<PAGE> 1
VAN KAMPEN MERRITT
U.S. GOVERNMENT FUND
Van Kampen Merritt U.S. Government Fund (the "Fund") is a diversified
sub-trust of the Van Kampen Merritt U.S. Government Trust (the "Trust"), an
open-end management investment company. The Fund's investment objective is to
provide a high level of current income, with liquidity and safety of principal.
The Fund invests primarily in obligations issued or guaranteed by the U.S.
Government or by its agencies or instrumentalities. The Fund may invest a
substantial portion of its assets in mortgage-backed securities issued by
agencies of the U.S. Government, some of which are backed by the full faith and
credit of the U.S. Government and others of which are backed only by the right
of the issuer to borrow from the U.S. Treasury or the credit of the issuer. The
Fund may engage in strategic transactions including borrowing for investment
purposes and utilizing financial derivative instruments, subject to the
limitations set forth in this Prospectus. Such transactions may entail certain
risks, which are described under "How the Fund Seeks Its Investment Objective."
The net asset value and the return of the Fund will fluctuate depending on
market conditions and other factors. The Fund is managed by Van Kampen American
Capital Investment Advisory Corp. (the "Adviser").
Investors may elect to purchase Class A Shares, Class B Shares or Class C
Shares, each with different sales charges and expenses. The different classes of
shares permit an investor to choose the method of purchasing shares that is more
beneficial to the investor, taking into account the amount of the purchase, the
length of time the investor expects to hold the shares and other circumstances.
See "How to Buy Shares."
Additional information about the Fund is contained in a Statement of
Additional Information dated April 30, 1995, which has been filed with the
Securities and Exchange Commission, a copy of which may be obtained without
charge by calling: 1-800-225-2222, ext. 6504. This Prospectus, which
incorporates by reference the entire Statement of Additional Information,
concisely sets forth certain information about the Fund that a prospective
shareholder should know before investing in the Fund. Shareholders should read
this Prospectus carefully and retain it for future reference.
------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, GUARANTEED OR
ENDORSED BY, ANY BANK OR DEPOSITORY INSTITUTION; FURTHER, SUCH SHARES ARE NOT
INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD
OR ANY OTHER GOVERNMENT AGENCY. SHARES OF THE FUND INVOLVE INVESTMENT RISKS,
INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
------------------
VAN KAMPEN AMERICAN CAPITAL(SM)
------------------
One Parkview Plaza
Oakbrook Terrace, Illinois 60181
(800) 225-2222
APRIL 30, 1995
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary of Fund Expenses............................................ 3
Financial Highlights................................................ 5
The Fund's Investment Objective..................................... 8
How the Fund Seeks Its Investment Objective......................... 8
How to Buy Shares................................................... 12
Distributions and Taxes............................................. 15
How the Fund Values Its Shares...................................... 15
How to Sell Shares.................................................. 16
How the Fund Is Managed............................................. 18
How the Fund Executes Portfolio Transactions........................ 19
Distribution and Service Plans...................................... 20
Shareholder Services................................................ 22
Fund Performance.................................................... 22
Fund Organization................................................... 23
Additional Information.............................................. 23
</TABLE>
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS, IN CONNECTION WITH THE OFFER CONTAINED IN THIS PROSPECTUS AND, IF
GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON
AS HAVING BEEN AUTHORIZED BY THE FUND, THE ADVISER, OR THE DISTRIBUTOR. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER BY THE FUND OR BY THE DISTRIBUTOR TO
SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY
IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL FOR THE FUND TO MAKE
SUCH AN OFFER IN SUCH JURISDICTION.
2
<PAGE> 3
- --------------------------------------------------------------------------------
SUMMARY OF FUND EXPENSES
- --------------------------------------------------------------------------------
Expenses are one of several factors to consider when you invest in the Fund.
The expense summary format below is used by all mutual funds and is provided
here to help you make your investment decision.
SHAREHOLDER TRANSACTION EXPENSES
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
SHARES SHARES SHARES
-------- ------------ ------------
<S> <C> <C> <C>
Maximum sales load imposed on
purchases (as a percentage of the
offering price).................. 4.75% (1) None None
Maximum sales load imposed on
reinvested dividends (as a
percentage of the offering
price)........................... None None(3) None(3)
Deferred sales load (as a
percentage of original purchase
price or redemption proceeds).... None (2) Year 1--4.00% Year 1--1.00%
Year 2--3.75%
Year 3--3.50%
Year 4--2.50%
Year 5--1.50%
Year 6--1.00%
Year 7--None
Redemption fees (as a percentage
of amount redeemed).............. None None None
Exchange fees..................... None None None
</TABLE>
- ----------------
(1) Reduced on investments of $100,000 or more.
(2) Investments of $1,000,000 or more are not subject to an initial sales
charge, but a contingent deferred sales charge of 1.00% may be imposed on
redemptions made within one year of the purchase.
(3) Subject to a 12b-1 fee, a portion of which may indirectly pay for the
initial sales commission incurred on behalf of the investor. See
"Distribution and Service Plans."
3
<PAGE> 4
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average daily net assets)
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
SHARES SHARES SHARES
-------- ------- -------
<S> <C> <C> <C>
Management Fees...................................... 0.51% 0.51% 0.51%
12b-1 Fees........................................... 0.20%(1) 1.00% 1.00%
Other Expenses:
Miscellaneous Other Expenses....................... 0.21% 0.23% 0.23%
Interest Expenses.................................. 0.08% 0.09% 0.10%
Total Other Expenses................................. 0.29% 0.32% 0.33%
------ ----- -----
Total Expenses(2).................................... 1.00% 1.83% 1.84%
</TABLE>
- ----------------
(1) 12b-1 and Service Fees for Class A Shares are being phased-in. It is
anticipated that such fees will increase over time to a maximum aggregate
amount of 0.30% of the net assets attributable to the Class A Shares. See
"Distribution and Service Plans."
(2) The Fund incurred financing expenses related to borrowings for investment
purposes. Borrowings provide the opportunity for increased net income, but
may increase the Fund's investment risk. Total Expenses without regard to
the interest expense would have been 0.92%, 1.74% and 1.74% for each of the
Class A Shares, Class B Shares and Class C Shares, respectively. See
"Financial Highlights" and "How the Fund Seeks Its Investment Objection."
EXAMPLE
A $1,000 investment would have the following transaction costs and operating
expenses assuming a 5% annual return. This example should not be considered
indicative of actual or expected Fund performance or expenses, both of which
will vary.
<TABLE>
<CAPTION>
WITH REDEMPTION AT
THE END OF PERIOD: ONE YEAR THREE YEARS FIVE YEARS TEN YEARS(1)
- ---------------------------------- -------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Class A Shares.................... $56 $75 $ 96 $155
Class B Shares.................... $58 $90 $109 $164
Class C Shares.................... $28 $55 $ 94 $205
</TABLE>
<TABLE>
<CAPTION>
WITHOUT REDEMPTION AT THE END OF
PERIOD:
- ----------------------------------
<S> <C> <C> <C> <C>
Class A Shares.................... $56 $75 $96 $155
Class B Shares.................... $18 $55 $94 $164
Class C Shares.................... $18 $55 $94 $205
</TABLE>
- ----------------
(1) Class B Shares convert to Class A Shares at the end of six years after
purchase; ten-year amounts reflect lower expenses applicable to such shares
after conversion.
4
<PAGE> 5
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FINANCIAL HIGHLIGHTS
(for a share outstanding throughout the period)
- --------------------------------------------------------------------------------
The following schedule presents financial highlights for one Class A Share,
one Class B Share and one Class C Share of the Fund outstanding throughout the
periods indicated. The financial highlights have been audited by KPMG Peat
Marwick LLP, independent certified public accountants, for each of the periods
indicated, and their report thereon appears in the Statement of Additional
Information. This information should be read in conjunction with the financial
statements and related notes thereto included in the Statement of Additional
Information.
<TABLE>
<CAPTION>
CLASS A SHARES
----------------------------------------------------
YEAR ENDED DECEMBER 31
----------------------------------------------------
1994 1993 1992 1991 1990
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period...................... $ 15.662 $ 15.720 $ 16.130 $ 15.253 $ 15.280
-------- -------- -------- -------- --------
Net Investment Income....... 1.777 1.286 1.365 1.390 1.407
Net Realized and Unrealized
Gain/Loss on
Investments............... (1.965) (.060) (.407) .897 (.024)
-------- -------- -------- -------- --------
Total from Investment
Operations.................. (.788) 1.226 .958 2.287 1.383
-------- -------- -------- -------- --------
Less:
Distributions from and in
Excess of Net Investment
Income.................... 1.176 1.284 1.368 1.410 1.410
Distributions from Net
Realized Gain on
Investments............... -- -- -- -- --
Return of Capital
Distribution.............. -- -- -- -- --
-------- -------- -------- -------- --------
Total Distributions........... 1.176 1.284 1.368 1.410 1.410
-------- -------- -------- -------- --------
Net Asset Value, End of
Period...................... $ 13.698 $ 15.662 $ 15.720 $ 16.130 $ 15.253
======== ======== ======== ======== ========
Total Return
(Non-annualized)............ (5.10%) 7.95% 6.27% 15.80% 9.62%
Net Assets at End of Period
(In millions)............... $2,924.4 $3,653.6 $3,571.7 $3,505.9 $3,329.0
Ratio of operating Expenses to
Average Net Assets
(Annualized)................ .92% .87% .77% .68% .72%
Ratio of Interest Expense to
Average Net Assets
(Annualized)................ .08% N/A N/A N/A N/A
Ratio of Net Investment Income
to Average Net Assets
(Annualized)................ 8.13% 8.08% 8.64% 8.97% 9.38%
Portfolio Turnover............ 43.69% 67.04% 110.94% 26.87% 56.16%
</TABLE>
- ---------------
N/A -- Prior to 1994, interest expense was immaterial and subsequently netted
against interest income.
See Financial Statements and Notes Thereto
5
<PAGE> 6
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS (CONTINUED)
(for a share outstanding throughout the period)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A SHARES
--------------------------------------------------------
YEAR ENDED DECEMBER 31
--------------------------------------------------------
1989 1988 1987 1986 1985
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning
of Period................ $ 14.695 $ 15.046 $ 16.568 $ 16.253 $ 15.067
-------- -------- -------- -------- --------
Net Investment Income.... 1.404 1.319 1.384 1.510 1.701
Net Realized and
Unrealized Gain/Loss on
Investments............ .558 (.221) (1.264) .634 1.436
-------- -------- -------- -------- --------
Total from Investment
Operations............... 1.962 1.098 .120 2.144 3.137
-------- -------- -------- -------- --------
Less:
Distributions from and in
Excess of Net
Investment Income...... 1.377 1.319 1.400 1.498 1.716
Distributions from Net
Realized Gain on
Investments............ -- -- .081 .331 .235
Return of Capital
Distribution........... -- .130 .161 -- --
-------- -------- -------- -------- --------
Total Distributions........ 1.377 1.449 1.642 1.829 1.951
-------- -------- -------- -------- --------
Net Asset Value, End of
Period................... $ 15.280 $ 14.695 $ 15.046 $ 16.568 $ 16.253
======== ======== ======== ======== ========
Total Return (Non-
annualized).............. 13.88% 7.50% 1.45% 14.09% 22.33%
Net Assets at End of Period
(In millions)............ $3,550.5 $3,825.6 $4,814.6 $4,450.3 $1,810.2
Ratio of Operating Expenses
to Average Net Assets
(Annualized)............. .65% .71% .60% .56% .61%
Ratio of Interest Expense
to Average Net Assets
(Annualized)............. N/A N/A N/A N/A N/A
Ratio of Net Investment
Income to Average Net
Assets (Annualized)...... 9.37% 8.85% 8.96% 8.97% 10.01%
Portfolio Turnover......... 101.12% 166.70% 124.19% 154.33% 171.66%
</TABLE>
- ---------------
N/A -- Prior to 1994, interest expense was immaterial and subsequently netted
against interest income.
See Financial Statements and Notes Thereto
6
<PAGE> 7
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS (CONTINUED)
(for a share outstanding throughout the period)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B SHARES CLASS C SHARES
--------------------------------- -----------------------------
AUGUST 24, AUGUST 13,
1992 1993
(COMMENCEMENT (COMMENCEMENT
YEAR ENDED OF OF
DEC. 31 DISTRIBUTION) DISTRIBUTION)
----------------- TO DEC. 31, YEAR ENDED TO DEC. 31,
1994 1993 1992 DEC. 31, 1994 1993
------- ------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period.... $15.643 $15.709 $15.983 $15.626 $16.000
------- ------- ------- ------- -------
Net Investment
Income............. 1.055 1.149 .425 1.063 .433
Net Realized and
Unrealized Loss on
Investments........ (1.964) (.063) (.263) (1.956) (.364)
------- ------- ------- ------- -------
Total from Investment
Operations........... (.909) 1.086 .162 (.893) .069
------- ------- ------- ------- -------
Less:
Distributions from
Net Investment
Income............. 1.04 1.152 .436 1.04 .443
------- ------- ------- ------- -------
Net Asset Value, End
of Period............ $13.694 $15.643 $15.709 $13.693 $15.626
======= ======= ======= ======= =======
Total Return (Non-
annualized).......... (5.93%) 7.01% 1.64% (5.86%) .46%
Net Assets at End of
Period (In
millions)............ $ 436.3 $ 474.7 $ 103.1 $ 11.4 $ 9.6
Ratio of Operating
Expenses to Average
Net Assets
(Annualized)......... 1.74% 1.73% 1.61% 1.74% 1.71%
Ratio of Interest
Expense to Average
Net Assets
(Annualized)......... .09% N/A N/A .10% N/A
Ratio of Net Investment
Income to Average Net
Assets (Annualized).. 7.29% 7.00% 6.16% 7.29% 6.42%
Portfolio Turnover..... 43.69% 67.04% 110.94% 43.69% 67.04%
</TABLE>
- ---------------
N/A -- Prior to 1994, interest expense was immaterial and subsequently netted
against interest income.
See Financial Statements and Notes Thereto
7
<PAGE> 8
- --------------------------------------------------------------------------------
THE FUND'S INVESTMENT OBJECTIVE
- --------------------------------------------------------------------------------
The Fund's investment objective is to provide a high level of current income,
with liquidity and safety of principal. This objective is fundamental and cannot
be changed without shareholder approval. There are risks inherent in all
securities investments and there can be no assurance that the Fund will achieve
its objective.
- --------------------------------------------------------------------------------
HOW THE FUND SEEKS ITS INVESTMENT OBJECTIVE
- --------------------------------------------------------------------------------
The Fund seeks to achieve this objective by investing at least 65% of its
assets in obligations issued or guaranteed by the U.S. Government or in
obligations issued or guaranteed by agencies or instrumentalities of the U.S.
Government (collectively, "U.S. Government Securities"). This policy is
fundamental and cannot be changed without shareholder approval. U.S. Government
Securities are considered among the most creditworthy of fixed income
investments; however, the yields on U.S. Government securities generally are
lower than yields available from corporate debt securities. The value of U.S.
Government Securities (as with most fixed income securities) generally varies
inversely with changes in prevailing interest rates. The magnitude of these
fluctuations generally is greater for securities with longer maturities. The
fluctuating value of U.S. Government Securities affects the Fund's net asset
value but will not affect investment income from those securities.
U.S. Government Securities include: (1) U.S. Treasury obligations and (2)
obligations issued or guaranteed by U.S. Government agencies and
instrumentalities ("Agencies") which are supported by: (a) the full faith and
credit of the U.S. Government; (b) the right of the issuer or guarantor to
borrow an amount from a line of credit with the U.S. Treasury; (c) discretionary
power of the U.S. Government to purchase obligations of the Agencies or (d) the
credit of the Agencies. U.S. Government Securities may also include: (1) real
estate mortgage investment conduits ("REMICs"), collateralized mortgage
obligations ("CMOs") and other mortgage-backed securities ("Mortgage-Backed
Securities") issued or guaranteed by an Agency, (2) "when-issued" commitments
relating to the foregoing and (3) repurchase agreements ("Repos") collateralized
by U.S. Government Securities. The Fund invests in U.S. Government Securities of
varying maturities and interest rates, including investments in obligations
issued or guaranteed in zero coupon securities ("Zero Coupon Securities").
The Fund historically has invested substantially all of its assets in
Mortgage-Backed Securities that directly or indirectly represent a participation
in, or are secured by and payable from, mortgage loans secured by real property.
Mortgage Backed Securities are issued or guaranteed by U.S. Government agencies
or instrumentalities, such as certificates issued by the Government National
Mortgage Association ("GNMA"), the Federal National Mortgage Association
("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC").
Mortgage-Backed Securities also include mortgage pass-through certificates
representing participation interests in pools of mortgage loans originated by
the U.S. Government or private lenders and guaranteed by U.S.
8
<PAGE> 9
Government agencies such as GNMA, FNMA or FHLMC. Guarantees by GNMA are backed
by the full faith and credit of the United States. Guarantees by other agencies
or instrumentalities of the U.S. Government, such as FNMA or FHLMC, are not
backed by the full faith and credit of the United States, although FNMA and
FHLMC are authorized to borrow from the U.S. Treasury to meet their obligations.
The yield and payment characteristics of Mortgage-Backed Securities differ
from traditional debt securities. Interest and principal payments are made
regularly and frequently, usually monthly, over the life of the mortgage loans
unlike traditional debt securities and principal may be prepaid at any time
because the underlying mortgage loans generally may be prepaid at any time.
Faster or slower prepayments than expected on underlying mortgage loans can
dramatically alter the yield to maturity of a Mortgage-Backed Security. The
value of most Mortgage-Backed Securities, like traditional debt securities,
tends to vary inversely with changes in interest rates (i.e., as interest rates
increase, the value of such securities decrease). Mortgage-Backed Securities,
however, may benefit less than traditional debt securities from declining
interest rates because prepayment of mortgages tends to accelerate during
periods of declining interest rates. When mortgage loans underlying
Mortgage-Backed Securities held by the Fund are prepaid, the Fund reinvests the
prepaid amounts in other income-producing securities, the yields of which will
reflect interest rates prevailing at the time. Therefore, the Fund's ability to
maintain a portfolio of higher-yielding Mortgage-Backed Securities will be
adversely affected to the extent that prepayments must be reinvested in
securities which have lower yields. A more complete description of
Mortgage-Backed Securities is contained in the Statement of Additional
Information.
The Fund may invest in CMOs, which are debt obligations collateralized by
mortgage loans or mortgage pass-through securities and multiclass pass-through
securities, which are equity interests in a trust composed of mortgage assets.
Payments of principal and interest on the mortgage assets, and any reinvestment
income thereon, provide the funds to pay debt service on the CMOs or make
scheduled distributions on the multiclass pass-through securities. A more
complete description of CMOs is contained in the Statement of Additional
Information.
The Fund may invest in Zero Coupon Securities. Zero Coupon Securities are U.S.
Treasury notes and bonds which are stripped of their unmatured interest coupons
and therefore pay no interest to its holder during the life thereof. Because
Zero Coupon Securities do not pay interest prior to maturity, such securities
usually trade at a deep discount from their face or par value and such
securities are subject to greater fluctuations of market value in response to
changing interest rates than debt obligations of comparable maturities which
make current distributions of interest. Even though the holder of a Zero Coupon
Security does not receive interest payments prior to maturity, a portion of the
purchase price discount must be accrued as income each year under current
federal tax law. A more complete description of Zero Coupon Securities is
contained in the Statement of Additional Information. In order to generate
sufficient cash to make distributions, the Fund may have to dispose of
securities that it would otherwise continue
9
<PAGE> 10
to hold, which, in some cases, may be disadvantageous to the Fund. See
"Distributions and Taxes."
The Fund may also engage in strategic transactions, purchase and sell
securities on a "when issued" and "delayed delivery" basis, enter into Repos and
reverse repurchase agreements, and lend portfolio securities in certain
circumstances, in each case subject to the limitations set forth below.
The Fund may purchase and sell derivative instruments such as exchange-listed
and over-the-counter put and call options on securities, financial futures,
equity and fixed-income indices, and other financial instruments, purchase and
sell financial futures contracts and options thereon, and enter into various
interest rate transactions such as swaps, caps, floors or collars. Collectively,
all of the above are referred to as "Strategic Transactions". The Fund generally
seeks to use Strategic Transactions as a hedging technique to seek to protect
against possible adverse changes in the market value of the Fund's securities,
protect the Fund's unrealized gains, facilitate the sale of certain securities
for investment purposes, manage the effective maturity or duration of the Fund's
portfolio, or establish positions in the derivatives markets as a temporary
substitute for purchasing or selling particular securities. The Fund may also
use some Strategic Transactions to seek to enhance income, although no more than
25% of the Fund's assets will be committed to Strategic Transactions entered
into for non-hedging purposes.
Strategic Transactions have risks including the possible default or
illiquidity of the other party to the transaction. Furthermore the ability to
successfully use Strategic Transactions depends on the Adviser's ability to
predict pertinent market movements, which cannot be assured. Thus, the use of
such Strategic Transactions may result in losses greater than if they had not
been used, require the Fund to sell or purchase portfolio securities at
inopportune times or for prices other than current market values, limit the
amount of appreciation the Fund can realize on an investment, or cause the Fund
to hold a security it might otherwise sell. Money paid by the Fund as premium
and money or other assets placed in margin accounts in connection with entering
into Strategic Transactions are not otherwise available to the Fund for
investment purposes. The Strategic Transactions that the Fund may use and some
of their risks are described more fully in the Fund's Statement of Additional
Information.
The Fund may purchase and sell "when issued" and "delayed delivery"
securities. The Fund accrues no income on such securities until the Fund
actually takes delivery of such securities. These transactions are subject to
market fluctuation; the value of the securities at delivery may be more or less
than their purchase price. The yields generally available on comparable
securities when delivery occurs may be higher than yields on the securities
obtained pursuant to such transactions. Because the Fund relies on the buyer or
seller to consummate the transaction, failure by the other party to complete the
transaction may result in the Fund missing the opportunity of obtaining a price
or yield considered to be advantageous. The Fund will engage in when issued and
delayed delivery transactions for the purpose of acquiring securities consistent
with the Fund's investment objective and policies and not for the purpose of
investment leverage.
10
<PAGE> 11
The Fund may enter into Repos whereby the Fund acquires securities and agrees
to resell the securities at an agreed upon time and at an agreed upon price. The
difference between the purchase amount and resale amount is accrued as interest
in the Fund's net income. Failure of the seller to repurchase the securities may
cause losses for the Fund. Thus, the Fund must consider the credit-worthiness of
such party. In the event of default by such party, the Fund may not have a right
to the underlying security and there may be possible delays and expenses in
liquidating the security purchased, resulting in a decline in its value and loss
of interest. The Fund will use Repos for short-term investments. The Fund
generally will not invest more than 15% of its total assets in Repos with a term
of seven days or more.
The Fund is authorized to borrow money from banks and to engage in reverse
repurchase agreements and dollar rolls in an aggregate amount up to 33 1/3% of
the Fund's total assets (after giving effect to any such borrowing); provided,
however, that with respect to such amount no more than 5% may be invested in
bank borrowings and reverse repurchase agreements. The use of such transactions
to purchase additional securities is known as "leverage". Leverage transactions
create an opportunity for increased net income but, at the same time, may
increase the volatility of the Fund's net asset value as a result of
fluctuations in market interest rates and increase the risk of the Fund's
portfolio. The principal amount of these transactions is fixed when the
transaction is opened, but the Fund's assets may change in value during the time
these transactions are outstanding. As a result, interest expenses and other
costs from these transactions may exceed the interest income and other revenues
earned from portfolio assets, and the net income of the Fund may be less than if
these transactions were not used. Reverse repurchase agreements are transactions
whereby the Fund sells certain securities concurrently with an agreement to
repurchase the same securities at a later date at a fixed price. During the
reverse repurchase agreement period, the Fund continues to receive principal and
interest payments on these securities. Dollar rolls are transactions whereby the
Fund sells securities for delivery in the current month and simultaneously
contracts to repurchase substantially similar securities on a specified future
date. During the roll period, the Fund forgoes principal and interest paid on
such securities. Reverse repurchase agreements and dollar rolls involve the risk
that the market value of the securities retained by the Fund may decline below
the price of the securities the Fund has sold but is obligated to repurchase
under the agreement.
