decline in interest rates
could increase the value.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Mortgage securities differ from conventional bonds in that
principal is paid back over the life of the security rather than
at maturity. As a result, the holder of a mortgage security
(i.e., the Fund) receives monthly scheduled payments of principal
and interest, and may receive unscheduled principal payments
representing prepayments on the underlying mortgages. The
incidence of unscheduled principal prepayments is also likely to
increase in mortgage pools owned by the Fund when prevailing
mortgage loan rates fall below the mortgage rates of the
securities underlying the individual pool. The effect of such
prepayments in a falling rate environment is to (1) cause the
Fund to reinvest principal payments at the then lower prevailing
interest rate, and (2) reduce the potential for capital
appreciation beyond the face amount of the security. Conversely,
the Fund may realize a gain on prepayments of mortgage pools
trading at a discount. Such prepayments will provide an early
return of principal which may then be reinvested at the then
higher prevailing interest rate.
The market value of adjustable rate mortgage securities
("ARMs"), like other U.S. government securities, will generally
vary inversely with changes in market interest rates, declining
when interest rates rise and rising when interest rates decline.
Because of their periodic adjustment feature, ARMs should be more
sensitive to short-term interest rates than long-term rates.
They should also display less volatility than long-term mortgage
securities. Thus, while having less risk of a decline during
periods of rapidly rising rates, ARMs may also have less
potential for capital appreciation than other investments of
comparable maturities. Interest rate caps on mortgages
underlying ARM securities may prevent income on the ARM from
increasing to prevailing interest rate levels and cause the
securities to decline in value. In addition, to the extent ARMs
are purchased at a premium, mortgage foreclosures and unscheduled
principal prepayments may result in some loss of the holders'
principal investment to the extent of the premium paid. On the
other hand, if ARMs are purchased at a discount, both a scheduled
payment of principal and an unscheduled prepayment of principal
will increase current and total returns and will accelerate the
recognition of income which when distributed to shareholders will
be taxable as ordinary income.
Corporate Income, High Yield, New Income, Personal Strategy, and
Short-Term Bond Funds
Risk Factors of Foreign Investing
There are special risks in foreign investing. Certain of
these risks are inherent in any mutual fund investing in foreign
securities while others relate more to the countries in which the
Funds will invest. Many of the risks are more pronounced for
investments in developing or emerging countries, such as many of
the countries of Southeast Asia, China, Latin America, Eastern
Europe, the countries of the former Soviet Union, Africa and the
Middle East. Although there is no universally accepted
definition, a developing country is generally considered to be a
country which is in the initial stages of its industrialization
cycle with a per capita gross national product of less than
$8,000.
PAGE 5
Political and Economic Factors. Individual foreign
economies of certain countries may differ favorably or
unfavorably from the United States' economy in such respects as
growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments
position. The internal politics of certain foreign countries are
not as stable as in the United States. For example, in 1991, the
existing government in Thailand was overthrown in a military
coup. In 1992, there were two military coup attempts in
Venezuela and in 1992 the President of Brazil was impeached. In
addition, significant external political risks currently affect
some foreign countries. Both Taiwan and China still claim
sovereignty of one another and there is a demilitarized border
between North and South Korea.
Governments in certain foreign countries continue to
participate to a significant degree, through ownership interest
or regulation, in their respective economies. Action by these
governments could have a significant effect on market prices of
securities and payment of dividends. The economies of many
foreign countries are heavily dependent upon international trade
and are accordingly affected by protective trade barriers and
economic conditions of their trading partners. The enactment by
these trading partners of protectionist trade legislation could
have a significant adverse effect upon the securities markets of
such countries.
Currency Fluctuations. The Funds will invest in securities
denominated in various currencies. Accordingly, a change in the
value of any such currency against the U.S. dollar will result in
a corresponding change in the U.S. dollar value of the Funds'
assets denominated in that currency. Such changes will also
affect the Funds' income. Generally, when a given currency
appreciates against the dollar (the dollar weakens) the value of
the Fund's securities denominated in that currency will rise.
When a given currency depreciates against the dollar (the dollar
strengthens) the value of the Funds' securities denominated in
that currency would be expected to decline.
Investment and Repatriation Restrictions. Foreign
investment in the securities markets of certain foreign countries
is restricted or controlled in varying degrees. These
restrictions may limit at times and preclude investment in
certain of such countries and may increase the cost and expenses
of the Funds. Investments by foreign investors are subject to a
variety of restrictions in many developing countries. These
restrictions may take the form of prior governmental approval,
limits on the amount or type of securities held by foreigners,
and limits on the types of companies in which foreigners may
invest. Additional or different restrictions may be imposed at
any time by these or other countries in which the Funds invest.
In addition, the repatriation of both investment income and
capital from several foreign countries is restricted and
controlled under certain regulations, including in some cases the
need for certain government consents. For example, capital
invested in Chile normally cannot be repatriated for one
year.
Market Characteristics. Foreign stock and bond markets are
generally not as developed or efficient as, and may be more
volatile than, those in the United States. While growing in
volume, they usually have substantially less volume than U.S.
markets and the Funds' portfolio securities may be less liquid
and subject to more rapid and erratic price movements than
securities of comparable U.S. companies. Equity securities may
trade at price/earnings multiples higher than comparable United
States securities and such levels may not be sustainable. Fixed
commissions on foreign stock exchanges are generally higher than
negotiated commissions on United States exchanges, although the
Funds will endeavor to achieve the most favorable net results on
their portfolio transactions. There is generally less government
supervision and regulation of foreign stock exchanges, brokers
and listed companies than in the United States. Moreover,
settlement practices for transactions in foreign markets may
differ from those in United States markets. Such differences may
include delays beyond periods customary in the United States and
practices, such as delivery of securities
PAGE 6
prior to receipt of payment, which increase the likelihood of a
"failed settlement." Failed settlements can result in losses to
a Fund.
Investment Funds. The Funds may invest in investment funds
which have been authorized by the governments of certain
countries specifically to permit foreign investment in securities
of companies listed and traded on the stock exchanges in these
respective countries. The Funds' investment in these funds is
subject to the provisions of the 1940 Act. If the Funds invest
in such investment funds, the Funds' shareholders will bear not
only their proportionate share of the expenses of the Funds
(including operating expenses and the fees of the investment
manager), but also will bear indirectly similar expenses of the
underlying investment funds. In addition, the securities of
these investment funds may trade at a premium over their net
asset value.
Information and Supervision. There is generally less
publicly available information about foreign companies comparable
to reports and ratings that are published about companies in the
United States. Foreign companies are also generally not subject
to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those
applicable to United States companies. It also may be more
difficult to keep currently informed of corporate actions which
affect the prices of portfolio securities.
Taxes. The dividends and interest payable on certain of the
Funds' foreign portfolio securities may be subject to foreign
withholding taxes, thus reducing the net amount of income
available for distribution to the Funds' shareholders.
Other. With respect to certain foreign countries,
especially developing and emerging ones, there is the possibility
of adverse changes in investment or exchange control regulations,
expropriation or confiscatory taxation, limitations on the
removal of funds or other assets of the Funds, political or
social instability, or diplomatic developments which could affect
investments by U.S. persons in those countries.
Eastern Europe and Russia. Changes occurring in Eastern
Europe and Russia today could have long-term potential
consequences. As restrictions fall, this could result in rising
standards of living, lower manufacturing costs, growing consumer
spending, and substantial economic growth. However, investment
in the countries of Eastern Europe and Russia is highly
speculative at this time. Political and economic reforms are too
recent to establish a definite trend away from centrally-planned
economies and state owned industries. In many of the countries
of Eastern Europe and Russia, there is no stock exchange or
formal market for securities. Such countries may also have
government exchange controls, currencies with no recognizable
market value relative to the established currencies of western
market economies, little or no experience in trading in
securities, no financial reporting standards, a lack of a banking
and securities infrastructure to handle such trading, and a legal
tradition which does not recognize rights in private property.
In addition, these countries may have national policies which
restrict investments in companies deemed sensitive to the
country's national interest. Further, the governments in such
countries may require governmental or quasi-governmental
authorities to act as custodian of a Fund's assets invested in
such countries and these authorities may not qualify as a foreign
custodian under the Investment Company Act of 1940 and exemptive
relief from such Act may be required. All of these
considerations are among the factors which could cause
significant risks and uncertainties to investment in Eastern
Europe and Russia. Each Fund will only invest in a company
located in, or a government of, Eastern Europe and Russia, if it
believes the potential return justifies the risk.
Latin America
PAGE 7
Inflation. Most Latin American countries have experienced,
at one time or another, severe and persistent levels of
inflation, including, in some cases, hyperinflation. This has,
in turn, led to high interest rates, extreme measures by
governments to keep inflation in check and a generally
debilitating effect on economic growth. Although inflation in
many countries has lessened, there is no guarantee it will remain
at lower levels.
Political Instability. The political history of certain
Latin American countries has been characterized by political
uncertainty, intervention by the military in civilian and
economic spheres, and political corruption. Such developments,
if they were to reoccur, could reverse favorable trends toward
market and economic reform, privatization and removal of trade
barriers and result in significant disruption in securities
markets.
Foreign Currency. Certain Latin American countries may have
managed currencies which are maintained at artificial levels to
the U.S. dollar rather than at levels determined by the market.
This type of system can lead to sudden and large adjustments in
the currency which, in turn, can have a disruptive and negative
effect on foreign investors. For example, in late 1994 the value
of the Mexican peso lost more than one-third of its value
relative to the dollar. Certain Latin American countries also
may restrict the free conversion of their currency into foreign
currencies, including the U.S. dollar. There is no significant
foreign exchange market for certain currencies and it would, as a
result, be difficult for the Fund to engage in foreign currency
transactions designed to protect the value of the Fund's
interests in securities denominated in such currencies.
Sovereign Debt. A number of Latin American countries are
among the largest debtors of developing countries. There have
been moratoria on, and reschedulings of, repayment with respect
to these debts. Such events can restrict the flexibility of
these debtor nations in the international markets and result in
the imposition of onerous conditions on their economies.
To the extent any securities issued by companies in Eastern
Europe, Russia, and Latin America are considered illiquid, each
Fund will be required to include such securities within its 15%
restriction on investing in illiquid securities.
Corporate Income, High Yield, and Personal Strategy Funds
Special Risks of Investing in Junk Bonds
The following special considerations are additional risk
factors associated with the Fund's investments in lower rated
debt securities.
Youth and Growth of the Lower Rated Debt Securities Market.
The market for lower rated debt securities is relatively new and
its growth has paralleled a long economic expansion. Past
experience may not, therefore, provide an accurate indication of
future performance of this market, particularly during periods of
economic recession. An economic downturn or increase in interest
rates is likely to have a greater negative effect on this market,
the value of lower rated debt securities in the Fund's portfolio,
the Fund's net asset value and the ability of the bonds' issuers
to repay principal and interest, meet projected business goals
and obtain additional financing than on higher rated securities.
These circumstances also may result in a higher incidence of
defaults than with respect to higher rated securities. An
investment in this Fund is more speculative than investment in
shares of a fund which invests only in higher rated debt
securities.
Sensitivity to Interest Rate and Economic Changes. Prices
of lower rated debt securities may be more sensitive to adverse
economic changes or corporate developments than higher rated
investments. Debt securities with longer maturities, which may
have higher yields, may increase or decrease in value more
PAGE 8
than debt securities with shorter maturities. Market prices of
lower rated debt securities structured as zero coupon or pay-in-
kind securities are affected to a greater extent by interest rate
changes and may be more volatile than securities which pay
interest periodically and in cash. Where it deems it appropriate
and in the best interests of Fund shareholders, the Fund may
incur additional expenses to seek recovery on a debt security on
which the issuer has defaulted and to pursue litigation to
protect the interests of security holders of its portfolio
companies.
Liquidity and Valuation. Because the market for lower rated
securities may be thinner and less active than for higher rated
securities, there may be market price volatility for these
securities and limited liquidity in the resale market. Nonrated
securities are usually not as attractive to as many buyers as
rated securities are, a factor which may make nonrated securities
less marketable. These factors may have the effect of limiting
the availability of the securities for purchase by the Fund and
may also limit the ability of the Fund to sell such securities at
their fair value either to meet redemption requests or in
response to changes in the economy or the financial markets.
Adverse publicity and investor perceptions, whether or not based
on fundamental analysis, may decrease the values and liquidity of
lower rated debt securities, especially in a thinly traded
market. To the extent the Fund owns or may acquire illiquid or
restricted lower rated securities, these securities may involve
special registration responsibilities, liabilities and costs, and
liquidity and valuation difficulties. Changes in values of debt
securities which the Fund owns will affect its net asset value
per share. If market quotations are not readily available for
the Fund's lower rated or nonrated securities, these securities
will be valued by a method that the Fund's Board of Directors
believes accurately reflects fair value. Judgment plays a
greater role in valuing lower rated debt securities than with
respect to securities for which more external sources of
quotations and last sale information are available.
Taxation. Special tax considerations are associated with
investing in lower rated debt securities structured as zero
coupon or pay-in-kind securities. The Fund accrues income on
these securities prior to the receipt of cash payments. The Fund
must distribute substantially all of its income to its
shareholders to qualify for pass-through treatment under the tax
laws and may, therefore, have to dispose of its portfolio
securities to satisfy distribution requirements.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions
of the risks associated with the investments and practices
described therein as they apply to the Fund.
INVESTMENT PROGRAM
Types of Securities
Set forth below is additional information about certain of
the investments described in the Fund's prospectus.
Debt Securities
Fixed income securities in which the Fund may invest
include, but are not limited to, those described below.
All Funds
U.S. Government Obligations. Bills, notes, bonds and other
debt securities issued by the U.S. Treasury. These are direct
obligations of the U.S. Government and differ mainly in the
length of their maturities.
PAGE 9
U.S. Government Agency Securities. Issued or guaranteed by
U.S. Government sponsored enterprises and federal agencies.
These include securities issued by the Federal National Mortgage
Association, Government National Mortgage Association, Federal
Home Loan Bank, Federal Land Banks, Farmers Home Administration,
Banks for Cooperatives, Federal Intermediate Credit Banks,
Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these
securities are supported by the full faith and credit of the U.S.
Treasury; and the remainder are supported only by the credit of
the instrumentality, which may or may not include the right of
the issuer to borrow from the Treasury.
The GNMA, U.S. Treasury Money, Intermediate, and Long-Term
Funds may only invest in these securities if they are supported
by the full faith and credit of the U.S. government.
All Funds, except GNMA, U.S. Treasury Money, Intermediate and
Long-Term Funds
Bank Obligations. Certificates of deposit, bankers'
acceptances, and other short-term debt obligations. Certificates
of deposit are short-term obligations of commercial banks. A
bankers' acceptance is a time draft drawn on a commercial bank by
a borrower, usually in connection with international commercial
transactions. Certificates of deposit may have fixed or variable
rates. The Fund may invest in U.S. banks, foreign branches of
U.S. banks, U.S. branches of foreign banks, and foreign branches
of foreign banks.
Corporate Debt Securities. Outstanding nonconvertible
corporate debt securities (e.g., bonds and debentures).
Corporate notes may have fixed, variable, or floating rates.
Commercial Paper. Short-term promissory notes issued by
corporations primarily to finance short-term credit needs.
Certain notes may have floating or variable rates.
Foreign Government Securities. Issued or guaranteed by a
foreign government, province, instrumentality, political
subdivision or similar unit thereof.
Savings and Loan Obligations. Negotiable certificates of
deposit and other short-term debt obligations of savings and loan
associations.
Supranational Agencies. Securities of certain supranational
entities, such as the International Development Bank.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Mortgage-Related Securities
Mortgage-related securities in which the Fund may invest
include, but are not limited to, those described below. The
GNMA, U.S. Treasury Intermediate and U.S. Treasury Long-Term
Funds may only invest in these securities to the extent they are
backed by the full faith and credit of the U.S. Government.
Mortgage-Backed Securities. Mortgage-backed securities are
securities representing an interest in a pool of mortgages. The
mortgages may be of a variety of types, including adjustable
rate, conventional 30-year fixed rate, graduated payment, and 15-
year. Principal and interest payments made on the mortgages in
the underlying mortgage pool are passed through to the Fund. This
is in contrast to traditional bonds where principal is normally
paid back at maturity in a lump sum. Unscheduled prepayments of
principal shorten the securities' weighted average life and may
lower their total return. (When a mortgage in the underlying
mortgage pool is prepaid, an unscheduled principal
PAGE 10
prepayment is passed through to the Fund. This principal is
returned to the Fund at par. As a result, if a mortgage security
were trading at a premium, its total return would be lowered by
prepayments, and if a mortgage security were trading at a
discount, its total return would be increased by prepayments.)
The value of these securities also may change because of changes
in the market's perception of the creditworthiness of the federal
agency that issued them. In addition, the mortgage securities
market in general may be adversely affected by changes in
governmental regulation or tax policies.
U.S. Government Agency Mortgage-Backed Securities. These
are obligations issued or guaranteed by the United States
Government or one of its agencies or instrumentalities, such as
the Government National Mortgage Association ("Ginnie Mae" or
"GNMA"), the Federal National Mortgage Association ("Fannie Mae"
or "FNMA") the Federal Home Loan Mortgage Corporation ("Freddie
Mac" or "FHLMC"), and the Federal Agricultural Mortgage
Corporation ("Farmer Mac" or "FAMC"). FNMA, FHLMC, and FAMC
obligations are not backed by the full faith and credit of the
U.S. Government as GNMA certificates are, but they are supported
by the instrumentality's right to borrow from the United States
Treasury. U.S. Government Agency Mortgage-Backed Certificates
provide for the pass-through to investors of their pro-rata share
of monthly payments (including any prepayments) made by the
individual borrowers on the pooled mortgage loans, net of any
fees paid to the guarantor of such securities and the servicer of
the underlying mortgage loans. Each of GNMA, FNMA, FHLMC, and
FAMC guarantees timely distributions of interest to certificate
holders. GNMA and FNMA guarantee timely distributions of
scheduled principal. FHLMC has in the past guaranteed only the
ultimate collection of principal of the underlying mortgage loan;
however, FHLMC now issues Mortgage-Backed Securities (FHLMC Gold
PCs) which also guarantee timely payment of monthly principal
reductions.
Ginnie Mae Certificates. Ginnie Mae is a wholly-owned
corporate instrumentality of the United States within the
Department of Housing and Urban Development. The National
Housing Act of 1934, as amended (the "Housing Act"), authorizes
Ginnie Mae to guarantee the timely payment of the principal of
and interest on certificates that are based on and backed by a
pool of mortgage loans insured by the Federal Housing
Administration under the Housing Act, or Title V of the Housing
Act of 1949 ("FHA Loans"), or guaranteed by the Department of
Veterans Affairs under the Servicemen's Readjustment Act of 1944,
as amended ("VA Loans"), or by pools of other eligible mortgage
loans. The Housing Act provides that the full faith and credit
of the United States government is pledged to the payment of all
amounts that may be required to be paid under any guaranty. In
order to meet its obligations under such guaranty, Ginnie Mae is
authorized to borrow from the United States Treasury with no
limitations as to amount.
Fannie Mae Certificates. Fannie Mae is a federally
chartered and privately owned corporation organized and existing
under the Federal National Mortgage Association Charter Act of
1938. FNMA Certificates represent a pro-rata interest in a group
of mortgage loans purchased by Fannie Mae. FNMA guarantees the
timely payment of principal and interest on the securities it
issues. The obligations of FNMA are not backed by the full faith
and credit of the U.S. Government.
Freddie Mac Certificates. Freddie Mac is a corporate
instrumentality of the United States created pursuant to the
Emergency Home Finance Act of 1970, as amended (the "FHLMC Act").
Freddie Mac Certificates represent a pro-rata interest in a group
of mortgage loans (a "Freddie Mac Certificate group") purchased
by Freddie Mac. Freddie Mac guarantees timely payment of
interest and principal on certain securities it issues and timely
payment of interest and eventual payment of principal on other
securities is issues. The obligations of Freddie Mac are
obligations solely of Freddie Mac and are not backed by the full
faith and credit of the U.S. Government.
PAGE 11
Farmer Mac Certificates. The Federal Agricultural Mortgage
Corporation ("Farmer Mac") is a federally chartered
instrumentality of the United States established by Title VIII of
the Farm Credit Act of 1971, as amended ("Charter Act"). Farmer
Mac was chartered primarily to attract new capital for financing
of agricultural real estate by making a secondary market in
certain qualified agricultural real estate loans. Farmer Mac
provides guarantees of timely payment of principal and interest
on securities representing interests in, or obligations backed
by, pools of mortgages secured by first liens on agricultural
real estate ("Farmer Mac Certificates"). Similar to Fannie Mae
and Freddie Mac, Farmer Mac's Certificates are not supported by
the full faith and credit of the U.S. Government; rather, Farmer
Mac may borrow up from the U.S. Treasury to meet its guaranty
obligations.
As discussed above, prepayments on the underlying mortgages
and their effect upon the rate of return of a Mortgage-Backed
Security, is the principal investment risk for a purchaser of
such securities, like the Fund. Over time, any pool of mortgages
will experience prepayments due to a variety of factors,
including (1) sales of the underlying homes (including
foreclosures), (2) refinancings of the underlying mortgages, and
(3) increased amortization by the mortgagee. These factors, in
turn, depend upon general economic factors, such as level of
interest rates and economic growth. Thus, investors normally
expect prepayment rates to increase during periods of strong
economic growth or declining interest rates, and to decrease in
recessions and rising interest rate environments. Accordingly,
the life of the Mortgage-Backed Security is likely to be
substantially shorter than the stated maturity of the mortgages
in the underlying pool. Because of such variation in prepayment
rates, it is not possible to predict the life of a particular
Mortgage-Backed Security, but FHA statistics indicate that 25- to
30-year single family dwelling mortgages have an average life of
approximately 12 years. The majority of Ginnie Mae Certificates
are backed by mortgages of this type, and, accordingly, the
generally accepted practice treats Ginnie Mae Certificates as 30-
year securities which prepay full in the 12th year. FNMA and
Freddie Mac Certificates may have differing prepayment
characteristics.
Fixed Rate Mortgage-Backed Securities bear a stated "coupon
rate" which represents the effective mortgage rate at the time of
issuance, less certain fees to GNMA, FNMA and FHLMC for providing
the guarantee, and the issuer for assembling the pool and for
passing through monthly payments of interest and principal.
Payments to holders of Mortgage-Backed Securities consist of
the monthly distributions of interest and principal less the
applicable fees. The actual yield to be earned by a holder of
Mortgage-Backed Securities is calculated by dividing interest
payments by the purchase price paid for the Mortgage-Backed
Securities (which may be at a premium or a discount from the face
value of the certificate).
Monthly distributions of interest, as contrasted to semi-
annual distributions which are common for other fixed interest
investments, have the effect of compounding and thereby raising
the effective annual yield earned on Mortgage-Backed Securities.
Because of the variation in the life of the pools of mortgages
which back various Mortgage-Backed Securities, and because it is
impossible to anticipate the rate of interest at which future
principal payments may be reinvested, the actual yield earned
from a portfolio of Mortgage-Backed Securities will differ
significantly from the yield estimated by using an assumption of
a certain life for each Mortgage-Backed Security included in such
a portfolio as described above.
U.S. Government Agency Multiclass Pass-Through Securities.
Unlike CMOs, U.S. Government Agency Multiclass Pass-Through
Securities, which include FNMA Guaranteed REMIC Pass-Through
Certificates and FHLMC Multi-Class Mortgage Participation
Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references
herein to CMOs include multiclass pass-through securities.
PAGE 12
Multi-Class Residential Mortgage Securities. Such
securities represent interests in pools of mortgage loans to
residential home buyers made by commercial banks, savings and
loan associations or other financial institutions. Unlike GNMA,
FNMA and FHLMC securities, the payment of principal and interest
on Multi-Class Residential Mortgage Securities is not guaranteed
by the U.S. Government or any of its agencies. Accordingly,
yields on Multi-Class Residential Mortgage Securities have been
historically higher than the yields on U.S. government mortgage
securities. However, the risk of loss due to default on such
instruments is higher since they are not guaranteed by the U.S.
Government or its agencies. Additionally, pools of such
securities may be divided into senior or subordinated segments.
Although subordinated mortgage securities may have a higher yield
than senior mortgage securities, the risk of loss of principal is
greater because losses on the underlying mortgage loans must be
borne by persons holding subordinated securities before those
holding senior mortgage securities.
Privately-Issued Mortgage-Backed Certificates. These are
pass-through certificates issued by non-governmental issuers.
Pools of conventional residential mortgage loans created by such
issuers generally offer a higher rate of interest than government
and government-related pools because there are no direct or
indirect government guarantees of payment. Timely payment of
interest and principal of these pools is, however, generally
supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance. The insurance
and guarantees are issued by government entities, private
insurance or the mortgage poolers. Such insurance and guarantees
and the creditworthiness of the issuers thereof will be
considered in determining whether a mortgage-related security
meets the Fund's quality standards. The Fund may buy mortgage-
related securities without insurance or guarantees if through an
examination of the loan experience and practices of the poolers,
the investment manager determines that the securities meet the
Fund's quality standards.
Collateralized Mortgage Obligations (CMOs). CMOs are bonds
that are collateralized by whole loan mortgages or mortgage pass-
through securities. The bonds issued in a CMO deal are divided
into groups, and each group of bonds is referred to as a
"tranche." Under the traditional CMO structure, the cash flows
generated by the mortgages or mortgage pass-through securities in
the collateral pool are used to first pay interest and then pay
principal to the CMO bondholders. The bonds issued under a CMO
structure are retired sequentially as opposed to the pro rata
return of principal found in traditional pass-through
obligations. Subject to the various provisions of individual CMO
issues, the cash flow generated by the underlying collateral (to
the extent it exceeds the amount required to pay the stated
interest) is used to retire the bonds. Under the CMO structure,
the repayment of principal among the different tranches is
prioritized in accordance with the terms of the particular CMO
issuance. The "fastest-pay" tranche of bonds, as specified in
the prospectus for the issuance, would initially receive all
principal payments. When that tranche of bonds is retired, the
next tranche, or tranches, in the sequence, as specified in the
prospectus, receive all of the principal payments until they are
retired. The sequential retirement of bond groups continues
until the last tranche, or group of bonds, is retired.
Accordingly, the CMO structure allows the issuer to use cash
flows of long maturity, monthly-pay collateral to formulate
securities with short, intermediate and long final maturities and
expected average lives.
CMO structures may also include floating rate CMOs, planned
amortization classes, accrual bonds and CMO residuals. These
structures affect the amount and timing of principal and interest
received by each tranche from the underlying collateral. Under
certain of these structures, given classes of CMOs have priority
over others with respect to the receipt of prepayments on the
mortgages. Therefore, depending on the type of CMOs in which the
Fund invests, the investment may be subject to a greater or
lesser risk of prepayment than other types of mortgage-related
securities.
PAGE 13
The primary risk of any mortgage security is the uncertainty
of the timing of cash flows. For CMOs, the primary risk results
from the rate of prepayments on the underlying mortgages serving
as collateral. An increase or decrease in prepayment rates
(resulting from a decrease or increase in mortgage interest
rates) will affect the yield, average life and price of CMOs.
The prices of certain CMOs, depending on their structure and the
rate of prepayments, can be volatile. Some CMOs may also not be
as liquid as other securities.
Stripped Mortgage-Backed Securities. Stripped Mortgage-
Backed securities represent interests in a pool of mortgages, the
cash flow of which has been separated into its interest and
principal components. "IOs" (interest only securities) receive
the interest portion of the cash flow while "POs" (principal only
securities) receive the principal portion. IOs and POs are
usually structured as tranches of a CMO. Stripped
Mortgage-Backed Securities may be issued by U.S. Government
Agencies or by private issuers similar to those described above
with respect to CMOs and privately-issued mortgage-backed
certificates. As interest rates rise and fall, the value of IOs
tends to move in the same direction as interest rates. The value
of the other mortgage-backed securities described herein, like
other debt instruments, will tend to move in the opposite
direction compared to interest rates. Under the Internal Revenue
Code of 1986, as amended (the "Code"), POs may generate taxable
income from the current accrual of original issue discount,
without a corresponding distribution of cash to the Fund.
The cash flows and yields on IO and PO classes are extremely
sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets. In the
case of IOs, prepayments affect the amount, but not the timing,
of cash flows provided to the investor. In contrast, prepayments
on the mortgage pool affect the timing, but not the amount, of
cash flows received by investors in POs. A rapid or slow rate of
principal payments may have a material adverse effect on the
prices of IOs or POs, respectively. If the underlying mortgage
assets experience greater than anticipated prepayments of
principal, an investor may fail to recoup fully its initial
investment in an IO class of a stripped mortgage-backed security,
even if the IO class is rated AAA or Aaa or is derived from a
full faith and credit obligation. Conversely, if the underlying
mortgage assets experience slower than anticipated prepayments of
principal, the price on a PO class will be affected more severely
than would be the case with a traditional mortgage-backed
security.
The staff of the Securities and Exchange Commission has
advised the Fund that it believes the Fund should treat IOs and
POs, other than government-issued IOs or POs backed by fixed rate
mortgages, as illiquid securities and, accordingly, limit its
investments in such securities, together with all other illiquid
securities, to 15% of the Fund's net assets. Under the Staff's
position, the determination of whether a particular
government-issued IO and PO backed by fixed rate mortgages may be
made on a case by case basis under guidelines and standards
established by the Fund's Board of Directors/Trustees. The
Fund's Board of Directors/Trustees has delegated to T. Rowe Price
the authority to determine the liquidity of these investments
based on the following guidelines: the type of issuer; type of
collateral, including age and prepayment characteristics; rate of
interest on coupon relative to current market rates and the
effect of the rate on the potential for prepayments; complexity
of the issue's structure, including the number of tranches; size
of the issue and the number of dealers who make a market in the
IO or PO. The Fund will treat non-government-issued IOs and POs
not backed by fixed or adjustable rate mortgages as illiquid
unless and until the Securities and Exchange Commission modifies
its position.
Adjustable Rate Mortgages. Adjustable rate mortgage (ARM)
securities are collateralized by adjustable rate, rather than
fixed rate, mortgages.
PAGE 14
ARMs, like fixed rate mortgages, have a specified maturity
date, and the principal amount of the mortgage is repaid over the
life of the mortgage. Unlike fixed rate mortgages, the interest
rate on ARMs is adjusted at regular intervals based on a
specified, published interest rate "index" such as a Treasury
rate index. The new rate is determined by adding a specific
interest amount, the "margin," to the interest rate of the index.
Investment in ARM securities allows the Fund to participate in
changing interest rate levels through regular adjustments in the
coupons of the underlying mortgages, resulting in more variable
current income and lower price volatility than longer term fixed
rate mortgage securities. The ARM securities in which the Fund
expects to invest will generally adjust their interest rates at
regular intervals of one year or less. ARM securities are a less
effective means of locking in long-term rates than fixed rate
mortgages since the income from adjustable rate mortgages will
increase during periods of rising interest rates and decline
during periods of falling rates.
Characteristics of Adjustable Rate Mortgage Securities -
Interest Rate Indices. The interest rates paid on adjustable
rate securities are readjusted periodically to an increment over
some predetermined interest rate index. Such readjustments occur
at intervals ranging from one to 60 months. There are three main
categories of indexes: (1) those based on U.S. Treasury
securities (2) those derived from a calculated measure such as a
cost of funds index ("COFI") or a moving average of mortgage
rates and (3) those based on actively traded or prominently
posted short-term, interest rates. Commonly utilized indexes
include the one-year, three-year and five-year constant maturity
Treasury rates, the three-month Treasury bill rate, the 180-day
Treasury bill rate, rates on longer-term Treasury securities, the
11th District Federal Home Loan Bank Cost of Funds, the National
Median Cost of Funds, the one-month, three-month, six-month or
one-year London Interbank Offered Rate (LIBOR), the prime rate of
a specific bank, or commercial paper rates. Some indexes, such
as the one-year constant maturity Treasury rate, closely mirror
changes in market interest rate levels. Others, such as the 11th
District Home Loan Bank Cost of Funds index, tend to lag behind
changes in market rate levels. The market value of the Fund's
assets and of the net asset value of the Fund's shares will be
affected by the length of the adjustment period, the degree of
volatility in the applicable indexes and the maximum increase or
decrease of the interest rate adjustment on any one adjustment
date, in any one year and over the life of the securities. These
maximum increases and decreases are typically referred to as
"caps" and "floors", respectively.
A number of factors affect the performance of the Cost of
Funds Index and may cause the Cost of Funds Index to move in a
manner different from indices based upon specific interest rates,
such as the One Year Treasury Index. Additionally, there can be
no assurance that the Cost of Funds Index will necessarily move
in the same direction or at the same rate as prevailing interest
rates. Furthermore, any movement in the Cost of Funds Index as
compared to other indices based upon specific interest rates may
be affected by changes instituted by the FHLB of San Francisco in
the method used to calculate the Cost of Funds Index. To the
extent that the Cost of Funds Index may reflect interest changes
on a more delayed basis than other indices, in a period of rising
interest rates, any increase may produce a higher yield later
than would be produced by such other indices, and in a period of
declining interest rates, the Cost of Funds Index may remain
higher than other market interest rates which may result in a
higher level of principal prepayments on mortgage loans which
adjust in accordance with the Cost of Funds Index than mortgage
loans which adjust in accordance with other indices.
LIBOR, the London interbank offered rate, is the interest
rate that the most creditworthy international banks dealing in
U.S. dollar-denominated deposits and loans charge each other for
large dollar-denominated loans. LIBOR is also usually the base
rate for large dollar-denominated loans in the international
PAGE 15
market. LIBOR is generally quoted for loans having rate
adjustments at one, three, six or 12 month intervals.
Caps and Floors. ARMs will frequently have caps and floors
which limit the maximum amount by which the interest rate to the
residential borrower may move up or down, respectively, each
adjustment period and over the life of the loan. Interest rate
caps on ARM securities may cause them to decrease in value in an
increasing interest rate environment. Such caps may also prevent
their income from increasing to levels commensurate with
prevailing interest rates. Conversely, interest rate floors on
ARM securities may cause their income to remain higher than
prevailing interest rate levels and result in an increase in the
value of such securities. However, this increase may be tempered
by the acceleration of prepayments.
Mortgage securities generally have a maximum maturity of up
to 30 years. However, due to the adjustable rate feature of ARM
securities, their prices are considered to have volatility
characteristics which approximate the average period of time
until the next adjustment of the interest rate. As a result, the
principal volatility of ARM securities may be more comparable to
short- and intermediate-term securities than to longer term fixed
rate mortgage securities. Prepayments, however, will increase
their principal volatility. See also the discussion of Mortgage-
Backed Securities on page 9. Several characteristics of ARMs may
make them more susceptible to prepayments than other Mortgage-
Backed Securities. An adjustable rate mortgage has greater
incentives to refinance with a fixed rate mortgage during
favorable interest rate environments, in order to avoid interest
rate risk. Also, homes financed with adjustable rate mortgages
may be sold more frequently because of the prevalence of first-
time home buyers in the adjustable rate mortgage market. Also,
delinquency and foreclosure rates are higher in this market since
many buyers use adjustable rate mortgages to purchase homes that
they could not otherwise finance on a fixed rate basis.
Significant increases in the index rates for the adjustable rate
mortgages may also result in increased delinquency and default
rates, which in turn, may affect prepayment rates on the ARMs.
Other Mortgage Related Securities. The Fund expects that
governmental, government-related or private entities may create
mortgage loan pools offering pass-through investments in addition
to those described above. The mortgages underlying these
securities may be alternative mortgage instruments, that is,
mortgage instruments whose principal or interest payments may
vary or whose terms to maturity may differ from customary long-
term fixed rate mortgages. As new types of mortgage-related
securities are developed and offered to investors, the investment
manager will, consistent with the Fund's objective, policies and
quality standards, consider making investments in such new types
of securities.
All Funds (except GNMA, U.S. Treasury Money, Intermediate and
Long-Term Funds)
Asset-Backed Securities
The credit quality of most asset-backed securities depends
primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated
from the credit risk of the originator or any other affiliated
entities and the amount and quality of any credit support
provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of
principal payments received on the underlying assets which in
turn may be affected by a variety of economic and other factors.
As a result, the yield on any asset-backed security is difficult
to predict with precision and actual yield to maturity may be
more or less than the anticipated yield to maturity. Asset-
backed securities may be classified as pass-through certificates
or collateralized obligations.
PAGE 16
Pass-through certificates are asset-backed securities which
represent an undivided fractional ownership interest in an
underlying pool of assets. Pass-through certificates usually
provide for payments of principal and interest received to be
passed through to their holders, usually after deduction for
certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest
in the underlying assets, the holders thereof bear directly the
risk of any defaults by the obligors on the underlying assets not
covered by any credit support. See "Types of Credit Support".
Asset-backed securities issued in the form of debt
instruments, also known as collateralized or pay-through
obligations, are generally issued as the debt of a special
purpose entity organized solely for the purpose of owning such
assets and issuing such debt. Such assets are most often trade,
credit card or automobile receivables. The assets
collateralizing such asset-backed securities are pledged to a
trustee or custodian for the benefit of the holders thereof.
Such issuers generally hold no assets other than those underlying
the asset-backed securities and any credit support provided. As
a result, although payments on such asset-backed securities are
obligations of the issuers, in the event of defaults on the
underlying assets not covered by any credit support (see "Types
of Credit Support"), the issuing entities are unlikely to have
sufficient assets to satisfy their obligations on the related
asset-backed securities.
Methods of Allocating Cash Flows. While many asset-backed
securities are issued with only one class of security, many
asset-backed securities are issued in more than one class, each
with different payment terms. Multiple class asset-backed
securities are issued for two main reasons. First, multiple
classes may be used as a method of providing credit support.
This is accomplished typically through creation of one or more
classes whose right to payments on the asset-backed security is
made subordinate to the right to such payments of the remaining
class or classes. See "Types of Credit Support". Second,
multiple classes may permit the issuance of securities with
payment terms, interest rates or other characteristics differing
both from those of each other and from those of the underlying
assets. Examples include so-called "strips" (asset-backed
securities entitling the holder to disproportionate interests
with respect to the allocation of interest and principal of the
assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of
non-asset-backed securities, such as floating interest rates
(i.e., interest rates which adjust as a specified benchmark
changes) or scheduled amortization of principal.
Asset-backed securities in which the payment streams on the
underlying assets are allocated in a manner different than those
described above may be issued in the future. The Fund may invest
in such asset-backed securities if such investment is otherwise
consistent with its investment objectives and policies and with
the investment restrictions of the Fund.
Types of Credit Support. Asset-backed securities are often
backed by a pool of assets representing the obligations of a
number of different parties. To lessen the effect of failures by
obligors on underlying assets to make payments, such securities
may contain elements of credit support. Such credit support
falls into two classes: liquidity protection and protection
against ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to
ensure that scheduled payments on the underlying pool are made in
a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through
guarantees, insurance policies or letters of credit obtained from
third parties ("external credit enhancement"), through various
means of structuring the transaction ("internal credit
enhancement") or through a combination of such approaches.
Examples of asset-backed securities with internal credit
enhancement include "senior-
PAGE 17
subordinated securities" (multiple class asset-backed securities
with certain classes subordinate to other classes as to the
payment of principal thereon, with the result that defaults on
the underlying assets are borne first by the holders of the
subordinated class) and asset-backed securities that have
"reserve funds" (where cash or investments, sometimes funded from
a portion of the initial payments on the underlying assets, are
held in reserve against future losses) or that have been "over
collateralized" (where the scheduled payments on, or the
principal amount of, the underlying assets substantially exceeds
that required to make payment of the asset-backed securities and
pay any servicing or other fees). The degree of credit support
provided on each issue is based generally on historical
information respecting the level of credit risk associated with
such payments. Depending upon the type of assets securitized,
historical information on credit risk and prepayment rates may be
limited or even unavailable. Delinquency or loss in excess of
that anticipated could adversely affect the return on an
investment in an asset-backed security.
Automobile Receivable Securities. The Fund may invest in
Asset Backed Securities which are backed by receivables from
motor vehicle installment sales contracts or installment loans
secured by motor vehicles ("Automobile Receivable Securities").
Since installment sales contracts for motor vehicles or
installment loans related thereto ("Automobile Contracts")
typically have shorter durations and lower incidences of
prepayment, Automobile Receivable Securities generally will
exhibit a shorter average life and are less susceptible to
prepayment risk.
Most entities that issue Automobile Receivable Securities
create an enforceable interest in their respective Automobile
Contracts only by filing a financing statement and by having the
servicer of the Automobile Contracts, which is usually the
originator of the Automobile Contracts, take custody thereof. In
such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in
violation of its obligation not to do so, there is a risk that
such party could acquire an interest in the Automobile Contracts
superior to that of the holders of Automobile Receivable
Securities. Also although most Automobile Contracts grant a
security interest in the motor vehicle being financed, in most
states the security interest in a motor vehicle must be noted on
the certificate of title to create an enforceable security
interest against competing claims of other parties. Due to the
large number of vehicles involved, however, the certificate of
title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually
is not amended to reflect the assignment of the seller's security
interest for the benefit of the holders of the Automobile
Receivable Securities. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be
available to support payments on the securities. In addition,
various state and federal securities laws give the motor vehicle
owner the right to assert against the holder of the owner's
Automobile Contract certain defenses such owner would have
against the seller of the motor vehicle. The assertion of such
defenses could reduce payments on the Automobile Receivable
Securities.
Credit Card Receivable Securities. The Fund may invest in
Asset Backed Securities backed by receivables from revolving
credit card agreements ("Credit Card Receivable Securities").
Credit balances on revolving credit card agreements ("Accounts")
are generally paid down more rapidly than are Automobile
Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order
to lengthen the maturity of Credit Card Receivable Securities,
most such securities provide for a fixed period during which only
interest payments on the underlying Accounts are passed through
to the security holder and principal payments received on such
Accounts are used to fund the transfer to the pool of assets
supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial
fixed period usually may be shortened upon the occurrence of
specified events which signal
PAGE 18
a potential deterioration in the quality of the assets backing
the security, such as the imposition of a cap on interest rates.
The ability of the issuer to extend the life of an issue of
Credit Card Receivable Securities thus depends upon the continued
generation of additional principal amounts in the underlying
accounts during the initial period and the non-occurrence of
specified events. An acceleration in cardholders' payment rates
or any other event which shortens the period during which
additional credit card charges on an Account may be transferred
to the pool of assets supporting the related Credit Card
Receivable Security could shorten the weighted average life and
yield of the Credit Card Receivable Security.
Credit cardholders are entitled to the protection of a
number of state and federal consumer credit laws, many of which
give such holder the right to set off certain amounts against
balances owed on the credit card, thereby reducing amounts paid
on Accounts. In addition, unlike most other Asset Backed
Securities, Accounts are unsecured obligations of the cardholder.
Other Assets. Asset Backed Securities backed by assets
other than those described above, including, but not limited to,
small business loans and accounts receivable, equipment leases,
commercial real estate loans, boat loans and manufacturing
housing loans. The Fund may invest in such securities in the
future if such investment is otherwise consistent with its
investment objective and policies.
There are, of course, other types of securities that are, or
may become available, which are similar to the foregoing and the
Fund reserves the right to invest in these securities.
High Yield Fund
Collateralized Bond or Loan Obligations
CBOs are bonds collateralized by corporate bonds and CLOs
are bonds collateralized by bank loans. CBOs and CLOs are
structured into tranches, and payments are allocated such that
each tranche has a predictable cash flow stream and average life.
CBOs are fairly recent entrants to the fixed income market. Most
issues to date have been collateralized by high yield bonds or
loans, with heavy credit enhancement.
Loan Participations and Assignments
Loan participations and assignments (collectively
"participations") will typically be participating interests in
loans made by a syndicate of banks, represented by an agent bank
which has negotiated and structured the loan, to corporate
borrowers to finance internal growth, mergers, acquisitions,
stock repurchases, leveraged buy-outs and other corporate
activities. Such loans may also have been made to governmental
borrowers, especially governments of developing countries (LDC
debt). LDC debt will involve the risk that the governmental
entity responsible for the repayment of the debt may be unable or
unwilling to do so when due. The loans underlying such
participations may be secured or unsecured, and the Fund may
invest in loans collateralized by mortgages on real property or
which have no collateral. The loan participations themselves may
extend for the entire term of the loan or may extend only for
short "strips" that correspond to a quarterly or monthly floating
rate interest period on the underlying loan. Thus, a term or
revolving credit that extends for several years may be subdivided
into shorter periods.
The loan participations in which the Fund will invest will
also vary in legal structure. Occasionally, lenders assign to
another institution both the lender's rights and obligations
under a credit agreement. Since this type of assignment relieves
the original lender of its obligations, it is call a novation.
More typically, a lender assigns only its right to receive
payments
PAGE 19
of principal and interest under a promissory note, credit
agreement or similar document. A true assignment shifts to the
assignee the direct debtor-creditor relationship with the
underlying borrower. Alternatively, a lender may assign only
part of its rights to receive payments pursuant to the underlying
instrument or loan agreement. Such partial assignments, which
are more accurately characterized as "participating interests,"
do not shift the debtor-creditor relationship to the assignee,
who must rely on the original lending institution to collect sums
due and to otherwise enforce its rights against the agent bank
which administers the loan or against the underlying borrower.
There may not be a recognizable, liquid public market for
loan participations. To the extent this is the case, the Fund
would consider the loan participation as illiquid and subject to
the Fund's restriction on investing no more than 15% of its net
assets in illiquid securities.
Where required by applicable SEC positions, the Fund will
treat both the corporate borrower and the bank selling the
participation interest as an issuer for purposes of its
fundamental investment restriction on diversification.
Various service fees received by the Fund from loan
participations, may be treated as non-interest income depending
on the nature of the fee (commitment, takedown, commission,
service or loan origination). To the extent the service fees are
not interest income, they will not qualify as income under
Section 851(b) of the Internal Revenue Code. Thus the sum of
such fees plus any other non-qualifying income earned by the Fund
cannot exceed 10% of total income.
Trade Claims
Trade claims are non-securitized rights of payment arising
from obligations other than borrowed funds. Trade claims
typically arise when, in the ordinary course of business, vendors
and suppliers extend credit to a company by offering payment
terms. Generally, when a company files for bankruptcy protection
payments on these trade claims cease and the claims are subject
to compromise along with the other debts of the company. Trade
claims typically are bought and sold at a discount reflecting the
degree of uncertainty with respect to the timing and extent of
recovery. In addition to the risks otherwise associated with
low-quality obligations, trade claims have other risks, including
the possibility that the amount of the claim may be disputed by
the obligor.
Over the last few years a market for the trade claims of
bankrupt companies has developed. Many vendors are either
unwilling or lack the resources to hold their claim through the
extended bankruptcy process with an uncertain outcome and timing.
Some vendors are also aggressive in establishing reserves against
these receivables, so that the sale of the claim at a discount
may not result in the recognition of a loss.
Trade claims can represent an attractive investment
opportunity because these claims typically are priced at a
discount to comparable public securities. This discount is a
reflection of both a less liquid market, a smaller universe of
potential buyers and the risks peculiar to trade claim investing.
It is not unusual for trade claims to be priced at a discount to
public securities that have an equal or lower priority claim.
As noted above, investing in trade claims does carry some
unique risks which include:
Establishing the Amount of the Claim. Frequently, the
supplier's estimate of its receivable will differ from
the customer's estimate
PAGE 20
of its payable. Resolution of these differences can
result in a reduction in the amount of the claim. This
risk can be reduced by only purchasing scheduled claims
(claims already listed as liabilities by the debtor) and
seeking representations from the seller.
Defenses to Claims. The debtor has a variety of defenses
that can be asserted under the bankruptcy code against
any claim. Trade claims are subject to these defenses,
the most common of which for trade claims relates to
preference payments. (Preference payments are all
payments made by the debtor during the 90 days prior to
the filing. These payments are presumed to have
benefited the receiving creditor at the expense of the
other creditors. The receiving creditor may be required
to return the payment unless it can show the payments
were received in the ordinary course of business.) While
none of these defenses can result in any additional
liability of the purchaser of the trade claim, they can
reduce or wipe out the entire purchased claim. This risk
can be reduced by seeking representations and
indemnification from the seller.
Documentation/Indemnification. Each trade claim
purchased requires documentation that must be negotiated
between the buyer and seller. This documentation is
extremely important since it can protect the purchaser
from losses such as those described above. Legal
expenses in negotiating a purchase agreement can be
fairly high. Additionally, it is important to note that
the value of an indemnification depends on the sellers
credit.
Volatile Pricing Due to Illiquid Market. There are only
a handful of brokers for trade claims and the quoted
price of these claims can be volatile. Generally, it is
expected that Trade Claims would be considered illiquid
investments.
No Current Yield/Ultimate Recovery. Trade claims are
almost never entitled to earn interest. As a result, the
return on such an investment is very sensitive to the
length of the bankruptcy, which is uncertain. Although
not unique to trade claims, it is worth noting that the
ultimate recovery on the claim is uncertain and there is
no way to calculate a conventional yield to maturity on
this investment. Additionally, the exit for this
investment is a plan of reorganization which may include
the distribution of new securities. These securities may
be as illiquid as the original trade claim investment.
Tax Issue. Although the issue is not free from doubt, it
is likely that Trade Claims would be treated as non-
securities investments. As a result, any gains would be
considered "non-qualifying" under the Internal Revenue
Code. The Fund may have up to 10% of its gross income
(including capital gains) derived from non-qualifying
sources.
High Yield and Personal Strategy Funds
Zero Coupon and Pay-in-Kind Bonds
A zero coupon security has no cash coupon payments.
Instead, the issuer sells the security at a substantial discount
from its maturity value. The interest received by the investor
from holding this security to maturity is the difference between
the maturity value and the purchase price. The advantage to the
investor is that reinvestment risk of the income received during
the life of the bond is eliminated. However, zero-coupon bonds
like other bonds retain interest rate and credit risk and usually
display more price volatility than those securities that pay a
cash coupon.
PAGE 21
Pay-in-Kind (PIK) Instruments are securities that pay
interest in either cash or additional securities, at the issuer's
option, for a specified period. PIK's, like zero coupon bonds,
are designed to give an issuer flexibility in managing cash flow.
PIK bonds can be either senior or subordinated debt and trade
flat (i.e., without accrued interest). The price of PIK bonds is
expected to reflect the market value of the underlying debt plus
an amount representing accrued interest since the last payment.
PIK's are usually less volatile than zero coupon bonds, but more
volatile than cash pay securities.
For federal income tax purposes, these types of bonds will
require the recognition of gross income each year even though no
cash may be paid to the Fund until the maturity or call date of
the bond. The Fund will nonetheless be required to distribute
substantially all of this gross income each year to comply with
the Internal Revenue Code, and such distributions could reduce
the amount of cash available for investment by the Fund.
High Yield, New Income, and Personal Strategy Funds
Warrants
The Fund may acquire warrants. Warrants are pure
speculation in that they have no voting rights, pay no dividends
and have no rights with respect to the assets of the corporation
issuing them. Warrants basically are options to purchase equity
securities at a specific price valid for a specific period of
time. They do not represent ownership of the securities, but
only the right to buy them. Warrants differ from call options in
that warrants are issued by the issuer of the security which may
be purchased on their exercise, whereas call options may be
written or issued by anyone. The prices of warrants do not
necessarily move parallel to the prices of the underlying
securities.
Corporate Income, High Yield, New Income, Personal Strategy,
Short-Term Bond, and Short-Term U.S. Government Funds
Hybrid Instruments
Hybrid Instruments have been developed and combine the
elements of futures contracts or options with those of debt,
preferred equity or a depository instrument (hereinafter "Hybrid
Instruments"). Generally, a Hybrid Instrument will be a debt
security, preferred stock, depository share, trust certificate,
certificate of deposit or other evidence of indebtedness on which
a portion of or all interest payments, and/or the principal or
stated amount payable at maturity, redemption or retirement, is
determined by reference to prices, changes in prices, or
differences between prices, of securities, currencies,
intangibles, goods, articles or commodities (collectively
"Underlying Assets") or by another objective index, economic
factor or other measure, such as interest rates, currency
exchange rates, commodity indices, and securities indices
(collectively "Benchmarks"). Thus, Hybrid Instruments may take a
variety of forms, including, but not limited to, debt instruments
with interest or principal payments or redemption terms
determined by reference to the value of a currency or commodity
or securities index at a future point in time, preferred stock
with dividend rates determined by reference to the value of a
currency, or convertible securities with the conversion terms
related to a particular commodity.