The Fund may lend its portfolio securities to banks or broker-dealers, to a
maximum of 25% of the total assets of the Fund, provided such loans are callable
at any time and are continuously secured by collateral consisting of cash or
U.S. Government Securities equal to at least 100% of the value of the securities
loaned, including accrued interest. The Fund will receive income for having made
the loan. The Fund is the beneficial owner of the loaned securities so that any
gain or loss in the market price during the loan inures to the Fund and its
shareholders.
11
<PAGE> 12
- --------------------------------------------------------------------------------
HOW TO BUY SHARES
- --------------------------------------------------------------------------------
The Fund currently offers three classes of shares, designated Class A Shares,
Class B Shares and Class C Shares. Shares of each class are offered at a price
equal to their net asset value per share plus a sales charge which, at the
election of the purchaser, may be imposed (a) at the time of purchase ("Class A
Shares") or (b) on a contingent deferred basis (Class A Share accounts over
$1,000,000, "Class B Shares" and "Class C Shares"). The three classes of shares
permit an investor to choose the method of purchasing shares that is most
beneficial to the investor, taking into account the amount of the purchase, the
length of time the investor expects to hold the shares, whether the investor
wishes to receive dividends in cash or to reinvest them in additional shares of
the Fund, and other circumstances. Class A Share accounts over $1,000,000 or
otherwise subject to a contingent deferred sales charge ("CDSC"), Class B Shares
and Class C Shares sometimes are referred to herein collectively as "Contingent
Deferred Sales Charge Shares" or "CDSC Shares." The minimum initial investment
with respect to each class of shares is $1,000 and the minimum subsequent
investment with respect to each class of shares is $100. It is presently the
policy of the distributor of the Fund's shares not to accept any order for Class
B Shares or Class C Shares in an amount in excess of $1,000,000 or more because
it ordinarily will be more advantageous for an investor making such an
investment to purchase Class A Shares.
Each class of shares represents an interest in the same portfolio of
investments of the Fund and has the same rights, except each class of shares
has: (i) distribution fees, service fees and administrative expenses unique to
its respective class of shares, (ii) exclusive voting rights on certain
provisions of the Fund's Rule 12b-1 distribution plan which relate only to such
class and (iii) different exchange privileges. Furthermore, the Class B Shares
have a conversion feature (discussed below).
The Fund offers its three classes of shares to the public on a continuous
basis through Van Kampen American Capital Distributors, Inc. (the
"Distributor"), as principal underwriter, which is located at One Parkview
Plaza, Oakbrook Terrace, Illinois 60181. Shares are also offered through members
of the National Association of Securities Dealers, Inc. ("NASD") who are acting
as securities dealers ("dealers") and through NASD members or eligible non-NASD
members who are acting as brokers or agents for investors ("brokers"). The Fund
reserves the right to suspend or terminate the continuous public offering at any
time and without prior notice.
INITIAL SALES CHARGE ALTERNATIVE. Investors choosing the initial sales charge
alternative purchase Class A Shares. The public offering price of Class A Shares
is equal to the net asset value per share plus an initial sales charge which
varies depending upon the total amount of the sale. The table below shows sales
charges and the aggregate amount of the sales charges which are paid as dealer
concessions or broker agency commissions on sales
12
<PAGE> 13
of Class A Shares. The sales charges collected from the investor are allocated
between the investor's broker, dealer or financial intermediary and the
Distributor.
<TABLE>
<CAPTION>
DEALER
CONCESSIONS
OR AGENCY
TOTAL SALES CHARGE COMMISSION
------------------------- -----------
PERCENTAGE PERCENTAGE PERCENTAGE
SIZE OF TRANSACTION OF OFFERING OF NET OF OFFERING
AT OFFERING PRICE PRICE ASSET VALUE PRICE
- ----------------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
$100 but less than $100,000.................... 4.75% 4.99% 4.25%
$100,000 but less than $250,000................ 3.75 3.90 3.25
$250,000 but less than $500,000................ 2.75 2.83 2.25
$500,000 but less than $1,000,000.............. 2.00 2.04 1.75
$1,000,000 or more............................. * * *
</TABLE>
- ----------------
* No sales charge is payable at the time of purchase on investments of
$1,000,000 or more, although for such investments the Fund imposes a
contingent deferred sales charge of 1.00% on redemptions made within one year
of the purchase. See "How to Buy Shares -- Deferred Sales Charge Alternatives"
for additional information.
DEFERRED SALES CHARGE ALTERNATIVE. Investors choosing the deferred sales
charge alternative may purchase Class A Shares in an amount of $1,000,000 or
more, Class B Shares or Class C Shares. The public offering price of these CDSC
Shares is equal to the net asset value per share. The investor incurs no initial
sales charge at the time of purchase. However, as discussed below, the investor
may be subject to a contingent deferred sales charge upon disposition of such
shares depending on the length of time the investor holds such shares. The
Distributor compensates brokers, dealers and financial intermediaries for
participating in the continuous public offering of the CDSC Shares but does so
out of its own assets and not out of the assets of the Fund. The amount paid to
brokers, dealers and financial intermediaries varies as a percentage of the
dollar value of the CDSC Shares purchased from the Fund by such brokers, dealers
and financial intermediaries. The percentage rate equals: (i) 1.00% with respect
to Class A Shares in an amount of $1,000,000 or more; (ii) 4.00% with respect to
the Class B Shares and (iii) 1.00% with respect to the Class C Shares. When an
investor sells its CDSC Shares, any applicable CDSC is paid to the Distributor
and used by the Distributor to defray its expenses related to providing
distribution-related services to the Fund in connection with the sale of such
CDSC Shares, including the payment of compensation to dealers and agents for
selling such shares. The discussions of Class A Shares, Class B Shares and Class
C Shares below summarize an investor's contingent deferred sales charge. The
contingent deferred sales charge and the distribution and service fees (See
"Distribution and Service Plans" below) enable the Fund to sell such CDSC Shares
without an initial sales charge.
CLASS A SHARE PURCHASES OF $1,000,000 OR MORE. No sales charge is payable at
the time of purchase on investments in Class A Shares of $1,000,000 or more,
although for such investments the Fund imposes a contingent deferred sales
charge of 1.00% on redemptions
13
<PAGE> 14
made within one year of the purchase. A commission will be paid to dealers who
initiate and are responsible for purchases of $1,000,000 or more as follows: 1%
on sales to $2 million, plus 0.80% on the next million, plus 0.20% on the next
$2 million and 0.08% on the excess over $5 million.
CLASS B SHARES. Class B Shares redeemed within six years of purchase generally
will be subject to a contingent deferred sales charge at the rates set forth
below, charged as a percentage of the dollar amount redeemed:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
SALES CHARGE AS A
PERCENTAGE OF
DOLLAR AMOUNT
YEAR SINCE PURCHASE REDEEMED
- ----------------------------------------------------------- --------------------
<S> <C>
First...................................................... 4.00%
Second..................................................... 3.75%
Third...................................................... 3.50%
Fourth..................................................... 2.50%
Fifth...................................................... 1.50%
Sixth...................................................... 1.00%
Seventh and after.......................................... 0.00%
</TABLE>
Conversion Feature. Six years after the end of the month in which a
shareholder's order to purchase a Class B Share of the Fund was accepted, such
Class B Share automatically will convert to a Class A Share and will no longer
be subject to the higher aggregate distribution and service fees. The purpose of
the conversion feature is to relieve the holders of Class B Shares that have
been outstanding for a period of time sufficient for the Distributor to have
been compensated for distribution expenses related to the Class B Shares from
most of the burden of such distribution-related expenses. The conversion feature
is subject to the continuing availability of an opinion of counsel to the Fund
regarding certain tax matters and the Fund may suspend such conversion feature
in the absence of such opinion.
CLASS C SHARES. Class C Shares redeemed within the first twelve months of
purchase generally will be subject to a contingent deferred sales charge of
1.00% of the dollar amount subject thereto. Class C Shares redeemed thereafter
will not be subject to a contingent deferred sales charge.
OTHER PURCHASE INFORMATION. Purchases of a Fund's shares will be made in full
and fractional shares. In the interest of economy and convenience, certificates
for shares will generally not be issued.
The Distributor may from time to time implement special programs or contests
which are intended to result in sales of shares of the Fund. Such programs,
which will be conducted pursuant to objective criteria established by the
Distributor, generally will result in brokers, dealers and financial
intermediaries being paid additional amounts than those described above with
respect to sales of shares of the Fund. Such payments are made by the
Distributor out of its own assets and not out of the assets of the Fund. These
14
<PAGE> 15
programs will not change the price an investor pays for shares or the amount the
Fund will receive from such sale.
The Fund's Statement of Additional Information contains more detailed
information about the Alternative Sales Arrangements and other information
relating to purchasing shares of the Fund, including Quantity Discounts, Unit
Investment Trust Reinvestment Programs and Net Asset Value Purchase Options.
Interested investors may obtain a free copy of the Fund's Statement of
Additional Information by calling 1-800-225-2222, ext. 6504.
DIVIDEND REINVESTMENT PROGRAM. The Fund will automatically credit monthly and
annual distributions to a shareholder's account in additional shares of the
Fund, without a sales charge, unless a shareholder elects another treatment for
such distributions. An election to receive distributions in cash may be made by
calling 1-800-341-2911 or by writing the Transfer Agent.
- --------------------------------------------------------------------------------
DISTRIBUTIONS AND TAXES
- --------------------------------------------------------------------------------
The Fund will declare distributions on a daily basis and will pay such
distributions from net investment income and net realized short-term capital
gains on a monthly basis. The Fund will also distribute annually any remaining
short-term capital gains together with long-term capital gains, if any.
Distributions with respect to each class of shares will be calculated in the
same manner on the same day and will be in the same amount, except that the
different distribution and service fees and any incremental administrative
expenses relating to each class of shares will be borne exclusively by the
respective class and may cause the distributions relating to the different
classes of shares to differ.
In order to qualify as a regulated investment company under the Internal
Revenue Code of 1986, as amended, the Fund intends distribute substantially of
its net investment income and capital gains at least annually. Any distributions
in excess of the Fund's net investment income and capital gains will be a return
of principal, which will reduce the investor's tax basis in the shares.
Distributions of the Fund's net investment income are taxable to shareholders as
ordinary income whether received in shares or in cash. Distributions of the
Fund's net capital gains ("capital gains dividends") are taxable to shareholders
as long-term capital gains regardless of the length of time the shares of the
Fund have been held by such shareholders.
Redemption or resale of shares of the Fund will be a taxable transaction for
federal income tax purposes. For further information with respect to taxes, see
the Statement of Additional Information.
- --------------------------------------------------------------------------------
HOW THE FUND VALUES ITS SHARES
- --------------------------------------------------------------------------------
The net asset value per share of the Fund will be determined separately for
each class of shares. The net asset value per share of a given class of shares
of the Fund is determined by calculating the total value of the Fund's assets
attributable to such class of shares, deducting the total liabilities
attributable to such class of shares, and dividing the result by
15
<PAGE> 16
the number of shares of such class outstanding. Generally, the net asset value
for the Fund is computed once daily as of 5:00 p.m. Eastern time Monday through
Friday.
Portfolio securities are valued by using market quotations, prices provided by
market makers or estimates of market values obtained from yield data relating to
instruments or securities with similar characteristics in accordance with
procedures established in good faith by the Board of Trustees of the Trust, of
which the Fund is a sub-trust.
- --------------------------------------------------------------------------------
HOW TO SELL SHARES
- --------------------------------------------------------------------------------
Shareholders may sell shares without charge (other than, with respect to the
CDSC Shares, any applicable contingent deferred sales charge) at any time by
mailing a written redemption request in proper form to the Transfer Agent, by
calling the Fund at 1-800-341-2911 before 3:00 p.m. Central Standard time to
request a redemption or shareholders may sell shares (whether in certificate or
book-entry form) through their securities dealer, who will telephone the request
to the Distributor. Shareholders will receive the net asset value next
determined after such shareholder places the sell order. Any applicable
contingent deferred sales charge with respect to CDSC Shares redeemed will be
deducted from the redemption proceeds prior to transmittal of such proceeds to
the shareholder.
There is a $500 minimum and a $1,000,000 maximum per request if the redemption
proceeds are to be mailed to the shareholder. If the redemption proceeds are to
be wired to a bank there is a minimum of $5,000 and a $1,000,000 maximum per
request. In written requests for redemption, if the amount being redeemed is in
excess of $50,000 or if the redemption proceeds will be sent to an address other
than the address of record, or if the account of record has changed within 30
days of the request, the signature(s) must be guaranteed by a member firm of a
principal stock exchange, a commercial bank or trust company which is a member
of the Federal Deposit Insurance Corporation, a credit union or a savings
association. The guarantee must state the words "Signature Guaranteed" along
with the name of the granting institution. Prior to redeeming shares by
telephone, the "Expedited Telephone Redemption" section of either the Account
Application or the Expedited Telephone Redemption and Exchange Request Form (the
"Authorization") must be completed and on file with the Transfer Agent. The
signature(s) on the Authorization must be guaranteed by a member firm of a
principal stock exchange, a commercial bank or trust company which is a member
of the Federal Deposit Insurance Corporation, a credit union or a savings
association, unless the Authorization is completed at the time an account is
originally established. The guarantee must state the words "Signature
Guaranteed" along with the name of the granting institution. The proceeds would
then be made payable to the registered shareowner(s) and mailed to the address
registered on the account or wired to a bank, as requested on the
Authorizations. Shareholders cannot redeem shares by telephone if: stock
certificates are held for those shares, the shares are held in an Individual
Retirement Account for which State Street Bank and Trust Company acts as
custodian or if the shares were purchased by check, until 15 days after
purchase.
16
<PAGE> 17
For shares redeemed through dealers, it is the responsibility of the
investor's broker, dealer or financial intermediary to transmit the redemption
order to the Distributor. Because the Fund generally will determine net asset
value once each business day as of the close of business, sell orders placed
through an investor's broker, dealer or financial intermediary must be
transmitted to the Distributor by such broker, dealer or financial intermediary
prior to such time in order for the investor's order to be fulfilled on the
basis of the net asset value to be determined that day. Any change in the
redemption price due to the failure of the Distributor to receive a sell order
prior to such time must be settled between the investor and the broker, dealer
or financial intermediary submitting the order. Shareholders must submit a
written redemption request in proper form to their securities dealer within five
business days after calling the dealer with the sell order. The request should
indicate the number of shares to be redeemed and the class designation of such
shares, identify the account number and the order or confirmation number
assigned to the trade and be signed by the shareholder exactly as the shares are
registered. Shareholders whose shares are held in an Individual Retirement
Account ("IRA") for which State Street Bank and Trust Company acts as custodian
may not sell their shares through their securities dealers.
Neither the Trust nor its Transfer Agent will be liable for any loss, cost or
expense for acting on instructions (whether in writing or by telephone) believed
by the party receiving such instructions to be genuine and in accordance with
the procedures described in this Prospectus. The Fund, the Trust, the
Distributor, the Transfer Agent and National Financial Data Services ("NFDS")
seek to employ procedures reasonably believed to confirm that instructions
communicated by telephone are genuine. Such procedures include requiring a
person attempting to redeem shares by telephone to provide, on a recorded line,
the name on the account, a social security or tax identification number and such
additional information as may be included in the Authorization. An investor
agrees that no such person will be liable for any loss, liability, cost or
expense arising out of any request, including any fraudulent or unauthorized
request.
Whether shares are redeemed by the Fund or sold through a securities dealer, a
check for the proceeds (net of any required tax withholding and any applicable
contingent deferred sales charge) ordinarily will be mailed to shareholders or
their dealer, as the case may be, within seven calendar days after a redemption
request or repurchase order and share certificates (if any) are received in
proper form as set forth above. Wire transfers from the Fund of redemption
proceeds, in the manner described above, ordinarily will be transmitted to the
shareholder within one business day. If any shares are redeemed or repurchased
shortly after purchase, the Fund will not mail the proceeds until checks
received for the purchase of shares have cleared, which may take 10 days or
more. The proceeds, of course, may be more or less than the cost of the shares.
The right of redemption or resale to the Fund may be suspended or the date of
payment postponed during any period when the New York Stock Exchange is closed
(other than customary weekend and holiday closings), when an emergency exists as
defined by rules and regulations of the SEC, or during any period when the SEC
has by order permitted such suspension or postponement.
17
<PAGE> 18
The Fund reserves the right to redeem any investment if the value of an
account falls below $500. Before the Fund makes such redemption it will provide
the shareholder with written notice and 30 days in which to make an additional
investment sufficient to increase the value of the account to at least $500.
The Fund's Statement of Additional Information contains more detailed
information about selling shares of the Fund, including telephone redemptions
and other programs. Interested investors may obtain a copy of the Fund's
Statement of Additional Information free of charge by calling 1-800-225-2222,
ext. 6504.
- --------------------------------------------------------------------------------
HOW THE FUND IS MANAGED
- --------------------------------------------------------------------------------
THE ADVISER. Van Kampen American Capital Investment Advisory Corp. (the
"Adviser") is the investment adviser for the Fund. The Adviser is a wholly-owned
subsidiary of Van Kampen American Capital, Inc. ("Van Kampen American Capital").
Van Kampen American Capital is a diversified asset management company with more
than two million retail investor accounts, extensive capabilities for managing
institutional portfolios, and nearly $50 billion under management or
supervision. Van Kampen American Capital's more than 40 open-end and 38
closed-end funds and more than 2,700 unit investment trusts are professionally
distributed by leading financial advisers nationwide.
Van Kampen American Capital is a wholly-owned subsidiary of VK/AC Holding,
Inc. VK/AC Holding, Inc. is controlled, through the ownership of a substantial
majority of its common stock, by The Clayton & Dubilier Private Equity Fund IV
Limited Partnership ("C&D L.P."), a Connecticut limited partnership. C&D L.P. is
managed by Clayton, Dubilier & Rice, Inc. a New York based private investment
firm. The General Partner of C&D L.P. is Clayton & Dubilier Associates IV
Limited Partnership ("C&D Associates L.P."). The general partners of C&D
Associates L.P. are Joseph L. Rice, III, B. Charles Ames, William A. Barbe,
Alberto Cribiore, Donald J. Gogel, Leon J. Hendrix, Jr., Hubbard C. Howe and
Andrall E. Pearson, each of whom is a principal of Clayton, Dubilier & Rice,
Inc. In addition, certain officers, directors and employees of Van Kampen
American Capital Inc. own, in the aggregate, not more than 6% of the common
stock of VK/AC Holding Inc. and have the right to acquire, upon the exercise of
options, approximately an additional 10% of the common stock of VK/AC Holding,
Inc.
ADVISORY AGREEMENT. The business and affairs of the Fund will be managed under
the direction of the Board of Trustees of the Trust, of which the Fund is a
sub-trust. Subject to the Trustees' authority, the Adviser and the Fund's
officers supervise and implement
18
<PAGE> 19
the Fund's investment activities. The Fund pays the Adviser a fee (accrued daily
and paid monthly) equal to a percentage of the average daily net assets of the
Fund as follows:
<TABLE>
<CAPTION>
AVERAGE DAILY
NET ASSETS
(MILLIONS) % PER ANNUM
- ---------------------------------------------------------------- -----------
<S> <C>
First $500...................................................... 0.550%
Next $500....................................................... 0.525%
Next $2,000..................................................... 0.500%
Next $2,000..................................................... 0.475%
Next $2,000..................................................... 0.450%
Next $2,000..................................................... 0.425%
Thereafter...................................................... 0.400%
</TABLE>
Under its investment advisory agreement with the Adviser dated February 17,
1993, and approved by shareholders of the Fund at a meeting held on January 14,
1993, the Fund has agreed to assume and pay the charges and expenses of the
Fund's operations, including the compensation of the Trustees of the Trust
(other than those who are affiliated persons, as defined in the Investment
Company Act of 1940 (the "Investment Company Act"), of the Adviser, the
Distributor or Van Kampen American Capital), the charges and expenses of
independent accountants, legal counsel, any transfer or dividend disbursing
agent and the custodian (including fees for safekeeping of securities), costs of
calculating net asset value, costs of acquiring and disposing of portfolio
securities, interest (if any) on obligations incurred by the Fund, costs of
share certificates, membership dues in the Investment Company Institute or any
similar organization, reports and notices to shareholders, costs of registering
shares of the Fund under the federal securities laws, miscellaneous expenses and
all taxes and fees to federal, state or other governmental agencies.
PORTFOLIO MANAGER. John E. Doyle, First Vice President of the Adviser, is
primarily responsible for the day to day management of the Fund's portfolio. Mr.
Doyle has been employed by the Adviser for the last five years.
- --------------------------------------------------------------------------------
HOW THE FUND EXECUTES PORTFOLIO TRANSACTIONS
- --------------------------------------------------------------------------------
The Adviser is responsible for: decisions to buy and sell securities for the
Fund, the selection of brokers and dealers to effect the transactions and the
negotiation of prices and any brokerage commissions. The securities in which the
Fund invests are traded principally in the over-the-counter market.
Over-the-counter securities are generally traded on a net basis with dealers
acting as principal for their own accounts without a stated commission, although
the price of the security usually includes a mark-up to the dealer. Securities
purchased in underwritten offerings generally include, in the price, a fixed
amount of compensation for the advisers, underwriters and dealers. The Fund may
also purchase certain money market instruments directly from an issuer, in which
case no commissions or discounts are paid. Purchases and sales of securities on
a stock exchange are effected through brokers who charge a commission for their
services.
19
<PAGE> 20
The Adviser's primary considerations in selecting the manner of executing
securities transactions for the Fund will be prompt execution of orders, the
size and breadth of the market for the security, the reliability, integrity and
financial condition and execution capability of the firm, the size of and
difficulty in executing the order, and the best net price. There are many
instances when, in the judgment of the Adviser, more than one firm can offer
comparable execution services. In selecting among such firms, consideration is
given to those firms which supply research and other services in addition to
execution services. For more information, see "Portfolio Transactions and
Brokerage Allocation" in the Statement of Additional Information.
In effecting purchases and sales of the Fund's portfolio securities, the
Adviser and the Fund may place orders with and pay brokerage commissions to
brokers, including brokers which may be affiliated with the Fund, the Adviser,
the Distributor or dealers participating in the offering of the Fund's shares.
- --------------------------------------------------------------------------------
DISTRIBUTION AND SERVICE PLANS
- --------------------------------------------------------------------------------
The Fund has adopted a distribution plan (the "Distribution Plan") with
respect to each class of its shares pursuant to Rule 12b-1 under the Investment
Company Act. The Fund also has adopted a service plan (the "Service Plan") with
respect to each class of its shares. The Distribution Plan and the Service Plan
provide that the Fund may spend a portion of the Fund's average daily net assets
attributable to each class of shares in connection with distribution of the
respective class of shares and in connection with the provision of ongoing
services to shareholders of each class. The Fund may spend up to 0.25% per year
of the Fund's average daily net assets attributable to each class of shares
pursuant to the Service Plan in connection with the ongoing provision of
services to holders of such shares by the Distributor and financial
intermediaries in connection with the maintenance of such shareholders'
accounts. The Distribution Plan and the Service Plan are implemented through an
agreement with the Distributor, sub-agreements between the Distributor and
members of the NASD who are acting as securities dealers and/or NASD members or
eligible non-members who are acting as brokers or agents, and similar agreements
between the Fund and financial intermediaries who are acting as brokers
(collectively, "Selling Agreements") that may provide customers certain services
or assistance. Brokers, dealers and financial intermediaries that have entered
into Selling Agreements with the Distributor and sell shares of the Fund are
referred to herein as "financial intermediaries."