Hybrid Instruments can be an efficient means of creating
exposure to a particular market, or segment of a market, with the
objective of enhancing total return. For example, a Fund may
wish to take advantage of expected declines in interest rates in
several European countries, but avoid the transactions costs
associated with buying and currency-hedging the foreign bond
positions. One solution would be to purchase a U.S. dollar-
denominated
PAGE 22
Hybrid Instrument whose redemption price is linked to the average
three year interest rate in a designated group of countries. The
redemption price formula would provide for payoffs of greater
than par if the average interest rate was lower than a specified
level, and payoffs of less than par if rates were above the
specified level. Furthermore, the Fund could limit the downside
risk of the security by establishing a minimum redemption price
so that the principal paid at maturity could not be below a
predetermined minimum level if interest rates were to rise
significantly. The purpose of this arrangement, known as a
structured security with an embedded put option, would be to give
the Fund the desired European bond exposure while avoiding
currency risk, limiting downside market risk, and lowering
transactions costs. Of course, there is no guarantee that the
strategy will be successful and the Fund could lose money if, for
example, interest rates do not move as anticipated or credit
problems develop with the issuer of the Hybrid.
The risks of investing in Hybrid Instruments reflect a
combination of the risks of investing in securities, options,
futures and currencies. Thus, an investment in a Hybrid
Instrument may entail significant risks that are not associated
with a similar investment in a traditional debt instrument that
has a fixed principal amount, is denominated in U.S. dollars or
bears interest either at a fixed rate or a floating rate
determined by reference to a common, nationally published
Benchmark. The risks of a particular Hybrid Instrument will, of
course, depend upon the terms of the instrument, but may include,
without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the
instrument is linked. Such risks generally depend upon factors
which are unrelated to the operations or credit quality of the
issuer of the Hybrid Instrument and which may not be readily
foreseen by the purchaser, such as economic and political events,
the supply and demand for the Underlying Assets and interest rate
movements. In recent years, various Benchmarks and prices for
Underlying Assets have been highly volatile, and such volatility
may be expected in the future. Reference is also made to the
discussion of futures, options, and forward contracts herein for
a discussion of the risks associated with such investments.
Hybrid Instruments are potentially more volatile and carry
greater market risks than traditional debt instruments.
Depending on the structure of the particular Hybrid Instrument,
changes in a Benchmark may be magnified by the terms of the
Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices
of the Hybrid Instrument and the Benchmark or Underlying Asset
may not move in the same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred
dividends at below market (or even relatively nominal) rates.
Alternatively, Hybrid Instruments may bear interest at above
market rates but bear an increased risk of principal loss (or
gain). The latter scenario may result if "leverage" is used to
structure the Hybrid Instrument. Leverage risk occurs when the
Hybrid Instrument is structured so that a given change in a
Benchmark or Underlying Asset is multiplied to produce a greater
value change in the Hybrid Instrument, thereby magnifying the
risk of loss as well as the potential for gain.
Hybrid Instruments may also carry liquidity risk since the
instruments are often "customized" to meet the portfolio needs of
a particular investor, and therefore, the number of investors
that are willing and able to buy such instruments in the
secondary market may be smaller than that for more traditional
debt securities. In addition, because the purchase and sale of
Hybrid Instruments could take place in an over-the-counter market
without the guarantee of a central clearing organization or in a
transaction between the Fund and the issuer of the Hybrid
Instrument, the creditworthiness of the counter party or issuer
of the Hybrid Instrument would be an additional risk
PAGE 23
PAGE 23
factor which the Fund would have to consider and monitor. Hybrid
Instruments also may not be subject to regulation of the
Commodities Futures Trading Commission ("CFTC"), which generally
regulates the trading of commodity futures by U.S. persons, the
SEC, which regulates the offer and sale of securities by and to
U.S. persons, or any other governmental regulatory authority.
The various risks discussed above, particularly the market
risk of such instruments, may in turn cause significant
fluctuations in the net asset value of the Fund. Accordingly,
the Fund will limit its investments in Hybrid Instruments to 10%
of net assets. However, because of their volatility, it is
possible that the Fund's investment in Hybrid Instruments will
account for more than 10% of the Fund's return (positive or
negative).
All Funds
When-Issued Securities and Forward Commitment Contracts
The Fund may purchase securities on a "when-issued" or
delayed delivery basis ("When-Issueds") and may purchase
securities on a forward commitment basis ("Forwards"). Any or
all of the Fund's investments in debt securities may be in the
form of When-Issueds and Forwards. The price of such securities,
which may be expressed in yield terms, is fixed at the time the
commitment to purchase is made, but delivery and payment take
place at a later date. Normally, the settlement date occurs
within 90 days of the purchase for When-Issueds, but may be
substantially longer for Forwards. During the period between
purchase and settlement, no payment is made by the Fund to the
issuer and no interest accrues to the Fund. The purchase of
these securities will result in a loss if their value declines
prior to the settlement date. This could occur, for example, if
interest rates increase prior to settlement. The longer the
period between purchase and settlement, the greater the risks
are. At the time the Fund makes the commitment to purchase these
securities, it will record the transaction and reflect the value
of the security in determining its net asset value. The Fund
will cover these securities by maintaining cash and/or liquid,
high-grade debt securities with its custodian bank equal in value
to commitments for them during the time between the purchase and
the settlement. Therefore, the longer this period, the longer
the period during which alternative investment options are not
available to the Fund (to the extent of the securities used for
cover). Such securities either will mature or, if necessary, be
sold on or before the settlement date.
To the extent the Fund remains fully or almost fully
invested (in securities with a remaining maturity of more than
one year) at the same time it purchases these securities, there
will be greater fluctuations in the Fund's net asset value than
if the Fund did not purchase them.
Additional Adjustable Rate Securities
Certain securities may be issued with adjustable interest
rates that are reset periodically by pre-determined formulas or
indexes in order to minimize movements in the principal value of
the investment. Such securities may have long-term maturities,
but may be treated as a short-term investment under certain
conditions. Generally, as interest rates decrease or increase,
the potential for capital appreciation or depreciation on these
securities is less than for fixed-rate obligations. These
securities may take the following forms:
Variable Rate Securities. Variable rate instruments are
those whose terms provide for the adjustment of their interest
rates on set dates and which, upon such adjustment, can
reasonably be expected to have a market value that approximates
its par value. A variable rate instrument, the principal
PAGE 24
PAGE 24
amount of which is scheduled to be paid in 397 days or less, is
deemed to have a maturity equal to the period remaining until the
next readjustment of the interest rate. A variable rate
instrument which is subject to a demand feature entitles the
purchaser to receive the principal amount of the underlying
security or securities, either (i) upon notice of no more than 30
days or (ii) at specified intervals not exceeding 397 days and
upon no more than 30 days' notice, is deemed to have a maturity
equal to the longer of the period remaining until the next
readjustment of the interest rate or the period remaining until
the principal amount can be recovered through demand.
Floating Rate Securities. Floating rate instruments are
those whose terms provide for the adjustment of their interest
rates whenever a specified interest rate changes and which, at
any time, can reasonably be expected to have a market value that
approximates its par value. The maturity of a floating rate
instrument is deemed to be the period remaining until the date
(noted on the face of the instrument) on which the principal
amount must be paid, or in the case of an instrument called for
redemption, the date on which the redemption payment must be
made. Floating rate instruments with demand features are deemed
to have a maturity equal to the period remaining until the
principal amount can be recovered through demand.
Put Option Bonds. Long-term obligations with maturities
longer than one year may provide purchasers an optional or
mandatory tender of the security at par value at predetermined
intervals, often ranging from one month to several years (e.g., a
30-year bond with a five-year tender period). These instruments
are deemed to have a maturity equal to the period remaining to
the put date.
Corporate Income, High Yield, New Income, Personal Strategy,
Prime Reserve, and Short-Term Bond, and Short-Term U.S.
Government Funds
Illiquid or Restricted Securities
Restricted securities may be sold only in privately
negotiated transactions or in a public offering with respect to
which a registration statement is in effect under the Securities
Act of 1933 (the "1933 Act"). Where registration is required,
the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to
sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop,
the Fund might obtain a less favorable price than prevailed when
it decided to sell. Restricted securities will be priced at fair
value as determined in accordance with procedures prescribed by
the Fund's Board of Directors/Trustees. If through the
appreciation of illiquid securities or the depreciation of liquid
securities, the Fund should be in a position where more than 15%
(10% for Prime Reserve and U.S. Treasury Money Funds) of the
value of its net assets is invested in illiquid assets, including
restricted securities, the Fund will take appropriate steps to
protect liquidity.
Notwithstanding the above, the Fund may purchase securities
which, while privately placed, are eligible for purchase and sale
under Rule 144A under the 1933 Act. This rule permits certain
qualified institutional buyers, such as the Fund, to trade in
privately placed securities even though such securities are not
registered under the 1933 Act. T. Rowe Price under the
supervision of the Fund's Board of Directors/Trustees, will
consider whether securities purchased under Rule 144A are
illiquid and thus subject to the Fund's restriction of investing
no more than 15% (10% for Prime Reserve and U.S. Treasury Money
Funds) of its net assets in illiquid securities. A determination
of whether a Rule 144A security is liquid or not is a question of
fact. In making this determination, T. Rowe Price will consider
the
PAGE 25
PAGE 25
trading markets for the specific security taking into account the
unregistered nature of a Rule 144A security. In addition, T.
Rowe Price could consider the (1) frequency of trades and quotes,
(2) number of dealers and potential purchases, (3) dealer
undertakings to make a market, and (4) the nature of the security
and of marketplace trades (e.g., the time needed to dispose of
the security, the method of soliciting offers and the mechanics
of transfer). The liquidity of Rule 144A securities would be
monitored, and if as a result of changed conditions it is
determined that a Rule 144A security is no longer liquid, the
Fund's holdings of illiquid securities would be reviewed to
determine what, if any, steps are required to assure that the
Fund does not invest more than 15% (10% for Prime Reserve and
U.S. Treasury Money Funds) of its net assets in illiquid
securities. Investing in Rule 144A securities could have the
effect of increasing the amount of the Fund's assets invested in
illiquid securities if qualified institutional buyers are
unwilling to purchase such securities.
New Income and Short-Term Bond Funds
Industry Concentration
When the market for corporate debt securities is dominated
by issues in the gas utility, gas transmission utility, electric
utility, telephone utility, or petroleum industry, the Fund will
as a matter of fundamental policy concentrate more than 25%, but
not more than 50%, of its assets, in any one such industry, if
the Fund has cash for such investment (i.e., will not sell
portfolio securities to raise cash) and, if in T. Rowe Price's
judgment, the return available and the marketability, quality,
and availability of the debt securities of such industry
justifies such concentration in light of the Fund's investment
objective. Domination would exist with respect to any one such
industry, when, in the preceding 30-day period, more than 25% of
all new-issue corporate debt offerings (within the four highest
grades of Moody's or S&P and with maturities of 10 years or less)
of $25,000,000 or more consisted of issues in such industry.
Although the Fund will normally purchase corporate debt
securities in the secondary market as opposed to new offerings,
T. Rowe Price believes that the new issue-based dominance
standard, as defined above, is appropriate because it is easily
determined and represents an accurate correlation to the
secondary market. Investors should understand that concentration
in any industry may result in increased risk. Investments in any
of these industries may be affected by environmental conditions,
energy conservation programs, fuel shortages, difficulty in
obtaining adequate return on capital in financing operations and
large construction programs, and the ability of the capital
markets to absorb debt issues. In addition, it is possible that
the public service commissions which have jurisdiction over these
industries may not grant future increases in rates sufficient to
offset increases in operating expenses. These industries also
face numerous legislative and regulatory uncertainties at both
federal and state government levels. Management believes that
any risk to the Fund which might result from concentration in any
industry will be minimized by the Fund's practice of diversifying
its investments in other respects. The Fund's policy with
respect to industry concentration is a fundamental policy. (For
investment restriction on industry concentration, see Investment
Restriction (3) on page 45.)
PORTFOLIO MANAGEMENT PRACTICES
Lending of Portfolio Securities
Securities loans are made to broker-dealers or institutional
investors or other persons, pursuant to agreements requiring that
the loans be continuously secured by collateral at least equal at
all times to the value of the securities lent marked to market on
a daily basis. The collateral received will consist of cash,
U.S. government securities, letters of credit
PAGE 26
or such other collateral as may be permitted under its investment
program. While the securities are being lent, the Fund will
continue to receive the equivalent of the interest or dividends
paid by the issuer on the securities, as well as interest on the
investment of the collateral or a fee from the borrower. The
Fund has a right to call each loan and obtain the securities
within the lesser of five business days or the normal settlement
period for such securities. The Fund will not have the right to
vote securities while they are being lent, but it will call a
loan in anticipation of any important vote. The risks in lending
portfolio securities, as with other extensions of secured credit,
consist of possible delay in receiving additional collateral or
in the recovery of the securities or possible loss of rights in
the collateral should the borrower fail financially. Loans will
only be made to firms deemed by T. Rowe Price to be of good
standing and will not be made unless, in the judgment of T. Rowe
Price, the consideration to be earned from such loans would
justify the risk.
Other Lending/Borrowing
Subject to approval by the Securities and Exchange
Commission and certain state regulatory agencies, the Fund may
make loans to, or borrow funds from, other mutual funds sponsored
or advised by T. Rowe Price or Rowe Price-Fleming International,
Inc. (collectively, "Price Funds"). The Fund has no current
intention of engaging in these practices at this time.
Repurchase Agreements
The Fund may enter into a repurchase agreement through which
an investor (such as the Fund) purchases a security (known as the
"underlying security") from a well-established securities dealer
or a bank that is a member of the Federal Reserve System. Any
such dealer or bank will be on T. Rowe Price's approved list. At
that time, the bank or securities dealer agrees to repurchase the
underlying security at the same price, plus specified interest.
Repurchase agreements are generally for a short period of time,
often less than a week. Repurchase agreements which do not
provide for payment within seven days will be treated as illiquid
securities. The Fund will only enter into repurchase agreements
where (i) (A) Prime Reserve and U.S. Treasury Money Funds--the
underlying securities are either U.S. government securities or
securities that, at the time the repurchase agreement is entered
into, are rated in the highest rating category by the requisite
number of NRSROs (as required by Rule 2a-7 under the 1940 Act)
and otherwise are of the type (excluding maturity limitations)
which the Fund's investment guidelines would allow it to purchase
directly, (B) GNMA, High Yield, New Income, Personal Strategy,
Short-Term Bond, Short-Term U.S. Government, and U.S. Treasury
Intermediate and Long-Term Funds--the underlying securities are
of the type (excluding maturity limitations) which the Fund's
investment guidelines would allow it to purchase directly, (ii)
the market value of the underlying security, including interest
accrued, will be at all times equal to or exceed the value of the
repurchase agreement, and (iii) payment for the underlying
security is made only upon physical delivery or evidence of book-
entry transfer to the account of the custodian or a bank acting
as agent. 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 security and losses,
including: (a) possible decline in the value of the underlying
security during the period while 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.
Reverse Repurchase Agreements
Although the Fund has no current intention, in the
foreseeable future, of engaging in reverse repurchase agreements,
the Fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a Fund is
the seller of, rather than the investor in, securities, and
agrees to repurchase them at an agreed upon time and price. Use
of a reverse
PAGE 27
repurchase agreement may be preferable to a regular sale and
later repurchase of the securities because it avoids certain
market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the Fund,
subject to Investment Restriction (1). (See "Investment
Restrictions," page 45.)
High Yield Fund
Short Sales
The Fund may make short sales for hedging purposes to
protect the Fund against companies whose credit is deteriorating.
Short sales are transactions in which the Fund sells a security
it does not own in anticipation of a decline in the market value
of that security. The Fund's short sales would be limited to
situations where the Fund owns a debt security of a company and
would sell short the common or preferred stock or another debt
security at a different level of the capital structure of the
same company. No securities will be sold short if, after the
effect is given to any such short sale, the total market value of
all securities sold short would exceed 2% of the value of the
Fund's net assets.
To complete a short sale transaction, the Fund must borrow
the security to make delivery to the buyer. The Fund then is
obligated to replace the security borrowed by purchasing it at
the market price at the time of replacement. The price at such
time may be more or less than the price at which the security was
sold by the Fund. Until the security is replaced, the Fund is
required to pay to the lender amounts equal to any dividends or
interest which accrue during the period of the loan. To borrow
the security, the Fund also may be required to pay a premium,
which would increase the cost of the security sold. The proceeds
of the short sale will be retained by the broker, to the extent
necessary to meet margin requirements, until the short position
is closed out.
Until the Fund replaces a borrowed security in connection
with a short sale, the Fund will: (a) maintain daily a segregated
account, containing cash or U.S. government securities, at such a
level that (i) the amount deposited in the account plus the
amount deposited with the broker as collateral will equal the
current value of the security sold short and (ii) the amount
deposited in the segregated account plus the amount deposited
with the broker as collateral will not be less than the market
value of the security at the time its was sold short; or (b)
otherwise cover its short position.
The Fund will incur a loss as a result of the short sale if
the price of the security sold short increases between the date
of the short sale and the date on which the Fund replaces the
borrowed security. The Fund will realize a gain if the security
sold short declines in price between those dates. This result is
the opposite of what one would expect from a cash purchase of a
long position in a security. The amount of any gain will be
decreased, and the amount of any loss increased, by the amount of
any premium, dividends or interest the Fund may be required to
pay in connection with a short sale. Any gain or loss on the
security sold short would be separate from a gain or loss on the
Fund security being hedged by the short sale.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Options
Options are a type of potentially high-risk derivative.
Writing Covered Call Options
The Fund may write (sell) American or European style
"covered" call options and purchase options to close out options
previously written by a
PAGE 28
Fund. In writing covered call options, the Fund expects to
generate additional premium income which should serve to enhance
the Fund's total return and reduce the effect of any price
decline of the security or currency involved in the option.
Covered call options will generally be written on securities or
currencies which, in T. Rowe Price's opinion, are not expected to
have any major price increases or moves in the near future but
which, over the long term, are deemed to be attractive
investments for the Fund.
A call option gives the holder (buyer) the "right to
purchase" a security or currency at a specified price (the
exercise price) at expiration of the option (European style) or
at any time until a certain date (the expiration date) (American
style). So long as the obligation of the writer of a call option
continues, he may be assigned an exercise notice by the broker-
dealer through whom such option was sold, requiring him to
deliver the underlying security or currency against payment of
the exercise price. This obligation terminates upon the
expiration of the call option, or such earlier time at which the
writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his
obligation to deliver the underlying security or currency in the
case of a call option, a writer is required to deposit in escrow
the underlying security or currency or other assets in accordance
with the rules of a clearing corporation.
The Fund will write only covered call options. This means
that the Fund will own the security or currency subject to the
option or an option to purchase the same underlying security or
currency, having an exercise price equal to or less than the
exercise price of the "covered" option, or will establish and
maintain with its custodian for the term of the option, an
account consisting of cash, U.S. government securities or other
liquid high-grade debt obligations having a value equal to the
fluctuating market value of the optioned securities or
currencies.
Portfolio securities or currencies on which call options may
be written will be purchased solely on the basis of investment
considerations consistent with the Fund's investment objective.
The writing of covered call options is a conservative investment
technique believed to involve relatively little risk (in contrast
to the writing of naked or uncovered options, which the Fund will
not do), but capable of enhancing the Fund's total return. When
writing a covered call option, a Fund, in return for the premium,
gives up the opportunity for profit from a price increase in the
underlying security or currency above the exercise price, but
conversely retains the risk of loss should the price of the
security or currency decline. Unlike one who owns securities or
currencies not subject to an option, the Fund has no control over
when it may be required to sell the underlying securities or
currencies, since it may be assigned an exercise notice at any
time prior to the expiration of its obligation as a writer. If a
call option which the Fund has written expires, the Fund will
realize a gain in the amount of the premium; however, such gain
may be offset by a decline in the market value of the underlying
security or currency during the option period. If the call
option is exercised, the Fund will realize a gain or loss from
the sale of the underlying security or currency. The Fund does
not consider a security or currency covered by a call to be
"pledged" as that term is used in the Fund's policy which limits
the pledging or mortgaging of its assets.
The premium received is the market value of an option. The
premium the Fund will receive from writing a call option will
reflect, among other things, the current market price of the
underlying security or currency, the relationship of the exercise
price to such market price, the historical price volatility of
the underlying security or currency, and the length of the option
period. Once the decision to write a call option has been made,
T. Rowe Price, in determining whether a particular call option
should be written on a particular security or currency, will
consider the reasonableness of the anticipated premium and the
likelihood that a liquid secondary market will
PAGE 29
exist for those options. The premium received by the Fund for
writing covered call options will be recorded as a liability of
the Fund. This liability will be adjusted daily to the option's
current market value, which will be the latest sale price at the
time at which the net asset value per share of the Fund is
computed (close of the New York Stock Exchange), or, in the
absence of such sale, the latest asked price. The option will be
terminated upon expiration of the option, the purchase of an
identical option in a closing transaction, or delivery of the
underlying security or currency upon the exercise of the option.
Closing transactions will be effected in order to realize a
profit on an outstanding call option, to prevent an underlying
security or currency from being called, or, to permit the sale of
the underlying security or currency. Furthermore, effecting a
closing transaction will permit the Fund to write another call
option on the underlying security or currency with either a
different exercise price or expiration date or both. If the Fund
desires to sell a particular security or currency from its
portfolio on which it has written a call option, or purchased a
put option, it will seek to effect a closing transaction prior
to, or concurrently with, the sale of the security or currency.
There is, of course, no assurance that the Fund will be able to
effect such closing transactions at favorable prices. If the
Fund cannot enter into such a transaction, it may be required to
hold a security or currency that it might otherwise have sold.
When the Fund writes a covered call option, it runs the risk of
not being able to participate in the appreciation of the
underlying securities or currencies above the exercise price, as
well as the risk of being required to hold on to securities or
currencies that are depreciating in value. This could result in
higher transaction costs. The Fund will pay transaction costs in
connection with the writing of options to close out previously
written options. Such transaction costs are normally higher than
those applicable to purchases and sales of portfolio securities.
Call options written by the Fund will normally have
expiration dates of less than nine months from the date written.
The exercise price of the options may be below, equal to, or
above the current market values of the underlying securities or
currencies at the time the options are written. From time to
time, the Fund may purchase an underlying security or currency
for delivery in accordance with an exercise notice of a call
option assigned to it, rather than delivering such security or
currency from its portfolio. In such cases, additional costs may
be incurred.
The Fund will realize a profit or loss from a closing
purchase transaction if the cost of the transaction is less or
more than the premium received from the writing of the option.
Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying
security or currency, any loss resulting from the repurchase of a
call option is likely to be offset in whole or in part by
appreciation of the underlying security or currency owned by the
Fund.
In order to comply with the requirements of several states,
the Fund will not write a covered call option if, as a result,
the aggregate market value of all portfolio securities or
currencies covering call or put options exceeds 25% of the market
value of the Fund's net assets. Should these state laws change
or should the Fund obtain a waiver of its application, the Fund
reserves the right to increase this percentage. In calculating
the 25% limit, the Fund will offset, against the value of assets
covering written calls and puts, the value of purchased calls and
puts on identical securities or currencies with identical
maturity dates.
Writing Covered Put Options
The Fund may write American or European style covered put
options and purchase options to close out options previously
written by the Fund. A put option gives the purchaser of the
option the right to sell, and the writer
PAGE 30
(seller) has the obligation to buy, the underlying security or
currency at the exercise price during the option period (American
style) or at the expiration of the option (European style). So
long as the obligation of the writer continues, he may be
assigned an exercise notice by the broker-dealer through whom
such option was sold, requiring him to make payment of the
exercise price against delivery of the underlying security or
currency. The operation of put options in other respects,
including their related risks and rewards, is substantially
identical to that of call options.
The Fund would write put options only on a covered basis,
which means that the Fund would maintain in a segregated account
cash, U.S. government securities or other liquid high-grade debt
obligations in an amount not less than the exercise price or the
Fund will own an option to sell the underlying security or
currency subject to the option having an exercise price equal to
or greater than the exercise price of the "covered" option at all
times while the put option is outstanding. (The rules of a
clearing corporation currently require that such assets be
deposited in escrow to secure payment of the exercise price.)
The Fund would generally write covered put options in
circumstances where T. Rowe Price wishes to purchase the
underlying security or currency for the Fund's portfolio at a
price lower than the current market price of the security or
currency. In such event the Fund would write a put option at an
exercise price which, reduced by the premium received on the
option, reflects the lower price it is willing to pay. Since the
Fund would also receive interest on debt securities or currencies
maintained to cover the exercise price of the option, this
technique could be used to enhance current return during periods
of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency
would decline below the exercise price less the premiums
received. Such a decline could be substantial and result in a
significant loss to the Fund. In addition, the Fund, because it
does not own the specific securities or currencies which it may
be required to purchase in exercise of the put, cannot benefit
from appreciation, if any, with respect to such specific
securities or currencies.
In order to comply with the requirements of several states,
the Fund will not write a covered put option if, as a result, the
aggregate market value of all portfolio securities or currencies
covering put or call options exceeds 25% of the market value of
the Fund's net assets. Should these state laws change or should
the Fund obtain a waiver of its application, the Fund reserves
the right to increase this percentage. In calculating the 25%
limit, the Fund will offset, against the value of assets covering
written puts and calls, the value of purchased puts and calls on
identical securities or currencies with identical maturity dates.
Purchasing Put Options
The Fund may purchase American or European style put
options. As the holder of a put option, the Fund has the right
to sell the underlying security or currency at the exercise price
at any time during the option period (American style) or at the
expiration of the option (European style). The Fund may enter
into closing sale transactions with respect to such options,
exercise them or permit them to expire. The Fund may purchase
put options for defensive purposes in order to protect against an
anticipated decline in the value of its securities or currencies.
An example of such use of put options is provided below.
The Fund may purchase a put option on an underlying security
or currency (a "protective put") owned by the Fund as a defensive
technique in order to protect against an anticipated decline in
the value of the security or currency. Such hedge protection is
provided only during the life of the put option when the Fund, as
the holder of the put option, is able to sell the underlying
security or currency at the put exercise price regardless of any
PAGE 31
decline in the underlying security's market price or currency's
exchange value. For example, a put option may be purchased in
order to protect unrealized appreciation of a security or
currency where T. Rowe Price deems it desirable to continue to
hold the security or currency because of tax considerations. The
premium paid for the put option and any transaction costs would
reduce any capital gain otherwise available for distribution when
the security or currency is eventually sold.