Class A Shares. The Fund may spend an aggregate amount up to 0.30% per year of
the average daily net assets attributable to the Class A Shares of the Fund
pursuant to the Distribution Plan and the Service Plan. The Fund pays the
Distributor the lesser of the balance of the 0.30% not paid to financial
intermediaries pursuant to the Service Plan or the amount of the Distributor's
actual distribution-related expenses.
Class B Shares. The Fund may spend up to 0.75% per year of the average daily
net assets attributable to the Class B Shares of the Fund pursuant to the
Distribution Plan. In addition, the Fund may spend up to 0.25% per year of the
Fund's average daily net assets
20
<PAGE> 21
attributable to the Class B Shares pursuant to the Service Plan in connection
with the ongoing provision of services to holders of such shares by the
Distributor and by financial intermediaries and in connection with the
maintenance of such shareholders' accounts.
Class C Shares. The Fund may spend up to 0.75% per year of the average daily
net assets attributable to the Class C Shares of the Fund pursuant to the
Distribution Plan. From such amount, the Fund, or the Distributor as agent for
the Fund, pays financial intermediaries in connection with the distribution of
the Class C Shares up to 0.75% of the Fund's average daily net assets
attributable to Class C Shares maintained in the Fund more than one year by such
financial intermediary's customers. The Fund pays the Distributor the lesser of
the balance of 0.75% not paid to such financial intermediaries or the amount of
the Distributor's actual distribution-related expense attributable to the Class
C Shares. In addition, the Fund may spend up to 0.25% per year of the Fund's
average daily net assets attributable to the Class C Shares pursuant to the
Service Plan in connection with the ongoing provision of services to holders of
such shares by the Distributor and by financial intermediaries and in connection
with the maintenance of such shareholders' accounts.
Other Information. Amounts payable to the Distributor with respect to the
Class A Shares under the Distribution Plan in a given year may not fully
reimburse the Distributor for its actual distribution-related expenses during
such year. In such event, there is no carryover of such reimbursement
obligations to succeeding years.
The Distributor's expenses with respect to a class of CDSC Shares (for
purposes of this paragraph excluding any Class A Shares that may be subject to a
CDSC) for any given year may exceed the amounts payable to the Distributor with
respect to such class of CDSC Shares under the Distribution Plan, the Service
Plan and payments received pursuant to the contingent deferred sales charge. Any
unreimbursed expenses will be carried forward and paid by the Fund (up to the
amount of the actual expenses incurred) in future years so long as such
Distribution Plan is in effect. Except as mandated by applicable law, the Fund
does not impose any limit with respect to the number of years into the future
that such unreimbursed expenses may be carried forward. Because such expenses
are accounted on a Fund level basis, in periods of extreme net asset value
fluctuation, amounts paid to the Distributor with respect to a particular CDSC
Share may be greater or less than the amount of the initial commission
(including carrying cost) paid by the Distributor with respect to such CDSC
Share. In such circumstances, the holder of such CDSC Share may be deemed to
incur expenses attributable to other shareholders of such class. As of December
31, 1994, there were $678,772 and $20,214 of unreimbursed distribution expenses
with respect to Class B Shares and Class C Shares, respectively, representing
0.02% and 0.00% of the Fund's total net assets. If the Distribution Plan was
terminated or not continued, the Fund would not be contractually obligated to
pay the Distributor for any expenses not previously reimbursed by the Fund or
recovered through contingent deferred sales charges.
Because the Fund is a sub-trust of the Trust, amounts paid to the Distributor
as reimbursement for expenses of one sub-trust of the Trust may indirectly
benefit the other funds which are sub-trusts of the Trust. The Distributor will
endeavor to allocate such
21
<PAGE> 22
expenses among such funds in an equitable manner. The Distributor will not use
the proceeds from the contingent deferred sales charge applicable to a
particular class of CDSC Shares to defray distribution-related expenses
attributable to any other class of CDSC Shares. Various federal and state laws
prohibit national banks and some state-chartered commercial banks from
underwriting or dealing in the Fund's shares. In addition, state securities laws
on this issue may differ from the interpretations of federal law, and banks and
financial institutions may be required to register as dealers pursuant to state
law. In the unlikely event that a court were to find that these laws prevent
such banks from providing such services described above, the Fund would seek
alternate providers and expects that shareholders would not experience any
disadvantage.
- --------------------------------------------------------------------------------
SHAREHOLDER SERVICES
- --------------------------------------------------------------------------------
Shareholders of the Fund are automatically enrolled in or may elect to
participate in certain shareholder programs available to shareholders of funds
managed by the Adviser. These programs include Automatic Purchase Programs,
Dividend Reinvestment Programs, Systematic Withdrawal Programs and Exchange
Programs. The Fund's Statement of Additional Information contains more detailed
information about the various shareholder service programs. Interested investors
may obtain a copy of the Statement of Additional Information free of charge by
calling 1-800-225-2222, ext. 6504.
State Street Bank and Trust Company, c/o National Financial Data Services P.O.
Box 419001, Kansas City, MO 64141-6001, transfer agent for the Fund, performs
bookkeeping, data processing and administrative services related to the
maintenance of shareholder accounts.
- --------------------------------------------------------------------------------
FUND PERFORMANCE
- --------------------------------------------------------------------------------
From time to time advertisements and other sales materials for the Fund may
include information concerning the historical performance of the Fund. Any such
information will include the average total return of the Fund calculated on a
compounded basis for specified periods of time. Such advertisements and sales
material may also include a yield quotation as of a current period. In each
case, such total return and yield information, if any, will be calculated
pursuant to rules established by the SEC and will be computed separately for
each class of the Fund's shares.
Please consult the Statement of Additional Information for more information
regarding the Fund's performance.
22
<PAGE> 23
- --------------------------------------------------------------------------------
FUND ORGANIZATION
- --------------------------------------------------------------------------------
The Fund is a diversified, open-end management investment company. The Fund is
a sub-trust of the Van Kampen Merritt U.S. Government Trust, a Massachusetts
business trust organized on March 26, 1987 (the "Trust"). To date, the Fund is
the only sub-trust of the Trust, although the Trustees of the Trust are
empowered to designate other sub-trusts. Shares of the Trust entitle their
holders to one vote per share; however, separate votes are taken by each
sub-trust on matters affecting an individual sub-trust. The Trust does not
contemplate holding regular meetings of shareholders to elect Trustees or
otherwise. However, the holders of 10% or more of the outstanding Shares may by
written request require a meeting to consider the removal of Trustees by a vote
of a majority of the shares present and voting at such meeting. More detailed
information concerning the Trust is set forth in the Statement of Additional
Information.
The authorized capitalization of the Fund consists of an unlimited number of
shares of beneficial interest, without par value, divided into classes. The Fund
currently offers three classes of shares, designated Class A Shares, Class B
Shares and Class C Shares. Each class of shares represents an interest in the
same assets of the Fund and are identical in all respects except that each class
bears certain distribution expenses and has exclusive voting rights with respect
to its distribution fee.
Pursuant to an order of the SEC, the Fund is permitted to issue an unlimited
number of classes of shares. Each class of shares is equal as to earnings,
assets and voting privileges, except as noted above, and each class bears the
expenses related to the distribution of its shares. There are no conversion,
preemptive or other subscription rights, except with respect to the conversion
of Class B Shares into Class A Shares as described above. In the event of
liquidation, each of the shares of the Fund is entitled to its portion of all of
the Fund's net assets after all debt and expenses of the Fund have been paid.
Since Class B Shares and Class C Shares pay higher distribution expenses, the
liquidation proceeds to Class B Shareholders and Class C Shareholders are likely
to be lower than to other shareholders. The fiscal year end of the Fund is
December 31.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
This Prospectus and the Statement of Additional Information do not contain all
the information set forth in the Registration Statement filed by the Fund with
the SEC under the Securities Act of 1933. Copies of the Registration Statement
may be obtained at a reasonable charge from the SEC or may be examined, without
charge, at the office of the SEC in Washington, D.C.
Shareholder inquiries should be directed to: Van Kampen Merritt Funds, One
Parkview Plaza, Oakbrook Terrace, Illinois 60181, Attn: Correspondence. The
telephone number is 1-800-341-2911.
23
<PAGE> 24
EXISTING SHAREHOLDERS--
FOR INFORMATION ON YOUR
EXISTING ACCOUNT PLEASE
CALL THE FUND'S TOLL-FREE
NUMBER--1-800-341-2911.
PROSPECTIVE INVESTORS--CALL
YOUR BROKER OR 1-800-341-2911.
DEALERS--FOR DEALER
INFORMATION, SELLING
AGREEMENTS, WIRE ORDERS,
OR REDEMPTIONS CALL THE
DISTRIBUTOR'S TOLL-FREE
NUMBER--1-800-225-2222.
FOR SHAREHOLDER AND
DEALER INQUIRIES THROUGH
TELECOMMUNICATIONS
DEVICE FOR THE DEAF (TDD)
DIAL 1-800-772-8889
FOR AUTOMATED TELEPHONE
SERVICES DIAL 1-800-542-4344
VAN KAMPEN MERRITT
U.S. GOVERNMENT FUND
One Parkview Plaza
Oakbrook Terrace, IL 60181
Investment Adviser
VAN KAMPEN AMERICAN CAPITAL
INVESTMENT ADVISORY CORP.
One Parkview Plaza
Oakbrook Terrace, IL 60181
Distributor
VAN KAMPEN AMERICAN CAPITAL DISTRIBUTORS, INC.
One Parkview Plaza
Oakbrook Terrace, IL 60181
Transfer Agent
STATE STREET BANK AND
TRUST COMPANY
c/o National Financial Data Services
Attn: Van Kampen Merritt Funds
P.O. Box 419001
Kansas City, MO 64141-6001
Custodian
STATE STREET BANK AND
TRUST COMPANY
Attn: Van Kampen Merritt Funds
225 Franklin Street, P.O. Box 1713
Boston, MA 02105-1713
Legal Counsel
SKADDEN, ARPS, SLATE,
MEAGHER & FLOM
333 West Wacker Drive
Chicago, IL 60606
Independent Auditors
KPMG PEAT MARWICK LLP
Peat Marwick Plaza
303 East Wacker Drive
Chicago, IL 60601
<PAGE> 25
STATEMENT OF ADDITIONAL INFORMATION
VAN KAMPEN MERRITT U.S. GOVERNMENT FUND
Van Kampen Merritt U.S. Government Fund (the "Fund") is a mutual fund
organized as a diversified sub-trust of Van Kampen Merritt U.S. Government
Trust, a Massachusetts business trust (the "Trust"). The Trust is registered
with the SEC as an open-end management investment company. The Fund's investment
objective is to provide a high level of current income with liquidity and safety
of principal. The Fund invests in obligations issued or guaranteed by the U.S.
Government or by its agencies or instrumentalities. The net asset value and the
return of the Fund will fluctuate depending on market conditions and other
factors.
This Statement of Additional Information is not a prospectus but should be
read in conjunction with the Prospectus for Van Kampen Merritt U.S. Government
Fund dated April 30, 1995 (the "Prospectus"). This Statement of Additional
Information does not include all of the information that a prospective investor
should consider before purchasing shares of the Fund, and investors should
obtain and read the Prospectus prior to purchasing shares. A copy of the
Prospectus may be obtained without charge by calling the Fund's toll-free
number: 1-800-341-2911, ext. 6504.
The Prospectus and this Statement of Additional Information omit certain of
the information contained in the registration statement filed with the
Securities and Exchange Commission, Washington, D.C. (the "SEC"). These items
may be obtained from the SEC upon payment of the fee prescribed, or inspected at
the SEC's office at no charge.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
The Fund and the Trust............................................................... B-2
Investment Policies and Restrictions................................................. B-2
U.S. Government Securities........................................................... B-4
Additional Investment Considerations................................................. B-6
Officers and Trustees................................................................ B-13
Investment Advisory and Other Services............................................... B-16
Portfolio Transactions and Brokerage Allocation...................................... B-18
Tax Status of the Fund............................................................... B-19
The Distributor...................................................................... B-21
Legal Counsel........................................................................ B-22
Performance Information.............................................................. B-22
How to Buy Shares.................................................................... B-24
Distributions from the Fund.......................................................... B-30
How to Sell Shares................................................................... B-31
Shareholder Programs................................................................. B-33
Independent Auditors' Report......................................................... B-38
Financial Statements................................................................. B-39
Notes to Financial Statements........................................................ B-44
</TABLE>
THIS STATEMENT OF ADDITIONAL INFORMATION IS DATED APRIL 30, 1995
B-1
<PAGE> 26
THE FUND AND THE TRUST
The Fund is an open-end diversified management investment company. Currently,
the Fund is the only sub-trust of Van Kampen Merritt U.S. Government Trust (the
"Trust") a Massachusetts business trust. The Trust is an unincorporated business
trust established under the laws of the Commonwealth of Massachusetts by a
Declaration of Trust dated March 26, 1987. The Declaration of Trust permits the
Trustees to issue an unlimited number of full and fractional shares in separate
sub-trusts. The Trustees are empowered by the Declaration of Trust to designate
additional sub-trusts and issue shares thereof. Other sub-trusts may be
organized and offered in the future. The Fund was originally organized in 1984
as a Maryland corporation under the name Van Kampen Merritt U.S. Government Fund
Inc. Such corporation was reorganized into the Fund as of February 22, 1988.
Each share represents an equal proportionate interest in the assets of the
sub-trust with each other share in such sub-trust and no interest in any other
sub-trust. No sub-trust is subject to the liabilities of any other sub-trust.
The Declaration of Trust provides that shareholders are not liable for any
liabilities of the Trust or any of its sub-trusts, requires inclusion of a
clause to that effect in every agreement entered into by the Trust or any of its
sub-trusts and indemnifies shareholders against any such liability.
Shares of the Trust entitle their holders to one vote per share; however,
separate votes are taken by each sub-trust on matters affecting an individual
sub-trust. For example, a change in investment policy for a sub-trust would be
voted upon by shareholders of only the sub-trust involved. Shares do not have
cumulative voting rights, preemptive rights or any conversion or exchange
rights. The Trust does not contemplate holding regular meetings of shareholders
to elect Trustees or otherwise. However, the holders of 10% or more of the
outstanding shares may by written request require a meeting to consider the
removal of Trustees by a vote of a majority of the shares present and voting at
such meeting.
The Trustees may amend the Declaration of Trust (including with respect to any
sub-trust) in any manner without shareholder approval, except that the Trustees
may not adopt any amendment adversely affecting the rights of shareholders of
any sub-trust without approval by a majority of the shares of each affected
sub-trust present at a meeting of shareholders (or such higher vote as may be
required by the Investment Company Act of 1940, as amended (the "1940 Act") or
other applicable law) and except that the Trustees cannot amend the Declaration
of Trust to impose any liability on shareholders, make any assessment on shares
or impose liabilities on the Trustees without approval from each affected
shareholder or Trustee, as the case may be.
Statements contained in this Statement of Additional Information as to the
contents of any contract or other document referred to are not necessarily
complete, and, in each instance, reference is made to the copy of such contract
or other document filed as an exhibit to the Registration Statement of which
this Statement of Additional Information forms a part, each such statement being
qualified in all respects by such reference.
INVESTMENT POLICIES AND RESTRICTIONS
The investment objective of the Fund is to provide a high level of current
income, with liquidity and safety of principal. The Fund will invest at least
65% and up to 100% of its assets in obligations issued or guaranteed by the U.S.
Government or by its agencies or instrumentalities, including Government
National Mortgage Association Certificates of the modified pass-through type.
The Fund may also make other investments described in the Prospectus. The net
asset value and return of the Fund may vary.
Fundamental investment restrictions limiting the investments of the Fund
provide that the Fund may not:
1. Purchase any securities (other than obligations issued or guaranteed by
the United States Government or by its agencies or instrumentalities), if,
as a result, more than 5% of the Fund's total assets (taken at current
value) would then be invested in securities of a single issuer or, if, as
a result, the Fund would hold more than 10% of the outstanding voting
securities of an issuer. (There is no limit on the amount of the Fund's
assets which may be invested in the securities of any one issuer of
obligations issued or guaranteed by the United States Government or by its
agencies or instrumentalities.)
2. Issue senior securities, borrow money or enter into reverse repurchase
agreements or dollar rolls in the aggregate in excess of 33 1/3 of the
Fund's total assets (after giving effect to any such borrowing);
B-2
<PAGE> 27
provided, however, that with respect to such amount no more than 5% may be
invested in bank borrowings and reverse repurchase agreements. The Fund
will not mortgage, pledge or hypothecate any assets other than in
connection with issuances, borrowings, hedging transactions and risk
management techniques.
3. Buy any securities "on margin" or sell any securities "short."
4. Make investments for the purpose of exercising control or management.
5. Write, purchase or sell puts, calls or combinations thereof, or purchase
or sell interest rate futures contracts or related options, except that
the Fund may purchase or sell puts, calls or combinations thereof and may
purchase or sell commodities futures contracts on related put and call
options on such contracts for hedging purposes, in accordance with
applicable requirements of the Securities and Exchange Commission and the
Commodity Futures Trading Commission.
6. Invest in securities of other investment companies, except as part of a
merger, consolidation or other acquisition.
7. Invest in interests in oil, gas or other mineral exploration or
development programs.
8. Purchase or retain securities of any company if, to the knowledge of the
Fund, its officers and directors and officers and directors of the Fund's
investment adviser who individually own more than 1/2 of 1% of the
securities of such company together own beneficially more than 5% of such
securities.
9. Make loans, except that the Fund may purchase or hold debt obligations in
accordance with the investment restrictions set forth in paragraph 1
above, may enter into repurchase agreements, and may lend its portfolio
securities against collateral consisting of cash or of securities issued
or guaranteed by the U.S. Government or its agencies, which collateral is
equal at all times to at least 100% of the value of the securities loaned,
including accrued interest.
10. Act as an underwriter of securities, except to the extent the Fund may be
deemed to be an underwriter in connection with the sale of securities held
in its portfolio.
11. Purchase or sell real estate, commodities or commodity contracts, except
as set forth in 5 above.
12. Purchase or retain securities of issuers having a record of less than
three years continuous operation (such period of three years may include
the operation of predecessor companies or enterprises if the issuer came
into existence as a result of merger, consolidation or reorganization, or
the purchase of substantially all of the assets of the predecessor
companies or enterprises).
13. Invest more than 25% of its assets in a single industry. (Neither the U.S.
Government nor any of its agencies or instrumentalities will be considered
an industry for purposes of this restriction.)
The Fund may not change any of these investment restrictions without the
approval of the lesser of (i) more than 50% of the Fund's outstanding shares or
(ii) 67% of the Fund's shares present at a meeting at which the holders of more
than 50% of the outstanding shares are present in person or by proxy. As long as
the percentage restrictions described above are satisfied at the time of the
investment or borrowing, the Fund will be considered to have abided by those
restrictions even if, at a later time, a change in values or net assets causes
an increase or decrease in percentage beyond that allowed.
The Fund may invest up to 15% of its total assets in illiquid securities,
securities the disposition of which is subject to substantial legal or
contractual restrictions on resale and securities that are not readily
marketable. The sale of restricted and illiquid securities often requires more
time and results in higher brokerage charges or dealer discounts and other
selling expenses than does the sale of securities eligible for trading on
national securities exchanges or in the over-the-counter markets. Restricted
securities may sell at a price lower than similar securities that are not
subject to restrictions on resale. Restricted securities salable among qualified
institutional buyers without restriction pursuant to Rule 144A under the
Securities Act of 1933 that are determined to be liquid by the Adviser under
guidelines adopted by the Board of Trustees of the Trust (under which guidelines
the Adviser will consider factors such as trading activities and the
availability of price quotations), will not be treated as restricted securities
by the Fund pursuant to such rules. The Fund may,
B-3
<PAGE> 28
from time to time, adopt a more restrictive limitation with respect to
investment in illiquid and restricted securities in order to comply with the
most restrictive state securities law, currently 10%. This policy does not
include restricted securities eligible for resale pursuant to Rule 144A under
the Securities Act of 1933, as amended, which the Board of Trustees or the
Fund's investment adviser has determined under Board-approved guidelines to be
liquid. The Fund's policy with respect to investment in illiquid and restricted
securities is not a fundamental policy and may be changed by the Board of
Trustees, in consultation with the adviser, without obtaining shareholder
approval.
The Fund will not generally engage in the trading of securities for the
purpose of realizing short-term profits, but it will adjust its portfolio as it
deems advisable in view of prevailing or anticipated market conditions to
accomplish the Fund's investment objective. For example, the Fund may sell
portfolio securities in anticipation of a movement in interest rates or to avoid
loss of premiums paid and unrealized capital gains earned on GNMA Certificates
selling at a substantial premium. Frequency of portfolio turnover will not be a
limiting factor if the Fund considers it advantageous to purchase or sell
securities. The Fund anticipates that the portfolio turnover rate of the Fund
will normally be less than 200%, and may be significantly less in a period of
stable or rising interest rates.
U.S. GOVERNMENT SECURITIES
U.S. Treasury Securities. The Fund may invest in U.S. Treasury securities,
including bills, notes and bonds issued by the U.S. Treasury. These instruments
are direct obligations of the U.S. Government and, as such, are backed by the
full faith and credit of the United States. They differ primarily in their
interest rates, the lengths of their maturities and the dates of their
issuances.
Obligations Issued or Guaranteed by U.S. Government Agencies and
Instrumentalities. The Fund may invest in obligations issued by agencies of the
U.S. Government or instrumentalities established or sponsored by the U.S.
Government. These obligations, including those that are guaranteed by federal
agencies or instrumentalities, may or may not be backed by the full faith and
credit of the United States. Obligations of the Government National Mortgage
Association ("GNMA"), the Farmers Home Administration and the Export-Import Bank
are backed by the full faith and credit of the United States. Securities in
which the Fund may invest that are not backed by the full faith and credit of
the United States include, among others, obligations issued by the Tennessee
Valley Authority, the Resolution Trust Corporation, the Federal National
Mortgage Association ("FNMA"), the Federal Home Loan Mortgage Corporation
("FHLMC") and the United States Postal Service, each of which has the right to
borrow from the United States Treasury to meet its obligations, and obligations
of the Federal Farm Credit Bank and the Federal Home Loan Bank, the obligations
of which may be satisfied only by the individual credit of the issuing agency.
Investments in FHLMC, FNMA and other obligations may include collateralized
mortgage obligations and real estate mortgage investment conduits issued or
guaranteed by such entities. In the case of securities not backed by the full
faith and credit of the United States, the Fund must look principally to the
agency issuing or guaranteeing the obligation for ultimate repayment and may not
be able to assert a claim against the U.S. if the agency or instrumentality does
not meet its commitments.