The Fund may also purchase put options at a time when the
Fund does not own the underlying security or currency. By
purchasing put options on a security or currency it does not own,
the Fund seeks to benefit from a decline in the market price of
the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the
underlying security or currency remains equal to or greater than
the exercise price during the life of the put option, the Fund
will lose its entire investment in the put option. In order for
the purchase of a put option to be profitable, the market price
of the underlying security or currency must decline sufficiently
below the exercise price to cover the premium and transaction
costs, unless the put option is sold in a closing sale
transaction.
To the extent required by the laws of certain states, the
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing put and call options. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The premium paid
by the Fund when purchasing a put option will be recorded as an
asset of the Fund. This asset will be adjusted daily to the
option's current market value, which will be the latest sale
price at the time at which the net asset value per share of the
Fund is computed (close of New York Stock Exchange), or, in the
absence of such sale, the latest bid price. This asset will be
terminated upon expiration of the option, the selling (writing)
of an identical option in a closing transaction, or the delivery
of the underlying security or currency upon the exercise of the
option.
Purchasing Call Options
The Fund may purchase American or European style call
options. As the holder of a call option, the Fund has the right
to purchase the underlying security or currency at the exercise
price at any time during the option period (American style) or at
the expiration of the option (European style). The Fund may
enter into closing sale transactions with respect to such
options, exercise them or permit them to expire. The Fund may
purchase call options for the purpose of increasing its current
return or avoiding tax consequences which could reduce its
current return. The Fund may also purchase call options in order
to acquire the underlying securities or currencies. Examples of
such uses of call options are provided below.
Call options may be purchased by the Fund for the purpose of
acquiring the underlying securities or currencies for its
portfolio. Utilized in this fashion, the purchase of call
options enables the Fund to acquire the securities or currencies
at the exercise price of the call option plus the premium paid.
At times the net cost of acquiring securities or currencies in
this manner may be less than the cost of acquiring the securities
or currencies directly. This technique may also be useful to the
Fund in purchasing a large block of securities or currencies that
would be more difficult to acquire by direct market purchases.
So long as it holds such a call option rather than the underlying
security or currency itself, the Fund is partially protected from
any unexpected decline in the market price of the underlying
security or currency and in such event could allow the call
option to expire, incurring a loss only to the extent of the
premium paid for the option.
PAGE 32
To the extent required by the laws of certain states, the
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing call and put options. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The Fund may also
purchase call options on underlying securities or currencies it
owns in order to protect unrealized gains on call options
previously written by it. A call option would be purchased for
this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call
options may also be purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The Fund may engage in transactions involving dealer
options. Certain risks are specific to dealer options. While
the Fund would look to a clearing corporation to exercise
exchange-traded options, if the Fund were to purchase a dealer
option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the
dealer to do so would result in the loss of the premium paid by
the Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous liquid
market while dealer options have none. Consequently, the Fund
will generally be able to realize the value of a dealer option it
has purchased only by exercising it or reselling it to the dealer
who issued it. Similarly, when the Fund writes a dealer option,
it generally will be able to close out the option prior to its
expiration only by entering into a closing purchase transaction
with the dealer to which the Fund originally wrote the option.
While the Fund will seek to enter into dealer options only with
dealers who will agree to and which are expected to be capable of
entering into closing transactions with the Fund, there can be no
assurance that the Fund will be able to liquidate a dealer option
at a favorable price at any time prior to expiration. Until the
Fund, as a covered dealer call option writer, is able to effect a
closing purchase transaction, it will not be able to liquidate
securities (or other assets) or currencies used as cover until
the option expires or is exercised. In the event of insolvency
of the contra party, the Fund may be unable to liquidate a dealer
option. With respect to options written by the Fund, the
inability to enter into a closing transaction may result in
material losses to the Fund. For example, since the Fund must
maintain a secured position with respect to any call option on a
security it writes, the Fund may not sell the assets which it has
segregated to secure the position while it is obligated under the
option. This requirement may impair a Fund's ability to sell
portfolio securities or currencies at a time when such sale might
be advantageous.
The Staff of the SEC has taken the position that purchased
dealer options and the assets used to secure the written dealer
options are illiquid securities. The Fund may treat the cover
used for written OTC options as liquid if the dealer agrees that
the Fund may repurchase the OTC option it has written for a
maximum price to be calculated by a predetermined formula. In
such cases, the OTC option would be considered illiquid only to
the extent the maximum repurchase price under the formula exceeds
the intrinsic value of the option. Accordingly, the Fund will
treat dealer options as subject to the Fund's limitation on
illiquid securities. If the SEC changes its position on the
liquidity of dealer options, the Fund will change its treatment
of such instrument accordingly.
High Yield Fund
Spread Option Transactions
The Fund may purchase from and sell to securities dealers
covered spread options. Such covered spread options are not
presently exchange listed or traded. The purchase of a spread
option gives the Fund the right to put, or
PAGE 33
sell, a security that it owns at a fixed dollar spread or fixed
yield spread in relationship to another security that the Fund
does not own, but which is used as a benchmark. The risk to the
Fund in purchasing covered spread options is the cost of the
premium paid for the spread option and any transaction costs. In
addition, there is no assurance that closing transactions will be
available. The purchase of spread options will be used to
protect the Fund against adverse changes in prevailing credit
quality spreads, i.e., the yield spread between high quality and
lower quality securities. Such protection is only provided
during the life of the spread option. The security covering the
spread option will be maintained in a segregated account by the
Fund's custodian. The Fund does not consider a security covered
by a spread option to be "pledged" as that term is used in the
Fund's policy limiting the pledging or mortgaging of its assets.
The Fund may also buy and sell uncovered spread options. Such
options would be used for the same purposes and be subject to
similar risks as covered spread options. However, in an
uncovered spread option, the Fund would not own either of the
securities involved in the spread.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Futures Contracts
Futures are a type of potentially high-risk derivative.
Transactions in Futures
The Fund may enter into futures contracts, including stock
index, interest rate and currency futures ("futures or futures
contracts").
Stock index futures contracts may be used to provide a hedge
for a portion of the Fund's portfolio, as a cash management tool,
or as an efficient way for T. Rowe Price to implement either an
increase or decrease in portfolio market exposure in response to
changing market conditions. The Fund may purchase or sell
futures contracts with respect to any stock index. Nevertheless,
to hedge the Fund's portfolio successfully, the Fund must sell
futures contacts with respect to indices or subindices whose
movements will have a significant correlation with movements in
the prices of the Fund's portfolio securities.
Interest rate or currency futures contracts may be used as a
hedge against changes in prevailing levels of interest rates or
currency exchange rates in order to establish more definitely the
effective return on securities or currencies held or intended to
be acquired by the Fund. In this regard, the Fund could sell
interest rate or currency futures as an offset against the effect
of expected increases in interest rates or currency exchange
rates and purchase such futures as an offset against the effect
of expected declines in interest rates or currency exchange
rates.
The Fund will enter into futures contracts which are traded
on national or foreign futures exchanges, and are standardized as
to maturity date and underlying financial instrument. Futures
exchanges and trading in the United States are regulated under
the Commodity Exchange Act by the CFTC. Futures are traded in
London, at the London International Financial Futures Exchange,
in Paris, at the MATIF, and in Tokyo, at the Tokyo Stock
Exchange. Although techniques other than the sale and purchase
of futures contracts could be used for the above-referenced
purposes, futures contracts offer an effective and relatively low
cost means of implementing the Fund's objectives in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each
PAGE 34
case in accordance with rules and regulations of the CFTC and
applicable state law.
The Fund may not purchase or sell futures contracts or
related options if, with respect to positions which do not
qualify as bona fide hedging under applicable CFTC rules, the sum
of the amounts of initial margin deposits and premiums paid on
those positions would exceed 5% of the net asset value of the
Fund after taking into account unrealized profits and unrealized
losses on any such contracts it has entered into; provided,
however, that in the case of an option that is in-the-money at
the time of purchase, the in-the-money amount may be excluded in
calculating the 5% limitation. For purposes of this policy
options on futures contracts and foreign currency options traded
on a commodities exchange will be considered "related options".
This policy may be modified by the Board of Directors/Trustees
without a shareholder vote and does not limit the percentage of
the Fund's assets at risk to 5%.
In accordance with the rules of the State of California, the
Fund may have to apply the above 5% test without excluding the
value of initial margin and premiums paid for bona fide hedging
positions.
The Fund's use of futures contracts will not result in
leverage. Therefore, to the extent necessary, in instances
involving the purchase of futures contracts or the writing of
call or put options thereon by the Fund, an amount of cash, U.S.
government securities or other liquid, high-grade debt
obligations, equal to the market value of the futures contracts
and options thereon (less any related margin deposits), will be
identified in an account with the Fund's custodian to cover the
position, or alternative cover (such as owning an offsetting
position) will be employed. Assets used as cover or held in an
identified account cannot be sold while the position in the
corresponding option or future is open, unless they are replaced
with similar assets. As a result, the commitment of a large
portion of a Fund's assets to cover or identified accounts could
impede portfolio management or the fund's ability to meet
redemption requests or other current obligations.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund
would comply with such new restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party
and purchase by another party of a specified amount of a specific
financial instrument (e.g., units of a debt security) for a
specified price, date, time and place designated at the time the
contract is made. Brokerage fees are incurred when a futures
contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred
to as buying or purchasing a contract or holding a long position.
Entering into a contract to sell is commonly referred to as
selling a contract or holding a short position.
Unlike when the Fund purchases or sells a security, no price
would be paid or received by the Fund upon the purchase or sale
of a futures contract. Upon entering into a futures contract,
and to maintain the Fund's open positions in futures contracts,
the Fund would be required to deposit with its custodian in a
segregated account in the name of the futures broker an amount of
cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as
"initial margin." The margin required for a particular futures
contract is set by the exchange on which the contract is traded,
and may be significantly modified from time to time by the
exchange during the term of the contract. Futures contracts are
customarily purchased and sold on margins that may range upward
from less than 5% of the value of the contract being traded.
PAGE 35
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
These subsequent payments, called "variation margin," to and
from the futures broker, are made on a daily basis as the price
of the underlying assets fluctuate making the long and short
positions in the futures contract more or less valuable, a
process known as "marking to the market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require
actual future delivery of and payment for the underlying
instruments, in practice most futures contracts are usually
closed out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract sale or purchase, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able
to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the
underlying instrument is not delivered, the contractual
obligations arising from the sale of one contract of September
Treasury Bills on an exchange may be fulfilled at any time before
delivery of the contract is required (i.e., on a specified date
in September, the "delivery month") by the purchase of one
contract of September Treasury Bills on the same exchange. In
such instance, the difference between the price at which the
futures contract was sold and the price paid for the offsetting
purchase, after allowance for transaction costs, represents the
profit or loss to the Fund.
A futures contract on the Standard & Poor's 500 Stock Index,
composed of 500 selected common stocks, most of which are listed
on the New York Stock Exchange, provides an example of how
futures contracts operate. The S&P 500 Index assigns relative
weightings to the common stocks included in the Index, and the
Index fluctuates with changes in the market values of those
common stocks. In the case of futures contracts on the S&P 500
Index, the contracts are to buy or sell 500 units. Thus, if the
value of the S&P 500 Index were $150, one contract would be worth
$75,000 (500 units x $150). The contract specifies that no
delivery of the actual stocks making up the index will take
place. Instead, settlement in cash occurs. Over the life of the
contract, the gain or loss realized by the Fund will equal the
difference between the purchase (or sale) price of the contract
and the price at which the contract is terminated. For example,
if the Fund enters into the example contract above and the S&P
500 Index is at $154 on the termination date, the Fund will gain
$2,000 (500 units x gain of $4). If, however, the S&P 500 Index
is at $148 on that future date, the Fund will lose $1,000 (500
units x loss of $2).
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts
are volatile and are influenced, among other things, by actual
and anticipated changes in the market and interest rates, which
in turn are affected by fiscal and
PAGE 36
monetary policies and national and international political and
economic events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular
type of futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price
movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting
some futures traders to substantial losses.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a
relatively small price movement in a futures contract may result
in immediate and substantial loss, as well as gain, to the
investor. For example, if at the time of purchase, 10% of the
value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable
losses if, instead of the futures contract, it had invested in
the underlying financial instrument and sold it after the
decline. Furthermore, in the case of a futures contract
purchase, in order to be certain that the Fund has sufficient
assets to satisfy its obligations under a futures contract, the
Fund earmarks to the futures contract money market instruments
equal in value to the current value of the underlying instrument
less the margin deposit.
Liquidity. The Fund may elect to close some or all of its
futures positions at any time prior to their expiration. The
Fund would do so to reduce exposure represented by long futures
positions or short futures positions. The Fund may close its
positions by taking opposite positions which would operate to
terminate the Fund's position in the futures contracts. Final
determinations of variation margin would then be made, additional
cash would be required to be paid by or released to the Fund, and
the Fund would realize a loss or a gain.
Futures contracts may be closed out only on the exchange or
board of trade where the contracts were initially traded.
Although the Fund intends to purchase or sell futures contracts
only on exchanges or boards of trade where there appears to be an
active market, there is no assurance that a liquid market on an
exchange or board of trade will exist for any particular contract
at any particular time. In such event, it might not be possible
to close a futures contract, and in the event of adverse price
movements, the Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures
contracts have been used to hedge the underlying instruments, the
Fund would continue to hold the underlying instruments subject to
the hedge until the futures contracts could be terminated. In
such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses
on the futures contract. However, as described below, there is
no guarantee that the price of the underlying instruments will,
in fact, correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures
contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of unexpected market
behavior, market or interest rate
PAGE 37
trends. There are several risks in connection with the use by
the Fund of futures contracts as a hedging device. One risk
arises because of the imperfect correlation between movements in
the prices of the futures contracts and movements in the prices
of the underlying instruments which are the subject of the hedge.
T. Rowe Price will, however, attempt to reduce this risk by
entering into futures contracts whose movements, in its judgment,
will have a significant correlation with movements in the prices
of the Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging
purposes is also subject to T. Rowe Price's ability to correctly
predict movements in the direction of the market. It is possible
that, when the Fund has sold futures to hedge its portfolio
against a decline in the market, the index, indices, or
instruments underlying futures might advance and the value of the
underlying instruments held in the Fund's portfolio might
decline. If this were to occur, the Fund would lose money on the
futures and also would experience a decline in value in its
underlying instruments. However, while this might occur to a
certain degree, T. Rowe Price believes that over time the value
of the Fund's portfolio will tend to move in the same direction
as the market indices used to hedge the portfolio. It is also
possible that if the Fund were to hedge against the possibility
of a decline in the market (adversely affecting the underlying
instruments held in its portfolio) and prices instead increased,
the Fund would lose part or all of the benefit of increased value
of those underlying instruments that it has hedged, because it
would have offsetting losses in its futures positions. In
addition, in such situations, if the Fund had insufficient cash,
it might have to sell underlying instruments to meet daily
variation margin requirements. Such sales of underlying
instruments might be, but would not necessarily be, at increased
prices (which would reflect the rising market). The Fund might
have to sell underlying instruments at a time when it would be
disadvantageous to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
portfolio being hedged, the price movements of futures contracts
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions, which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by T.
Rowe Price might not result in a successful hedging transaction
over a very short time period.
Options on Futures Contracts
The Fund may purchase and sell options on the same types of
futures in which it may invest.
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the
right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase
or sell the futures contract, at a specified exercise price at
any time during the period of the option. Upon exercise of the
option, the
PAGE 38
delivery of the futures position by the writer of the option to
the holder of the option will be accompanied by the delivery of
the accumulated balance in the writer's futures margin account
which represents the amount by which the market price of the
futures contract, at exercise, exceeds (in the case of a call) or
is less than (in the case of a put) the exercise price of the
option on the futures contract. Purchasers of options who fail
to exercise their options prior to the exercise date suffer a
loss of the premium paid.
As an alternative to writing or purchasing call and put
options on interest rate futures, the Fund may write or purchase
call and put options on financial indices. Such options would be
used in a manner similar to the use of options on futures
contracts. From time to time, a single order to purchase or sell
futures contracts (or options thereon) may be made on behalf of
the Fund and other T. Rowe Price Funds. Such aggregated orders
would be allocated among the Funds and the other T. Rowe Price
Funds in a fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks of Transactions on
Futures Contracts" are substantially the same as the risks of
using options on futures. In addition, where the Fund seeks to
close out an option position by writing or buying an offsetting
option covering the same index, underlying instrument or contract
and having the same exercise price and expiration date, its
ability to establish and close out positions on such options will
be subject to the maintenance of a liquid secondary market.
Reasons for the absence of a liquid secondary market on an
exchange include the following: (i) there may be insufficient
trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or
series of options, or underlying instruments; (iv) unusual or
unforeseen circumstances may interrupt normal operations on an
exchange; (v) the facilities of an exchange or a clearing
corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic
or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or
series of options), in which event the secondary market on that
exchange (or in the class or series of options) would cease to
exist, although outstanding options on the exchange that had been
issued by a clearing corporation as a result of trades on that
exchange would continue to be exercisable in accordance with
their terms. There is no assurance that higher than anticipated
trading activity or other unforeseen events might not, at times,
render certain of the facilities of any of the clearing
corporations inadequate, and thereby result in the institution by
an exchange of special procedures which may interfere with the
timely execution of customers' orders.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in
futures or options transactions other than those described above,
it reserves the right to do so. Such futures and options trading
might involve risks which differ from those involved in the
futures and options described above.
Foreign Futures and Options
Participation in foreign futures and foreign options
transactions involves the execution and clearing of trades on or
subject to the rules of a foreign board of trade. Neither the
National Futures Association nor any domestic exchange regulates
activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the
PAGE 39
power to compel enforcement of the rules of a foreign board of
trade or any applicable foreign law. This is true even if the
exchange is formally linked to a domestic market so that a
position taken on the market may be liquidated by a transaction
on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or
foreign options transaction occurs. For these reasons, when the
Fund trades foreign futures or foreign options contracts, it may
not be afforded certain of the protective measures provided by
the Commodity Exchange Act, the CFTC's regulations and the rules
of the National Futures Association and any domestic exchange,
including the right to use reparations proceedings before the
Commission and arbitration proceedings provided by the National
Futures Association or any domestic futures exchange. In
particular, funds received from the Fund for foreign futures or
foreign options transactions may not be provided the same
protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any
foreign futures or foreign options contract and, therefore, the
potential profit and loss thereon may be affected by any variance
in the foreign exchange rate between the time the Fund's order is
placed and the time it is liquidated, offset or exercised.
U.S. Treasury Intermediate and Long-Term Funds
Limitations on Futures and Options for
Intermediate and Long-Term Funds
The Funds will not purchase a futures contract or option
thereon if, with respect to positions in futures or options on
futures which do not represent bona fide hedging, the aggregate
initial margin and premiums on such positions would exceed 5% of
the Fund's net asset value. In addition, neither of the Funds
will enter into a futures transaction if it would be obligated to
purchase or deliver under outstanding open futures contracts
amounts which would exceed 15% of the Fund's total assets.
A Fund will not write a covered call option if, as a result,
the aggregate market value of all portfolio securities covering
call options or subject to delivery under put options exceeds 15%
of the market value of the Fund's total assets.
A Fund will not write a covered put option if, as a result,
the aggregate market value of all portfolio securities subject to
such put options or covering call options exceeds 15% of the
market value of the Fund's total assets.
In order to comply with the laws of certain states, a Fund
will not invest more than 5% of its total assets in premiums on
put options. Should these state laws change or should a Fund
obtain a waiver of their applications, the Fund may invest up to
15% of its total assets in premiums on put options.
In order to comply with the laws of certain states, a Fund
will not invest more than 5% of its total assets in premiums on
call options. Should these state laws change or should a Fund
obtain a waiver of their applications, the Fund may invest up to
15% of its total assets in premiums on call options.
In order to comply with the laws of certain states, a Fund
will not purchase puts, calls, straddles, spreads and any
combination thereof if by reason thereof the value of its
aggregate investment in such classes of securities will exceed 5%
of its total assets. Should these state laws change or should a
Fund obtain a waiver of their application, the Fund may invest a
higher percentage of its total assets in puts, calls, straddles,
or spreads.
PAGE 40
The total amount of a Fund's total assets invested in
futures and options under any combination of the limitations
described above will not exceed 15% of the Fund's total assets.
Corporate Income, High Yield, New Income, Personal Strategy, and
Short-Term Bond Funds
Foreign Currency Transactions
A forward foreign currency exchange contract involves an
obligation to purchase or sell a specific currency at a future
date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are principally traded in the
interbank market conducted directly between currency traders
(usually large, commercial banks) and their customers. A forward
contract generally has no deposit requirement, and no commissions
are charged at any stage for trades.
The Fund may enter into forward contracts for a variety of
purposes in connection with the management of the foreign
securities portion of its portfolio. The Fund's use of such
contracts would include, but not be limited to, the following:
First, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, it may
desire to "lock in" the U.S. dollar price of the security. By
entering into a forward contract for the purchase or sale, for a
fixed amount of dollars, of the amount of foreign currency
involved in the underlying security transactions, the Fund will
be able to protect itself against a possible loss resulting from
an adverse change in the relationship between the U.S. dollar and
the subject foreign currency during the period between the date
the security is purchased or sold and the date on which payment
is made or received.
Second, when T. Rowe Price believes that one currency may
experience a substantial movement against another currency,
including the U.S. dollar, it may enter into a forward contract
to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. Alternatively,
where appropriate, the Fund may hedge all or part of its foreign
currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an
effective proxy for other currencies. In such a case, the Fund
may enter into a forward contract where the amount of the foreign
currency to be sold exceeds the value of the securities
denominated in such currency. The use of this basket hedging
technique may be more efficient and economical than entering into
separate forward contracts for each currency held in the Fund.
The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible
since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of
those securities between the date the forward contract is entered
into and the date it matures. The projection of short-term
currency market movement is extremely difficult, and the
successful execution of a short-term hedging strategy is highly
uncertain. Under normal circumstances, consideration of the
prospect for currency parities will be incorporated into the
longer term investment decisions made with regard to overall
diversification strategies. However, T. Rowe Price believes that
it is important to have the flexibility to enter into such
forward contracts when it determines that the best interests of
the Fund will be served.
Third, the Fund may use forward contracts when the Fund
wishes to hedge out of the dollar into a foreign currency in
order to create a synthetic bond or money market instrument--the
security would be issued in U.S. dollars but the dollar component
would be transformed into a foreign currency through a forward
contract.
PAGE 41
The Fund may enter into forward contacts for any other
purpose consistent with the Fund's investment objective and
program. However, the Fund will not enter into a forward
contract, or maintain exposure to any such contract(s), if the
amount of foreign currency required to be delivered thereunder
would exceed the Fund's holdings of liquid, high-grade debt
securities and currency available for cover of the forward
contract(s). In determining the amount to be delivered under a
contract, the Fund may net offsetting positions.
At the maturity of a forward contract, the Fund may sell the
portfolio security and make delivery of the foreign currency, or
it may retain the security and either extend the maturity of the
forward contract (by "rolling" that contract forward) or may
initiate a new forward contract.
If the Fund retains the portfolio security and engages in an
offsetting transaction, the Fund will incur a gain or a loss (as
described below) to the extent that there has been movement in
forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward
contract to sell the foreign currency. Should forward prices
decline during the period between the Fund's entering into a
forward contract for the sale of a foreign currency and the date
it enters into an offsetting contract for the purchase of the
foreign currency, the Fund will realize a gain to the extent the
price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward prices
increase, the Fund will suffer a loss to the extent of the price
of the currency it has agreed to purchase exceeds the price of
the currency it has agreed to sell.
The Fund's dealing in forward foreign currency exchange
contracts will generally be limited to the transactions described
above. However, the Fund reserves the right to enter into
forward foreign currency contracts for different purposes and
under different circumstances. Of course, the Fund is not
required to enter into forward contracts with regard to its
foreign currency-denominated securities and will not do so unless
deemed appropriate by T. Rowe Price. It also should be realized
that this method of hedging against a decline in the value of a
currency does not eliminate fluctuations in the underlying prices
of the securities. It simply establishes a rate of exchange at a
future date. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the
hedged currency, at the same time, they tend to limit any
potential gain which might result from an increase in the value
of that currency.
Although the Fund values its assets daily in terms of U.S.
dollars, it does not intend to convert its holdings of foreign
currencies into U.S. dollars on a daily basis. It will do so
from time to time, and investors should be aware of the costs of
currency conversion. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on
the difference (the "spread") between the prices at which they
are buying and selling various currencies. Thus, a dealer may
offer to sell a foreign currency to the Fund at one rate, while
offering a lesser rate of exchange should the Fund desire to
resell that currency to the dealer.
Federal Tax Treatment of Options, Futures Contracts and Forward
Foreign Exchange Contracts
The Fund may enter into certain options, futures, and
forward foreign exchange contracts, including options and futures
on currencies, which will be treated as Section 1256 contracts or
straddles.
Transactions which are considered Section 1256 contracts
will be considered to have been closed at the end of the Fund's
fiscal year and any gains or losses will be recognized for tax
purposes at that time. Such gains or losses from the normal
closing or settlement of such transactions will be characterized
as 60% long-term capital gain or loss and 40% short-term capital
gain or loss regardless of the holding period of the instrument.
The Fund
PAGE 42
will be required to distribute net gains on such transactions to
shareholders even though it may not have closed the transaction
and received cash to pay such distributions.
Options, futures and forward foreign exchange contracts,
including options and futures on currencies, which offset a
foreign dollar denominated bond or currency position may be
considered straddles for tax purposes, in which case a loss on
any position in a straddle will be subject to deferral to the
extent of unrealized gain in an offsetting position. The holding
period of the securities or currencies comprising the straddle
will be deemed not to begin until the straddle is terminated.
For securities offsetting a purchased put, this adjustment of the
holding period may increase the gain from sales of securities
held less than three months. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an
equity security will not include the period of time the option is
outstanding.
Losses on written covered calls and purchased puts on
securities, excluding certain "qualified covered call" options on
equity securities, may be long-term capital loss, if the security
covering the option was held for more than twelve months prior to
the writing of the option.
In order for the Fund to continue to qualify for federal
income tax treatment as a regulated investment company, at least
90% of its gross income for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income derived from
loans of securities, and gains from the sale of securities or
currencies. Pending tax regulations could limit the extent that
net gain realized from option, futures or foreign forward
exchange contracts on currencies is qualifying income for
purposes of the 90% requirement. In addition, gains realized on
the sale or other disposition of securities, including option,
futures or foreign forward exchange contracts on securities or
securities indexes and, in some cases, currencies, held for less
than three months, must be limited to less than 30% of the Fund's
annual gross income. In order to avoid realizing excessive gains
on securities or currencies held less than three months, the Fund
may be required to defer the closing out of option, futures or
foreign forward exchange contracts) beyond the time when it would
otherwise be advantageous to do so. It is anticipated that
unrealized gains on Section 1256 option, futures and foreign
forward exchange contracts, which have been open for less than
three months as of the end of the Fund's fiscal year and which
are recognized for tax purposes, will not be considered gains on
securities or currencies held less than three months for purposes
of the 30% test.
INVESTMENT RESTRICTIONS
Fundamental policies may not be changed without the approval
of the lesser of (1) 67% of the Fund's shares present at a
meeting of shareholders if the holders of more than 50% of the
outstanding shares are present in person or by proxy or (2) more
than 50% of the Fund's outstanding shares. Other restrictions in
the form of operating policies are subject to change by the
Fund's Board of Directors/Trustees without shareholder approval.
Any investment restriction which involves a maximum percentage of
securities or assets shall not be considered to be violated
unless an excess over the percentage occurs immediately after,
and is caused by, an acquisition of securities or assets of, or
borrowings by, the Fund.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing. Borrow money except that the Fund may
(i) borrow for non-leveraging, temporary or
emergency purposes and (ii) engage in reverse
repurchase agreements and make other investments
or engage in other transactions, which may
PAGE 43
involve a borrowing, in a manner consistent with
the Fund's investment objective and program,
provided that the combination of (i) and (ii)
shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount
borrowed) less liabilities (other than borrowings)
or such other percentage permitted by law. Any
borrowings which come to exceed this amount will
be reduced in accordance with applicable law. The
Fund may borrow from banks, other Price Funds or
other persons to the extent permitted by
applicable law.
(2) Commodities. Purchase or sell physical
commodities; except that the Fund (other than the
Prime Reserve and Treasury Money Funds) may enter
into futures contracts and options thereon;
(3) (a) Industry Concentration (All Funds, except High
Yield, New Income, Prime Reserve and Short-Term
Bond Funds). Purchase the securities of any
issuer if, as a result, more than 25% of the value
of the Fund's total assets would be invested in
the securities of issuers having their principal
business activities in the same industry;
(b) Industry Concentration (High Yield Fund).
Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's
total assets would be invested in the securities
of issuers having their principal business
activities in the same industry; provided,
however, that the Fund will normally invest more
than 25% of its total assets in the securities of
the banking industry including, but not limited
to, bank certificates of deposit and bankers'
acceptances, when the Fund's position in issues
maturing in one year or less equals 35% or more of
the Fund's total assets;
(c) Industry Concentration (New Income Fund).
Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's
total assets would be invested in the securities
of issuers having their principal business
activities in the same industry; provided,
however, that the Fund will invest more than 25%
of its total assets, but not more than 50%, in any
one of the gas utility, gas transmission utility,
electric utility, telephone utility, and petroleum
industries under certain circumstances, and
further provided that this limitation does not
apply to securities of the banking industry
including, but not limited to, certificates of
deposit and bankers' acceptances;
(d) Industry Concentration (Prime Reserve Fund).
Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's
total assets would be invested in the securities
of issuers having their principal business
activities in the same industry; provided,
however, that this limitation does not apply to
securities of the banking industry including, but
not limited to, certificates of deposit and
bankers' acceptances; and
(e) Industry Concentration (Short-Term Bond Fund).
Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's
total assets would be invested in the securities
of issuers having their principal business
activities in the same industry; provided,
however, that the Fund will normally invest more
than 25% of its total assets
PAGE 44
in the securities of the banking industry
including, but not limited to, bank certificates
of deposit and bankers' acceptances when the
Fund's position in issues maturing in one year or
less equals 35% or more of the Fund's total
assets; provided, further, that the Fund will
invest more than 25% of its total assets, but not
more than 50%, in any one of the gas utility, gas
transmission utility, electric utility, telephone
utility, and petroleum industries under certain
circumstances;
(4) Loans. Make loans, although the Fund may (i) lend
portfolio securities and participate in an
interfund lending program with other Price Funds
provided that no such loan may be made if, as a
result, the aggregate of such loans would exceed
33 1/3% of the value of the Fund's total assets;
(ii) purchase money market securities and enter
into repurchase agreements; and (iii) acquire
publicly-distributed or privately-placed debt
securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of its total assets,
more than 5% of the value of the Fund's total
assets would be invested in the securities of a
single issuer, except securities issued or
guaranteed by the U.S. Government or any of its
agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of the Fund's total
assets, more than 10% of the outstanding voting
securities of any issuer would be held by the Fund
(other than obligations issued or guaranteed by
the U.S. Government, its agencies or
instrumentalities);
(7) Real Estate. Purchase or sell real estate,
including limited partnership interests therein,
unless acquired as a result of ownership of
securities or other instruments (but this shall
not prevent the Fund from investing in securities
or other instruments backed by real estate or
securities of companies engaged in the real estate
business);
(8) Senior Securities. Issue senior securities except
in compliance with the Investment Company Act of
1940; or
(9) Underwriting. Underwrite securities issued by
other persons, except to the extent that the Fund
may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in
connection with the purchase and sale of its
portfolio securities in the ordinary course of
pursuing its investment program.
NOTES
The following Notes should be read in connection
with the above-described fundamental policies.
The Notes are not fundamental policies.
With respect to investment restrictions (1) and
(4) the Fund will not borrow from or lend to any
other T. Rowe Price Fund unless each Fund applies
for and receives an exemptive order from the SEC
or the SEC issues rules permitting such
transactions. The Fund has no current intention
of engaging
PAGE 45
in any such activity and there is no assurance the
SEC would grant any order requested by the Fund or
promulgate any rules allowing the transactions.
With respect to investment restriction (1), the
Prime Reserve and U.S. Treasury Money Funds have
no current intention of engaging in any borrowing
transactions.
With respect to investment restriction (2), the
Fund does not consider currency contracts or
hybrid instruments to be commodities.
For purposes of investment restriction (3), U.S.,
state or local governments, or related agencies or
instrumentalities, are not considered an industry.
Industries are determined by reference to the
classifications of industries set forth in the
Fund's Semi-annual and Annual Reports.
For purposes of investment restriction (4), the
Fund will consider the acquisition of a debt
security to include the execution of a note or
other evidence of an extension of credit with a
term of more than nine months.
For purposes of investment restriction (5), the
Fund will consider a repurchase agreement fully
collateralized with U.S. government securities to
be U.S. government securities.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing. The Fund will not purchase additional
securities when money borrowed exceeds 5% of its
total assets.
(2) Control of Portfolio Companies. Invest in
companies for the purpose of exercising management
or control;
(3) (a) Equity Securities (All Funds, except High
Yield and New Income Funds). Purchase any equity
securities, or securities convertible into equity
securities except as set forth in its prospectus
and operating policy on investment companies;
(b) Equity Securities (High Yield Fund). Invest
more than 20% of the Fund's total assets in equity
securities (including up to 5% in warrants);
(c) Equity Securities (New Income Fund). Invest
more than 25% of its total assets in equity
securities;
(4) Futures Contracts. Purchase a futures contract or
an option thereon if, with respect to positions in
futures or options on futures which do not
represent bona fide hedging, the aggregate initial
margin and premiums on such positions would exceed
5% of the Fund's net asset value.
(5) Illiquid Securities. Purchase illiquid securities
and securities of unseasoned issuers if, as a
result, more than 15% (10% for the Prime Reserve
and U.S. Treasury Money Funds) of its net of a
Fund's net assets would be invested in such
securities, provided that the Fund will not invest
more than 10% of its total assets in restricted
securities and not more than 5% in securities of
unseasoned issuers. Securities eligible for
resale under Rule 144A of the
PAGE 46
Securities Act of 1933 are not included in the 10%
limitation but are subject to the 15% limitation;
(6) Investment Companies. Purchase securities of
open-end or closed-end investment companies except
in compliance with the Investment Company Act of
1940 and applicable state law, and in the case of
the Prime Reserve and U.S. Treasury Money Funds,
only securities of other money market funds.
Duplicate fees may result from such purchases;
(7) Margin. Purchase securities on margin, except (i)
for use of short-term credit necessary for
clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection
with futures contracts or other permissible
investments;
(8) Mortgaging. Mortgage, pledge, hypothecate or, in
any manner, transfer any security owned by the
Fund as security for indebtedness except as may be
necessary in connection with permissible
borrowings or investments and then such
mortgaging, pledging or hypothecating may not
exceed 33 1/3%
of the Fund's total assets at the time of
borrowing or investment;
(9) Oil and Gas Programs. Purchase participations or
other direct interests or enter into leases with
respect to, oil, gas, or other mineral exploration
or development programs;
(10) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement
of Additional Information;
(11) Ownership of Portfolio Securities by Officers and
Directors. Purchase or retain the securities of
any issuer if those officers and directors of the
Fund, and of its investment manager, who each own
beneficially more than .5% of the outstanding
securities of such issuer, together own
beneficially more than 5% of such securities.
(12) (a) Short Sales (All Funds except High Yield
Fund). Effect short sales of securities;
(b) Short Sales (High Yield Fund). Effect short
sales of securities, other than as set forth in
its prospectus and Statement of Additional
Information;
(13) Unseasoned Issuers. Purchase a security (other
than obligations issued or guaranteed by the U.S.,
any foreign, state or local government, their
agencies or instrumentalities) if, as a result,
more than 5% of the value of the Fund's total
assets would be invested in the securities issuers
which at the time of purchase had been in
operation for less than three years (for this
purpose, the period of operation of any issuer
shall include the period of operation of any
predecessor or unconditional guarantor of such
issuer). This restriction does not apply to
securities of pooled investment vehicles or
mortgage or asset-backed securities; or
(14) Warrants. Invest in warrants if, as a result
thereof, more than 2% of the value of the net
assets of the Fund would be Stock Exchange, the
American Stock Exchange, or a recognized foreign
exchange, or more than 5% of the value of the net
PAGE 47
assets of the Fund would be invested in warrants
whether or not so listed. For purposes of these
percentage limitations, the warrants will be
valued at the lower of cost or market and warrants
acquired by the Fund in units or attached to
securities may be deemed to be without value.
Personal Strategy Funds
Notwithstanding anything in the above fundamental and
operating restrictions to the contrary, the Fund may invest all
of its assets in a single investment company or a series thereof
in connection with a "master-feeder" arrangement. Such an
investment would be made where the Fund (a "Feeder"), and one or
more other Funds with the same investment objective and program
as the Fund, sought to accomplish its investment objective and
program by investing all of its assets in the shares of another
investment company (the "Master"). The Master would, in turn,
have the same investment objective and program as the Fund. The
Fund would invest in this manner in an effort to achieve the
economies of scale associated with having a Master fund make
investments in portfolio companies on behalf of a number of
Feeder funds.
MANAGEMENT OF FUND
The officers and directors/trustees of the Fund are
listed below. Unless otherwise noted, the address of each is 100
East Pratt Street, Baltimore, Maryland 21202. Except as
indicated, each has been an employee of T. Rowe Price for more
than five years. In the list below, the Fund's
directors/trustees who are considered "interested persons" of T.
Rowe Price as defined under Section 2(a)(19) of the Investment
Company Act of 1940 are noted with an asterisk (*). These
directors/trustees are referred to as inside directors by virtue
of their officership, directorship, and/or employment with T.
Rowe Price.
All Funds, except Personal Strategy Funds
Independent Directors/Trustees
ROBERT P. BLACK, Retired; formerly President, Federal Reserve
Bank of Richmond; Address: 10 Dahlgren Road, Richmond, Virginia
23233
CALVIN W. BURNETT, Ph.D., President, Coppin State College;
Director, Maryland Chamber of Commerce and Provident Bank of
Maryland; Former President, Baltimore Area Council Boy Scouts of
America; Vice President, Board of Directors, The Walters Art
Gallery; Address: 2500 West North Avenue, Baltimore, Maryland
21216
ANTHONY W. DEERING, Director, President and Chief Operating
Officer, The Rouse Company, real estate developers, Columbia,
Maryland; Advisory Director, Kleinwort, Benson (North America)
Corporation, a registered broker-dealer; Address: 10275 Little
Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, President, F. Pierce Linaweaver &
Associates, Inc., Consulting Environmental & Civil Engineer(s);
formerly Executive Vice President, EA Engineering, Science, and
Technology, Inc., and President, EA Engineering, Inc., Baltimore,
Maryland; Address: 224 Wendover Road, Baltimore, Maryland 21218
JOHN G. SCHREIBER, President, Schreiber Investments, Inc., a real
estate investment company; Director, AMLI Residential Properties
Trust and Urban Shopping Centers, Inc.; Partner, Blackstone Real
Estate Partners, L.P.; Director and formerly Executive Vice
President, JMB Realty Corporation, a national real estate
investment manager and developer; Address: 1115 East Illinois
Road, Lake Forest, Illinois 60045
Personal Strategy Funds
PAGE 48
DONALD W. DICK, JR., Principal, Eurocapital Advisors, LLC, and
acquisition and management advisory Firm; formerly Principal,
Overseas Partners, Inc., a financial investment firm; formerly
Director and Vice President, Consumer Products Division,
McCormick & Company, Inc., international food processors;
formerly Director, Waverly Press, Inc., Baltimore, Maryland;
Address: P.O Box 491, Chilmark, MA 02535-0491
DAVID K. FAGIN, Chairman and Director, Golden Star Resources,
Ltd.; formerly President, Chief Operating Officer and Director,
Homestake Mining Company; Address: One Norwest Center, 1700
Lincoln Street, Suite 1950, Denver, Colorado 80203
HANNE M. MERRIMAN, Retail business consultant; formerly,
President and Chief Operating Officer, Nan Duskin, Inc., a
women's specialty store; Director and Chairman, Federal Reserve
Bank of Richmond; and President and Chief Executive Officer,
Honeybee, Inc., a division of Spiegel, Inc; Director, Ann Taylor
Stores Corporation; Central Illinois Public Service Company,
CIPSCO Incorporated; The Rouse Company; State Farm Mutual
Automobile Insurance Company and USAir Group, Inc.; Member,
National Women's Forum; Trustee, American-Scandinavian
Foundation; Address: One James Center, 901 East Cary Street,
Richmond, Virginia 23219-4030
HUBERT D. VOS, President, Stonington Capital Corporation, a
private investment company; Address: 1231 State Street, Suite
210, Santa Barbara, CA 93190-0409
PAUL M. WYTHES, Founding General Partner, Sutter Hill Ventures, a
venture capital limited partnership providing equity capital to
young high technology companies throughout the United States;
Director, Teltone Corporation (Seattle, WA), Interventional
Technologies Inc. (San Diego, CA), and Sutter Hill Investments,
Mauritius (Mauritius); Address: 755 Page Mill Road, Suite A200,
Palo Alto, California 94304
All Funds
Officers
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., T. Rowe Price Trust Company and T. Rowe Price Investment
Services, Inc.; Director, Rhone-Poulenc Rorer, Inc.
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Trust Company; Vice President, Price-Fleming and T. Rowe Price
Retirement Plan Services, Inc.
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price,
and T. Rowe Price Trust Company
ROGER L. FIERY, III, Assistant Vice President--Vice President,
Price-Fleming and T. Rowe Price
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President, T.
Rowe Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T.
Rowe Price
PAGE 49
Corporate Income Fund
*GEORGE J. COLLINS, Director--President, Managing Director and
Chief Executive Officer, T. Rowe Price; Director, Price-Fleming,
T. Rowe Price Trust Company and T. Rowe Price Retirement Plan
Services, Inc.; Chartered Investment Counselor
*WILLIAM T. REYNOLDS, Chairman of the Board--Managing Director,
T. Rowe Price; Chartered Financial Analyst
*PETER VAN DYKE, President and Chairman--Managing Director, T.
Rowe Price; Vice President, Price-Fleming and T. Rowe Price Trust
Company
MARK J. VASELKIV, Executive Vice President--Vice President, T.
Rowe Price
STEVEN G. BROOKS, Vice President--Vice President, T. Rowe Price;
Chartered Financial Analyst
PATRICK S. CASSIDY, Vice President--Vice President, T. Rowe
Price; Chartered Financial Analyst
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Price-Fleming
THEA N. WILLIAMS, Vice President--Vice President, T. Rowe Price
GNMA Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director and Chief Executive Officer, T. Rowe Price; Director,
Price-Fleming, T. Rowe Price Trust Company and T. Rowe Price
Retirement Plan Services, Inc.; Chartered Investment Counselor
PETER VAN DYKE, President--Managing Director, T. Rowe Price; Vice
President, Price-Fleming and T. Rowe Price Trust Company
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company; formerly charter member of the
U.S. Senior Executive Service and Director, Analysis and
Evaluation Division in the Office of Water Regulations and
Standards of the U.S. Environmental Protection Agency
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Price-Fleming
High Yield Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director and Chief Executive Officer, T. Rowe Price; Director,
Price-Fleming, T. Rowe Price Trust Company and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
ANDREW M. BROOKS, Vice President--Vice President, T. Rowe Price
JENNIFER PONCE DELEON, Vice President--Vice President, T. Rowe
Price
WILLIAM T. REYNOLDS, Vice President--Managing Director, T. Rowe
Price; Chartered Financial Analyst
HUBERT M. STILES, JR., Vice President--Vice President, T. Rowe
Price
MARK J. VASELKIV, Vice President--Vice President, T. Rowe Price
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price;
Vice President, Price-Fleming and T. Rowe Price Trust Company
THEA N. WILLIAMS, Vice President--Vice President, T. Rowe Price
New Income Fund
PAGE 50
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director, and Chief Executive Officer, T. Rowe Price; Director,
Price-Fleming, T. Rowe Price Trust Company and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
*CHARLES P. SMITH, President and Director--Managing Director, T.
Rowe Price; Vice President, Price-Fleming
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company; formerly charter member of the
U.S. Senior Executive Service and Director, Analysis and
Evaluation Division in the Office of Water Regulations and
Standards of the U.S. Environmental Protection Agency
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President--Vice President, T. Rowe
Price; formerly senior bond trader, Scudder, Stevens & Clark,
Boston, Massachusetts
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price;
Vice President, Price-Fleming and T. Rowe Price Trust Company
MICHAEL J. McGONIGLE, Assistant Vice President--Assistant Vice
President, T. Rowe Price
Personal Strategy Balanced, Growth and Income Funds
M. DAVID TESTA, Chairman of the Board--Managing Director, T. Rowe
Price; Director, Equity Division; Chairman of the Board, Price-
Fleming; Director and Vice President, T. Rowe Price Trust
Company; Chartered Financial Analyst
PETER VAN DYKE, President--Managing Director, T. Rowe Price; Vice
President of Price-Fleming, T. Rowe Price Trust Company and T.
Rowe Price Retirement Plan Services, Inc., Chartered Investment
Counselor
STEPHEN W. BOESEL, Executive Vice President--Managing Director,
T. Rowe Price
JOHN D. GILLESPIE, Executive Vice President--Vice President, T.
Rowe Price
EDMUND M. NOTZON, Executive Vice President--Vice President, T.
Rowe Price and T. Rowe Price Trust Company; formerly charter
member of the U.S. Senior Executive Service and Director,
Analysis and Evaluation Division in the Office of Water
Regulations and Standards of the U.S. Environmental Protection
Agency
JOHN H. LAPORTE, Vice President--Managing Director, T. Rowe
Price; Chartered Financial Analyst
DONALD J. PETERS, Vice President--Vice President, T. Rowe Price;
formerly portfolio manager, Geewax Terker and Company
WILLIAM T. REYNOLDS, Vice President--Managing Director, T. Rowe
Price; Chartered Financial Analyst
BRIAN C. ROGERS, Vice President--Managing Director, T. Rowe
Price; Chartered Financial Analyst
RICHARD T. WHITNEY, Vice President--Managing Director, T. Rowe
Price; Vice President, T. Rowe Price Trust Company; Chartered
Financial Analyst
J. JEFFREY LANG, Assistant Vice President--Assistant Vice
President, T. Rowe Price
Prime Reserve Fund
*GEORGE J. COLLINS, Vice President and Director--President,
Managing Director, and Chief Executive Officer, T. Rowe Price;
Director, Price-Fleming, T. Rowe Price Trust Company and T. Rowe
Price Retirement Plan Services, Inc., Chartered Investment
Counselor
*WILLIAM T. REYNOLDS, Chairman of the Board--Managing Director,
T. Rowe Price; Chartered Financial Analyst
EDWARD A. WIESE, President--Vice President, T. Rowe Price, Price-
Fleming and T. Rowe Price Trust Company
PAGE 51
ROBERT P. CAMPBELL, Executive Vice President--Vice President, T.
Rowe Price and Price-Fleming; formerly Vice President and
Director, Private Finance, New York Life Insurance Company, New
York, New York
JAMES M. MCDONALD, Executive Vice President--Vice President, T.
Rowe Price
PATRICE L. BERCHTENBREITER, Vice President--Vice President, T.
Rowe Price
PAUL W. BOLTZ, Vice President--Vice President and Financial
Economist of T. Rowe Price
DONNA M. DAVIS-ENNIS, Vice President--Assistant Vice President,
T. Rowe Price
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
BRIAN E. BURNS, Vice President--Assistant Vice President, T. Rowe
Price
GWENDOLYN G. WAGNER, Vice President--Vice President and
Economist, T. Rowe Price; Chartered Financial Analyst
Short-Term Bond Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director, and Chief Executive Officer, T. Rowe Price; Director,
Price-Fleming, T. Rowe Price Trust Company and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
EDWARD A. WIESE, President--Vice President, T. Rowe Price, Price-
Fleming and T. Rowe Price Trust Company
PAUL W. BOLTZ, Vice President--Vice President and Financial
Economist of T. Rowe Price
STEVEN G. BROOKS, Vice President--Vice President, T. Rowe Price;
Chartered Financial Analyst
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price
and Price-Fleming; formerly Vice President and Director, Private
Finance, New York Life Insurance Company, New York, New York
PATRICK S. CASSIDY, Vice President--Vice President, T. Rowe
Price; Chartered Financial Analyst
CHRISTY M. DIPIETRO, Vice President--Vice President, T. Rowe
Price and T. Rowe Price Trust Company
CHARLES B. HILL, Vice President--Vice President, T. Rowe Price
JAMES M. MCDONALD, Vice President--Vice President, T. Rowe Price
CHERYL A. REDWOOD, Vice President--Assistant Vice President, T.
Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Price-Fleming
THOMAS E. TEWKSBURY, Vice President--Vice President, T. Rowe
Price; formerly senior bond trader, Scudder, Stevens & Clark, New
York, New York
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price;
Vice President, Price-Fleming and T. Rowe Price Trust Company
GWENDOLYN G. WAGNER, Vice President--Vice President and Economist
of T. Rowe Price; Financial Analyst
Short-Term U.S. Government Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director, and Chief Executive Officer, T. Rowe Price; Director,
Price-Fleming, T. Rowe Price Trust Company and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
*PETER VAN DYKE, President and Director--Managing Director, T.
Rowe Price; Vice President of Price-Fleming and T. Rowe Price
Trust Company
HEATHER R. LANDON, Executive Vice President--Vice President, T.
Rowe Price and T. Rowe Price Trust Company
JAMES M. MCDONALD, Vice President--Vice President, T. Rowe Price
PAGE 52
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company; formerly, charter member of the
U.S. Senior Executive Services and Director, Analysis and
Evaluation Division in the Office of Water Regulations and
Standards of the U.S. Environmental Protection Agency
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Price-Fleming
GWENDOLYN G. WAGNER, Vice President--Vice President and
Economist, T. Rowe Price
DONNA M. DAVIS-ENNIS, Assistant Vice President--Assistant Vice
President, T. Rowe Price
U.S. Treasury Intermediate, Long-Term and Money Funds
*GEORGE J. COLLINS, Director--President, Managing Director, and
Chief Executive Officer, T. Rowe Price; Director, Price-Fleming,
T. Rowe Price Trust Company and T. Rowe Price Retirement Plan
Services, Inc., Chartered Investment Counselor
*PETER VAN DYKE, President and Director--Managing Director, T.
Rowe Price; Vice President, Price-Fleming and T. Rowe Price Trust
Company
*CHARLES P. SMITH, Executive Vice President and Director--
Managing Director, T. Rowe Price; Vice President, Price-Fleming
EDWARD A. WIESE, Executive Vice President--Managing Director, T.
Rowe Price; Vice President, Price-Fleming
PATRICE L. BERCHTENBREITER, Vice President--Vice President, T.
Rowe Price
PAUL W. BOLTZ, Vice President--Vice President and Financial
Economist of T. Rowe Price
BRIAN E. BURNS, Vice President--Assistant Vice President, T. Rowe
Price
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price
and Price-Fleming; formerly Vice President and Director, Private
Finance, New York Life Insurance Company, New York, New York
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President--Vice President, T. Rowe
Price; formerly senior bond trader, Scudder, Stevens & Clark,
Boston, Massachusetts
GWENDOLYN G. WAGNER, Vice President--Vice President and
Economics, T. Rowe Price; Chartered Financial Analyst
Each Fund's Executive Committee, consisting of the Fund's
interested directors/trustees, has been authorized by its
respective Board of Directors/Trustees to exercise all powers of
the Board to manage the Fund in the intervals between meetings of
the Board, except the powers prohibited by statute from being
delegated.
PAGE 53
COMPENSATION TABLE
The Funds do not pay pension or retirement benefits to its
officers or directors/trustees. Also, any director/trustee of a
Fund who is an officer or employee of T. Rowe Price does not
receive any renumeration from a Fund.