Mortgage-Backed Securities Issued or Guaranteed by U.S. Government
Instrumentalities. The Fund may invest in mortgage-backed securities issued or
guaranteed by U.S. Government agencies such as GNMA, FNMA or FHLMC and
representing undivided ownership interests in pools of mortgages. The mortgages
backing these securities may include conventional 30-year fixed rate mortgages,
15-year fixed rate mortgages, graduated payment mortgages and adjustable rate
mortgages. The U.S. Government or the issuing agency guarantees the payment of
the interest on and principal of these securities. However, the guarantees do
not extend to the securities' yield or value, which are likely to vary inversely
with fluctuations in interest rates, nor do the guarantees extend to the yield
or value of the Fund's shares. These securities are in most cases "pass-through"
instruments, through which the holders receive a share of all interest and
principal payments from the mortgages underlying the securities, net of certain
fees. Because the principal amounts of such underlying mortgages may generally
be prepaid in whole or in part by the mortgagees at any time without penalty and
the prepayment characteristics of the underlying mortgages vary, it is not
possible to predict accurately the average life of a particular issue of
pass-through securities. Mortgage-backed securities are subject to more
B-4
<PAGE> 29
rapid repayment than their stated maturity date would indicate as a result of
the pass-through of prepayments of principal on the underlying mortgage
obligations. The remaining maturity of a mortgage-backed security will be deemed
to be equal to the average maturity of the mortgages underlying such security
determined by the Adviser on the basis of assumed prepayment rates with respect
to such mortgages. The remaining expected average life of a pool of mortgages
underlying a mortgage-backed security is a prediction of when the mortgages will
be repaid and is based upon a variety of factors such as the demographic and
geographic characteristics of the borrowers and the mortgaged properties, the
length of time that each of the mortgages has been outstanding, the interest
rates payable on the mortgages and the current interest rate environment. While
the timing of prepayments of graduated payment mortgages differs somewhat from
that of conventional mortgages, the prepayment experience of graduated payment
mortgages is basically the same as that of the conventional mortgages of the
same maturity dates over the life of the pool. During periods of declining
interest rates, prepayment of mortgages underlying mortgage-backed securities
can be expected to accelerate. When the mortgage obligations are prepaid, the
Fund reinvests the prepaid amounts in other income producing securities, the
yields of which reflect interest rates prevailing at the time. Therefore, the
Fund's ability to maintain a portfolio of high-yielding mortgage- backed
securities will be adversely affected to the extent that prepayments of
mortgages must be reinvested in securities which have lower yields than the
prepaid mortgage-backed securities. Moreover, prepayments of mortgages which
underlie securities purchased by the Fund at a premium would result in capital
losses.
Collateralized Mortgage Obligations and Multiclass Pass-Through
Securities. The Fund may invest in collateralized mortgage obligations
("CMOs"). CMOs are debt obligations collateralized by mortgage loans or mortgage
pass-through securities. Typically, CMOs are collateralized by Ginnie Mae,
Fannie Mae or Freddie Mac Certificates, but also may be collateralized by whole
loans or private pass-through securities (such collateral collectively
hereinafter referred to as "Mortgage Assets"). Multiclass pass-through
securities are equity interests in a trust composed of Mortgage Assets. Unless
the context indicates otherwise, all references herein to CMOs include
multiclass pass-through securities. Payments of principal of and interest on the
Mortgage Assets, and any reinvestment income thereon, provide the funds to pay
debt service on the CMOs or make scheduled distributions on the multiclass
pass-through securities. CMOs deemed to be U.S. government securities are those
issued or guaranteed as to principal and interest by a person controlled or
supervised by and acting as an agency or instrumentality of the U.S. government.
The issuer of a series of CMOs may elect to be treated as a Real Estate Mortgage
Investment Conduit (a "REMIC").
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a "tranche", is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause the CMOs to be
retired substantially earlier than their stated maturities or final distribution
dates. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semi-annual basis. The principal of and interest on the Mortgage
Assets may be allocated among the several classes of a series of a CMO in
innumerable ways.
The Fund may invest in, among others, parallel pay CMOs and Planned
Amortization Class CMOs ("PAC Bonds"). Parallel pay CMOs are structured to
provide payments of principal on each payment date to more than one class. These
simultaneous payments are taken into account in calculating the stated maturity
date or final distribution date of each class, which, as with other CMO
structures, must be retired by its stated maturity date or final distribution
date but may be retired earlier. PAC Bonds generally require payments of a
specified amount of principal on each payment date. PAC Bonds are always
parallel pay CMOs with the required principal payment on such securities having
the highest priority after interest has been paid to all classes. Substantially
all of the CMOs in which the Fund invests are PAC Bonds.
Stripped Mortgage-Backed Securities. The Fund also may invest in stripped
mortgage-backed securities ("SMBS") An SMBS is a derivative multiclass mortgage
security. SMBS usually are structured with two classes that receive different
proportions of the interest and principal distribution on a pool of Mortgage
Assets. In the most extreme case, one class will receive all of the interest
(the interest-only or "IO" class), while the other class will receive all of the
principal (the principal-only or "PO" class). The yield to maturity on an IO
class is extremely sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on such
B-5
<PAGE> 30
security's yield to maturity. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, the Fund may fail to fully
recoup its initial investment in these securities. Conversely, if the underlying
mortgage assets experience less than anticipated prepayments of principal, the
yield of POs could be materially adversely affected. The market values of IOs
and POs are subject to greater risk of fluctuation in response to changes in
market rates of interest than many other types of government securities and, to
the extent the Fund invests in IOs and POs, increases the risk of fluctuations
in the net asset value of the Fund. The Adviser will seek to manage these risks
(and potential benefits) by investing in a variety of such securities and
through the use of Strategic Transactions (described below).
ADDITIONAL INVESTMENT CONSIDERATIONS
The Fund may also engage in strategic transactions, purchase and sell
securities on a "when issued" and "delayed delivery" basis, enter into
repurchase and reverse repurchase agreements, and lend its portfolio securities
in certain circumstances, in each case subject to the limitations set forth
below. These investments entail risks.
Strategic Transactions. The Fund may, but is not required to, utilize various
other investment strategies as described below to hedge various market risks
(such as interest rates and broad or specific market movements), to manage the
effective maturity or duration of the Fund's fixed-income securities or to
enhance potential gain. Such strategies are generally accepted by modern
portfolio managers and are regularly utilized by many mutual funds and other
institutional investors. Techniques and instruments may change over time as new
instruments and strategies are developed or regulatory changes occur.
In the course of pursuing these investment strategies, the Fund may purchase
and sell derivative securities such as exchange-listed and over-the-counter put
and call options on securities, fixed-income indices and other financial
instruments, purchase and sell financial futures contracts and options thereon,
enter into various interest rate transactions such as swaps, caps, floors or
collars (collectively, all the above are called "Strategic Transactions").
Strategic Transactions may be used to attempt to protect against possible
changes in the market value of securities held in or to be purchased for the
Fund's portfolio resulting from securities markets fluctuations, to protect the
Fund's unrealized gains in the value of its portfolio securities, to facilitate
the sale of such securities for investment purposes, to manage the effective
maturity or duration of the Fund's portfolio, or to establish a position in the
derivatives markets as a temporary substitute for purchasing or selling
particular securities.
Some Strategic Transactions may also be used to enhance potential gain
although no more than 25% of the Fund's assets will be committed to Strategic
Transactions entered into for non-hedging purposes. When the Fund sells an
option, if the underlying securities do not increase (in the case of a call
option) or decrease (in the case of a put option) to a price level that would
make the exercise of the option profitable to the holder of the option, the
option generally will expire without being exercised and the Fund will realize
as profit the premium received for such option. When a call option of which the
Fund is the writer is exercised, the option holder purchases the underlying
security at the strike price and the Fund does not participate in any increase
in the price of such securities above the strike price. In addition, the Fund
would need to replace the underlying securities at prices which may not be
advantageous to the Fund. When a put option of which the Fund is the writer is
exercised, the Fund will be required to purchase the underlying securities at
the strike price, which may be in excess of the market value of such securities.
Any or all of these investment techniques may be used at any time and there is
no particular strategy that dictates the use of one technique rather than
another, as use of any Strategic Transaction is a function of numerous variables
including market conditions. The ability of the Fund to utilize these Strategic
Transactions successfully will depend on the Adviser's ability to predict
pertinent market movements, which cannot be assured. The Fund will comply with
applicable regulatory requirements when implementing these strategies,
techniques and instruments. Strategic Transactions involving financial futures
and options thereon will be purchased, sold or entered into only for bona fide
hedging, risk management or portfolio management purposes and not for
speculative purposes.
B-6
<PAGE> 31
Strategic Transactions have risks associated with them including possible
default by the other party to the transaction, illiquidity and, to the extent
the Adviser's view as to certain market movements is incorrect, the risk that
the use of such Strategic Transactions could result in losses greater than if
they had not been used. Use of put and call options may result in losses to the
Fund, force the sale or purchase of portfolio securities at inopportune times or
for prices other than current market values, limit the amount of appreciation
the Fund can realize on its investments or cause the Fund to hold a security it
might otherwise sell. The use of options and futures transactions entails
certain other risks. In particular, the variable degree of correlation between
price movements of futures contracts and price movements in the related
portfolio position of the Fund creates the possibility that losses on the
hedging instrument may be greater than gains in the value of the Fund's
position. In addition, futures and options markets may not be liquid in all
circumstances and certain over-the-counter options may have no markets. As a
result, in certain markets, the Fund might not be able to close out a
transaction without incurring substantial losses, if at all. Although the use of
futures and options transactions for hedging should tend to minimize the risk of
loss due to a decline in the value of the hedged position, at the same time they
tend to limit any potential gain which might result from an increase in value of
such position. Finally, the daily variation margin requirements for futures
contracts would create a greater ongoing potential financial risk than would
purchases of options, where the exposure is limited to the cost of the initial
premium. Losses resulting from the use of Strategic Transactions would reduce
net asset value, and possibly income, and such losses can be greater than if the
Strategic Transactions had not been utilized. Income earned or deemed to be
earned, if any, by the Fund from its Strategic Transactions will generally be
taxable. See "Tax Status of the Fund."
General Characteristics of Options. Put options and call options typically
have similar structural characteristics and operational mechanics regardless of
the underlying instrument on which they are purchased or sold. Thus, the
following general discussion relates to each of the particular types of options
discussed in greater detail below. In addition, many Strategic Transactions
involving options require segregation of Fund assets in special accounts, as
described below under "Use of Segregated and Other Special Accounts."
A put option gives the purchaser of the option, upon payment of a premium, the
right to sell, and the writer the obligation to buy, the underlying security,
commodity, index, or other instrument at the exercise price. For instance, the
Fund's purchase of a put option on a security might be designed to protect its
holdings in the underlying instrument (or, in some cases, a similar instrument)
against a substantial decline in the market value by giving the Fund the right
to sell such instrument at the option exercise price. A call option, upon
payment of a premium, gives the purchaser of the option the right to buy, and
the seller the obligation to sell, the underlying instrument at the exercise
price. The Fund's purchase of a call option on a security, financial future,
index, or other instrument might be intended to protect the Fund against an
increase in the price of the underlying instrument that it intends to purchase
in the future by fixing the price at which it may purchase such instrument. An
American style put or call option may be exercised at any time during the option
period while a European style put or call option may be exercised only upon
expiration or during a fixed period prior thereto. The Fund is authorized to
purchase and sell exchange listed options and over-the-counter options ("OTC
options"). Exchange listed options are issued by a regulated intermediary such
as the Options Clearing Corporation ("OCC"), which guarantees the performance of
the obligations of the parties to such options. The discussion below uses the
OCC as a paradigm, but is also applicable to other financial intermediaries.
With certain exceptions, OCC issued and exchange listed options generally
settle by physical delivery of the underlying security or currency, although in
the future cash settlement may become available. Index options and Eurodollar
instruments are cash settled for the net amount, if any, by which the option is
"in-the-money" (i.e., where the value of the underlying instrument exceeds, in
the case of a call option, or is less than, in the case of a put option, the
exercise price of the option) at the time the option is exercised. Frequently,
rather than taking or making delivery of the underlying instrument through the
process of exercising the option, listed options are closed by entering into
offsetting purchase or sale transactions that do not result in ownership of the
new option.
The Fund's ability to close out its position as a purchaser or seller of an
OCC or exchange listed put or call option is dependent, in part, upon the
liquidity of the option market. Among the possible reasons for the
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<PAGE> 32
absence of a liquid option market on an exchange are: (i) insufficient trading
interest in certain options; (ii) restrictions on transactions imposed by an
exchange; (iii) trading halts, suspensions or other restrictions imposed with
respect to particular classes or series of options or underlying securities
including reaching daily price limits; (iv) interruption of the normal
operations of the OCC or an exchange; (v) inadequacy of the facilities of an
exchange or OCC to handle current trading volume; or (vi) a decision by one or
more exchanges to discontinue the trading of options (or a particular class or
series of options), in which event the relevant market for that option on that
exchange would cease to exist, although outstanding options on that exchange
would generally continue to be exercisable in accordance with their terms.
The hours of trading for listed options may not coincide with the hours during
which the underlying financial instruments are traded. To the extent that the
option markets close before the markets for the underlying financial
instruments, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
OTC options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contrast to exchange listed options, which
generally have standardized terms and performance mechanics, all the terms of an
OTC option, including such terms as method of settlement, term, exercise price,
premium, guarantees and security, are set by negotiation of the parties. The
Fund will only sell OTC options that are subject to a buy-back provision
permitting the Fund to require the Counterparty to sell the option back to the
Fund at a formula price within seven days. The Fund expects generally to enter
into OTC options that have cash settlement provisions, although it is not
required to do so.
Unless the parties provide for it, there is no central clearing or guaranty
function in an OTC option. As a result, if the Counterparty fails to make or
take delivery of the security, or other instrument underlying an OTC option it
has entered into with the Fund or fails to make a cash settlement payment due in
accordance with the terms of that option, the Fund will lose any premium it paid
for the option as well as any anticipated benefit of the transaction.
Accordingly, the Adviser must assess the creditworthiness of each such
Counterparty or any guarantor or credit enhancement of the Counterparty's credit
to determine the likelihood that the terms of the OTC option will be satisfied.
The Fund will engage in OTC option transactions only with United States
government securities dealers recognized by the Federal Reserve Bank of New York
as "primary dealers", or broker dealers, domestic or foreign banks or other
financial institutions which have received (or the guarantors of the obligation
of which have received) a short-term credit rating of "A-1" from Standard &
Poor's Ratings Group ("S&P") or "P-1" from Moody's Investor Services, Inc.
("Moody's") or an equivalent rating from any other nationally recognized
statistical rating organization ("NRSRO"). The staff of the SEC currently takes
the position that, in general, OTC options on securities other than U.S.
Government securities purchased by the Fund, and portfolio securities "covering"
the amount of the Fund's obligation pursuant to an OTC option sold by it (the
cost of the sell-back plus the in-the-money amount, if any) are illiquid, and
are subject to the Fund's limitation on investing no more than 15% of its assets
in illiquid securities.
If the Fund sells a call option, the premium that it receives may serve as a
partial hedge, to the extent of the option premium, against a decrease in the
value of the underlying securities or instruments in its portfolio or will
increase the Fund's income. The sale of put options can also provide income.
The Fund may purchase and sell call options on securities, including U.S.
Treasury and agency securities, municipal obligations, mortgage-backed
securities and Eurodollar instruments that are traded on U.S. and foreign
securities exchanges and in the over-the-counter markets. All calls sold by the
Fund must be "covered" (i.e., the Fund must own the securities or futures
contract subject to the call) or must meet the asset segregation requirements
described below as long as the call is outstanding. Even though the Fund will
receive the option premium to help protect it against loss, a call sold by the
Fund exposes the Fund during the term of the option to possible loss of
opportunity to realize appreciation in the market price of the underlying
security or instrument and may require the Fund to hold a security or instrument
which it might otherwise have sold.
The Fund may purchase and sell put options on securities including U.S.
Treasury and agency securities, mortgage-backed securities, municipal
obligations and Eurodollar instruments (whether or not it holds the
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<PAGE> 33
above securities in its portfolio.) The Fund will not sell put options if, as a
result, more than 50% of the Fund's assets would be required to be segregated to
cover its potential obligations under such put options other than those with
respect to futures and options thereon. In selling put options, there is a risk
that the Fund may be required to buy the underlying security at a
disadvantageous price above the market price.
General Characteristics of Futures. The Fund may enter into financial futures
contracts or purchase or sell put and call options on such futures as a hedge
against anticipated interest rate or fixed-income market changes, for duration
management and for risk management purposes. Futures are generally bought and
sold on the commodities exchanges where they are listed with payment of initial
and variation margin as described below. The purchase of a futures contract
creates a firm obligation by the Fund, as purchaser, to take delivery from the
seller the specific type of financial instrument called for in the contract at a
specific future time for a specified price (or, with respect index futures and
Eurodollar instruments, the net cash amount). The sale of a futures contract
creates a firm obligation by the Fund, as seller, to deliver to the buyer the
specific type of financial instrument called for in the contract at a specific
future time for a specified price (or, with respect to index futures and
Eurodollar instruments, the net cash amount). Options on futures contracts are
similar to options on securities except that an option on a futures contract
gives the purchaser the right in return for the premium paid to assume a
position in a futures contract and obligates the seller to deliver such option.
The Fund's use of financial futures and options thereon will in all cases be
consistent with applicable regulatory requirements and in particular the rules
and regulations of the Commodity Futures Trading Commission and will be entered
into only for bona fide hedging, risk management (including duration management)
or other portfolio management purposes. Typically, maintaining a futures
contract or selling an option thereon requires the Fund to deposit with a
financial intermediary as security for its obligations an amount of cash or
other specified assets (initial margin) which initially is typically 1% to 10%
of the face amount of the contract (but may be higher in some circumstances).
Additional cash or assets (variation margin) may be required to be deposited
thereafter on a daily basis as the mark to market value of the contract
fluctuates. The purchase of options on financial futures involves payment of a
premium for the option without any further obligation on the part of the Fund.
If the Fund exercises an option on a futures contract it will be obligated to
post initial margin (and potential subsequent variation margin) for the
resulting futures position just as it would for any position. Futures contracts
and options thereon are generally settled by entering into an offsetting
transaction but there can be no assurance that the position can be offset prior
to settlement at an advantageous price nor that delivery will occur.
The Fund will not enter into a futures contract or related option (except for
closing transactions) if, immediately thereafter, the sum of the amount of its
initial margin and premiums on open futures contracts and options thereon would
exceed 5% of the Fund's total assets (taken at current value); however, in the
case of an option that is in-the-money at the time of the purchase, the
in-the-money amount may be excluded in calculating the 5% limitation. The
segregation requirements with respect to futures contracts and options thereon
are described below.
Options on Securities Indices and Other Financial Indices. The Fund also may
purchase and sell call and put options on securities indices and other financial
indices and in so doing can achieve many of the same objectives it would achieve
through the sale or purchase of options on individual securities or other
instruments. Options on securities indices and other financial indices are
similar to options on a security or other instrument except that, rather than
settling by physical delivery of the underlying instrument, they settle by cash
settlement, i.e., an option on an index gives the holder the right to receive,
upon exercise of the option, an amount of cash if the closing level of the index
upon which the option is based exceeds, in the case of a call, or is less than,
in the case of a put, the exercise price of the option (except if, in the case
of an OTC option, physical delivery is specified). This amount of cash is equal
to the excess of the closing price of the index over the exercise price of the
option, which also may be multiplied by a formula value. The seller of the
option is obligated, in return for the premium received, to make delivery of
this amount. The gain or loss on an option on an index depends on price
movements in the instruments making up the market, market segment, industry or
other composite on which the underlying index is based, rather than price
movements in individual securities, as is the case with respect to options on
securities.
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<PAGE> 34
Combined Transactions. The Fund may enter into multiple transactions,
including multiple options transactions, multiple futures transactions and
multiple interest rate transactions and any combination of futures, options and
interest rate transactions ("component" transactions), instead of a single
Strategic Transaction, as part of a single or combined strategy when, in the
opinion of the Adviser, it is in the best interests of the Fund to do so. A
combined transaction will usually contain elements of risk that are present in
each of its component transactions. Although combined transactions are normally
entered into based on the Adviser's judgment that the combined strategies will
reduce risk or otherwise more effectively achieve the desired portfolio
management goal, it is possible that the combination will instead increase such
risks or hinder achievement of the portfolio management objective.
Swaps, Caps, Floors and Collars. Among the Strategic Transactions into which
the Fund may enter are interest rate and index swaps and the purchase or sale of
related caps, floors and collars. The Fund expects to enter into these
transactions primarily to preserve a return or spread on a particular investment
or portion of its portfolio, as a duration management technique or to protect
against any increase in the price of securities the Fund anticipates purchasing
at a later date. The Fund intends to use these transactions as hedges and not as
speculative investments and will not sell interest rate caps or floors where it
does not own securities or other instruments providing the income stream the
Fund may be obligated to pay. Interest rate swaps involve the exchange by the
Fund with another party of their respective commitments to pay or receive
interest, e.g., an exchange of floating rate payments for fixed rate payments
with respect to a notional amount of principal. An index swap is an agreement to
swap cash flows on a notional amount based on changes in the values of the
reference indices. The purchase of a cap entitles the purchaser to receive
payments on a notional principal amount from the party selling such cap to the
extent that a specified index exceeds a predetermined interest rate or amount.
The purchase of a floor entitles the purchaser to receive payments on a notional
principal amount from the party selling such floor to the extent that a
specified index falls below a predetermined interest rate or amount. A collar is
a combination of a cap and a floor that preserves a certain return within a
predetermined range of interest rates or values.
The Fund will usually enter into swaps on a net basis, i.e., the two payment
streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with the Fund receiving or paying, as the case may
be, only the net amount of the two payments. Inasmuch as these swaps, caps,
floors and collars are entered into for good faith hedging purposes, the Adviser
and the Fund believe such obligations do not constitute senior securities under
the 1940 Act and, accordingly, will not treat them as being subject to its
borrowing restrictions. The Fund will not enter into any swap, cap, floor or
collar transaction unless, at the time of entering into such transaction, the
unsecured long-term debt of the Counterparty, combined with any credit
enhancements, is rated at least "A" by S&P or Moody's or has an equivalent
equity rating from an NRSRO or is determined to be of equivalent credit quality
by the Adviser. If there is a default by the Counterparty, the Fund may have
contractual remedies pursuant to the agreements related to the transaction. The
swap market has grown substantially in recent years with a large number of banks
and investment banking firms acting both as principals and agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid. Caps, floors and collars are more recent innovations for
which standardized documentation has not yet been fully developed and,
accordingly, they are less liquid than swaps.
Use of Segregated and Other Special Accounts. Many Strategic Transactions, in
addition to other requirements, require that the Fund segregate liquid
high-grade assets with its custodian to the extent Fund obligations are not
otherwise "covered" through ownership of the underlying security, financial
instrument or currency. In general, either the full amount of any obligation by
the Fund to pay or deliver securities or assets must be covered at all times by
the securities, instruments or currency required to be delivered, or, subject to
any regulatory restrictions, an amount of cash or liquid high-grade securities
at least equal to the current amount of the obligation must be segregated with
the custodian. The segregated assets cannot be sold or transferred unless
equivalent assets are substituted in their place or it is no longer necessary to
segregate them. For example, a call option written by the Fund will require the
Fund to hold the securities subject to the call (or securities convertible into
the needed securities without additional consideration) or to segregate liquid
high-grade securities sufficient to purchase and deliver the securities if the
call is exercised. A call option sold by the Fund on an index will require the
Fund to own portfolio securities which correlate with the index or to segregate
liquid high-grade assets equal to the excess of the index value over the
exercise price on a current
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<PAGE> 35
basis. A put option written by the Fund requires the Fund to segregate liquid,
high-grade assets equal to the exercise price.
OTC options entered into by the Fund, including those on securities, financial
instruments or indices and OCC issued and exchange listed index options, will
generally provide for cash settlement. As a result, when the Fund sells these
instruments it will only segregate an amount of assets equal to its accrued net
obligations, as there is no requirement for payment or delivery of amounts in
excess of the net amount. These amounts will equal 100% of the exercise price in
the case of a non cash-settled put, the same as an OCC guaranteed listed option
sold by the Fund, or the in-the-money amount plus any sell-back formula amount
in the case of a cash-settled put or call. In addition, when the Fund sells a
call option on an index at a time when the in-the-money amount exceeds the
exercise price, the Fund will segregate, until the option expires or is closed
out, cash or cash equivalents equal in value to such excess. OCC issued and
exchange listed options sold by the Fund other than those above generally settle
with physical delivery, and the Fund will segregate an amount of assets equal to
the full value of the option. OTC options settling with physical delivery, or
with an election of either physical delivery or cash settlement, will be treated
the same as other options settling with physical delivery.
In the case of a futures contract or an option thereon, the Fund must deposit
initial margin and possible daily variation margin in addition to segregating
assets sufficient to meet its obligation to purchase or provide securities or
currencies, or to pay the amount owed at the expiration of an index- based
futures contract. Such assets may consist of cash, cash equivalents, liquid debt
or equity securities or other acceptable assets.
With respect to swaps, the Fund will accrue the net amount of the excess, if
any, of its obligations over its entitlements with respect to each swap on a
daily basis and will segregate an amount of cash or liquid high-grade securities
having a value equal to the accrued excess. Caps, floors and collars require
segregation of assets with a value equal to the Fund's net obligation, if any.
Strategic Transactions may be covered by other means when consistent with
applicable regulatory policies. The Fund may also enter into offsetting
transactions so that its combined position, coupled with any segregated assets,
equals its net outstanding obligation in related options and Strategic
Transactions. For example, the Fund could purchase a put option if the strike
price of that option is the same or higher than the strike price of a put option
sold by the Fund. Moreover, instead of segregating assets if the Fund held a
futures or forward contract, it could purchase a put option on the same futures
or forward contract with a strike price as high or higher than the price of the
contract held. Other Strategic Transactions may also be offset in combinations.
If the offsetting transaction terminates at the time of or after the primary
transaction no segregation is required, but if it terminates prior to such time,
assets equal to any remaining obligation would need to be segregated.
The Fund's activities involving Strategic Transactions may be limited by the
requirements of Subchapter M of the Internal Revenue Code for qualification as a
regulated investment company. See "Tax Status of the Fund."
"When Issued" and "Delayed Delivery" Transactions. The Fund may also purchase
and sell portfolio securities on a "when issued" and "delayed delivery" basis.
No income accrues to the Fund on securities in connection with such purchase
transactions prior to the date the Fund actually takes delivery of such
securities. These transactions are subject to market fluctuation; the value of
the securities at delivery may be more or less than their purchase price, and
yields generally available on comparable securities when delivery occurs may be
higher or lower than yields on the securities obtained pursuant to such
transactions. Because the Fund relies on the buyer or seller, as the case may
be, to consummate the transaction, failure by the other party to complete the
transaction may result in the Fund missing the opportunity of obtaining a price
or yield considered to be advantageous. When the Fund is the buyer in such a
transaction, however, it will maintain, in a segregated account with its
custodian, cash or portfolio securities having an aggregate value equal to the
amount of such purchase commitments until payment is made. The Fund will make
commitments to purchase securities on such basis only with the intention of
actually acquiring these securities, but the Fund may sell such securities prior
to the settlement date if such sale is considered to be advisable. To the extent
the Fund engages in "when issued" and "delayed delivery" transactions, it will
do so for the purpose of acquiring securities for the Fund's portfolio
consistent with the Fund's investment objective and policies and not for the
purpose of investment leverage.
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<PAGE> 36
Repurchase Agreements. The Fund may enter into repurchase agreements with
banks and broker-dealers, under which the Fund purchases securities and agrees
to resell the securities at an agreed upon time and at an agreed upon price.
Under the 1940 Act, repurchase agreements may be considered collateralized loans
by the Fund, and the difference between the amount the Fund pays for the
securities and the amount it receives upon resale is accrued as interest and
reflected in the Fund's net income. When the Fund enters into repurchase
agreements, it relies on the seller to repurchase the securities. Failure to do
so may result in a loss for the Fund if the market value of the securities is
less than the repurchase price. At the time the Fund enters into a repurchase
agreement, the value of the underlying security including accrued interest will
be equal to or exceed the value of the repurchase agreement and, for repurchase
agreements that mature in more than one day, the seller will agree that the
value of the underlying security including accrued interest will continue to be
at least equal to the value of the repurchase agreement. In determining whether
to enter into a repurchase agreement with a bank or broker-dealer, the Fund will
take into account the credit-worthiness of such party. In the event of default
by such party, the Fund may not have a right to the underlying security and
there may be possible delays and expenses in liquidating the security purchased,
resulting in a decline in its value and loss of interest. The Fund will use
repurchase agreements as a means of making short-term investments, and will
invest in repurchase agreements of duration of seven days or less in an amount
not exceeding 25% of the net assets of the Fund. The Fund's ability to invest in
repurchase agreements that mature in more than seven days is subject to an
investment restriction that limits the Fund's investment in "illiquid"
securities, including such repurchase agreements, to 15% of the Fund's net
assets.
Reverse Repurchase Agreements and Dollar Rolls. In order to seek a high level
of current income, the Fund may enter into reverse repurchase agreements with
respect to securities which could otherwise be sold by the Fund. Reverse
repurchase agreements involve sales by the Fund of portfolio assets concurrently
with an agreement by the Fund to repurchase the same assets at a later date at a
fixed price. During the reverse repurchase agreement period, the Fund continues
to receive principal and interest payments on these securities.
In order to seek a high level of current income, the Fund may enter into
dollar rolls in which the Fund sells securities for delivery in the current
month and simultaneously contracts to repurchase, typically in 30 or 60 days,
substantially similar (same type, coupon and maturity) securities on a specified
future date. During the roll period, the Fund forgoes principal and interest
paid on such securities. The Fund is compensated by the difference between the
current sales price and the forward price for the future purchase (often
referred to as the "drop") as well as by the interest earned on the cash
proceeds of the initial sale. A "covered roll" is a specific type of dollar roll
for which there is an offsetting cash position or cash equivalent security
position which matures on or before the forward settlement date of the dollar
roll transaction.
The Fund will establish a segregated account with its custodian in which it
will maintain cash, U.S. Government securities or other liquid high-grade debt
obligations equal in value to its obligations in respect of reverse repurchase
agreements and dollar rolls and, accordingly, the Fund will not treat such
obligations as senior securities for purposes of the 1940 Act. "Covered rolls"
are not subject to these segregation requirements. Reverse repurchase agreements
and dollar rolls involve the risk that the market value of the securities
retained by the Fund may decline below the price of the securities the Fund has
sold but is obligated to repurchase under the agreement. In the event the buyer
of securities under a reverse repurchase agreement or dollar roll files for
bankruptcy or becomes insolvent, the Fund's use of the proceeds of the agreement
may be restricted pending a determination by the other party, or its trustee or
receiver, whether to enforce the Fund's obligation to repurchase the securities.
The Fund is authorized to borrow money from banks or otherwise in an amount up
to 33 1/3% of the Fund's total assets (after giving effect to any such
borrowing). The Fund considers reverse repurchase agreements and dollar rolls to
be borrowings for purposes of such percentage limitation. No more than 5% of the
Fund's total assets may be invested in bank borrowings and reverse repurchase
agreements. The Fund will borrow only when the Adviser believes that such
borrowings will benefit the Fund.
Borrowing by the Fund creates an opportunity for increased net income but, at
the same time, increases the risk of the Fund's portfolio. Leveraging by the
Fund will generally increase the volatility of the Fund's net asset value in
response to fluctuations in market interest rates and accordingly may increase
the risk of the
B-12
<PAGE> 37
Fund's portfolio. Although the principal of such borrowings will be fixed, the
Fund's assets may change in value during the time the borrowing is outstanding.
Borrowing will create interest expenses for the Fund which can exceed the income
from the assets retained. To the extent the income derived from securities
purchased with borrowed funds exceeds the interest the Fund will have to pay,
the Fund's net income will be greater than if borrowing were not used.
Conversely, if the income from the assets retained with borrowed funds is not
sufficient to cover the cost of borrowing, the net income of the Fund will be
less than if borrowing were not used, and therefore the amount available for
distribution to stockholders as dividends will be reduced.
Loans of Portfolio Securities. Consistent with applicable regulatory
requirements, the Fund may lend its portfolio securities to banks or
broker-dealers, to a maximum of 25% of the assets of the Fund, where such loans
are callable at any time and are continuously secured by collateral consisting
of cash or of securities issued or guaranteed by the U.S. Government or its
agencies, which collateral is equal at all times to at least 100% of the value
of the securities loaned, including accrued interest. The Fund will receive
amounts equal to earned income for having made the loan. Any cash collateral
pursuant to these loans will be invested in short-term instruments. The Fund is
the beneficial owner of the loaned securities in that any gain or loss in the
market price during the loan inures to the Fund and its shareholders. Thus, when
the loan is terminated, the value of the securities may be more or less than
their value at the beginning of the loan. In determining whether to lend its
portfolio securities to a bank or broker-dealer, the Fund will take into account
the credit-worthiness of such borrower and will monitor such credit-worthiness
on an ongoing basis inasmuch as default by the other party may cause delays or
other collection difficulties. The Fund may pay finders' fees in connection with
loans of its portfolio securities.
OFFICERS AND TRUSTEES
The officers and Trustees of the Trust (of which the Fund is a sub-trust),
their principal occupations for the last five years and their affiliations, if
any, with the Adviser, Van Kampen American Capital Asset Management, Inc., Van
Kampen American Capital Distributors, Inc., McCarthy, Crisanti & Maffei, Inc.,
MCM Asia Pacific Company, Limited, Van Kampen American Capital Management, Inc.,
Van Kampen American Capital, Inc. or VK/AC Holding Inc., are as follows:
DENNIS J. MCDONNELL,* President, Chief Executive Officer and Trustee
One Parkview Plaza, Oakbrook Terrace, IL 60181
Director of VK/AC Holding, Inc. and Van Kampen American Capital, Inc.
President, Chief Operating Officer and Director of Van Kampen American
Capital Investment Advisory Corp., Van Kampen American Capital Asset
Management, Inc., and Van Kampen American Capital Management, Inc.
Director of McCarthy, Crisanti & Maffei, Inc.
Chairman and Director of MCM Asia Pacific Company, Limited
Prior to December, 1991, Senior Vice President of Van Kampen Merritt Inc.
R. CRAIG KENNEDY, Trustee
Dennis Trading Group, Inc., 250 S. Wacker Drive, Suite 650, Chicago, IL
60606
Advisor to the Dennis Trading Group Inc.
Prior to 1993, President and Chief Executive Officer, Director and member
of the Investment Committee of the Joyce Foundation, a private foundation.
PHILIP G. GAUGHAN, Trustee
9615 Torresdale Avenue, Philadelphia, PA 19114
Prior to February 1989, former Managing Director and Manager of Municipal
Bond Department, W.H. Newbold's Son & Co.
DONALD C. MILLER, Trustee
415 North Adams, Hinsdale, IL 60521
Prior to 1992, Director of Royal Group, Inc. of Charlotte, North Carolina,
a company in insurance-related businesses.
B-13
<PAGE> 38
JACK E. NELSON, Trustee
423 Country Club Drive, Winter Park, FL 32789
President of Nelson Investment Planning Services, Inc., a financial
planning company.
JEROME L. ROBINSON, Trustee
115 River Road, Edgewater, New Jersey 07020
President of Robinson Technical Products Corporation, a processor and
distributor of welding alloys, supplies and equipment.
Director of Pacesetter Software, a software programming company
specializing in white collar productivity.
Director and majority shareholder Hilarius Haarlem B.V., Haarlem, Holland,
a manufacturer and distributor of welding alloys.
WAYNE W. WHALEN,* Trustee
333 West Wacker Drive, Chicago, IL 60606
Partner in the law firm of Skadden, Arps, Slate, Meagher & Flom.
PETER W. HEGEL,* Vice President
One Parkview Plaza, Oakbrook Terrace, IL 60181
Senior Vice President and Portfolio Manager of Van Kampen American Capital
Investment Advisory Corp.
Senior Vice President of Van Kampen American Capital Management, Inc.
Director of McCarthy, Crisanti & Maffei, Inc.
RONALD A. NYBERG,* Vice President and Secretary
One Parkview Plaza, Oakbrook Terrace, IL 60181
Executive Vice President, General Counsel and Secretary of VK/AC Holding,
Inc. and Van Kampen American Capital, Inc.
Executive Vice President, General Counsel and Director of Van Kampen
American Capital Investment Advisory Corp., Van Kampen American Capital
Asset Management, Inc., Van Kampen American Capital Management, Inc. and
Van Kampen American Capital Distributors, Inc.
General Counsel and Assistant Secretary of McCarthy, Crisanti & Maffei,
Inc.
Director of ICI Mutual Insurance Co., a provider of insurance to members of
the Investment Company Institute.
Prior to March, 1991, Secretary of Van Kampen Merritt Inc., Van Kampen
Merritt Investment Advisory Corp. and McCarthy, Crisanti & Maffei, Inc.
EDWARD C. WOOD, III,* Vice President, Treasurer and Chief Financial Officer
One Parkview Plaza, Oakbrook Terrace, IL 60181
First Vice President of Van Kampen American Capital Investment Advisory
Corp.
SCOTT E. MARTIN,* Assistant Secretary
One Parkview Plaza, Oakbrook Terrace, IL 60181
First Vice President, Deputy General Counsel and Assistant Secretary of
VK/AC Holding, Inc. and Van Kampen American Capital, Inc.
First Vice President, Deputy General Counsel and Secretary of Van Kampen
American Capital Investment Advisory Corp., Van Kampen American Capital
Asset Management, Inc., Van Kampen American Capital Management, Inc. and
Van Kampen American Capital Distributors, Inc.
Deputy General Counsel and Secretary of McCarthy, Crisanti & Maffei, Inc.
B-14
<PAGE> 39
WESTON B. WETHERELL,* Assistant Secretary
One Parkview Plaza, Oakbrook Terrace, IL 60181
Vice President, Associate General Counsel and Assistant Secretary of Van
Kampen American Capital, Inc., Van Kampen American Capital Investment
Advisory Corp., Van Kampen American Capital Asset Management, Inc., Van
Kampen American Capital Management, Inc. and Van Kampen American Capital
Distributors, Inc.
Assistant Secretary of McCarthy, Crisanti & Maffei, Inc.
JOHN L. SULLIVAN,* Controller
One Parkview Plaza, Oakbrook Terrace, IL 60181
Vice President of Van Kampen American Capital Investment Advisory Corp.
STEVEN M. HILL,* Assistant Treasurer
One Parkview Plaza, Oakbrook Terrace, IL 60181
Assistant Vice President of Van Kampen American Capital Investment Advisory
Corp.
- ---------------
* Interested persons of the Fund as defined in the 1940 Act.
Each of the foregoing trustees of the Fund acts as a trustee for other
investment companies advised by the Adviser, and each of the foregoing officers
holds the same position(s) with other investment companies advised by the
Adviser.
The compensation of the officers and directors who are affiliated persons (as
defined in the 1940 Act) of the Adviser is paid by the Adviser and the
compensation of the officers and trustees who are affiliated persons of the
Distributor or Van Kampen American Capital, Inc. is paid by the respective
entity. The Fund pays the compensation of all other officers and trustees.
During the next year, the Fund expects to pay trustees who are not affiliated
persons of the Adviser, the Distributor or Van Kampen American Capital, Inc.
$2,500, plus $250 per meeting of the Board of Trustees, plus expenses. Under the
Fund's retirement plan, trustees who are not affiliated with the Adviser, the
Distributor or Van Kampen American Capital, Inc., have at least ten years of
service and retire at or after attaining the age of 60, are eligible to receive
a retirement benefit equal to the annual retainer for each of the ten years
following such trustees's retirement. Under certain conditions, reduced benefits
are available for early retirement. Under the Fund's deferred compensation plan,
a trustee who is not affiliated with the Adviser, the Distributor or Van Kampen
American Capital, Inc. can elect to defer receipt of all or a portion of the
trustee's fees earned by such trustee until such trustee's retirement. The
deferred compensation earns a rate of return determined by reference to the Fund
or other Van Kampen Merritt mutual funds advised by the Adviser as selected by
the trustee. To the extent permitted by the 1940 Act, the Fund may invest in
securities of other Van Kampen Merritt mutual funds advised by the Adviser in
order to match the deferred compensation obligation. The deferred compensation
plan is not funded and obligations thereunder represent general unsecured claims
against the general assets of the Fund.
COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
PENSION OR
RETIREMENT TOTAL COMPENSATION
AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL FROM REGISTRANT
COMPENSATION FROM AS PART OF FUND BENEFITS UPON AND FUND COMPLEX
NAME REGISTRANT(2) EXPENSES(3) RETIREMENT(4) PAID TO TRUSTEE(5)
- ------------------------------- ------------------ ---------------- ---------------- ------------------
<S> <C> <C> <C> <C>
R. Craig Kennedy............... $3,785 $0 $2,500 $ 62,362
Philip G. Gaughan.............. 3,778 0 2,500 63,250
Donald C. Miller............... 3,774 0 2,500 62,178
Jack A. Nelson................. 3,785 0 2,500 62,362
Jerome L. Robinson............. 3,778 0 2,500 58,475
Wayne W. Whalen................ 2,903 0 2,500 49,875
</TABLE>
- ---------------
(1) Messrs. Merritt and McDonnell, Trustees of the Registrant during fiscal year
1994, are affiliated persons of the Adviser and are not eligible for
compensation or retirement benefits from the Registrant.
B-15
<PAGE> 40
(2) The Registrant is Van Kampen Merritt U.S. Government Trust (the "Trust").
The amounts shown in this column are from the Trust's 1994 fiscal year.
Beginning in October 1994, each Trustee, except Messrs. Gaughan and Whalen,
began deferring his entire aggregate compensation. The total combined amount
of deferred compensation (including interest) accrued with respect to each
Trustee from the Fund Complex (as defined herein) as of December 31, 1994 is
as follows: Mr. Kennedy $14,737; Mr. Miller $14,553; Mr. Nelson $14,737 and
Mr. Robinson $13,725.
(3) The Retirement Plan commenced as of August 1, 1994 for the Registrant. As of
December 31, 1994 fiscal year, no amounts had been accrued for retirement
benefits because such amounts were considered to be immaterial to the net
assets of the Registrant at such time. The Registrant will accrue amounts
for retirement benefits by the end of fiscal year 1995.
(4) This is the estimated annual benefits payable per year for the 10-year
period commencing in the year of such Trustee's retirement by the Fund
assuming: the Trustee has 10 or more years of service on the Board of the
Fund, retires at or after attaining the age of 60 and the annual retainer in
the year prior to the Trustee's retirement is $2,500. Trustees retiring
prior to the age of 60 or with fewer than 10 years of service may receive
reduced retirement benefits from the Fund.
(5) The Fund Complex consists of 20 mutual funds advised by the Adviser that
have the same members on each funds' Board of Trustees. The amounts shown in
this column are accumulated from the Aggregate Compensation of each of these
20 mutual funds in the Fund Complex during the calendar year ended December
31, 1994. The Adviser also serves as investment adviser for other investment
companies; however, with the exception of Messrs. Merritt, McDonnell and
Whalen, the Trustees are not trustees of such investment companies.
Combining the Fund Complex with other investment companies advised by the
Adviser, Mr. Whalen received Total Compensation of $161,850 during the
calendar year ended December 31, 1994.
As of April 13, 1995, the trustees and officers as a group own less than 1% of
the shares of the Fund.
The authorized stock of the Fund currently consists of an unlimited number of
full and fractional shares of beneficial interest, without par value.
No officer or trustee of the Fund owns or would be able to acquire 5% or more
of the common stock of VK/AC Holding, Inc.
To the knowledge of the Fund, as of April 13, 1995, no person owned of record
or beneficially 5% or more of the Fund's Class A Shares or Class B Shares.
As of April 13, 1995, the following persons owned of record or beneficially 5%
or more of the Fund's Class C Shares: Bishop of the Roman Catholic Diocese of
Charlotte, NC c/o W.G. Weldon, P.O. Box 36776, Charlotte, NC 28236-6776, 7%;
Donaldson, Lufkin, Jenrette Securities Inc., P.O. Box 2052, Jersey City, NJ
07303-2052, 6%, and Martha J. Ruoff Estate and Russell Ruoff Conservator, 435
North Alfred, Los Angeles, CA 90048-2504, 7%.
INVESTMENT ADVISORY AND OTHER SERVICES
INVESTMENT ADVISORY AGREEMENT
Van Kampen American Capital Investment Advisory Corp. (the "Adviser") is the
Fund's investment adviser. The Adviser was incorporated as a Delaware
corporation in 1982 (and through December 31, 1987 transacted business under the
name of American Portfolio Advisory Service Inc.). The Adviser's principal
office is located at One Parkview Plaza, Oakbrook Terrace, Illinois 60181.
The Adviser is a wholly-owned subsidiary of Van Kampen American Capital, Inc.,
which in turn is a wholly-owned subsidiary of VK/AC Holding, Inc. VK/AC Holding,
Inc. is controlled, through the ownership of a substantial majority of its
common stock by The Clayton & Dubilier Private Equity Fund IV Limited
Partnership ("C&D L.P."), a Connecticut limited partnership. C&D L.P. is managed
by Clayton, Dubilier & Rice, Inc., a New York based private investment firm. The
General Partner of C&D L.P. is Clayton & Dubilier Associates IV Limited
Partnership ("C&D Associates L.P."). The general partners of C&D Associates L.P.
are Joseph L. Rice, III, B. Charles Ames, William A. Barbe, Alberto Cribiore,
Donald J.
B-16
<PAGE> 41
Gogel, Leon J. Hendrix, Jr., and Hubbard C. Howe and Andrall E. Pearson, each of
whom is a principal of Clayton, Dubilier & Rice, Inc. In addition, certain
officers, directors and employees of Van Kampen American Capital, Inc. own, in
the aggregate, not more than 6% of the common stock of VK/AC Holding, Inc. and
have the right to acquire, upon the exercise of options, approximately an
additional 10% of the common stock of VK/AC Holding, Inc.
The investment advisory agreement between the Adviser and the Fund provides
that the Adviser will supply investment research and portfolio management,
including the selection of securities for the Fund to purchase, hold or sell and
the selection of brokers through whom the Fund's portfolio transactions are
executed. The Adviser also administers the business affairs of the Fund,
furnishes offices, necessary facilities and equipment, provides administrative
services, and permits its officers and employees to serve without compensation
as officers of the Fund and trustees of the Trust if duly elected to such
positions.
The agreement provides that the Adviser shall not be liable for any error of
judgment or of law, or for any loss suffered by the Fund in connection with the
matters to which the agreement relates, except a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of the Adviser in the
performance of its obligations and duties, or by reason of its reckless
disregard of its obligations and duties under the agreement.
The Adviser's activities are subject to the review and supervision of the
Board of Trustees of the Trust, of which the Fund is a sub-trust, to whom the
Adviser renders periodic reports of the Fund's investment activities.
The investment advisory agreement dated February 17, 1993 was approved by the
shareholders of the Fund at a shareholders meeting held on January 14, 1993. The
agreement will remain in effect from year to year if specifically approved by
the Trustees of the Trust or the Fund's shareholders and by the disinterested
Trustees of the Trust in compliance with the requirements of the 1940 Act. The
agreement may be terminated without penalty upon 60 days written notice by
either party and will automatically terminate in the event of assignment.