_________________________________________________________________
_____________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Complex
Person, from Paid to
Position Fund(a) Directors(b)
_________________________________________________________________
_____________
GNMA Fund
Robert P. Black, $2,250 $56,000
Trustee
Calvin W. Burnett, 2,250 56,000
Ph.D, Trustee
Anthony W. Deering, 2,250 68,250
Trustee
F. Pierce Linaweaver, 2,250 56,000
Trustee
John G. Schreiber, 2,250 56,000
Trustee
_________________________________________________________________
_____________
High Yield Fund
Robert P. Black, $2,787 $56,000
Director
Calvin W. Burnett, 2,787 56,000
Ph.D, Director
Anthony W. Deering, 2,787 68,250
Director
F. Pierce Linaweaver, 2,787 56,000
Director
John G. Schreiber, 2,787 56,000
Director
_________________________________________________________________
_____________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Complex
Person, from Paid to
Position Fund(a) Directors(b)
_________________________________________________________________
_____________
New Income Fund
Robert P. Black, $3,381 $56,000
Director
Calvin W. Burnett, 3,381 56,000
PAGE 54
Ph.D, Director
Anthony W. Deering, 3,381 68,250
Director
F. Pierce Linaweaver, 3,381 56,000
Director
John G. Schreiber, 3,381 56,000
Director
_________________________________________________________________
_____________
Personal Strategy Balanced Fund
Donald W. Dick, Jr., $720 $70,083
Director
David K. Fagin, 720 57,833
Director
Hanne M. Merriman, 720 57,833
Director
Hubert D. Vos, 720 57,833
Director
Paul M. Wythes, 720 57,833
Director
PAGE 55
_________________________________________________________________
_____________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Complex
Person, from Paid to
Position Fund(a) Directors(b)
_________________________________________________________________
_____________
Personal Strategy Growth
Donald W. Dick, Jr., $688 $70,083
Director
Hanne M. Merriman, 688 57,833
Director
Hubert D. Vos, 688 57,833
Director
Paul M. Wythes, 688 57,833
Director
_________________________________________________________________
_____________
Personal Strategy Income
Donald W. Dick, Jr., $706 $70,083
Director
David K. Fagin, 706 57,833
Director
Hubert D. Vos, 706 57,833
Director
Paul M. Wythes, 706 57,833
Director
_________________________________________________________________
_____________
Prime Reserve Fund
Robert P. Black, $6,692 $56,000
Director
Calvin W. Burnett, 6,692 56,000
Ph.D, Director
Anthony W. Deering, 6,692 68,250
Director
_________________________________________________________________
_____________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Complex
Person, from Paid to
Position Fund(a) Directors(b)
_________________________________________________________________
_____________
F. Pierce Linaweaver, $6,692 $56,000
Director
John G. Schreiber, 6,692 56,000
Director
PAGE 56
_________________________________________________________________
_____________
Short-Term Bond Fund
Robert P. Black, $1,696 $56,000
Director
Calvin W. Burnett, 1,696 56,000
Ph.D, Director
Anthony W. Deering, 1,696 68,250
Director
F. Pierce Linaweaver, 1,696 56,000
Director
John G. Schreiber, 1,696 56,000
Director
_________________________________________________________________
_____________
Short-Term U.S. Government Fund
Robert P. Black, $1,128 $56,000
Director
Calvin W. Burnett, 1,128 56,000
Ph.D, Director
Anthony W. Deering, 1,128 68,250
Director
F. Pierce Linaweaver, 1,128 56,000
Director
PAGE 57
_________________________________________________________________
_____________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Complex
Person, from Paid to
Position Fund(a) Directors(b)
_________________________________________________________________
_____________
John G. Schreiber, $1,128 $56,000
Director
_________________________________________________________________
_____________
U.S. Treasury Intermediate
Robert P. Black, $1,230 $56,000
Director
Calvin W. Burnett, 1,230 56,000
Ph.D, Director
Anthony W. Deering, 1,230 68,250
Director
F. Pierce Linaweaver, 1,230 56,000
Director
John G. Schreiber, 1,230 56,000
Director
_________________________________________________________________
_____________
U.S. Treasury Long-Term
Robert P. Black, $1,145 $56,000
Director
Calvin W. Burnett, 1,145 56,000
Ph.D, Director
Anthony W. Deering, 1,145 66,333
Director
F. Pierce Linaweaver, 1,145 56,000
Director
John G. Schreiber, 1,145 56,000
Director
_________________________________________________________________
_____________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Complex
Person, from Paid to
Position Fund(a) Directors(b)
_________________________________________________________________
_____________
U.S. Treasury Money
Robert P. Black, $2,074 $56,000
Director
Calvin W. Burnett, 2,074 56,000
Ph.D, Director
PAGE 58
Anthony W. Deering, 2,074 68,250
Director
F. Pierce Linaweaver, 2,074 56,000
Director
John G. Schreiber, 2,074 56,000
Director
(a) Amounts in this column are for the period June 1, 1995
through May 31, 1996.
(b) Amounts in this column are for calendar year 1995.
PAGE 59
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and directors
of the Fund, as a group, owned less than 1% of the outstanding
shares of the Fund.
As of September 3, 1996, the following shareholders benefically
owned more
than 5% of the outstanding shares of the funds listed: Yachtcrew
& Co., FBO Spectrum Income Account, State Street Bank and Trust
Co., 1776 Heritage Drive-4W, North Quincy, MA 02171-2010 of the
GNMA, High Yield, and New Income Funds; State Street Bank & Trust
Co., Trustee for TJX Companies Inc., Savings/ PSP Trust, Attn:
Robert Hannigan, P.O. Box 1992, Boston, MA 02105-1992 of the
Short-Term Bond Fund; Saxon & Co., FBO 42-43-202-215665,
Retirement Plan/Salary & Non-Union Employees of Huls America,
P.O. Box 7780-1888, Philadelphia, PA 19182 of the U.S. Treasury
Long-Term Fund; and T. Rowe Price RPS Inc. Co. Simplex Time ESOP,
Plan #104850, New Business Group #12, P.O. Box 17215, Baltimore,
MD 21203-7215 of the Personal Strategy Balanced Fund.
INVESTMENT MANAGEMENT SERVICES
Services
Under the Management Agreement, T. Rowe Price provides the
Fund with discretionary investment services. Specifically, T.
Rowe Price is responsible for supervising and directing the
investments of the Fund in accordance with the Fund's investment
objectives, program, and restrictions as provided in its
prospectus and this Statement of Additional Information. T. Rowe
Price is also responsible for effecting all security transactions
on behalf of the Fund, including the negotiation of commissions
and the allocation of principal business and portfolio brokerage.
In addition to these services, T. Rowe Price provides the Fund
with certain corporate administrative services, including:
maintaining the Fund's corporate existence and corporate records;
registering and qualifying Fund shares under federal and state
laws; monitoring the financial, accounting, and administrative
functions of the Fund; maintaining liaison with the agents
employed by the Fund such as the Fund's custodian and transfer
agent; assisting the Fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as
officers, directors, and committee members of the Fund without
cost to the Fund.
The Management Agreement also provides that T. Rowe Price,
its directors, officers, employees, and certain other persons
performing specific functions for the Fund will only be liable to
the Fund for losses resulting from willful misfeasance, bad
faith, gross negligence, or reckless disregard of duty.
Management Fee
The Fund pays T. Rowe Price a fee ("Fee") which consists of
two components: a Group Management Fee ("Group Fee") and an
Individual Fund Fee ("Fund Fee"). The Fee is paid monthly to T.
Rowe Price on the first business day of the next succeeding
calendar month and is calculated as described below.
The monthly Group Fee ("Monthly Group Fee") is the sum of the
daily Group Fee accruals ("Daily Group Fee Accruals") for each
month. The Daily Group Fee Accrual for any particular day is
computed by multiplying the Price Funds' group fee accrual as
determined below ("Daily Price Funds' Group Fee Accrual") by the
ratio of the Fund's net assets for that day to the sum of the
aggregate net assets of the Price Funds for that day. The Daily
Price Funds' Group Fee Accrual for any particular day is
calculated by multiplying the fraction of one (1) over the number
of calendar days in the year by the annualized Daily Price Funds'
Group Fee Accrual for that day as determined in accordance with
the following schedule:
PAGE 60
Price Funds'
Annual Group Base Fee
Rate for Each Level of Assets
0.480%First $1 billion
0.450% Next $1 billion
0.420% Next $1 billion
0.390% Next $1 billion
0.370% Next $1 billion
0.360% Next $2 billion
0.350% Next $2 billion
0.340% Next $5 billion
0.330% Next $10 billion
0.320% Next $10 billion
0.310% Next $16 billion
0.305% Thereafter
For the purpose of calculating the Group Fee, the Price
Funds include all the mutual funds distributed by T. Rowe Price
Investment Services, Inc., (excluding T. Rowe Price Spectrum
Fund, Inc. and any institutional or private label mutual funds).
For the purpose of calculating the Daily Price Funds' Group Fee
Accrual for any particular day, the net assets of each Price Fund
are determined in accordance with the Fund's prospectus as of the
close of business on the previous business day on which the Fund
was open for business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the
daily Fund Fee accruals ("Daily Fund Fee Accruals") for each
month. The Daily Fund Fee Accrual for any particular day is
computed by multiplying the fraction of one (1) over the number
of calendar days in the year by the individual Fund Fee Rate and
multiplying this product by the net assets of the Fund for that
day, as determined in accordance with the Fund's prospectus as of
the close of business on the previous business day on which the
Fund was open for business. The individual fund fees for each
Fund are listed in the chart below:
Individual Fund Fees
Corporate Income Fund 0.15%
GNMA Fund 0.15%
High Yield Fund 0.30%
New Income Fund 0.15%
Personal Strategy Growth Fund 0.30%
Personal Strategy Balanced Fund 0.25%
Personal Strategy Income Fund 0.15%
Prime Reserve Fund 0.05%
Short-Term Bond Fund 0.10%
Short-Term U.S. Government Fund 0.10%
U.S. Treasury Intermediate Fund 0.05%
U.S. Treasury Long-Term Fund 0.05%
U.S. Treasury Money Fund 0.00%
The following chart sets forth the total management fees, if
any, paid to T. Rowe Price by each Fund, for the fiscal years
ended May 31, 1996, and May 31, 1995, the three-month fiscal year
ended May 31, 1994 and for the fiscal year ended February 28,
1994:
Fund 1996 1995 1994* 1994
Corporate Income ** N/A N/A N/A
GNMA $4,223,000 $3,835,000 $ 1,034,000$ 4,626,000
High Yield 7,752,000 7,367,000 2,197,000 10,554,000
PAGE 61
New Income 7,886,000 6,972,000 1,748,000 7,750,000
Prime Reserve 15,320,000 14,784,000 3,601,000 13,617,000
Short-Term Bond 2,099,000 2,280,000 708,000 2,873,000
Short-Term U.S.
Government 281,000 284,000 100,000 526,000
U.S. Treasury 684,000 671,000 173,000 755,000
Intermediate
U.S. Treasury 240,000 157,000 26,000 180,000
Long-Term
U.S. Treasury 2,507,000 2,341,000 569,000 2,084,000
Money
Personal Strategy ** ** N/A N/A
Income
Personal Strategy 150,000 ** N/A N/A
Balanced
Personal Strategy ** ** N/A N/A
Growth
* For the three-month fiscal year ended May 31, 1994.
** Due to the Fund's expense limitation in effect at that time,
no management fee was paid by the Fund to T. Rowe Price.
PAGE 62
Limitation on Fund Expenses
The Management Agreement between the Fund and T. Rowe Price
provides that the Fund will bear all expenses of its operations
not specifically assumed by T. Rowe Price. However, in
compliance with certain state regulations, T. Rowe Price will
reimburse the Fund for certain expenses which in any year exceed
the limits prescribed by any state in which the Fund's shares are
qualified for sale. Presently, the most restrictive expense
ratio limitation imposed by any state is 2.5% of the first $30
million of the Fund's average daily net assets, 2% of the next
$70 million of the Fund's assets, and 1.5% of net assets in
excess of $100 million. Reimbursement by the Fund to T. Rowe
Price of any expenses paid or assumed under a state expense
limitation may not be made more than two years after the end of
the fiscal year in which the expenses were paid or assumed.
The following chart sets forth expense ratio limitations and
the periods for which they are effective. For each, T. Rowe
Price has agreed to bear any Fund expenses which would cause the
Fund's ratio of expenses to average net assets to exceed the
indicated percentage limitations. The expenses borne by T. Rowe
Price are subject to reimbursement by the Fund through the
indicated reimbursement date, provided no reimbursement will be
made if it would result in the Fund's expense ratio exceeding its
applicable limitation.
Expense
Limitation Ratio Reimbursement
Fund Period Limitation Date
Personal Strategy June 1, 1996- 0.95% May 31, 2000
Income Fund May 31, 1998
Personal Strategy June 1, 1996- 1.05% May 31, 2000
Balanced Fund May 31, 1998
Personal Strategy June 1, 1996- 1.10% May 31, 2000
Growth Fund May 31, 1998
Short-Term U.S.
Government+ March 1, 1996- 0.70% May 31, 2000
May 31, 1998
U.S. Treasury March 1, 1995- 0.80% May 31, 1999
Long-Term++ May 31, 1997
Corporate Income October 31, 1995- 0.80% May 31, 1999
May 31, 1997
+ The Short-Term U.S. Government Fund previously operated under
a 0.70% limitation that expired May 31, 1996. The
reimbursement period for this limitation extends through May
31, 1998.
++ The Long-Term Fund operated under a 0.80% limitation that
expired February 28, 1995. The reimbursement period for this
limitation extends through February 28, 1997.
Each of the above-referenced Fund's Management Agreement also
provides that one or more additional expense limitation periods
(of the same or different time periods) may be implemented after
the expiration of the current expense limitation, and that with
respect to any such additional limitation period, the Fund may
reimburse T. Rowe Price, provided the reimbursement does not
result in the Fund's aggregate expenses exceeding the additional
expense limitation.
Pursuant to the Corporate Income Fund's
current expense limitation, $20,000 of management fees were not
accrued by the fund for the year ended May 31, 1996, and $59,000
of other expenses were borne by the manager.
Pursuant to the Short-Term U.S. Government
Fund's current expense limitation, $183,000 of management fees
were not accrued by the Fund for the fiscal year
PAGE 63
ended May 31, 1995. Pursuant to a previous agreement, $596,000 of
unaccrued fees from the prior periods are subject to
reimbursement through May 31, 1998.
Pursuant to the Long-Term Fund's current expense limitation,
$15,000 of management fees were not accrued by the Fund for the
fiscal year ended May 31, 1996, and $8,000 of unaccrued
management fees from the prior period subject to reimbursement.
Additionally, $107,000 of unaccrued management fees related to a
previous agreement are subject to reimbursement through February
28, 1997.
GNMA, High Yield, New Income, Prime Reserve and Short-Term Bond
Funds
T. Rowe Price Spectrum Fund, Inc.
The Fund is a party to a Special Servicing Agreement
("Agreement") between and among T. Rowe Price Spectrum Fund, Inc.
("Spectrum Fund"), T. Rowe Price, T. Rowe Price Services, Inc.
and various other T. Rowe Price funds which, along with the Fund,
are funds in which Spectrum Fund invests (collectively all such
funds "Underlying Price Funds").
The Agreement provides that, if the Board of
Directors/Trustees of any Underlying Price Fund determines that
such Underlying Fund's share of the aggregate expenses of
Spectrum Fund is less than the estimated savings to the
Underlying Price Fund from the operation of Spectrum Fund, the
Underlying Price Fund will bear those expenses in proportion to
the average daily value of its shares owned by Spectrum Fund,
provided further that no Underlying Price Fund will bear such
expenses in excess of the estimated savings to it. Such savings
are expected to result primarily from the elimination of numerous
separate shareholder accounts which are or would have been
invested directly in the Underlying Price Funds and the resulting
reduction in shareholder servicing costs. Although such cost
savings are not certain, the estimated savings to the Underlying
Price Funds generated by the operation of Spectrum Fund are
expected to be sufficient to offset most, if not all, of the
expenses incurred by Spectrum Fund.
All Funds
DISTRIBUTOR FOR FUND
T. Rowe Price Investment Services, Inc. ("Investment
Services"), a Maryland corporation formed in 1980 as a wholly-
owned subsidiary of T. Rowe Price, serves as the Fund's
distributor. Investment Services is registered as a broker-
dealer under the Securities Exchange Act of 1934 and is a member
of the National Association of Securities Dealers, Inc. The
offering of the Fund's shares is continuous.
Investment Services is located at the same address as the
Fund and T. Rowe Price -- 100 East Pratt Street, Baltimore,
Maryland 21202.
Investment Services serves as distributor to the Fund
pursuant to an Underwriting Agreement ("Underwriting Agreement"),
which provides that the Fund will pay all fees and expenses in
connection with: registering and qualifying its shares under the
various state "blue sky" laws; preparing, setting in type,
printing, and mailing its prospectuses and reports to
shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Underwriting Agreement provides that Investment Services
will pay all fees and expenses in connection with: printing and
distributing prospectuses and reports for use in offering and
selling Fund shares; preparing, setting in type, printing, and
mailing all sales literature and advertising; Investment
Services' federal and state registrations as a broker-dealer; and
offering and selling Fund
PAGE 64
shares, except for those fees and expenses specifically assumed
by the Fund. Investment Services' expenses are paid by T. Rowe
Price.
Investment Services acts as the agent of the Fund in
connection with the sale of its shares in all states in which the
shares are qualified and in which Investment Services is
qualified as a broker-dealer. Under the Underwriting Agreement,
Investment Services accepts orders for Fund shares at net asset
value. No sales charges are paid by investors or the Fund.
SHAREHOLDER SERVICES
The Fund from time to time may enter into agreements with
outside parties through which shareholders hold Fund shares. The
shares would be held by such parties in omnibus accounts. The
agreements would provide for payments by the Fund to the outside
party for shareholder services provided to shareholders in the
omnibus accounts.
CUSTODIAN
State Street Bank and Trust Company is the custodian for the
Fund's domestic securities and cash, but it does not participate
in the Fund's investment decisions. Portfolio securities
purchased in the U.S. are maintained in the custody of the Bank
and may be entered into the Federal Reserve Book Entry System, or
the security depository system of the Depository Trust
Corporation. The Fund (other than the GNMA, Prime Reserve and
U.S. Treasury Intermediate, Long-Term and Money Funds) has
entered into a Custodian Agreement with The Chase Manhattan Bank,
N.A., London, pursuant to which portfolio securities which are
purchased outside the United States are maintained in the custody
of various foreign branches of The Chase Manhattan Bank and such
other custodians, including foreign banks and foreign securities
depositories as are approved by the Fund's Board of
Directors/Trustees in accordance with regulations under the
Investment Company Act of 1940. State Street's main office is at
225 Franklin Street, Boston, Massachusetts 02110. The address
for The Chase Manhattan Bank, N.A., London is Woolgate House,
Coleman Street, London, EC2P 2HD, England.
CODE OF ETHICS
The Funds' investment adviser (T. Rowe Price) has a written
Code of Ethics which requires all employees to obtain prior
clearance before engaging in any personal securities
transactions. In addition, all employees must report their
personal securities transactions within ten days of their
execution. Employees will not be permitted to effect
transactions in a security: If there are pending client orders in
the security; the security has been purchased or sold by a client
within seven calendar days; the security is being considered for
purchase for a client; a change has occurred in T. Rowe Price's
rating of the security within five days; or the security is
subject to internal trading restrictions. In addition, employees
are prohibited from engaging in short-term trading (e.g.,
purchases and sales involving the same security within 60 days).
Any material violation of the Code of Ethics is reported to the
Board of the Fund. The Board also reviews the administration of
the Code of Ethics on an annual basis.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
PAGE 65
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund are made by T. Rowe Price. T.
Rowe Price is also responsible for implementing these decisions,
including the negotiation of commissions and the allocation of
portfolio brokerage and principal business. The Fund's purchases
and sales of fixed-income portfolio securities are normally done
on a principal basis and do not involve the payment of a
commission although they may involve the designation of selling
concessions. That part of the discussion below relating solely
to brokerage commissions would not normally apply to the Fund
(except to the extent it purchases equity securities (High Yield,
New Income, and Personal Strategy Funds only)). However, it is
included because T. Rowe Price does manage a significant number
of common stock portfolios which do engage in agency transactions
and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the
Fund.
How Brokers and Dealers are Selected
Equity Securities
In purchasing and selling the Fund's portfolio securities, it
is T. Rowe Price's policy to obtain quality execution at the most
favorable prices through responsible brokers and dealers and, in
the case of agency transactions, at competitive commission rates.
However, under certain conditions, the Fund may pay higher
brokerage commissions in return for brokerage and research
services. As a general practice, over-the-counter orders are
executed with market-makers. In selecting among market-makers,
T. Rowe Price generally seeks to select those it believes to be
actively and effectively trading the security being purchased or
sold. In selecting broker-dealers to execute the Fund's
portfolio transactions, consideration is given to such factors as
the price of the security, the rate of the commission, the size
and difficulty of the order, the reliability, integrity,
financial condition, general execution and operational
capabilities of competing brokers and dealers, and brokerage and
research services provided by them. It is not the policy of T.
Rowe Price to seek the lowest available commission rate where it
is believed that a broker or dealer charging a higher commission
rate would offer greater reliability or provide better price or
execution.
Fixed Income Securities
Fixed income securities are generally purchased from the
issuer or a primary market-maker acting as principal for the
securities on a net basis, with no brokerage commission being
paid by the client although the price usually includes an
undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the
bid and asked prices. Securities may also be purchased from
underwriters at prices which include underwriting fees.
With respect to equity and fixed income securities, T. Rowe
Price may effect principal transactions on behalf of the Fund
with a broker or dealer who furnishes brokerage and/or research
services, designate any such broker or dealer to receive selling
concessions, discounts or other allowances, or otherwise deal
with any such broker or dealer in connection with the acquisition
of securities in underwritings. T. Rowe Price may receive
research services in connection with brokerage transactions,
including designations in fixed price offerings.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for
transactions executed on behalf of the Fund. In evaluating the
reasonableness of commission rates, T. Rowe Price considers: (a)
historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors
PAGE 66
are paying, based on available public information; (c) rates
quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
Description of Research Services Received from Brokers and
Dealers
T. Rowe Price receives a wide range of research services from
brokers and dealers. These services include information on the
economy, industries, groups of securities, individual companies,
statistical information, accounting and tax law interpretations,
political developments, legal developments affecting portfolio
securities, technical market action, pricing and appraisal
services, credit analysis, risk measurement analysis, performance
analysis and analysis of corporate responsibility issues. These
services provide both domestic and international perspective.
Research services are received primarily in the form of written
reports, computer generated services, telephone contacts and
personal meetings with security analysts. In addition, such
services may be provided in the form of meetings arranged with
corporate and industry spokespersons, economists, academicians
and government representatives. In some cases, research services
are generated by third parties but are provided to T. Rowe Price
by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information
presently provided by brokers and dealers. T. Rowe Price pays
cash for certain research services received from external
sources. T. Rowe Price also allocates brokerage for research
services which are available for cash. While receipt of research
services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could
be materially increased if it attempted to generate such
additional information through its own staff. To the extent that
research services of value are provided by brokers or dealers, T.
Rowe Price may be relieved of expenses which it might otherwise
bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
Commissions to Brokers who Furnish Research Services
Certain brokers and dealers who provide quality brokerage and
execution services also furnish research services to T. Rowe
Price. With regard to the payment of brokerage commissions, T.
Rowe Price has adopted a brokerage allocation policy embodying
the concepts of Section 28(e) of the Securities Exchange Act of
1934, which permits an investment adviser to cause an account to
pay commission rates in excess of those another broker or dealer
would have charged for effecting the same transaction, if the
adviser determines in good faith that the commission paid is
reasonable in relation to the value of the brokerage and research
services provided. The determination may be viewed in terms of
either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over
which it exercises investment discretion. Accordingly, while T.
Rowe Price cannot readily determine the extent to which
commission rates or net prices charged by broker-
PAGE 67
dealers reflect the value of their research services, T. Rowe
Price would expect to assess the reasonableness of commissions in
light of the total brokerage and research services provided by
each particular broker. T. Rowe Price may receive research, as
defined in Section 28(e), in connection with selling concessions
and designations in fixed price offerings in which the Funds
participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific
amount of business to any broker or dealer over any specific time
period. Historically, the majority of brokerage placement has
been determined by the needs of a specific transaction such as
market-making, availability of a buyer or seller of a particular
security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for
that portion of its discretionary client brokerage business where
special needs do not exist, or where the business may be
allocated among several brokers or dealers which are able to meet
the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers or dealers,
and attempts to allocate a portion of its brokerage business in
response to these assessments. Research analysts, counselors,
various investment committees, and the Trading Department each
seek to evaluate the brokerage and research services they receive
from brokers or dealers and make judgments as to the level of
business which would recognize such services. In addition,
brokers or dealers sometimes suggest a level of business they
would like to receive in return for the various brokerage and
research services they provide. Actual brokerage received by any
firm may be less than the suggested allocations but can, and
often does, exceed the suggestions, because the total business is
allocated on the basis of all the considerations described above.
In no case is a broker or dealer excluded from receiving business
from T. Rowe Price because it has not been identified as
providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent
a substantial majority of all assets under management. Research
services furnished by brokers or dealers through which T. Rowe
Price effects securities transactions may be used in servicing
all accounts (including non-Fund accounts) managed by T. Rowe
Price. Conversely, research services received from brokers or
dealers which execute transactions for the Fund are not
necessarily used by T. Rowe Price exclusively in connection with
the management of the Fund.
From time to time, orders for clients may be placed through a
computerized transaction network.
The Fund does not allocate business to any broker-dealer on
the basis of its sales of the Fund's shares. However, this does
not mean that broker-dealers who purchase Fund shares for their
clients will not receive business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Fund. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each
PAGE 68
participating client's proportionate share of such order reflects
the average price paid or received with respect to the total
order. T. Rowe Price has established a general investment policy
that it will ordinarily not make additional purchases of a common
stock of a company for its clients (including the T. Rowe Price
Funds) if, as a result of such purchases, 10% or more of the
outstanding common stock of such company would be held by its
clients in the aggregate.
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through
T. Rowe Price Investment Services, Inc., the Fund's distributor.
At the present time, T. Rowe Price does not recapture commissions
or underwriting discounts or selling group concessions in
connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession
or underwriting discount when purchasing tax-exempt municipal
securities on behalf of its clients in underwritten offerings.
High Yield, New Income, Personal Strategy, Short-Term Bond, and
Short-Term U.S. Government Funds
Transactions with Related Brokers and Dealers
As provided in the Investment Management Agreement between
the Fund and T. Rowe Price, T. Rowe Price is responsible not only
for making decisions with respect to the purchase and sale of the
Fund's portfolio securities, but also for implementing these
decisions, including the negotiation of commissions and the
allocation of portfolio brokerage and principal business. It is
expected that T. Rowe Price may place orders for the Fund's
portfolio transactions with broker-dealers through the same
trading desk T. Rowe Price uses for portfolio transactions in
domestic securities. The trading desk accesses brokers and
dealers in various markets in which the Fund's foreign securities
are located. These brokers and dealers may include certain
affiliates of Robert Fleming Holdings Limited ("Robert Fleming
Holdings") and Jardine Fleming Group Limited ("JFG"), persons
indirectly related to T. Rowe Price. Robert Fleming Holdings,
through Copthall Overseas Limited, a wholly-owned subsidiary,
owns 25% of the common stock of Rowe Price-Fleming International,
Inc. ("RPFI"), an investment adviser registered under the
Investment Advisers Act of 1940. Fifty percent of the common
stock of RPFI is owned by TRP Finance, Inc., a wholly-owned
subsidiary of T. Rowe Price, and the remaining 25% is owned by
Jardine Fleming Holdings Limited, a subsidiary of JFG. JFG is
50% owned by Robert Fleming Holdings and 50% owned by Jardine
Matheson Holdings Limited. Orders for the Fund's portfolio
transactions placed with affiliates of Robert Fleming Holdings
and JFG will result in commissions being received by such
affiliates.