The agreement specifies that the Adviser will reimburse the Fund for annual
expenses of the Fund which exceed the most stringent limits prescribed by any
state in which the Fund shares are offered for sale. The most stringent limit as
of the date of this Statement of Additional Information, as affecting the Fund,
requires the Adviser to reimburse the Fund to the extent that aggregate expenses
of the Fund (excluding interest, taxes and other expenses which may be
excludable under applicable state law) exceed in any fiscal year 2 1/2% of the
average annual net assets of the Fund up to $30 million, 2% of the average
annual net assets of the Fund of the next $70 million, and 1 1/2% of the
remaining average annual net assets of the Fund. In addition to making any
required reimbursements, the Adviser may in its discretion, but is not obligated
to, waive all or any portion of its fee or assume all or any portion of the
expenses of the Fund.
For the years ended December 31, 1994, 1993 and 1992, the Fund recognized
advisory expenses of $18,897,359, $19,904,333 and $15,462,526, respectively.
OTHER AGREEMENTS
SUPPORT SERVICES AGREEMENT. Under a support services agreement with the
Distributor the Fund receives support services for shareholders, including the
handling of all written and telephonic communications, except initial order
entry and other distribution-related communications. Upon entering into such
agreement, the Fund realized a reduction in the fee which would have been paid
to the Transfer Agent if the Transfer Agent had provided such services. Payment
by the Fund for such services is made on cost basis for the employment of the
personnel and the equipment necessary to render the support services. The Fund,
and the other Van Kampen Merritt mutual funds distributed by the Distributor,
share such costs proportionately among themselves based upon their respective
net asset values.
For the years ended December 31, 1994, 1993 and 1992, the Fund recognized
expenses of approximately $1,755,000, $1,622,650 and $1,382,598, respectively,
representing the Distributor's cost of providing certain support services.
B-17
<PAGE> 42
FUND ACCOUNTING AGREEMENT. The Fund has also entered into an accounting
services agreement pursuant to which the Adviser provides accounting services
supplementary to those provided by the Custodian. Such services are expected to
enable the Fund to more closely monitor and maintain its accounts and records.
The Fund shares together with the other Van Kampen Merritt mutual funds
distributed by the Distributor in the cost of employment of up to six persons to
provide such services, with 25% of such costs shared proportionately based on
the number of outstanding classes of securities per fund and with the remaining
75% of such cost being paid by the Fund and such other Van Kampen Merritt funds
based proportionally on their respective net assets.
For the years ended December 31, 1994, 1993 and 1992, the Fund recognized
expenses of approximately $80,100, $80,675 and $54,810, respectively,
representing the Adviser's cost of providing accounting services.
LEGAL SERVICES AGREEMENT. The Fund has entered into a Legal Services
Agreement pursuant to which Van Kampen American Capital, Inc. provides legal
services, including without limitation: accurate maintenance of the Fund's
minute books and records, preparation and oversight of the Fund's regulatory
reports, and other information provided to shareholders, as well as responding
to day-to-day legal issues on behalf of the Fund. Payment by the Fund for such
services is made on a cost basis for the salary and salary related benefits,
including but not limited to bonuses, group insurances and other regular wages
for the employment of personnel, as well as overhead and the expenses related to
the office space and the equipment necessary to render the legal services. The
Fund, and the other Van Kampen Merritt mutual funds distributed by the
Distributor, share one half (50%) of such costs equally. The remaining one half
(50%) of such costs are allocated to specific funds based on specific time
allocations, or in the event services are attributable only to types of funds
(i.e. closed-end or open-end), the relative amount of time spent on each type of
fund and then further allocated between funds of that type based upon their
respective net asset values.
For the years ended December 31, 1994, 1993 and 1992, the Fund recognized
expenses of approximately $62,900, $60,300 and $38,800, respectively,
representing Van Kampen American Capital, Inc.'s cost of providing legal
services.
CUSTODIAN AND INDEPENDENT AUDITORS
State Street Bank and Trust Company, 225 Franklin Street, P.O. Box 1713,
Boston, MA 02105-1713, is the custodian of the Fund and has custody of all
securities and cash of the Fund. The custodian, among other things, attends to
the collection of principal and income, and payment for and collection of
proceeds of securities bought and sold by the Fund.
The independent auditors for the Fund are KPMG Peat Marwick LLP, 303 East
Wacker Drive, Chicago, IL 60601. The selection of independent auditors will be
subject to ratification by the shareholders of the Fund at any annual meeting of
shareholders.
PORTFOLIO TRANSACTIONS AND BROKERAGE ALLOCATION
The Adviser will place orders for portfolio transactions for the Fund with
broker-dealer firms giving consideration to the quality, quantity and nature of
each firm's professional services. These services include execution, clearance
procedures, wire service quotations and statistical and other research
information provided to the Fund and the investment adviser, including
quotations necessary to determine the value of the Fund's net assets. Any
research benefits derived are available for all clients of the investment
adviser. Since statistical and other research information is only supplementary
to the research efforts of the Adviser and still must be analyzed and reviewed
by its staff, the receipt of research information is not expected to materially
reduce its expenses.
If it is believed to be in the best interests of the Fund, the Adviser may
place portfolio transactions with brokers who provide the types of research
service described above, even if it means the Fund will have to pay a higher
commission, (or, if the broker's profit is part of the cost of the security,
will have to pay a higher price for the security) than would be the case if no
weight were given to the broker's furnishing of those research services. This
will be done, however, only if, in the opinion of the Adviser, the amount of
additional commission or increased cost is reasonable in relation to the value
of such services.
B-18
<PAGE> 43
In selecting among the firms believed to meet the criteria for handling a
particular transaction, the Adviser may take into consideration that certain
firms (i) provide market, statistical or other research information such as that
set forth above to the Fund and the Adviser, (ii) have sold or are selling
shares of the Fund and (iii) may select firms that are affiliated with the Fund,
its investment adviser or its distributor and other principal underwriters. If
purchases or sales of securities of the Fund and of one or more other investment
companies or clients supervised by the Adviser are considered at or about the
same time, transactions in such securities will be allocated among the several
investment companies and clients in a manner deemed equitable to all by the
Adviser, taking into account the respective sizes of the funds and the amount of
securities to be purchased or sold. Although it is possible that in some cases
this procedure could have a detrimental effect on the price or volume of the
security as far as the Fund is concerned, it is also possible that the ability
to participate in volume transactions and to negotiate lower brokerage
commissions will be beneficial to the Fund.
While the Adviser will be primarily responsible for the placement of the
Fund's business, the policies and practices in this regard must be consistent
with the foregoing and will at all times be subject to review by the Trustees.
The Trustees have adopted certain policies incorporating the standards of Rule
17e-1 issued by the Securities and Exchange Commission under the 1940 Act which
requires that the commissions paid to the Distributor and other affiliates of
the Fund must be reasonable and fair compared to the commissions, fees or other
remuneration received or to be received by other brokers in connection with
comparable transactions involving similar securities during a comparable period
of time. The rule and procedures also contain review requirements and require
the Adviser to furnish reports to the Trustees and to maintain records in
connection with such reviews. After consideration of all factors deemed
relevant, the Trustees will consider from time to time whether the advisory fee
will be reduced by all or a portion of the brokerage commission given to
affiliated brokers.
State securities laws may differ from the interpretations of federal law
expressed herein, and banks and financial institutions may be required to
register as dealers pursuant to state law.
TAX STATUS OF THE FUND
The Trust and each of its sub-trusts, including the Fund, will be treated as
separate corporations for income tax purposes. The Fund may be subject to tax if
it fails to distribute net capital gains, or if its annual distributions, as a
percentage of its income, are less than the distributions required by tax laws.
The Fund has qualified and intends to continue to qualify as a regulated
investment company under Subchapter M of the Internal Revenue Code of 1986, as
amended (the "Code"). To qualify as a regulated investment company, the Fund
must comply with certain requirements of the Code relating to, among other
things, the source of its income and diversification of its assets. If the Fund
so qualifies and if it distributes each year to its shareholders at least 90% of
its net investment income (which includes net short-term capital gains, but not
net capital gains, which are the excess of net long-term capital gains over net
short-term capital losses), it will not be required to pay federal income taxes
on the income distributed to shareholders. The Fund intends to distribute at
least the minimum amount of net investment income to satisfy the 90%
distribution requirement. The Fund will not be subject to federal income tax on
any net capital gains distributed to its shareholders. As a sub-trust of a
Massachusetts business trust, the Fund will not be subject to any excise or
income taxes in Massachusetts as long as it qualifies as a regulated investment
company for federal income tax purposes.
In order to avoid a 4% excise tax the Fund will be required to distribute by
December 31 of each year at least 98% of its ordinary income for such year and
at least 98% of its net capital gains (the latter of which is generally computed
on the basis of the one-year period ending on October 31 of such year), plus any
required distribution amounts that were not distributed in previous taxable
years. For purposes of the excise tax, any ordinary income or net capital gain
retained by, and subject to federal income tax in the hands of, the Fund will be
treated as having been distributed.
B-19
<PAGE> 44
Some of the Fund's investment practices are subject to special provisions of
the Code, that may, among other things, defer the use of certain losses of the
Fund and affect the holding period of the securities held by the Fund and the
character of gains or losses realized by the Fund. These provisions may also
require the Fund to mark-to-market some of the positions in its portfolio (i.e.,
treat them as if they were closed out), which may cause the Fund to recognize
income without receiving the cash with which to make distributions in amounts
necessary to satisfy the distribution requirements for avoiding federal income
and excise taxes. The Fund will monitor its transactions and may make certain
tax elections in order to mitigate the effect of these rules and prevent
disqualification of the Fund as a regulated investment company.
Investments of the Fund in securities issued at a discount or providing for
deferred interest or payment of interest in kind are subject to special tax
rules that will affect the amount, timing and character of distributions to
shareholders. For example, with respect to securities issued at a discount, the
Fund will be required to accrue as income each year a portion of the discount
and to distribute such income each year in order to maintain its qualification
as a regulated investment company and to avoid income and excise taxes. In order
to generate sufficient cash to make distributions necessary to satisfy the 90%
distribution requirement and avoid income and excise taxes, the Fund may have to
dispose of securities that it would otherwise have continued to hold.
The Fund's ability to dispose of portfolio securities may be limited by the
requirement for qualification as a regulated investment company that less than
30% of the Fund's gross income be derived from the disposition of securities
held for less than three months.
Distributions of the Fund's net investment income are taxable to shareholders
as ordinary income whether received in shares or in cash. Shareholders who
receive distributions in the form of additional shares will have a basis for
federal income tax purposes in each such share equal to the fair market value
thereof on the reinvestment date. Distributions of the Fund's net capital gains
("capital gains dividends") are taxable to shareholders as long-term capital
gains regardless of the length of time the shares of the Fund have been held by
such shareholders. Distributions in excess of the Fund's earnings and profits,
such as distributions of principal, first will reduce the adjusted tax basis of
the shares held by the shareholders and, after such adjusted tax basis is
reduced to zero, will constitute capital gains to such shareholders (assuming
such shares are held as a capital asset). The Fund will inform shareholders of
the source and tax status of such distributions promptly after the close of each
calendar year. Distributions from the Fund will not be eligible for the
dividends received deduction for corporations.
Redemption or resale of shares of the Fund will be a taxable transaction for
federal income tax purposes. Redeeming shareholders will recognize gain or loss
in an amount equal to the difference between their basis in such redeemed shares
of the Fund and the amount received. If such shares are held as a capital asset,
the gain or loss generally will be a capital gain or loss and will be long-term
if such shareholders have held their shares for more than one year. Any loss
realized on shares held for six months or less will be treated as long-term
capital loss to the extent of any amounts received by the shareholder as capital
gains dividends with respect to such shares.
Although dividends generally will be treated as distributed when paid,
dividends declared in October, November or December, payable to shareholders of
record on a specified date in such months and paid in January of the following
year will be treated as having been distributed by the Fund and received by the
shareholders on the December 31 of the year in which the dividends were
declared. In addition, certain other distributions made after the close of a
taxable year of the Fund may be "spilled back" and treated as having been paid
by the Fund (except for purposes of the 4% excise tax) during such taxable year.
In such case, shareholders will be treated as having received such dividends in
the taxable year in which the distribution is actually made.
The Fund is required in certain circumstances to withhold 31% of dividends and
certain other payments, including redemptions, paid to shareholders who do not
furnish to the Fund their correct taxpayer identification number (in the case of
individuals, their social security number) or who are otherwise subject to
backup withholding. Foreign shareholders, including shareholders who are
nonresident aliens, may be subject to U.S. withholding tax on certain
distributions (whether received in cash or in shares) at a rate of 30% or such
lower rate as prescribed by any applicable treaty.
B-20
<PAGE> 45
GENERAL. The federal income tax discussion set forth above is for general
information only. Prospective investors should consult their advisers regarding
the specific federal tax consequences of holding and disposing of shares, as
well as the effects of state, local and foreign tax laws.
THE DISTRIBUTOR
Shares of the Fund are offered on a continuous basis through Van Kampen
American Capital Distributors, Inc. (the "Distributor"), One Parkview Plaza,
Oakbrook Terrace, IL 60181. The Distributor is a wholly owned subsidiary of Van
Kampen American Capital, Inc., which is a subsidiary of VK/AC Holding, Inc., a
Delaware corporation that is controlled through an ownership of a substantial
majority of its common stock, by The Clayton & Dubilier Private Equity Fund IV
Limited Partnership ("C & D L.P."), a Connecticut limited partnership. In
addition, certain officers, directors and employees of Van Kampen American
Capital, Inc., and its subsidiaries own, in the aggregate not more than 6% of
the common stock of VK/AC Holding, Inc. and have the right to acquire, upon the
exercise of options, approximately an additional 10% of the common stock of
VK/AC Holding, Inc. C & D L.P. is managed by Clayton, Dubilier & Rice, Inc.
Clayton & Dubilier Associates IV Limited Partnership ("C & D Associates L.P.")
is the general partner of C & D L.P. Pursuant to a distribution agreement, the
Distributor will purchase shares of the Fund for resale to the public, either
directly or through securities dealers, and is obligated to purchase only those
shares for which it has received purchase orders. A discussion of how to
purchase and redeem the Fund's shares and how the Fund's shares are priced is
contained in the Prospectus.
The Fund has adopted a distribution plan (the "Distribution Plan") with
respect to each class of its shares pursuant to Rule 12b-1 under the 1940 Act.
The Fund also has adopted a service plan (the "Service Plan") with respect to
each class of its shares. The Distribution Plan and Service Plan sometimes are
referred to herein collectively as the Plans. The Plans provide that the Fund
may spend a portion of the Fund's average daily net assets attributable to each
class of shares in connection with distribution of the respective class of
shares and in connection with the provision of ongoing services to shareholders
of such class, respectively. The Plans are being implemented through an
agreement (the "Distribution and Service Agreement") with the Distributor,
sub-agreements between the Distributor and members of the NASD who are acting as
securities dealers and NASD members or eligible non-members who are acting as
brokers or agents and similar agreements between the Fund and banks who are
acting as brokers (collectively, "Selling Agreements") that may provide for
their customers or clients certain services or assistance, which may include,
but not be limited to, processing purchase and redemption transactions,
establishing and maintaining shareholder accounts regarding the Fund, and such
other services as may be agreed to from time to time and as may be permitted by
applicable statute, rule or regulation. Brokers, dealers and financial
intermediaries that have entered into sub-agreements with the Distributor and
sell shares of the Fund are referred to herein as "financial intermediaries."
Under the Distribution and Service Agreement and the Selling Agreements,
financial intermediaries that sold shares prior to July 1, 1987, or prior to the
beginning of the calendar quarter in which the Selling Agreement between the
Fund and such financial intermediary was approved by the Fund's Board of
Trustees (an "Implementation Date") are not eligible to receive compensation
pursuant to such Distribution and Service Agreement and/or Selling Agreement. To
the extent that there remain outstanding shares of the Fund that were purchased
prior to all Implementation Dates, the percentage of the total average daily net
asset value of a class of shares that may be utilized pursuant to the
Distribution and Service Agreement will be less than the maximum percentage
amount permissible with respect to such class of shares under the Distribution
and Service Agreement.
The Distributor must submit quarterly reports to the Board of Trustees of the
Trust, of which the Fund is a sub-trust, setting forth separately by class of
shares all amounts paid under the Plans and the purposes for which such
expenditures were made, together with such other information as from time to
time is reasonably requested by the Trustees. The Plans provide that they will
continue in full force and effect from year to year so long as such continuance
is specifically approved by a vote of the Trustees, and also by a vote of the
disinterested Trustees, cast in person at a meeting called for the purpose of
voting on the Plans. Each of the Plans may not be amended to increase materially
the amount to be spent for the services described therein
B-21
<PAGE> 46
with respect to either class of shares without approval by a vote of a majority
of the outstanding voting shares of such class, and all material amendments to
either of the Plans must be approved by the Trustees and also by the
disinterested Trustees. Each of the Plans may be terminated with respect to
either class of shares at any time by a vote of a majority of the disinterested
Trustees or by a vote of a majority of the outstanding voting shares of such
class.
For the year ended December 31, 1994, the Fund recognized expenses under the
Plans of $6,434,233, $4,715,679 and $119,027 for the Class A Shares, Class B
Shares and Class C Shares, respectively, of which $5,269,767; $1,137,098 and
$10,752 represent payments to financial intermediaries under the Selling
Agreements for Class A Shares, Class B Shares and Class C Shares, respectively.
For the year ended December 31, 1994, the Fund has reimbursed the Distributor
$784,001; $143,555 and $0 for advertising expenses, and $139,742; $106,683 and
$0 for compensation of the Distributor's sales personnel for Class A Shares,
Class B Shares and Class C Shares, respectively.
LEGAL COUNSEL
Counsel to the Fund is Skadden, Arps, Slate, Meagher & Flom, Chicago,
Illinois.
PERFORMANCE INFORMATION
The Fund's yield quotation is determined on a monthly basis with respect to
the immediately preceding 30 day period; yield is computed by first dividing the
Fund's net investment income per share of a given class earned during such
period by the Fund's maximum offering price (including, with respect to the
Class A Shares, the maximum sales charge) per share of such class on the last
day of such period. The Fund's net investment income per share is determined by
taking the interest attributable to a given class of shares earned by the Fund
during the period, subtracting the expenses attributable to a given class of
shares accrued for the period (net of any reimbursements), and dividing the
result by the average daily number of shares of each class outstanding during
the period that were entitled to receive dividends. The yield calculation
formula assumes net investment income is earned and reinvested at a constant
rate and annualized at the end of a six month period. Yield will be computed
separately for each class of shares. Class B Shares redeemed during the first
six years after their issuance and Class C Shares redeemed during the first year
after their issuance may be subject to a contingent deferred sales charge in a
maximum amount equal to 4.00% and 1.00%, respectively, of the lesser of the then
current net asset value of the shares redeemed or their initial purchase price
from the Fund. Yield quotations do not reflect the imposition of a contingent
deferred sales charge, and if any such contingent deferred sales charge imposed
at the time of redemption were reflected, it would reduce the performance
quoted.
The Fund calculates average compounded total return by determining the
redemption value (less any applicable contingent deferred sales charge) at the
end of specified periods (after adding back all dividends and other
distributions made during the period) of a $1,000 investment in a given class of
shares of the Fund (less the maximum sales charge, if any) at the beginning of
the period, annualizing the increase or decrease over the specified period with
respect to such initial investment and expressing the result as a percentage.
Average compounded total return will be computed separately for each class of
shares.
Total return figures utilized by the Fund are based on historical performance
and are not intended to indicate future performance. Total return and net asset
value per share of a given class can be expected to fluctuate over time, and
accordingly upon redemption a shareholder's shares may be worth more or less
than their original cost.
The Fund may, in supplemental sales literature, advertise non-standardized
total return figures representing the cumulative, non-annualized total return of
each class of shares of the Fund from a given date to a subsequent given date.
Cumulative total return is calculated by measuring the value of an initial
investment in a given class of shares of the Fund at a given time, and if
applicable may include or exclude the sales charge or CDSC as indicated,
determining the value of all subsequent reinvested distributions, and dividing
the net change in the value of the investment as of the end of the period by the
amount of the initial investment and expressing the result as a percentage.
Non-standardized total return will be calculated separately for each class
B-22
<PAGE> 47
of shares. Non-standardized total return calculations do not reflect the
imposition of a contingent deferred sales charge, and if any such contingent
deferred sales charge with respect to the CDSC imposed at the time of redemption
were reflected, it would reduce the performance quoted.
CLASS A SHARES
The average total return, including the payment of the maximum sales charge,
with respect to the Class A Shares for (i) the one year period ended December
31, 1994 was (9.51%); (ii) the 5 year period ended December 31, 1994 was 5.67%;
(iii) the 10 year period ended December 31, 1994 was 8.61% and (iv) the
approximately 10 year, 7 month period from May 27, 1984 (the commencement of
investment operations of the Fund) through December 31, 1994 was 9.34%.
The Fund's yield with respect to the Class A Shares for the 30 day period
ending December 30, 1994 (calculated in the manner described in the Prospectus
under the heading "Fund Performance") was 8.73%. The Fund's current distribution
rate with respect to the Class A Shares for the month ending December 31, 1994
(calculated in the manner described in the Prospectus under the heading "Fund
Performance") was 7.85%.
The Fund's cumulative non-standardized total return, including payment of the
maximum sales charge, with respect to the Class A Shares from its inception to
the end of the current period, was 157.31%.
The Fund's cumulative non-standardized total return, excluding payment of the
maximum sales charge, with respect to Class A Shares from its inception to the
end of the current period was 169.91%.
CLASS B SHARES
The average total return, including payment of the CDSC, with respect to the
Class B Shares for (i) the one year period ended December 31, 1994 was (9.43%)
and (ii) the approximately 2 year, 5 month period of August 24, 1992
(commencement of distribution) through December 31, 1994 was (0.29%).
The Fund's yield with respect to the Class B Shares for the 30 day period
ending December 30, 1994 (calculated in the manner described in the Prospectus
under the heading "Fund Performance") was 8.29%. The Fund's current distribution
rate with respect to the Class B Shares for the month ending December 31, 1994
(calculated in the manner described in the Prospectus under the heading "Fund
Performance") was 7.28%.
The Fund's cumulative non-standardized total return, including payment of the
CDSC, with respect to the Class B Shares from its inception to the end of the
current period was (0.70%).
The Fund's cumulative non-standardized total return, excluding payment of the
CDSC, with respect to the Class B Shares from its inception to the end of the
current period was 2.31%.
CLASS C SHARES
The average total return, including payment of the CDSC, with respect to the
Class C Shares for (i) the one year period ended December 31, 1994 was (6.73%)
and (ii) the approximately one year, 4 month period from August 13, 1993
(commencement of distribution) through December 31, 1994 was (3.86%).
The Fund's yield with respect to the Class C Shares for the 30 day period
ending December 30, 1994 (calculated in the manner described in the Prospectus
under the heading "Fund Performance") was 8.30%. The Fund's current distribution
rate with respect to the Class C Shares for the month ending December 31, 1994
(calculated in the manner described in the Prospectus under the heading "Fund
Performance") was 7.28%.
The Fund's cumulative non-standardized total return, including payment of the
CDSC, with respect to the Class C Shares from its inception to the end of the
current period was (5.43%).
The Fund's cumulative non-standardized total return, excluding payment of the
CDSC, with respect to the Class C Shares from its inception to the end of the
current period was (5.43%).