The Board of Directors/Trustees of the Fund has authorized T.
Rowe Price to utilize certain affiliates of Robert Fleming and
JFG in the capacity of broker in connection with the execution of
the Fund's portfolio transactions. These affiliates include, but
are not limited to, Jardine Fleming Securities Limited ("JFS"), a
wholly-owned subsidiary of JFG, Robert Fleming & Co. Limited
("RF&Co."), Jardine Fleming Australia Securities Limited, and
Robert Fleming, Inc. (a New York brokerage firm). Other
affiliates of Robert Fleming Holding and JFG also may be used.
Although it does not believe that the Fund's use of these brokers
would be subject to Section 17(e) of the Investment Company Act
of 1940, the Board of Directors/Trustees of the Fund has agreed
that the procedures set forth in Rule 17e-1 under that Act will
be followed when using such brokers.
PAGE 69
Other
For the fiscal years ended May 31, 1996,
May 31, 1995, and February 28, 1994 the Funds engaged in
portfolio transactions involving broker-dealers in the following
amounts:
Fund 1996 1995 1994
______ ____ ____ ____
Corporate Income $47,773,000 N/A N/A
GNMA 2,878,094,000 2,605,743,000 2,306,951,000
High Yield 8,397,015,000 14,045,057,000 18,554,222,000
New Income 5,290,374,000 5,469,278,000 20,265,475,000
Prime Reserve 52,505,379,000 53,302,615,000 29,024,172,000
Short-Term Bond 4,596,925,000 4,874,827,000 4,266,837,000
Short-Term U.S.
Government 646,520,000 1,033,107,000 793,565,000
U.S. Treasury
Intermediate 215,529,000 235,797,000 81,970,000
U.S. Treasury
Long-Term 149,585,000 185,478,000 142,513,000
U.S. Treasury
Money 5,834,599,000 5,593,158,000 3,449,951,000
Personal Strategy
Income 230,017,000 178,662,000 N/A
Personal Strategy
Balanced 554,041,000 70,729,000 N/A
Personal Strategy
Growth 128,451,000 111,347,000 N/A
The Funds engaged in portfolio transactions involving broker-
dealers in the following amounts for the three-month fiscal year
ended May 31, 1994:
Fund 1994
_____ ____
GNMA $ 620,027,000
High Yield 4,476,795,000
New Income 1,649,029,000
Prime Reserve 5,945,733,000
Short-Term Bond 1,149,888,000
Short-Term U.S. Government 63,449,000
U.S. Treasury Intermediate 35,433,000
U.S. Treasury Long-Term 85,972,000
U.S. Treasury Money 10,087,000
PAGE 70
With respect to the GNMA, Prime Reserve,
Short-Term U.S. Government, U.S. Treasury Intermediate, Long-Term
and Money Funds the entire amount for each of these years
represented principal transactions as to which the Funds have no
knowledge of the profits or losses realized by the respective
broker-dealers for the fiscal years ended May 31, 1996, and May
31, 1995, three-month fiscal year ended May 31, 1994, and for the
fiscal year ended February 28, 1994.
With respect to the New Income and Short-Term Bond Funds, the
entire amount for the three-month fiscal year ended May 31, 1994
represented principal transactions as to which the Bond Funds
have no knowledge of the profits or losses realized by the
respective broker-dealers.
With respect to the High Yield Fund, for
the three-month fiscal year ended May 31, 1994, $4,398,879,000
consisted of principal transactions as to which the Fund has no
knowledge of the profits or losses realized by the respective
broker-dealers; and $77,916,000 involved trades with brokers
acting as agents or underwriters, in which such broker received
total commissions, including discounts received in connection
with underwritings of $1,385,000.
With respect to the Corporate Income, High
Yield, New Income, Short-Term Bond, Personal Strategy Income,
Personal Strategy Growth, and Personal Strategy Balanced Funds,
the following amounts consisted of principal transactions as to
which the Funds have no knowledge of the profits or losses
realized by the respective broker-dealers for the fiscal years
ended May 31, 1996, May 31, 1995, and February 28, 1994:
Fund 1996 1995 1994
______ ____ ____ ____
Corporate Income $46,566,000 N/A N/A
High Yield 7,702,492,000 13,782,740,000 17,956,306,000
New Income 5,273,923,000 5,469,278,000 20,206,382,000
Short-Term Bond 4,590,728,000 4,874,827,000 4,266,837,000
Personal Strategy
Income 220,100,000 170,562,000 N/A
Personal Strategy
Growth 111,536,000 62,481,000 N/A
Personal Strategy
Balanced 479,660,000 103,137,000 N/A
PAGE 71
The following amounts involved trades with brokers acting as
agents or underwriters for the fiscal years ended May 31, 1996,
May 31, 1995, and February 28, 1994:
Fund 1996 1995 1994
______ ____ ____ ____
Corporate Income $1,207,000 N/A N/A
High Yield 694,523,000 262,317,000 597,916,000
New Income 16,451,000 0 59,093,000
Short-Term Bond 6,197,000 0 0
Personal Strategy
Income 9,917,000 8,100,000 N/A
Personal Strategy
Growth 16,915,000 8,248,000 N/A
Personal Strategy
Balanced 74,381,000 8,210,000 N/A
The amounts shown below involved trades with brokers acting
as agents or underwriters, in which such brokers received total
commissions, including discounts received in connection with
underwritings for the fiscal years ended May 31, 1996, May 31,
1995, and February 28, 1994:
Fund 1996 1995 1994
______ ____ ____ ____
Corporate Income $34,000 N/A N/A
High Yield 15,925,000 4,704,000 16,730,000
New Income 61,000 0 169,000
Short-Term Bond 21,000 0 0
GNMA 0 3,000 0
Personal Strategy
Income 136,000 47,000 N/A
Personal Strategy
Growth 124,000 11,000 N/A
Personal Strategy
Balanced 334,000 13,000 N/A
The percentage of total portfolio transactions, placed with
firms which provided research, statistical, or other services to
T. Rowe Price in connection with the management of the Funds, or
in some cases, to the Funds for the fiscal years ended May 31,
1996, and May 31, 1995, three-month fiscal year ended May 31,
1994, and for the fiscal year ended February 28, 1994, are shown
below:
Fund 1996 1995 1994* 1994
______ ____ ____ ____ ____
Corporate Income 66% N/A N/A N/A
GNMA 99% 97% 98% 91%
High Yield 85% 97% 48% 70%
New Income 71% 73% 68% 61%
Prime Reserve 72% 90% 78% 87%
Short-Term Bond 64% 66% 83% 61%
Short-Term U.S.
Government 68% 81% 100% 100%
U.S. Treasury
Intermediate 94% 95% 87% 85%
U.S. Treasury Long-Term 96% 100% 100% 98%
U.S. Treasury Money 56% 67% 32% 66%
PAGE 72
Personal Strategy
Income 46% 30% N/A N/A
Personal Strategy
Growth 46% 30% N/A N/A
Personal Strategy
Balanced 36% 40% N/A N/A
* For the three-month fiscal year ended May 31, 1994.
The portfolio turnover rates for the following Funds for the
fiscal years ended May 31, 1996, and May 31, 1995, the three-
month fiscal year ended May 31, 1994, and for the fiscal year
ended February 28, 1994, are as follows:
Fund 1996 1995 1994* 1994
______ _____ ____ ____ ____
Corporate Income 70.5% N/A N/A N/A
GNMA 113.6% 121.3% 151.8% 92.5%
High Yield 100.1% 74.2% 62.5% 107.0%
New Income 35.5% 54.1% 91.5% 58.3%
Short-Term Bond 118.7% 136.9% 222.8% 90.8%
Short-Term U.S.
Government 152.8% 100.0% 27.6% 70.4%
U.S. Treasury
Intermediate 40.7% 81.1% 45.5% 20.2%
U.S. Treasury Long-Term 60.1% 99.3% 246.9% 59.4%
Personal Strategy
Income 34.1% 50.5% N/A N/A
Personal Strategy
Growth 39.5% 25.7% N/A N/A
Personal Strategy
Balanced 47.7% 25.8% N/A N/A
* For the three-month fiscal year ended May 31, 1994.
PAGE 73
Prime Reserve Fund
The Fund, in pursuing its objectives, may engage in short-term
trading to take advantage of market variations. The Fund will
seek to protect principal, improve liquidity of its securities,
or enhance yield by purchasing and selling securities based upon
existing or anticipated market discrepancies.
Money Fund
The Fund, in pursuing its objectives, may engage in short-term
trading to take advantage of market variations. The Fund will
seek to protect principal, improve liquidity of its securities,
or enhance yield by purchasing and selling securities based upon
existing or anticipated market discrepancies.
PRICING OF SECURITIES
Corporate Income, GNMA, High Yield, New Income, Personal
Strategy, Short-Term
Bond, Short-Term U.S. Government, U.S. Treasury Intermediate and
Long-Term Funds
Fixed income securities are generally traded in the over-the-
counter market. Investments in domestic securities with
remaining maturities of one year or more and foreign securities
are stated at fair value using a bid-side valuation as furnished
by dealers who make markets in such securities or by an
independent pricing service, which considers yield or price of
bonds of comparable quality, coupon, maturity, and type, as well
as prices quoted by dealers who make markets in such securities.
Domestic securities with remaining maturities less than one year
are stated at fair value which is determined by using a matrix
system that establishes a value for each security based on bid-
side money market yields. The Personal Strategy Funds value
short-term debt securities at their cost in local currency which,
when combined with accrued interest, approximate fair value.
There are a number of pricing services available, and the
Board of Directors/Trustees, on the basis of ongoing evaluation
of these services, may use or may discontinue the use of any
pricing service in whole or in part.
Corporate Income, High Yield, New Income, and Personal Strategy
Funds
Equity securities listed or regularly traded on a securities
exchange are valued at the last quoted sales price on the day the
valuations are made. A security which is listed or traded on
more than one exchange is valued at the quotation on the exchange
determined to be the primary market for such security. Listed
securities that are not traded on a particular day and securities
that are regularly traded in the over-the-counter market are
valued at the mean of the latest bid and asked prices. Other
equity securities are valued at a price within the limits of the
latest bid and asked prices deemed by the Board of
Directors/Trustees, or by persons delegated by the Board, best to
reflect fair value.
Prime Reserve and U.S. Treasury Money Funds
Securities are valued at amortized cost.
All Funds
PAGE 74
For the purposes of determining the Fund's net asset value
per share, all assets and liabilities initially expressed in
foreign currencies are converted into U.S. dollars at the mean of
the bid and offer prices of such currencies against U.S. dollars
quoted by any major bank.
Assets and liabilities for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value are stated at fair value, as determined in good faith by or
under the supervision of officers of the Funds, as authorized by
the Board of Directors/Trustees.
Prime Reserve and U.S. Treasury Money Funds
Maintenance of Net Asset Value Per Share
It is the policy of the Fund to attempt to maintain a net
asset value of $1.00 per share by using the amortized cost method
of valuation as permitted by Rule 2a-7 under the Investment
Company Act of 1940. Under this method, securities are valued by
reference to the fund's acquisition cost as adjusted for
amortization of premium or accumulation of discount rather than
by reference to their market value. Under Rule 2a-7:
(a) The Board of Directors must establish written procedures
reasonably designed, taking into account current market
conditions and the fund's investment objectives, to stabilize
the fund's net asset value per share, as computed for the
purpose of distribution, redemption and repurchase, at a
single value;
(b) the Fund must (i) maintain a dollar-weighted average
portfolio maturity appropriate to its objective of
maintaining a stable price per share, (ii) not purchase any
instrument with a remaining maturity greater than 397 days,
and (iii) maintain a dollar-weighted average portfolio
maturity of 90 days or less;
(c) the Fund must limit its purchase of portfolio
instruments, including repurchase agreements, to those U.S.
dollar-denominated instruments which the Fund's Board of
Directors determines present minimal credit risks, and which
are eligible securities as defined by Rule 2a-7; and
(d) the Board of Directors must determine that (i) it is in
the best interest of the Fund and its shareholders to
maintain a stable net asset value per share under the
amortized cost method; and (ii) the Fund will continue to use
the amortized cost method only so long as the Board of
Directors believes that it fairly reflects the Fund's market
based net asset value per share.
Although the Fund believes that it will be able to maintain
its net asset value at $1.00 per share under most conditions,
there can be no absolute assurance that it will be able to do so
on a continuous basis. If the Fund's net asset value per share
declined, or was expected to decline, below $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
temporarily reduce or suspend dividend payments in an effort to
maintain the net asset value at $1.00 per share. As a result of
such reduction or suspension of dividends, an investor would
receive less income during a given period than if such a
reduction or suspension had not taken place. Such action could
result in an investor receiving no dividend for the period during
which he holds his shares and in his receiving, upon redemption,
a price per share lower than that which he paid. On the other
hand, if the Fund's net asset value per share were to increase,
or were anticipated to increase above $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
supplement dividends in an effort to maintain the net asset value
at $1.00 per share.
PAGE 75
Prime Reserve Fund
Prime Money Market Securities Defined. Prime money market
securities are those which are described as First Tier Securities
under Rule 2a-7 of the Investment Company Act of 1940. These
include any security with a remaining maturity of 397 days or
less that is rated (or that has been issued by an issuer that is
rated with respect to a class of short-term debt obligations, or
any security within that class that is comparable in priority and
security with the security) by any two nationally recognized
statistical rating organizations (NRSROs) (or if only one NRSRO
has issued a rating, that NRSRO) in the highest rating category
for short-term debt obligations (within which there may be sub-
categories). First Tier Securities also include unrated
securities comparable in quality to rated securities, as
determined by T. Rowe Price under the supervision of the Fund's
Board of Directors.
All Funds
NET ASSET VALUE PER SHARE
The purchase and redemption price of the Fund's shares is
equal to the Fund's net asset value per share or share price.
The Fund determines its net asset value per share by subtracting
the Fund's liabilities (including accrued expenses and dividends
payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
share of the Fund is normally calculated as of the close of
trading on the New York Stock Exchange ("NYSE") every day the
NYSE is open for trading. The NYSE is closed on the following
days: New Year's Day, Washington's Birthday, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day.
Determination of net asset value (and the offering, sale
redemption and repurchase of shares) for the Fund may be
suspended at times (a) during which the NYSE is closed, other
than customary weekend and holiday closings, (b) during which
trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the Fund of securities
owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net
assets, or (d) during which a governmental body having
jurisdiction over the Fund may by order permit such a suspension
for the protection of the Fund's shareholders; provided that
applicable rules and regulations of the Securities and Exchange
Commission (or any succeeding governmental authority) shall
govern as to whether the conditions prescribed in (b), (c), or
(d) exist.
DIVIDENDS AND DISTRIBUTIONS
Unless you elect otherwise, the Fund's annual capital gain
distribution, if any, will be reinvested on the reinvestment date
using the NAV per share of that date. The reinvestment date
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
TAX STATUS
The Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
A portion of the dividends paid by the Fund may be eligible
for the dividends-received deduction for corporate shareholders.
For tax purposes, it does not make any difference whether
dividends and capital gain distributions are paid in cash or in
additional shares. The Fund must declare dividends by
PAGE 76
December 31 of each year equal to at least 98% of ordinary income
(as of December 31) and capital gains (as of October 31) in order
to avoid a federal excise tax and distribute within 12 months
100% of ordinary income and capital gains as of its tax year-end
to avoid federal income tax.
At the time of your purchase, the Fund's net asset value may
reflect undistributed capital gains or net unrealized
appreciation of securities held by the Fund. A subsequent
distribution to you of such amounts, although constituting a
return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Fund is
permitted to carry forward its net realized capital losses, if
any, for eight years and realize net capital gains up to the
amount of such losses without being required to pay taxes on, or
distribute such gains. On May 31, 1996, the books of each Fund
indicated that each Fund's aggregate net assets included
undistributed net income, net realized capital gains, and
unrealized appreciation which are listed below.
PAGE 77
Net Realized Unrealized
Undistributed Capital Appreciation/
Fund Net Income Gains/(Losses) (Depreciation)
GNMA $(5,340,000)$(26,739,000) $(2,024,000)
High Yield 911,000 (220,005,000) 16,579,000
New Income 2,679,000 (11,496,000) 363,000
Prime Reserve 814,000 (2,308,000) 0
Short-Term Bond (2,161,000) (38,439,000) (3,265,000)
Short-Term U.S.
Government (486,000) (23,352,000) (1,312,000)
U.S. Treasury Intermediate 250,000 (2,510,000) (16,000)
U.S. Treasury Long-Term 12,000 (676,000) 218,000
U.S. Treasury Money 81,000 124,000 0
Personal Strategy Income 203,000 998,000 2,470,000
Personal Strategy Balanced 657,000 890,000 3,018,000
Personal Strategy Growth 132,000 663,000 3,007,000
Corporate Income 8,000 (28,000) (567,000)
If, in any taxable year, the Fund should not qualify as a
regulated investment company under the Code: (i) the Fund would
be taxed at normal corporate rates on the entire amount of its
taxable income, if any, without deduction for dividends or other
distributions to shareholders; and (ii) the Fund's distributions
to the extent made out of the Fund's current or accumulated
earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been
considered capital gain dividends).
Taxation of Foreign Shareholders
The Code provides that dividends from net income will be
subject to U.S. tax. For shareholders who are not engaged in a
business in the U.S., this tax would be imposed at the rate of
30% upon the gross amount of the dividends in the absence of a
Tax Treaty providing for a reduced rate or exemption from U.S.
taxation. Distributions of net long-term capital gains realized
by the Fund are not subject to tax unless the foreign shareholder
is a nonresident alien individual who was physically present in
the U.S. during the tax year for more than 182 days.
To the extent a Fund invests in foreign securities, the
following would apply:
Passive Foreign Investment Companies
Each Fund may purchase the securities of certain foreign
investment funds or trusts called passive foreign investment
companies. Capital gains on the sale of such holdings will be
deemed to be ordinary income regardless of how long the Fund
holds its investment. In addition to bearing their proportionate
share of the funds expenses (management fees and operating
expenses) shareholders will also indirectly bear similar expenses
of such funds. In addition, the Funds may be subject to
corporate income tax and an interest charge on certain dividends
and capital gains earned from these investments, regardless of
whether such income and gains were distributed to shareholders.
To avoid such tax and interest, the Funds in accordance with
tax regulations, intend to treat these securities as sold on the
last day of a Fund's fiscal year and recognize any gains for tax
purposes at that time; losses will not be recognized. Such gains
will be considered ordinary income which a Fund will be required
to distribute even though it has not sold the security and
received cash to pay such distributions.
PAGE 78
Foreign Currency Gains and Losses
Foreign currency gains and losses, including the portion of
gain or loss on the sale of debt securities attributable to
foreign exchange rate fluctuations, are taxable as ordinary
income. If the net effect of these transactions is a gain, the
ordinary income dividend paid by the Fund will be increased. If
the result is a loss, the income dividend paid by the Fund will
be decreased, or to the extent such dividend has already been
paid, a portion may be reclassified as a return of capital.
Adjustments to reflect these gains and losses will be made at the
end of the Fund's taxable year.
YIELD INFORMATION
From time to time, the Fund may advertise a yield figure
calculated in the following manner:
GNMA and Short-Term U.S. Government Funds
In conformity with regulations of the Securities and
Exchange Commission, an income factor is calculated for each
security in the portfolio based upon the security's coupon rate.
The income factors are then adjusted for any gains or losses
which have resulted from prepayments of principal during the
period. The income factors are then totalled for all securities
in the portfolio. Next, expenses of the Fund for the period net
of expected reimbursements, are deducted from the income to
arrive at net income, which is then converted to a per-share
amount by dividing net income by the average number of shares
outstanding during the period. The net income per share is
divided by the net asset value on the last day of the period to
produce a monthly yield which is then annualized. Quoted yield
factors are for comparison purposes only, and are not intended to
indicate future performance or forecast the dividend per share of
the Fund.
The yields of the GNMA and Short-Term U.S. Government Funds
calculated under the above-described method for the month ended
May 31, 1996 were 6.81% and 5.95%, respectively.
Corporate Income, High Yield, New Income, Short-Term Bond, U.S.
Treasury Intermediate and U.S. Treasury Long-Term Funds
An income factor is calculated for each security in the
portfolio based upon the security's market value at the beginning
of the period and yield as determined in conformity with
regulations of the Securities and Exchange Commission. The
income factors are then totalled for all securities in the
portfolio. Next, expenses of the Fund for the period net of
expected reimbursements are deducted from the income to arrive at
net income, which is then converted to a per-share amount by
dividing net income by the average number of shares outstanding
during the period. The net income per share is divided by the
net asset value on the last day of the period to produce a
monthly yield which is then annualized. Quoted yield factors are
for comparison purposes only, and are not intended to indicate
future performance or forecast the dividend per share of the
Fund.
The yields of the Corporate Income, High Yield, New
Income, Short-Term Bond, Intermediate and Long-Term Funds
calculated under the above-described method for the month ended
May 31, 1996, were 8.04%, 9.16%, 6.37%, 5.99%, 5.89% and 6.33%,
respectively.
Prime Reserve and U.S. Treasury Money Funds
The Fund's current and historical yield for a period is
calculated by dividing the net change in value of an account
(including all dividends
PAGE 79
accrued and dividends reinvested in additional shares) by the
account value at the beginning of the period to obtain the base
period return. This base period return is divided by the number
of days in the period then multiplied by 365 to arrive at the
annualized yield for that period. The Fund's annualized compound
yield for such period is compounded by dividing the base period
return by the number of days in the period, and compounding that
figure over 365 days.
The seven-day yields ending May 31, 1996 for the Prime
Reserve and U.S. Treasury Money Funds were 4.68% and 4.58%,
respectively, and the Funds' compound yield for the same period
were 4.79% and 4.68%, respectively.
All Funds
INVESTMENT PERFORMANCE
Total Return Performance
The Fund's calculation of total return performance includes
the reinvestment of all capital gain distributions and income
dividends for the period or periods indicated, without regard to
tax consequences to a shareholder in the Fund. Total return is
calculated as the percentage change between the beginning value
of a static account in the Fund and the ending value of that
account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital
gains dividends. The results shown are historical and should not
be considered indicative of the future performance of the Fund.
Each average annual compound rate of return is derived from the
cumulative performance of the Fund over the time period
specified. The annual compound rate of return for the Fund over
any other period of time will vary from the average.
PAGE 80
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
5/31/96 5/31/96 5/31/96 5/31/96
GNMA Fund
T. Rowe Price GNMA Fund 3.72% 40.51% 112.83% 121.82%
(11/26/85)
Salomon Brothers 30-Year
GNMA Index 5.43 45.59 141.28 156.58
Lehman Brothers GNMA
Bond Index 5.36 44.69 140.20 154.86
Lipper GNMA Funds Average 3.94 39.55 114.23 126.19
High Yield Fund
T. Rowe Price High
Yield Fund 9.06% 72.07% 121.84% 201.93%
(12/31/84)
Merrill Lynch High
Yield Index 9.55 90.94 182.26 287.58
Merrill Lynch Medium Quality
Long Corporate Index 4.46 63.41 165.98 273.02
Lipper's Average of High
Current Yield Funds 11.39 87.37 138.34 213.32
New Income Fund
T. Rowe Price New
Income Fund 3.70% 42.72% 111.98% 588.04%
(8/31/73)
Salomon Bros. Broad
Investment Grade Index 4.35 47.35 131.43 N/A
Salomon Bros. High Grade
Corporate Bond Index 3.40 57.78 150.92 699.02
Lehman Bros. Govt./Corp.
Bond Index 4.10 48.08 127.60 656.33
Lipper Corporate Bond Funds
-A Rated Average 3.43 46.92 120.75 583.48
PAGE 81
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
5/31/96 5/31/96 5/31/96 5/31/96
Personal Strategy Funds
Personal Strategy Income 13.84% -- --
28.52%
(7/29/94)
S&P 500 28.44 -- -- 53.22
Lehman Bros. Gov't/Corp.
Bond Index 4.10 -- -- 14.18
Personal Strategy Balanced 17.97% -- --
34.90%
(7/29/94)
S&P 500 28.44 -- -- 53.22
Lehman Bros. Gov't/Corp.
Bond Index 4.10 -- -- 14.18
Personal Strategy Growth 22.83% -- --
42.05%
(7/29/94)
S&P 500 28.44 -- -- 53.22
Lehman Bros. Gov't/Corp.
Bond Index 4.10 -- -- 14.18
Short-Term Bond Fund
T. Rowe Price Short-Term
Bond Fund 4.58% 28.64% 84.36%
136.87%
(3/2/84)
T. Rowe Price Prime
Reserve Fund 5.25 21.92 72.80
359.58
(1/26/76)
IBC's Money Fund Report
Averages TM- All Taxable 5.23 22.10 N/A N/A
(1/21.76)
Lehman Bros. 1-3 Year
Govt./Corp. Bond Index 5.34 35.62 102.41
168.79
(2/29/84)
Lipper Short Investment
Grade Debt Funds Average 4.92 33.31 95.68
163.54
(2/29/84)
PAGE 82
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
5/31/96 5/31/96 5/31/96 5/31/96
Short-Term U.S. Government Fund
T. Rowe Price Short-Term
U.S. Government Fund, Inc. 4.31% -- --
19.84%
(9/30/91)
Lipper Short-Term U.S.