B-23
<PAGE> 48
HOW TO BUY SHARES
The Fund currently offers three classes of shares to the public on a
continuous basis through the Distributor, as principal underwriter, which is
located at One Parkview Plaza, Oakbrook Terrace, Illinois 60181. Shares are also
offered through members of the National Association of Securities Dealers, Inc.
("NASD") who are acting as securities dealers ("dealers") and through NASD
members or eligible non-NASD members who are acting as brokers or agents for
investors ("brokers"). The Fund reserves the right to suspend or terminate the
continuous public offering at any time and without prior notice.
ALTERNATIVE SALES ARRANGEMENTS
The Alternative Sales Arrangements permit an investor to choose the method of
purchasing shares that is more beneficial to the investor, taking into account
the amount of the purchase, the length of time the investor expects to hold the
shares, whether the investor wishes to receive dividends in cash or to reinvest
them in additional shares of the Fund, and other circumstances. Investors should
consider such factors together with the amount of sales charges and accumulated
distribution fees with respect to each class of shares that may be incurred over
the anticipated duration of their investment in the Fund.
The Fund currently offers three classes of shares, designated Class A Shares,
Class B Shares and Class C Shares. Shares of the Fund referred to as Class C
Shares in this Prospectus were referred to as Class D Shares in prospectuses
dated prior to March 7, 1994. Shares of each class are offered at a price equal
to their net asset value per share plus a sales charge which, at the election of
the purchaser, may be imposed (a) at the time of purchase ("Class A Shares") or
(b) on a contingent deferred basis (Class A Share accounts over $1,000,000,
"Class B Shares" and "Class C Shares"). Class A Share accounts over $1,000,000
or otherwise subject to a contingent deferred sales charge ("CDSC"), Class B
Shares and Class C Shares sometimes are referred to herein collectively as
"Contingent Deferred Sales Charge Shares" or "CDSC Shares."
The minimum initial investment with respect to each class of shares is $1,000.
The minimum subsequent investment with respect to each class of shares is $100.
It is presently the policy of the Distributor not to accept any order for Class
B Shares or Class C Shares in an amount of $1,000,000 or more because it
ordinarily will be more advantageous for an investor making such an investment
to purchase Class A Shares.
An investor should carefully consider the sales charges applicable to each
class of shares and the estimated period of their investment to determine which
class of shares is more beneficial for the investor to purchase. For example,
investors who would qualify for a significant purchase price discount from the
maximum sales charge on Class A Shares may determine that payment of such a
reduced front-end sales charge is superior to electing to purchase Class B
Shares or Class C Shares, each with no front-end sales charge but subject to a
CDSC and a higher aggregate distribution and service fee. However, because
initial sales charges are deducted at the time of purchase of Class A Share
accounts under $1,000,000, a purchaser of such Class A Shares would not have all
of his or her funds invested initially and, therefore, would initially own fewer
shares than if Class B Shares or Class C Shares had been purchased. On the other
hand, an investor whose purchase would not qualify for price discounts
applicable to Class A Shares and intends to remain invested until after the
expiration of the applicable CDSC may wish to defer the sales charge and have
all his or her funds initially invested in Class B Shares or Class C Shares. If
such an investor anticipates that he or she will redeem such shares prior to the
expiration of the CDSC period applicable to Class B Shares, the investor may
wish to acquire Class C Shares. Investors must weigh the benefits of deferring
the sales charge and having all of their funds invested against the higher
aggregate distribution and service fee applicable to Class B Shares and Class C
Shares (discussed below). Investors who intend to hold their shares for a
significantly long time may not wish to continue to bear the ongoing
distribution and service expenses of Class C Shares which, in the aggregate,
eventually would exceed the aggregate amount of initial sales charge and
distribution and service expenses applicable to Class A Shares, irrespective of
the fact that a CDSC would eventually not apply to a redemption of Class C
Shares.
Each class of shares represents an interest in the same portfolio of
investments of the Fund and has the same rights, except each class of shares (i)
bears those distribution fees, service fees and administrative expenses
applicable to the respective class of shares as a result of its sales
arrangements, (ii) has exclusive voting rights with respect to those provisions
of the Fund's Rule 12b-1 distribution plan which relate only to
B-24
<PAGE> 49
such class and (iii) has a different exchange privilege. Only the Class B Shares
are subject to a conversion feature (discussed below). Generally, a class of
shares subject to a higher ongoing distribution fee, service fee or, where
applicable, the conversion feature will have a higher expense ratio and pay
lower dividends than a class of shares subject to a lower ongoing distribution
fee, service fee or not subject to the conversion feature. The per share net
asset values of the different classes of shares are expected to be substantially
the same; from time to time, however, the per share net asset values of the
classes may differ. The net asset value per share of each class of shares of the
Fund will be determined as described in this Prospectus under "How the Fund
Values Its Shares."
The administrative expenses that may be allocated to a specific class of
shares may consist of (i) transfer agency expenses attributable to a specific
class of shares, which expenses typically will be higher with respect to classes
of shares subject to the conversion feature; (ii) printing and postage expenses
related to preparing and distributing materials such as shareholder reports,
prospectuses and proxy statements to current shareholders of a specific class;
(iii) Securities and Exchange Commission (the "SEC") registration fees incurred
by a class of shares; (iv) the expense of administrative personnel and services
as required to support the shareholders of a specific class; (v) Trustees' fees
or expense incurred as a result of issues relating to one class of shares; (vi)
accounting expenses relating solely to one class of shares; and (vii) any other
incremental expenses subsequently identified that should be properly allocated
to one or more classes of shares that shall be approved by the SEC pursuant to
an amended exemptive order. All such expenses incurred by a class will be borne
on a pro rata basis by the outstanding shares of such class. All allocations of
administrative expenses to a particular class of shares will be limited to the
extent necessary to preserve the Fund's qualification as a regulated investment
company under the Internal Revenue Code of 1986, as amended.
The Fund's shares are offered at the net asset value per share next computed
after an investor places an order to purchase directly with the investor's
securities broker, dealer or financial intermediary or with the Distributor,
plus any applicable sales charge. Sales personnel of brokers, dealers and
financial intermediaries distributing the Fund's shares may receive differing
compensation for selling different classes of shares. It is the responsibility
of the investor's broker, dealer or financial intermediary to transmit the order
to the Distributor. Because the Fund generally will determine net asset value
once each business day as of the close of business, purchase orders placed
through an investor's broker, dealer or financial intermediary must be
transmitted to the Distributor by such broker, dealer or financial intermediary
prior to such time in order for the investor's order to be fulfilled on the
basis of the net asset value to be determined that day. Any change in the
purchase price due to the failure of the Distributor to receive a purchase order
prior to such time must be settled between the investor and the broker, dealer
or financial intermediary submitting the order. See "How the Fund Values Its
Shares" in the Prospectus.
The Distributor may from time to time implement programs under which a broker,
dealer or financial intermediary's sales force may be eligible to win nominal
awards for certain sales efforts or under which the Distributor will reallow to
any broker, dealer or financial intermediary that sponsors sales contests or
recognition programs conforming to criteria established by the Distributor, or
participates in sales programs sponsored by the Distributor, an amount not
exceeding the total applicable sales charges on the sales generated by the
broker, dealer or financial intermediary at the public offering price during
such programs. Other programs provide, among other things and subject to certain
conditions, certain favorable distribution arrangements for shares of the Fund.
Also, the Distributor in its discretion may from time to time, pursuant to
objective criteria established by it, pay fees and sponsor business seminars to
qualifying brokers, dealers or financial intermediary for certain services or
activities which are primarily intended to result in sales of shares of the
Fund. Fees may include payment for travel expenses, including lodging, incurred
in connection with trips taken by invited registered representatives and members
of their families to locations within or outside of the United States for
meetings or seminars of a business nature. Such fees paid for such services and
activities with respect to the Fund will not exceed in the aggregate 1.25% of
the average total daily net assets of the Fund on an annual basis. The
Distributor may provide additional compensation to Edward D. Jones & Co. or an
affiliate thereof based on a combination of its sales of shares and increases in
assets under management. In addition, the Distributor is sponsoring a sales
contest for INVEST Financial Corporation ("INVEST") relating to the Fund and
other funds distributed by the Distributor, pursuant to which the Distributor
may provide an INVEST broker an award valued up to $750.00 for sales of such
funds during the period April 1,
B-25
<PAGE> 50
1995, through May 31, 1995. Such payments are made by the Distributor out of its
own assets, and not out of the assets of the Fund. These programs will not
change the price an investor will pay for shares or the amount that the Fund
will receive from such sale.
INITIAL SALES CHARGE ALTERNATIVE
Investors choosing the initial sales charge alternative purchase Class A
Shares. The public offering price of Class A Shares is equal to the net asset
value per share plus an initial sales charge which is a variable percentage of
the offering price depending upon the amount of the sale. The table below shows
total sales charges and dealer concessions reallowed to dealers and agency
commissions paid to brokers with respect to sales of Class A Shares. The sales
charge is allocated between the investor's broker, dealer or financial
intermediary and the Distributor. As indicated previously, at the discretion of
the Distributor the entire sales charge may be reallowed to such broker, dealer
or financial intermediary. The staff of the SEC has taken the position that
dealers who receive more than 90% or more of the sales charge may be deemed to
be "underwriters" as that term is defined in the Securities Act of the 1933.
<TABLE>
<CAPTION>
DEALER
CONCESSION
OR AGENCY
COMMISSION
TOTAL SALES CHARGE ----------
-------------------------- PERCENTAGE
PERCENTAGE PERCENTAGE OF
SIZE OF TRANSACTION OF OFFERING OF NET OFFERING
AT OFFERING PRICE PRICE ASSET VALUE PRICE
- ------------------------------------------------------------ ----------- ----------- ----------
<S> <C> <C> <C>
Less than $100,000.......................................... 4.75% 4.99% 4.25%
$100,000 but less than $250,000............................. 3.75 3.90 3.25
$250,000 but less than $500,000............................. 2.75 2.83 2.25
$500,000 but less than $1,000,000........................... 2.00 2.04 1.75
$1,000,000 or more.......................................... * * *
</TABLE>
- ---------------
* No sales charge is payable at the time of purchase on investments of
$1,000,000 or more, although for such investments the Fund imposes a
contingent deferred sales charge of 1.00% on redemptions made within one year
of the purchase. A commission will be paid to dealers who initiate and are
responsible for purchases of $1 million or more as follows: 1% on sales to $2
million, plus 0.80% on the next million, plus 0.20% on the next $2 million and
0.08% on the excess over $5 million. See "How to Buy Shares--Deferred Sales
Charge Alternatives" for additional information with respect to contingent
deferred sales charges.
QUANTITY DISCOUNTS. Purchasers of Class A Shares may be entitled to reduced
initial sales charges through a combination of investments, rights of
accumulation or a letter of intent (even if an investor currently is not making
an investment of a size that normally would qualify for a quantity discount).
Investors, or their broker, dealer or financial intermediary must notify the
Fund whenever a quantity discount is applicable to purchases. Upon such
notification, an investor will receive the lowest applicable sales charge.
Quantity discounts may be modified or terminated at any time. For more
information about quantity discounts, investors should contact their broker,
dealer, financial intermediary or the Distributor.
For purposes of determining whether a purchase qualifies for a reduced initial
sales charge, the term "any person" is defined as any one of the following:
(i) an individual, their spouse and children under the age of 21,
trust or custodial accounts established for any of their sole benefit(s)
and any corporation, partnership or sole proprietorship which is 100%
owned, either alone or in combination, by any of the foregoing; or
(ii) a trustee or other fiduciary purchasing for a single trust estate
(including a pension, profit-sharing or other employee benefit trust
created pursuant to a plan qualified under Section 401 of the Internal
Revenue Code, as amended); or
(iii) a "company" as defined in Section 2(a)(8) of the 1940 Act.
B-26
<PAGE> 51
1. Combination of Investments. Purchases of Class A Shares of the Fund, or
shares of other Van Kampen Merritt funds distributed by the Distributor subject
to an initial sales charge ("ISC Shares"), which are made at any one time by
"any person" may be combined to receive a quantity discount.
2. Rights of Accumulation. Under the rights of accumulation, in determining
the sales charge to be paid for a current purchase of Class A Shares, "any
person" may combine their current purchase with the current public offering
price of Class A Shares of the Fund or ISC Shares, which are owned by such
person. If the account an investor is combining for rights of accumulation
differs from the account into which the investor's current purchase is placed,
the investor must indicate to the Transfer Agent the account number (and, if
applicable, fund name) of such other account.
3. Letter of Intent. Purchasers of Class A Shares may qualify immediately for
a reduced sales charge by stating their intention to purchase an amount of Class
A Shares, during a 13 month period, that would qualify the investor for a
reduced sales charge. An investor may do this by signing a nonbinding Letter of
Intent, which may be signed at any time within 90 days after the first
investment to be included under the Letter of Intent. Class A Shares purchased
under the "Rights of Accumulation" described above (including investments in ISC
Shares) may be, at the time of the signing of the Letter of Intent, applied
towards completion of an investor's Letter of Intent. In addition, if an
investor's broker, dealer or financial intermediary and the Distributor agree to
refund the appropriate portion of their respective concessions to the Fund, the
sales charge on an investor's previous purchases made within 90 days may be
adjusted to the reduced sales charge under the Letter of Intent, and the
refunded concession will be used to purchase shares of the Fund or Funds at the
public offering price next determined after receipt of such funds. Each
investment made after signing the Letter of Intent will be entitled to the
initial sales charge applicable to the total investment indicated in the Letter
of Intent. If an investor does not complete the necessary purchases under the
Letter of Intent within 13 months from the date of the first purchase included
thereunder, the sales charge will be adjusted upward, corresponding to the
amount actually purchased.
When an investor signs a Letter of Intent, Class A Shares of the Fund
purchased with a value of 5% of the amount specified in the Letter of Intent
will be restricted; that is, these Class A Shares cannot be sold or redeemed
until the Letter of Intent is satisfied or the additional sales charges have
been paid. If the total purchases made under the Letter of Intent, less
redemptions, equal or exceed the amount specified in the Letter of Intent, these
Class A Shares will no longer be restricted. If the total purchases, less
redemptions, exceed the amount so specified, and qualify an investor for a
further quantity discount, the Distributor and the investor's securities broker,
dealer or financial intermediary will, upon request, remit their respective
portions of the sales concession and with that amount, purchase additional Class
A Shares of the Fund for the investor's account at the next computed offering
price. If an investor does not complete the necessary purchases under the Letter
of Intent, the sales charges will be adjusted upward and if, after written
notice, the investor does not pay the increased sales charge, sufficient
restricted Class A Shares will be redeemed to pay such charge.
Other Purchase Programs. Purchasers of Class A Shares may be entitled to
reduced initial sales charges in connection with unit trust reinvestment
programs and purchases by registered representatives of selling firms or
purchases by persons affiliated with the Fund or the Distributor. The Fund
reserves the right to modify or terminate these arrangements at any time.
1. Unit Trust Reinvestment Programs. The Fund permits unitholders of unit
investment trusts to reinvest distributions from such trusts in Class A Shares
of the Fund and other ISC Shares with no minimum initial or subsequent
investment requirement, and with a lower sales charge if the administrator of an
investor's unit investment trust program meets certain uniform criteria relating
to cost savings by the Fund and the Distributor. The total sales charge for all
investments made from unit trust distributions will be 1.00% of the offering
price (1.01% of net asset value). Of this amount, the Distributor will pay to
the dealer or broker, if any, through which such participation in the qualifying
program was initiated 0.50% of the offering price as a dealer concession or
agency commission. Persons desiring more information with respect to this
program, including the applicable terms and conditions thereof, should contact
their securities broker or dealer or the Distributor.
B-27
<PAGE> 52
The administrator of such a unit investment trust must have an agreement with
the Distributor pursuant to which the administrator will (1) submit a single
bulk order and make payment with a single remittance for all investments in the
Fund during each distribution period by all investors who choose to invest in
the Fund through the program and (2) provide the Fund's transfer agent with
appropriate backup data for each participating investor in a computerized format
fully compatible with the transfer agent's processing system.
As further requirements for obtaining these special benefits, the Fund also
requires that all dividends and other distributions by the Fund be reinvested in
additional shares without any systematic withdrawal program. There will be no
minimum for reinvestments from unit investment trusts. The Fund will send
account activity statements to such participants on a monthly basis only, even
if their investments are made more frequently. The Fund reserves the right to
modify or terminate this program at any time.
2. NAV Purchase Options
The classes of investors entitled to purchase shares of the Fund at net asset
value are as follows:
(a) Current or retired Trustees/Directors of funds advised by Van Kampen
American Capital Investment Advisory Corp., Van Kampen American Capital
Asset Management, Inc. or John Govett & Co. Limited and such persons'
families and their beneficial accounts. The term "families" includes a
person's spouse, children and grandchildren, parents, and a person's
spouse's parents.
(b) Current or retired directors, officers and employees of VK/AC Holding,
Inc. and any of its subsidiaries, Clayton, Dubilier & Rice, Inc.,
employees of an investment subadviser to any such fund or an affiliate of
such subadviser; and such persons' families and their beneficial accounts.
(c) Directors, officers, employees and registered representatives of financial
institutions that have a selling agreement with the Distributor and their
spouses and minor children when purchasing for any accounts they
beneficially own, or, in the case of any such financial institution, when
purchasing for retirement plans for such institution's employees.
(d) Registered investment advisers, trust companies and bank trust departments
investing on their own behalf or on behalf of their clients provided that
the aggregate amount invested in the Fund alone, or in any combination of
Class A Shares of the Fund and ISC Shares of other funds distributed by
the Distributor as described herein under "How to Buy Shares--Initial
Sales Charge Alternative--Quantity Discounts," during the 13 month period
commencing with the first investment pursuant hereto equals at least $1
million. The Distributor may pay such entities through which purchases are
made an amount up to 0.50% of the amount invested, over a twelve month
period following such transaction.
(e) Trustees and other fiduciaries purchasing shares for retirement plans of
organizations with retirement plan assets of $10 million or more. The
Distributor may pay commissions of up to 1% for such purchases.
(f) Accounts as to which a selling firm charges an account management fee
("wrap accounts"), provided the selling firm has executed a supplemental
agreement to their existing selling agreement with the Distributor.
(g) Investors purchasing shares of the Fund with redemption proceeds from
other mutual fund complexes on which the investor has paid a front-end
sales charge or was subject to a deferred sales charge, whether or not
paid, if such redemption has occurred no more than 30 days prior to such
purchase.
DEFERRED SALES CHARGE ALTERNATIVES
Investors choosing the deferred sales charge alternative may purchase Class A
Shares in an amount of $1,000,000 or more, Class B Shares and Class C Shares.
The public offering price of a CDSC Share is equal to the net asset value per
share without the imposition of a sales charge at the time of purchase. CDSC
Shares are sold without an initial sales charge so that the Fund may invest the
full amount of the investor's purchase payment. The Distributor will compensate
brokers, dealers and financial intermediaries participating in the continuous
public offering of the CDSC Shares out of its own assets, and not out of the
assets of the Fund, at a
B-28
<PAGE> 53
percentage rate of the dollar value of the CDSC Shares purchased from the Fund
by such brokers, dealers and financial intermediaries, which percentage rate
will be equal to (i) 1.00% with respect to Class A Shares in an amount of
$1,000,000 or more; (ii) 4.00% with respect to Class B Shares, and (iii) 1.00%
with respect to Class C Shares. Such compensation will not change the price an
investor will pay for CDSC Shares or the amount that the Fund will receive from
such sale. Sales compensation with respect to Class A Shares subject to a CDSC
is set forth under "How to Buy Shares--Initial Sales Charge Alternative."
CDSC Shares redeemed within a specified period of time generally will be
subject to a contingent deferred sales charge at the rates set forth below. The
amount of the contingent deferred sales charge will vary depending on (i) the
class of CDSC Shares to which such shares belong and (ii) the number of years
from the time of payment for the purchase of the CDSC Shares until the time of
their redemption. The charge will be assessed on an amount equal to the lesser
of the then current market value or the original purchase price of the CDSC
Shares being redeemed. Accordingly, no sales charge will be imposed on increases
in net asset value above the initial purchase price. In addition, no contingent
deferred sales charge will be assessed on CDSC Shares derived from reinvestment
of dividends or capital gains distributions. Solely for purposes of determining
the number of years from the time of any payment for the purchase of CDSC
Shares, all payments during a month will be aggregated and deemed to have been
made on the last day of the month.
Proceeds from the contingent deferred sales charge applicable to a class of
CDSC Shares are paid to the Distributor and are used by the Distributor to
defray its expenses related to providing distribution related services to the
Fund in connection with the sale of shares of such class of CDSC Shares, such as
the payment of compensation to selected dealers and agents for selling such
shares. The combination of the contingent deferred sales charge and the
distribution and services fees facilitates the ability of the Fund to sell such
CDSC Shares without a sales charge being deducted at the time of purchase.
In determining whether a contingent deferred sales charge is applicable to a
redemption of CDSC Shares, it will be assumed that the redemption is made first
of any CDSC Shares acquired pursuant to reinvestment of dividends or
distributions, second of CDSC Shares that have been held for a sufficient period
of time such that the contingent deferred sales charge no longer is applicable
to such shares, third of Class A Shares in the shareholder's Fund account that
have converted from Class B Shares, if any, and fourth of CDSC Shares held
longest during the period of time that a contingent deferred sales charge is
applicable to such CDSC Shares. The charge will not be applied to dollar amounts
representing an increase in the net asset value per share since the time of
purchase.
To provide an example, assume an investor purchased 100 Class B Shares (as set
forth below) at $10 per share (at a cost of $1,000) and in the second year after
purchase, the net asset value per share is $12 and, during such time, the
investor has acquired 10 additional Class B Shares upon dividend reinvestment.
If at such time the investor makes his first redemption of 50 shares (proceeds
of $600), 10 shares will not be subject to charge because of dividend
reinvestment. With respect to the remaining 40 shares, the charge is applied
only to the original cost of $10 per share and not to the increase in net asset
value of $2 per share. Therefore, $400 of the $600 redemption proceeds will be
charged at a rate of 3.75% (the applicable rate in the second year after
purchase).
The contingent deferred sales charge is waived (i) on a redemption of shares
following the death of a shareholder, or (ii) to the extent that the redemption
represents a minimum required distribution from an IRA or other retirement plan
to a shareholder who has attained the age of 70 1/2.
CLASS A SHARE PURCHASES OF $1 MILLION OR MORE. No sales charge is payable at
the time of purchase on investments in Class A Shares of $1,000,000 or more,
although for such investments the Fund imposes a contingent deferred sales
charge of 1.00% on redemptions made within one year of the purchase. A
commission will be paid to dealers who initiate and are responsible for
purchases of $1 million or more as follows: 1% on sales to $2 million, plus
0.80% on the next million, plus 0.20% on the next $2 million and 0.08% on the
excess over $5 million.
B-29
<PAGE> 54
CLASS B SHARES. Class B Shares redeemed within six years of purchase generally
will be subject to a contingent deferred sales charge at the rates set forth
below, charged as a percentage of the dollar amount subject thereto:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
SALES CHARGE AS A
PERCENTAGE OF
DOLLAR AMOUNT
YEAR SINCE PURCHASE SUBJECT TO CHARGE
- ------------------- -------------------
<S> <C>
First.................................................. 4.00%
Second................................................. 3.75%
Third.................................................. 3.50%
Fourth................................................. 2.50%
Fifth.................................................. 1.50%
Sixth.................................................. 1.00%
Seventh and after...................................... 0.00%
</TABLE>
The contingent deferred sales charge is waived on redemptions of Class B
Shares made pursuant to the Systematic Withdrawal Program. See "Shareholder
Programs--Systematic Withdrawal Program."