Govt. Funds Average 4.51 -- -- 26.03
Merrill Lynch 1-3 Year
Govt. Index 5.40 -- -- 30.74
Salomon Brothers 1-Year
Treasury Index 5.73 -- -- 25.99
Salomon Brothers 2-Year
Treasury Index 4.90 -- -- 30.35
U.S. Treasury Intermediate Fund
T. Rowe Price U.S. Treasury
Intermediate Fund 3.52% 40.36% --
63.62%
(9/29/89)
Salomon 1-7 year
Treasury Index 5.69 41.36 -- 66.06
U.S. Treasury Long-Term Fund
T. Rowe Price U.S. Treasury
Long-Term Fund 1.02% 48.29% --
69.32%
(9/29/89)
Salomon Treasury Index 3.98 46.46 -- 70.91
PAGE 83
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
5/31/96 5/31/96 5/31/96 5/31/96
GNMA Fund
T. Rowe Price GNMA Fund 3.72% 7.04% 7.85% 7.88%
(11/26/85)
Salomon Brothers 30-Year
GNMA Index 5.43 7.80 9.21 9.38
Lehman Brothers GNMA Bond
Index 5.36 7.67 9.16 9.31
Lipper GNMA Funds Average 3.94 6.89 7.92 8.08
High Yield Fund
T. Rowe Price
High Yield Fund 9.06% 11.47% 8.29% 10.17%
(12/31/84)
Merrill Lynch High
Yield Index 9.55 13.81 10.93 12.60
Merrill Lynch Medium Quality
Long Corporate Index 4.46 10.32 10.28 12.23
Lipper's Average of High
Current Yield Funds 11.39 13.38 9.07 10.52
New Income Fund
T. Rowe Price
New Income Fund 3.70% 7.37% 7.80% 8.85%
(8/31/73)
Salomon Bros. Broad
Investment Grade Index 4.35 8.06 8.75 N/A
Salomon Bros. High Grade
Corporate Bond Index 3.40 9.55 9.64 9.56
Lehman Bros. Govt./Corp.
Bond Index 4.10 8.17 8.57 9.29
Lipper Corporate Bond Funds
-A Rated Average 3.43 8.00 8.24 8.81
PAGE 84
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
5/31/96 5/31/96 5/31/96 5/31/96
Personal Strategy Funds
Personal Strategy Income 13.84% -- --
14.62%
(7/29/94)
Personal Strategy Balanced 17.97 -- -- 17.68
(7/29/94)
Personal Strategy Growth 22.83 -- -- 21.03
(7/29/94)
Short-Term Bond Fund
T. Rowe Price Short-Term
Bond Fund 4.58% 5.17% 6.31% 7.30%
(3/2/84)
T. Rowe Price Prime
Reserve Fund 5.25 4.04 5.62 7.79
(1/26/76)
IBC's Money Fund Report
AveragesTM-All Taxable 5.23 4.07 N/A N/A
(1/31/76)
Lehman Bros. 1-3 Year
Govt./Corp. Bond Index 5.34 6.28 7.31 8.29
(2/29/84)
Lipper Short Investment
Grade Debt Funds Average 4.92 5.91 6.92 8.21
(2/29/84)
Short-Term U.S. Government Fund
T. Rowe Price Short-Term U.S.
Government Fund, Inc. 4.31% -- -- 3.95%
(9/30/91)
Lipper Short-Term U.S.
Govt. Funds Average 4.51 -- -- 5.08
Merrill Lynch 1-3 Year
Govt. Index 5.40 -- -- 5.91
Salomon Brothers 1-Year
Treasury Index 5.73 -- -- 5.07
Salomon Brothers 2-Year
Treasury Index 4.90 -- -- 5.84
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
5/31/96 5/31/96 5/31/96 5/31/96
U.S. Treasury Intermediate Fund
T. Rowe Price U.S. Treasury
Intermediate Fund 3.52% 7.02% -- 7.66%
(9/29/89)
Salomon 1-7 Year Treasury
Index 5.69 7.17 -- 7.90
U.S. Treasury Long-Term Fund
PAGE 85
T. Rowe Price U.S. Treasury
Long-Term Fund 1.02% 8.20% -- 8.22%
(9/29/89)
Salomon Treasury Index 3.98 7.93 -- 8.37
Outside Sources of Information
From time to time, in reports and promotional literature, one
or more of the T. Rowe Price funds, including this Fund, may
compare its performance to Overnight Government Repurchase
Agreements, Treasury bills, notes, and bonds, certificates of
deposit, and six-month money market certificates. Bank
certificates of deposit differ from mutual funds in several ways:
the interest rate established by the sponsoring bank is fixed for
the term of a CD; there are penalties for early withdrawal from
CDs; and the principal on a CD is insured. Performance may also
be compared to (1) indices of broad groups of managed or
unmanaged securities considered to be representative of or
similar to Fund portfolio holdings; such as: Lipper Analytical
Services, Inc., "Lipper-Fixed Income Fund Performance Analysis"
is a monthly publication which tracks net assets, total return,
principal return and yield on approximately 950 fixed income
mutual funds offered in the United States; Morningstar, Inc., is
a widely used independent research firm which rates mutual funds
by overall performance, investment objectives and assets.; (2)
other mutual funds; or (3) other measures of performance set
forth in publications such as:
Advertising News Service, Inc., "Bank Rate Monitor+ - The
Weekly Financial Rate Reporter" is a weekly publication which
lists the yields on various money market instruments offered to
the public by 100 leading banks and thrift institutions in the
U.S., including loan rates offered by these banks.
IBC/Donoghue Organization, Inc., "IBC/Donoghue's Money Fund
Report" is a weekly publication which tracks net assets, yield,
maturity and portfolio holdings on approximately 380 money
market mutual funds offered in the U.S. These funds are broken
down into various categories such as U.S. Treasury, Domestic
Prime and Euros, Domestic Prime and Euros and Yankees, and
Aggressive.
First Boston High Yield Index. It shows statistics on the
Composite Index and analytical data on new issues in the
marketplace and low-grade issuers.
Merrill Lynch, Pierce, Fenner & Smith, Inc., "Taxable Bond
Indices" is a monthly publication which lists principal, coupon
and total return on over 100 different taxable bond indices
tracked by Merrill Lynch, together with the par weighted
characteristics of each Index. The index used as a benchmark
for the High Yield Fund is the High Yield Index. The two
indices used as benchmarks for the Short-Term Bond Fund are the
91-Day Treasury Bill Index and the 1-2.99 Year Treasury Note
Index.
Salomon Brothers Inc., "Analytical Record of Yields and Yield
Spreads" is a publication which tracks historical yields and
yield spreads on short-term market rates, public obligations of
the U.S. Treasury and agencies of the U.S. government, public
corporate debt obligations, municipal debt obligations and
preferred stocks.
Salomon Brothers Inc., "Bond Market Round-up" is a weekly
publication which tracks the yields and yield spreads on a
large, but select, group of money market instruments, public
corporate debt obligations, and public obligations of the U.S.
Treasury and agencies of the U.S. Government.
Salomon Brothers Inc., "High Yield Composite Index" is an index
which provides performance and statistics for the high yield
market place.
PAGE 86
Salomon Brothers Inc., "Market Performance" is a monthly
publication which tracks principal return, total return and
yield on the Salomon Brothers Broad investment - Grade Bond
Index and the components of the Index.
Shearson Lehman Brothers, Inc., "The Bond Market Report" is a
monthly publication which tracks principal, coupon and total
return on the Shearson Lehman Govt./Corp. Index and Shearson
Lehman Aggregate Bond Index, as well as all the components of
these Indices.
Telerate Systems, Inc., is a market data distribution network
which tracks a broad range of financial markets including, the
daily rates on money market instruments, public corporate debt
obligations and public obligations of the U.S. Treasury and
agencies of the U.S. Government.
Wall Street Journal, is a national daily financial news
publication which lists the yields and current market values on
money market instruments, public corporate debt obligations,
public obligations of the U.S. Treasury and agencies of the
U.S. government as well as common stocks, preferred stocks,
convertible preferred stocks, options and commodities.
Indices prepared by the research departments of such financial
organizations as Shearson Lehman/American Express Inc., and
Merrill Lynch, Pierce, Fenner and Smith, Inc., including
information provided by the Federal Reserve Board.
Performance rankings and ratings reported periodically in
national financial publications such as MONEY, FORBES, BUSINESS
WEEK, BARRON'S, etc. will also be used.
PAGE 87
All Funds
IRAs
An IRA is a long-term investment whose objective is to
accumulate personal savings for retirement. Due to the long-term
nature of the investment, even slight differences in performance
will result in significantly different assets at retirement.
Mutual funds, with their diversity of choice, can be used for IRA
investments. Generally, individuals may need to adjust their
underlying IRA investments as their time to retirement and
tolerance for risk changes.
Other Features and Benefits
The Fund is a member of the T. Rowe Price Family of Funds
and may help investors achieve various long-term investment
goals, such as investing money for retirement, saving for a down
payment on a home, or paying college costs. To explain how the
Fund could be used to assist investors in planning for these
goals and to illustrate basic principles of investing, various
worksheets and guides prepared by T. Rowe Price Associates, Inc.
and/or T. Rowe Price Investment Services, Inc. may be made
available. These currently include: the Asset Mix Worksheet
which is designed to show shareholders how to reduce their
investment risk by developing a diversified investment plan; the
College Planning Guide which discusses various aspects of
financial planning to meet college expenses and assists parents
in projecting the costs of a college education for their
children; the Retirement Planning Kit (also available in a PC
version) includes a detailed workbook to determine how much money
you may need for retirement and suggests how you might invest to
achieve your objectives; and the Retirees Financial Guide which
includes a detailed workbook to determine how much money you can
afford to spend and still preserve your purchasing power and
suggests how you might invest to reach your goal. Tax
Considerations for Investors discusses the tax advantages of
annuities and municipal bonds and how to assess whether they are
suitable for your portfolio, reviews pros and cons of placing
assets in a gift to minors account and summarizes the benefits
and types of tax-deferred retirement plans currently available.
Personal Strategy Planner simplifies investment decision making
by helping investors define personal financial goals, establish
length of time the investor intends to invest, determine risk
"comfort zone" and select diversified investment mix; and the How
to Choose a Bond Fund guide which discusses how to choose an
appropriate bond fund for your portfolio. From time to time,
other worksheets and guides may be made available as well. Of
course, an investment in the Fund cannot guarantee that such
goals will be met.
PAGE 88
To assist investors in understanding the different returns
and risk characteristics of various investments, the
aforementioned guides will include presentation of historical
returns of various investments using published indices. An
example of this is shown below.
Historical Returns for Different Investments
Annualized returns for periods ended 12/31/95
50 years 20 years 10 years 5 years
Small-Company Stocks 13.8% 19.6% 11.9% 24.5%
Large-Company Stocks 11.9 14.6 14.8 16.6
Foreign Stocks N/A 15.1 13.9 9.7
Long-Term Corporate Bonds 5.7 10.5 11.2 12.1
Intermediate-Term U.S.
Gov't. Bonds 5.9 9.7 9.1 8.8
Treasury Bills 4.8 7.3 5.5 4.3
U.S. Inflation 4.4 5.2 3.5 2.8
Sources: Ibbotson Associates, Morgan Stanley. Foreign stocks
reflect performance of The Morgan Stanley Capital International
EAFE Index, which includes some 1,000 companies representing the
stock markets of Europe, Australia, New Zealand, and the Far
East. This chart is for illustrative purposes only and should
not be considered as performance for, or the annualized return
of, any T. Rowe Price Fund. Past performance does not guarantee
future results.
PAGE 89
Also included will be various portfolios demonstrating how these
historical indices would have performed in various combinations
over a specified time period in terms of return. An example of
this is shown below.
Performance of Retirement Portfolios*
Asset Mix Average Annualized Value
Returns 20 Years of
Ended 12/31/95 $10,000
Investment
After Period
________________ __________________ ____________
Nominal Real BestWorst
Portfolio Growth IncomeSafety ReturnReturn** YearYear
I. Low
Risk 40% 40% 20% 11.8% 6.5% 24.9% 0.1% $ 92,675
II. Moderate
Risk 60% 30% 10% 13.1% 7.9% 29.1% -1.8%$116,826
III. High
Risk 80% 20% 0% 14.3% 9.1% 33.4% -5.2%$145,611
Source: T. Rowe Price Associates; data supplied by Lehman
Brothers, Wilshire Associates and Ibbotson Associates.
* Based on actual performance for the 20 years ended 1995 of
stocks (85% Wilshire 5000 and 15% Europe, Australia, Far
East [EAFE] Index), bonds (Lehman Brothers Aggregate Bond
Index from 1976-95 and 30-day Treasury bills from January
1976 through December 1995). Past performance does not
guarantee future results. Figures include changes in
principal value and reinvested dividends and assume the same
asset mix is maintained each year. This exhibit is for
illustrative purposes only and is not representative of the
performance of any T. Rowe Price fund.
** Based on inflation rate of 5.2% for the 20-year period ended
12/31/95.
Insights
From time to time, Insights, a T. Rowe Price publication of
reports on specific investment topics and strategies, may be
included in the Fund's fulfillment kit. Such reports may include
information concerning: calculating taxable gains and losses on
mutual fund transactions, coping with stock market volatility,
benefiting from dollar cost averaging, understanding
international markets, investing in high-yield "junk" bonds,
growth stock investing, conservative stock investing, value
investing, investing in small companies, tax-free investing,
fixed income investing, investing in mortgage-backed securities,
as well as other topics and strategies.
Other Publications
From time to time, in newsletters and other publications
issued by T. Rowe Price Investment Services, Inc., reference may
be made to economic, financial and political developments in the
U.S. and abroad and their effect on securities prices. Such
discussions may take the form of commentary on these developments
by T. Rowe Price mutual fund portfolio managers and their views
and analysis on how such developments could affect investments in
mutual funds.
Redemptions in Kind
PAGE 90
In the unlikely event a shareholder were to receive an in
kind redemption of portfolio securities of the Fund, brokerage
fees could be incurred by the shareholder in a subsequent sale of
such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the Fund; (b) are acquired
for investment and not for resale except in accordance with
applicable law; (c) have a value that is readily ascertainable
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
All Funds, except GNMA Fund
CAPITAL STOCK
The Fund's Charter authorizes the Board of Directors to
classify and reclassify any and all shares which are then
unissued, including unissued shares of capital stock into any
number of classes or series, each class or series consisting of
such number of shares and having such designations, such powers,
preferences, rights, qualifications, limitations, and
restrictions, as shall be determined by the Board subject to the
Investment Company Act and other applicable law. The shares of
any such additional classes or series might therefore differ from
the shares of the present class and series of capital stock and
from each other as to preferences, conversions or other rights,
voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption, subject to
applicable law, and might thus be superior or inferior to the
capital stock or to other classes or series in various
characteristics. The Board of Directors may increase or decrease
the aggregate number of shares of stock or the number of shares
of stock of any class or series that the Fund has authorized to
issue without shareholder approval.
Except to the extent that the Fund's Board of Directors
might provide by resolution that holders of shares of a
particular class are entitled to vote as a class on specified
matters presented for a vote of the holders of all shares
entitled to vote on such matters, there would be no right of
class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Charter contains no
provision entitling the holders of the present class of capital
stock to a vote as a class on any matter. Accordingly, the
preferences, rights, and other characteristics attaching to any
class of shares, including the present class of capital stock,
might be altered or eliminated, or the class might be combined
with another class or classes, by action approved by the vote of
the holders of a majority of all the shares of all classes
entitled to be voted on the proposal, without any additional
right to vote as a class by the holders of the capital stock or
of another affected class or classes.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of directors (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
will be unable to elect any person as a director. As set forth
in the By-Laws
PAGE 91
of the Fund, a special meeting of shareholders of the Fund shall
be called by the Secretary of the Fund on the written request of
shareholders entitled to cast at least 10% of all the votes of
the Fund entitled to be cast at such meeting. Shareholders
requesting such a meeting must pay to the Fund the reasonably
estimated costs of preparing and mailing the notice of the
meeting. The Fund, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating
to the other shareholders of the Fund to the extent required by
Section 16(c) of the Investment Company Act of 1940.
GNMA Fund
DESCRIPTION OF THE FUND
For tax and business reasons, the Fund was organized in 1985
as a Massachusetts Business Trust and is registered with the
Securities and Exchange Commission under the Investment Company
Act of 1940 as a diversified, open-end investment company,
commonly known as a "mutual fund."
The Declaration of Trust permits the Board of Trustees to
issue an unlimited number of full and fractional shares of a
single class. The Declaration of Trust also provides that the
Board of Trustees may issue additional series or classes of
shares. Each share represents an equal proportionate beneficial
interest in the Fund. In the event of the liquidation of the
Fund, each share is entitled to a pro rata share of the net
assets of the Fund.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of trustees (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing trustees unless and
until such time as less than a majority of the trustees holding
office have been elected by shareholders, at which time the
trustees then in office will call a shareholders' meeting for the
election of trustees. Pursuant to Section 16(c) of the
Investment Company Act of 1940, holders of record of not less
than two-thirds of the outstanding shares of the Fund may remove
a trustee by a vote cast in person or by proxy at a meeting
called for that purpose. Except as set forth above, the trustees
shall continue to hold office and may appoint successor trustees.
Voting rights are not cumulative, so that the holders of more
than 50% of the shares voting in the election of trustees can, if
they choose to do so, elect all the trustees of the Trust, in
which event the holders of the remaining shares will be unable to
elect any person as a trustee. No amendments may be made to the
Declaration of Trust without the affirmative vote of a majority
of the outstanding shares of the Trust.
Shares have no preemptive or conversion rights; the right of
redemption and the privilege of exchange are described in the
prospectus. Shares are fully paid and nonassessable, except as
set forth below. The Trust may be terminated (i) upon the sale
of its assets to another diversified, open-end management
investment company, if approved by the vote of the holders of
two-thirds of the outstanding shares of the Trust, or (ii) upon
liquidation and distribution of the assets of the Trust, if
approved by the vote of the holders of a majority of the
outstanding shares of the Trust. If not so terminated, the Trust
will continue indefinitely.
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of
the Fund. However, the Declaration of Trust disclaims
shareholder liability for acts or obligations of the Fund and
requires that notice of such disclaimer be given in each
agreement, obligation or instrument entered into or executed by
the Fund or a Trustee. The Declaration of Trust provides for
indemnification from Fund property for all
PAGE 92
losses and expenses of any shareholder held personally liable for
the obligations of the Fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund itself would be unable
to meet its obligations, a possibility which T. Rowe Price
believes is remote. Upon payment of any liability incurred by
the Fund, the shareholders of the Fund paying such liability will
be entitled to reimbursement from the general assets of the Fund.
The Trustees intend to conduct the operations of the Fund in such
a way so as to avoid, as far as possible, ultimate liability of
the shareholders for liabilities of such Fund.
FEDERAL AND STATE REGISTRATION OF SHARES
The Fund's shares are registered for sale under the
Securities Act of 1933, and the Fund or its shares are registered
under the laws of all states which require registration, as well
as the District of Columbia and Puerto Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman, & Goodman, L.L.P., whose address
is 919 Third Avenue, New York, New York 10022, is legal counsel
to the Fund.
INDEPENDENT ACCOUNTANTS
Corporate Income, GNMA, High Yield, U.S. Treasury Intermediate,
U.S. Treasury Long-Term, New Income, Prime Reserve, Short-Term
Bond, Short-Term U.S. Government, and U.S. Treasury Money Funds
Price Waterhouse LLP, 7 St. Paul Street, Suite 1700,
Baltimore, Maryland 21202, are independent accountants to the
Fund.
Effective June 1, 1994, Price Waterhouse LLP became the
independent accountants to the Intermediate and Long-Term Funds,
and effective June 1, 1995, Price Waterhouse LLP became the
independent accountant to the Short-Term U.S. Government
Fund.
Personal Strategy Funds
Coopers & Lybrand L.L.P., 217 East Redwood Street,
Baltimore, Maryland 21202, are independent accountants to the
Fund.
Financial Statements
The financial statements of the Fund for the year ended May
31, 1996, and the report of independent accountants are included
in the Fund's Annual Report for the year ended May 31, 1996. A
copy of the Annual Report accompanies this Statement of
Additional Information. The following financial statements and
the report of independent accountants appearing in the Annual
Report for the year ended May 31, 1996, are incorporated into
this Statement of Additional Information by reference:
ANNUAL REPORT REFERENCES:
HIGH NEW PRIME
GNMA YIELD INCOME RESERVE
____ ______ _______ ________
Report of Independent
PAGE 93
Accountants 15 24 18 19
Statement of Net Assets,
May 31, 1996 7-9 10-18 7-12 7-14
Statement of Operations,
fiscal year ended
May 31, 1996 10 19 13 15
Statement of Changes in Net
Assets, fiscal years
ended May 31, 1996 and
May 31, 1995 11 20 14 16
Notes to Financial
Statements
May 31, 1996 12-14 21-23 15-17 17-18
Financial Highlights 6 9 6 6
PAGE 94
SHORT-TERM
SHORT- U.S.
TERM BOND GOVERNMENT
_____________ ____________
Report of Independent
Accountants 20 16
Statement of Net Assets,
May 31, 1996 8-14 7-10
Statement of Operations,
fiscal year ended
May 31, 1996 15 11
Statement of Changes in Net
Assets, fiscal years
ended May 31, 1996 and
May 31, 1995 16 12
Notes to Financial Statements
May 31, 1996 17-19 13-15
Financial Highlights 7 6
U.S. U.S. U.S.
TREASURY TREASURY TREASURY
MONEY INTERMEDIATE LONG-TERM
______________ __________ __________
Report of Independent
Accountants 26 26 26
Statement of Net Assets,
May 31, 1996 12-13 14-16 17-18
Statement of Operations,
fiscal year ended
May 31, 1996 19 19 19
Statement of Changes in Net
Assets, fiscal year
ended May 31, 1996 and
May 31, 1995 20 21 22
Notes to Financial Statements
May 31, 1996 23-25 23-25 23-25
Financial Highlights 9 10 11
PAGE 95
PERSONAL PERSONAL PERSONAL
STRATEGY STRATEGY STRATEGY
BALANCED GROWTH INCOME
______________ __________ __________
Report of Independent
Accountants 58 58 58
Statement of Net Assets,
May 31, 1996 22-37 38-50 10-21
Statement of Operations,
fiscal year ended
May 31, 1996 51 51 51
Statement of Changes in Net
Assets, fiscal year
ended May 31, 1996,
and July 29, 1994 (Commence-
ment of Operations) to
May 31, 1995 52 52 52
Notes to Financial Statements,
May 31, 1996 53-57 53-57 53-57
Financial Highlights 9 9 9
CORPORATE
INCOME
______________
Report of Independent
Accountants 18
Statement of Net Assets,
May 31, 1996 8-12
Statement of Operations,
fiscal year ended
October 31, 1995 (Commence-
ment of Operations) to
May 31, 1996 13
Statement of Changes in Net
Assets, fiscal year ended
October 31, 1995 (Commence-
ment of Operations) to
May 31, 1996 14
Notes to Financial Statements,
May 31, 1996 15-17
Financial Highlights 7
PAGE 96
RATINGS OF COMMERCIAL PAPER
High Yield, Prime Reserve, Short-Term Bond, and Short-Term U.S.
Government Funds
Moody's Investors Service, Inc.: The rating of Prime-1 is the
highest commercial paper rating assigned by Moody's. Among the
factors considered by Moody's in assigning ratings are the
following: valuation of the management of the issuer; economic
evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in
certain areas; evaluation of the issuer's products in relation to
competition and customer acceptance; liquidity; amount and
quality of long-term debt; trend of earnings over a period of 10
years; financial strength of the parent company and the
relationships which exist with the issuer; and recognition by the
management of obligations which may be present or may arise as a
result of public interest questions and preparations to meet such
obligations. These factors are all considered in determining
whether the commercial paper is rated P1, P2, or P3.
Standard & Poor's Corporation: Commercial paper rated A (highest
quality) by S&P has the following characteristics: liquidity
ratios are adequate to meet cash requirements; long-term senior
debt is rated "A" or better, although in some cases "BBB" credits
may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances.
Typically, the issuer's industry is well established and the
issuer has a strong position within the industry. The
reliability and quality of management are unquestioned. The
relative strength or weakness of the above factors determines
whether the issuer's commercial paper is rated A1, A2, or A3.
Prime Reserve Fund
Fitch Investors Service, Inc.: Fitch 1 - Highest grade.
Commercial paper assigned this rating is regarded as having the
strongest degree of assurance for timely payment. Fitch 2 - Very
good grade. Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest
issues.
PAGE 97
RATINGS OF CORPORATE DEBT SECURITIES
High Yield, New Income, Personal Strategy, Short-Term Bond, and
Short-Term U.S. Government Funds
Moody's Investors Services, Inc. (Moody's)
Aaa-Bonds rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are
generally referred to as "gilt edge."
Aa-Bonds rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds.
A-Bonds rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations.
Baa-Bonds rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly
secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as
well.
Ba-Bonds rated Ba are judged to have speculative elements:
their futures 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 characterize
bonds in this class.
B-Bonds rated B generally lack the characteristics of a
desirable investment. Assurance of interest and principal
payments or of maintenance of other terms of the contract over
any long period of time may be small.
Caa-Bonds rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with
respect to principal or interest.
Ca-Bonds rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked short-comings.
Standard & Poor's Corporation (S&P)
AAA-This is the highest rating assigned by Standard & Poor's
to a debt obligation and indicates an extremely strong capacity
to pay principal and interest.
AA-Bonds rated AA also qualify as high-quality debt
obligations. Capacity to pay principal and interest is very
strong.
A-Bonds rated A have a strong capacity to pay principal and
interest, although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions.
BBB-Bonds rated BBB are regarded as having an adequate
capacity to pay principal and interest. Whereas they normally
exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, C, CCC, CC-Bonds rated BB, B, CCC, and CC are regarded on
balance, as predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal. BB
indicates the lowest degree of speculation and CC the
PAGE 98
highest degree of speculation. While such bonds will likely have
some quality and protective characteristics, these are outweighed
by large uncertainties or major risk exposures to adverse
conditions.
D-In default.
Fitch Investors Service, Inc.
AAA-High grade, broadly marketable, suitable for investment by
trustees and fiduciary institutions, and liable to but slight
market fluctuation other than through changes in the money rate.
The prime feature of a "AAA" bond is the showing of earnings
several times or many times interest requirements for such
stability of applicable interest that safety is beyond reasonable
question whenever changes occur in conditions. Other features
may enter, such as a wide margin of protection through
collateral, security or direct lien on specific property.
Sinking funds or voluntary reduction of debt by call or purchase
or often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
AA-Of safety virtually beyond question and readily salable.
Their merits are not greatly unlike those of "AAA" class but a
bond so rated may be junior though of strong lien, or the margin
of safety is less strikingly broad. The issue may be the
obligation of a small company, strongly secured, but influenced
as to rating by the lesser financial power of the enterprise and
more local type of market.