CLASS C SHARES. Class C Shares redeemed within the first twelve months of
purchase generally will be subject to a contingent deferred sales charge of
1.00% of the dollar amount subject thereto. Class C Shares redeemed thereafter
will not be subject to a contingent deferred sales charge.
CONVERSION FEATURE. Six years after the end of the month in which a
shareholder's order to purchase a Class B Share of the Fund was accepted, such
Class B Share automatically will convert to a Class A Share and will no longer
be subject to the higher aggregate distribution and service fees. The purpose of
the conversion feature is to relieve the holders of Class B Shares that have
been outstanding for a period of time sufficient for the Distributor to have
been compensated for distribution expenses related to the Class B Shares from
most of the burden of such distribution-related expenses.
For purposes of conversion to Class A Shares, Class B Shares purchased through
the reinvestment of dividends and distributions paid in respect of Class B
Shares in a shareholder's account will be considered to be held in a separate
sub-account. Each time any Class B Shares in the shareholder's account (other
than those in the sub-account) convert to Class A Shares, an equal pro rata
portion of the Class B Shares in the sub-account also will convert to Class A
Shares. The holding period applicable to a Class B Share acquired through the
use of the exchange privilege (discussed below) shall be the holding period
applicable to a Class B Share of such Fund acquired other than through use of
the exchange privilege. For purposes of calculating the holding period
applicable to a Class B Share of the Fund prior to conversion, a Class B Share
of the Fund issued in connection with an exercise of the exchange privilege, or
a series of exchanges, shall be deemed to have been issued on the date on which
the investor's order to purchase the exchanged Class B Share was accepted or, in
the case of a series of exchanges, when the investor's order to purchase the
original Class B Share was accepted.
The conversion of Class B Shares to Class A Shares is subject to the
continuing availability of an opinion of counsel to the effect that (i) the
assessment of the higher distribution services fee and transfer agency costs
with respect to Class B Shares does not result in the Fund's dividends or
distributions constituting "preferential dividends" under the Internal Revenue
Code of 1986, as amended (the "Code"), and (ii) that the conversion of Class B
Shares does not constitute a taxable event under federal income tax law. The
conversion of Class B Shares to Class A Shares may be suspended if such an
opinion is no longer available. In that event, no further conversions of Class B
Shares would occur, and Class B Shares might continue to be subject to the
higher aggregate distribution and service fees for an indefinite period.
DISTRIBUTIONS FROM THE FUND
The Fund will declare distributions on a daily basis and will pay such
distributions from net investment income and net realized short-term capital
gains on a monthly basis. The monthly distribution is composed of
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all or a portion of investment income earned by the Fund plus all or a portion
of net short-term capital gains, if any, realized by the Fund on transactions in
securities and in futures and options, in each case less the Fund's expenses.
The Fund will also distribute annually any remaining short-term capital gains
together with long-term capital gains, if any. Long-term capital gains
distributions consist of the Fund's realized long-term gains on transactions in
securities and in futures and options, net of any realized capital losses, less
any carryover capital losses from previous years.
Distributions with respect to each class of shares will be calculated in the
same manner on the same day and will be in the same amount, except that the
different distribution and service fees and any incremental administrative
expenses relating to each class of shares will be borne exclusively by the
respective class and may cause the distributions relating to the different
classes of shares to differ. Generally, distributions with respect to a class of
shares subject to a higher distribution fee, service fee, or, where applicable,
the conversion feature will be lower than distributions with respect to a class
of shares subject to a lower distribution fee, service fee, or not subject to
the conversion feature.
Investors will be entitled to begin receiving dividends on their shares on the
business day after the Fund's transfer agent receives payments for such shares.
However, shares become entitled to dividends on the day the Fund's transfer
agent receives payment for the shares either through a fed wire or NSCC
settlement. Shares remain entitled to dividends through the day such shares are
processed for payment on redemption.
Distribution checks may be sent to parties other than the shareholder in whose
name the account is registered. Shareholders wishing to utilize this service
should complete the appropriate information under the "Distributions" section of
the Account Application or available from State Street Bank and Trust Company,
c/o National Financial Data Services, Van Kampen Merritt Funds, P.O. Box 419001,
Kansas City, MO 64141-6001 (the "Transfer Agent"). After the Transfer Agent
receives this completed form, distribution checks will be sent to the bank or
other person so designated by such shareholder.
PURCHASE OF ADDITIONAL SHARES WITH DISTRIBUTIONS. The Fund will automatically
credit monthly distributions and any annual net long-term capital gain
distributions to a shareholder's account in additional shares of the Fund valued
at net asset value, without a sales charge, unless a shareholder elects
otherwise to the Transfer Agent. This election may be made by telephone by
calling 1-800-341-2911 or in writing to the Transfer Agent. For inquiries
through Telecommunications Device for the Deaf (TDD), dial 1-800-772-8889. If a
shareholder elects to change the method of distribution, such change will be
effective only with regard to distributions for which the record date is seven
or more business days after the Transfer Agent has received the request.
HOW TO SELL SHARES
WRITTEN REDEMPTION REQUEST. Shareholders may sell shares without charge (other
than, with respect to the CDSC Shares, any applicable contingent deferred sales
charge) at any time by mailing a written redemption request in proper form to
the Transfer Agent. This request should be sent to State Street Bank and Trust
Company, c/o National Financial Data Services, Van Kampen Merritt Funds, P.O.
Box 419001, Kansas City, MO 64141-6001. The request should indicate the number
of shares to be redeemed of a particular fund and the class designations of such
shares and identify the account number and be signed exactly as the shares are
registered. If the amount being redeemed is in excess of $50,000 or if the
redemption proceeds will be sent to an address other than the address of record,
the signature(s) must be guaranteed by a member firm of a principal stock
exchange, a commercial bank or trust company which is a member of the Federal
Deposit Insurance Corporation (the "FDIC"), a credit union or a savings
association. The guarantee must state the words "Signature Guaranteed" along
with the name of the granting institution. Shareholders should verify with the
institution that it is an eligible guarantor prior to signing. A guarantee from
a notary public is not acceptable. If certificates are held for the shares being
redeemed, such certificates must be sent and endorsed for transfer or
accompanied by an endorsed stock power. Share certificates should be sent by
registered mail to National Financial Data Services, 1004 Baltimore Avenue,
Dwight Building, Sixth Floor, Kansas City, MO 64105-1807. Shareholders will
receive the net asset value per share next computed after the Transfer Agent
receives the redemption request and certificates (if any) in proper form. Any
applicable contingent deferred
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sales charge with respect to CDSC Shares redeemed will be deducted from the
redemption proceeds prior to transmittal of such proceeds to the shareholder.
TELEPHONE REDEMPTIONS. Shareholders may sell shares by calling the Fund at
1-800-341-2911 before 3:00 p.m. Central time to request a redemption by the
Fund. For inquiries through Telecommunications Device for the Deaf (TDD), dial
1-800-772-8889. There is a $500 minimum per request if the redemption proceeds
are to be mailed to the shareholder. If the redemption proceeds are to be wired
to a bank, there is a minimum of $5,000 per request. Prior to redeeming shares
by telephone the "Expedited Telephone Redemption" section of either the Account
Application or Expedited Telephone Redemption and Exchange Request Form (the
"Authorization") must be completed by the shareholder and be on file with the
Transfer Agent. The signature(s) on the Authorization must be guaranteed by a
member firm of a principal stock exchange, a commercial bank or trust company
which is a member of the FDIC, a credit union or a savings association unless
the Authorization is completed at the time an account is originally established.
The guarantee must state the words "Signature Guaranteed" along with the name of
the granting institution. Shareholders should verify with the institution that
it is an eligible guarantor prior to signing. A guarantee from a notary public
is not acceptable. A redemption requested by telephone will be processed at the
net asset value next determined after the request is received. Any applicable
contingent deferred sales charge with respect to CDSC Shares redeemed will be
deducted from the redemption proceeds prior to transmittal of such proceeds to
the shareholder. The proceeds would then be made payable to the registered
shareowner(s) and mailed to the address registered on the account or wired to a
bank, as requested on the Authorization. Shareholders cannot redeem shares by
telephone if certificates are held for those shares. This service is not
available with respect to shares held in an Individual Retirement Account for
which State Street Bank and Trust Company acts as custodian. In addition, this
service is not available with respect to shares purchased by check until 15 days
after purchase.
By establishing the telephone redemption service, a shareholder authorizes the
Fund or the Transfer Agent to act upon the instructions of any person by
telephone to redeem shares for any account for which such service has been
authorized to the address of record of such account or such other address as is
listed in the Authorization. The Fund, the Distributor, the Transfer Agent and
National Financial Data Services, Inc. ("NFDS") employ procedures reasonably
believed to confirm that instructions communicated by telephone are genuine.
Such procedures include requiring a person attempting to redeem shares by
telephone to provide, on a recorded line, the name on the account, a social
security number or tax identification number and such additional information as
may be included in the Authorization. An investor agrees that no such person
will be liable for any loss, liability, cost or expense arising out of any
request, including any fraudulent or unauthorized request. This service may be
amended or terminated at any time by the Transfer Agent or the Fund. If an
investor is unable to reach the Fund by telephone, he or she may redeem shares
pursuant to the procedures set forth above under the caption "Written Redemption
Request." During periods of extreme economic or market changes, it may be
difficult for investors to reach the Fund by telephone and to effect telephone
redemptions.
REDEMPTION THROUGH DEALERS. Shareholders may sell shares (whether in
certificate or book-entry form) through their securities dealer, who will
telephone the request to the Distributor. Shareholders will receive the net
asset value next determined after such shareholder places the sell order. Any
applicable contingent deferred sales charge with respect to CDSC Shares redeemed
will be deducted from the redemption proceeds prior to transmittal of such
proceeds to the shareholder. It is the responsibility of the shareholder's
broker, dealer or financial intermediary to transmit the redemption order to the
Distributor. Because the Fund generally will determine net asset value once each
business day as of the close of business, sell orders placed through a
shareholder's broker, dealer or financial intermediary must be transmitted to
the Distributor by such broker, dealer or financial intermediary prior to such
time in order for the shareholder's order to be fulfilled on the basis of the
net asset value to be determined that day. Any change in the redemption price
due to the failure of the Distributor to receive a sell order prior to such time
must be settled between the shareholder and the broker, dealer or financial
intermediary submitting the order. The Fund does not charge for this transaction
(other than any applicable contingent deferred sales charge). Shareholders must
submit a written redemption request in proper form to their securities dealer
within five business days after calling the dealer with the sell order. The
request should indicate the number of shares to be redeemed and the class
designation of such shares, identify the account number and the order or
confirmation number assigned to the trade, and
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be signed by the shareholder exactly as the shares are registered. If the amount
of the redemption exceeds $50,000 or if the redemption will be sent to an
address other than the address of record, signature(s) must be guaranteed by a
member firm of a principal stock exchange, a commercial bank or trust company
which is a member of the FDIC, a credit union or a savings association. The
guarantee must state the words "Signature Guaranteed" along with the name of the
granting institution. Shareholders should verify with the institution that it is
an eligible guarantor prior to signing. A guarantee from a notary public is not
acceptable. If certificates are held for the shares being redeemed, such
certificates must be sent endorsed for transfer or accompanied by an endorsed
stock power. Certificates should be sent by registered mail to State Street Bank
and Trust Company, c/o National Financial Data Services, Van Kampen Merritt
Funds, 1004 Baltimore Avenue, Dwight Building, 6th Floor, Kansas City, MO
64105-1807. Shareholders whose shares are held in an Individual Retirement
Account ("IRA") for which State Street Bank and Trust Company acts as custodian
may not sell their shares through their securities dealers.
REDEMPTION UPON DISABILITY. The Fund will waive the CDSC on Class B Share
redemptions following the disability of a Class B shareholder. An individual
will be considered disabled for this purpose if he or she meets the definition
thereof in Section 72(m)(7) of the Internal Revenue Code (the "Code"), which in
pertinent part defines a person as disabled if such person "is unable to engage
in any substantial gainful activity by reason of any medically determinable
physical or mental impairment which can be expected to result in death or to be
of long-continued and indefinite duration." While the Fund does not specifically
adopt the balance of the Code's definition which pertains to furnishing the
Secretary of Treasury with such proof as he or she may require, the Fund will
require satisfactory proof of disability before it determines to waive the CDSC
on Class B Shares.
In cases of disability, the CDSC on Class B Shares will be waived where the
disabled person is either an individual shareholder or owns the shares as a
joint tenant with right of survivorship or is the beneficial owner of a
custodial or fiduciary account, and where the redemption is made within one year
of the initial determination of disability. This waiver of the CDSC on Class B
Shares applies to a total or partial redemption, but only to redemptions of
shares held at the time of the initial determination of disability.
GENERAL. Whether shares are redeemed by the Fund or sold through a securities
dealer, a check for the proceeds (net of any required tax withholding and, with
respect to CDSC Shares, any applicable contingent deferred sales charge)
ordinarily will be mailed to shareholders or their dealer, as the case may be,
within seven calendar days after a redemption request or repurchase order and
share certificates (if any) are received in proper form as set forth above. Wire
transfers from the Fund of redemption proceeds, in the manner described above,
ordinarily will be transmitted to the shareholder within one business day. If
any shares are redeemed or repurchased shortly after purchase, the Fund will not
mail the proceeds until checks received for the purchase of shares have cleared,
which may take 10 days or more. The proceeds, of course, may be more or less
than the cost of the shares.
The right of redemption or resale to the Fund may be suspended or the date of
payment postponed during any period when the New York Stock Exchange is closed
(other than customary weekend and holiday closings), when an emergency exists as
defined by rules and regulations of the Securities and Exchange Commission, or
during any period when the Securities and Exchange Commission has by order
permitted such suspension or postponement.
The Fund reserves the right to redeem any investment if the value of an
account falls below $500. Before the Fund makes such redemption it will provide
the shareholder with written notice and 30 days in which to make an additional
investment sufficient to increase the value of the account to at least $500.
SHAREHOLDER PROGRAMS
SHARE CERTIFICATES. As a rule, the Fund will not issue share certificates.
However, upon written or telephone request to the Fund, a share certificate will
be issued for any or all of the full shares credited to a shareholder's account.
Share certificates which have been issued to a shareholder may be returned at
any time. If a shareholder requests share certificates to be issued, such
shareholder will be sent share certificates representing shares (with the
exception of fractional shares) of the Fund and will be required to surrender
such
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certificates upon redemption thereof. In addition, if such certificates are lost
the shareholder must write to State Street Bank and Trust Company, c/o National
Financial Data Services, P.O. Box 419001, Kansas City, MO 64141-6001, Attn: Van
Kampen Merritt Funds, requesting an "affidavit of loss" and obtain a Surety Bond
in a form acceptable to the Transfer Agent. On the date the letter is received
the Transfer Agent will calculate no more than 2.00% of the net asset value of
the issued shares, and bill the party to whom the certificate was mailed.
SYSTEMATIC WITHDRAWAL PROGRAM. If a shareholder's Class A Shares account or
Class B Shares account is valued at $10,000 or more, such shareholder's
dividends are being reinvested and a requested dollar amount may be paid from
such account to any person monthly, quarterly, semiannually or annually. The
minimum amount that may be withdrawn each period is $50: withdrawals will be
made on the seventh business day of the month in which they are scheduled to
occur. Depending upon the size of the payments requested and the fluctuations in
the net asset value of the shares redeemed, redemptions for the purpose of
making such payments may reduce or even exhaust the amounts in such account. If
an investor acquires additional shares of the Fund after joining the Systematic
Withdrawal Program, the investor must inform the Fund if he or she wants the new
shares to be subject to the Systematic Withdrawal Program by telephoning the
Fund at 1-800-341-2911.
With respect to redemptions of Class B Shares made pursuant to the Systematic
Withdrawal Program, an investor may annually redeem up to 12% of the net asset
value of the investor's initial investment in Class B Shares or, if the investor
does not join the program on the date of his or her initial investment, the net
asset value of the investor's Class B Shares on the date the investor elects to
participate in the Systematic Withdrawal Program. The Fund will waive the
contingent deferred sales charge applicable to Class B Shares redeemed pursuant
to the Fund's Systematic Withdrawal Program.
It will ordinarily be disadvantageous to purchase shares (except through
reinvestment of distributions) while participating in a systematic withdrawal
program because an investor will be paying a sales charge, or will become
subject to a contingent deferred sales charge, in order to purchase shares at
the same time that shares are being redeemed upon which a sales charge may
already have been paid. Therefore, the Fund will not knowingly permit an
investor to make additional investments in shares of less than $5,000 if at the
same time such investor is making systematic withdrawals at a rate greater than
the distribution being paid on such investor's shares. The Fund reserves the
right to amend or terminate the systematic withdrawal program on thirty days'
notice, and an investor may withdraw from the program at any time.
EXCHANGE PRIVILEGE. Any Class A Shares of the Fund which have been registered
in a shareholder's name for at least 15 days may be exchanged for ISC Shares of
other Van Kampen Merritt mutual funds distributed by the Distributor that offer
an exchange privilege. Under the exchange privilege, the Fund offers to exchange
its Class A Shares for ISC Shares on the basis of relative net asset value per
share. Any ISC Shares exchanged into the Fund that have been charged a sales
load lower than the sales load applicable to Class A Shares of the Fund will be
charged the applicable sales load differential upon exchange. ISC Shares of the
Van Kampen Merritt Money Market Fund and Van Kampen Merritt Tax Free Money Fund
which have not previously been charged a sales load (except for shares purchased
via the reinvestment option) will be charged the applicable sales load upon
exchange into the Fund.
Class B Shareholders of the Fund may exchange their Class B Shares
("Outstanding Class B Shares") for Class B Shares of other Van Kampen Merritt
mutual funds sponsored by the Distributor ("New Class B Shares") on the basis of
relative net asset value per Class B Share, without the payment of any
contingent deferred sales charge that might otherwise be due on redemption of
the Outstanding Class B Shares. Class B Shares of a fund acquired through use of
the exchange privilege will be subject to the deferred sales charge schedule
relating to the Class B Shares of the fund from which the purchase of Class B
Shares was originally made.
Class C Shares of the Fund are exchangeable for Class C Shares of other Van
Kampen Merritt mutual funds distributed by the Distributor on the same terms set
forth in the preceding paragraph with respect to Class B Shares, except that
Class C Shares do not convert to Class A Shares. The exchange privilege with
respect to any Van Kampen Merritt money market fund sponsored by the Distributor
is not available for Class C Shareholders.
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In order to qualify for the exchange privilege, it is required that the shares
being exchanged have a net asset value of at least $1,000 (unless prior approval
has been obtained from the Fund). Shareholders will be able to effect an
exchange by telephone by calling the Fund at 1-800-341-2911 prior to 3:00 p.m.
Central Standard time and requesting the exchange. For inquiries through
Telecommunications Device for the Deaf (TDD), dial 1-800-772-8889. Central
Standard Time. The exchange will be processed at the net asset value next
determined after receipt of such request. By utilizing the telephone exchange
service, a shareholder authorizes the Fund or the Transfer Agent to act upon the
instructions of any person by telephone to exchange shares from any account for
which such service has been authorized to any identically registered account(s)
with any Van Kampen Merritt fund distributed by the Distributor that offers an
exchange privilege. The Fund, the Distributor, the Transfer Agent and NFDS
employ procedures reasonably believed to confirm that instructions communicated
by telephone are genuine. Such procedures include requiring a person attempting
to exchange shares by telephone to provide, on a recorded line, the name on the
account, a social security or tax identification number and such additional
information as may be necessary or appropriate. An investor agrees that no such
person will be liable for any loss, liability, cost or expense arising out of
any request, including any fraudulent or unauthorized request. This service may
be amended or terminated at any time by the Transfer Agent or the Fund. If a
shareholder has certificates for any shares being exchanged, such certificates
must be surrendered prior to the exchange in the same manner as in redemption of
such shares. See "How to Sell Shares--Telephone Redemptions." Any shares
exchanged between the Fund and any of the other funds will begin earning
dividends on the next business day after the exchange is effected.
Before effecting an exchange, shareholders in the Fund should obtain and read
a current prospectus of the fund into which the exchange is to be made.
SHAREHOLDERS MAY ONLY EXCHANGE INTO SUCH OTHER FUNDS AS ARE LEGALLY AVAILABLE
FOR SALE IN THEIR STATE.
An exchange between funds pursuant to the exchange privilege is treated as a
sale for federal income tax purposes and, depending upon the circumstances, a
short- or long-term capital gain or loss may be realized.
The exchange privilege may be modified or terminated at any time, subject to
the requirement that the Fund give prominent notice thereof at least 60 days
prior to the effective date of the modification or termination in certain
circumstances. The Fund reserves the right to limit the number of times a
shareholder may exercise the exchange privilege.
AUTOMATED MULTIPLE ACCOUNT SHAREHOLDER SERVICES (AMASS SM).
1. Automated Clearing House ("ACH") Deposits. Holders of Class A Shares can
use ACH to have redemption proceeds deposited electronically into their bank
accounts. Redemptions transferred to a bank account via the ACH plan are
available to be credited to the account on the second business day following
normal payment. In order to utilize this option, the shareholder's bank must be
a member of Automated Clearing House. In addition, the shareholder must fill out
the appropriate section of the account application. The shareholder must also
include a voided check or deposit slip from the bank account into which
redemptions are to be deposited together with the completed application. Once
the Transfer Agent has received the application and the voided check or deposit
slip, such shareholder's designated bank account, following any redemption, will
be credited with the proceeds of such redemption. Once enrolled in the ACH plan,
a shareholder may terminate participation at any time by writing the Transfer
Agent.
2. Automated Dividend Programs. The Fund will, upon the election of a
shareholder, automatically invest distributions from a shareholder's account
directly into a shareholder's bank account.
3. Dividend Diversification. Monthly distributions and any net long-term
capital gain distributions to a shareholder's account may be invested in the
same class of shares of any other Van Kampen Merritt mutual fund distributed by
the Distributor at the then current net asset value, WITHOUT A SALES CHARGE,
upon election by a shareholder. This election may be made on the account
application bound in this prospectus, by written notice to the Transfer Agent or
by calling the Fund directly at 1-800-341-2911. For inquiries through
Telecommunications Device for the Deaf (TDD), dial 1-800-772-8889, during the
hours of 7:30 a.m. to 4:00 p.m. Central Standard Time. In order to qualify for
this privilege, a shareholder must have established an account in the other
mutual fund prior to electing this privilege. This privilege may be modified or
terminated by the Fund at any time.
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4. Easy Account Savings Enhancement Plan (EASE SM). Once a shareholder has
opened an account with the minimum $1,000 investment, the automatic investment
option may be utilized to make regular electronic monthly investments of $100 or
more into such shareholder's Fund account. In order to utilize this option, a
shareholder must fill out and sign the appropriate section of the account
application. Or the EASE SM application which is available from the Transfer
Agent, the Fund, such shareholder's broker, dealer or financial intermediary or
the Distributor. Once the Transfer Agent has received this application, such
shareholder's checking account at his or her designated local bank will be
debited each month in the amount authorized by such shareholder to purchase
shares of the Fund. Once enrolled in the EASE SM program, a shareholder may
change the monthly amount or terminate participation at any time by writing or
calling the Transfer Agent. Shareholders in the EASE SM program will receive a
confirmation of these transactions from the Fund monthly, and their regular bank
account statements will show the debit transaction each month.
By electing to utilize any of the foregoing services, a shareholder authorizes
the Transfer Agent or its agent to act upon the instructions indicated in the
appropriate section of the Application in performing such services by either
withdrawing funds for deposit in the Fund pursuant to the EASE SM Plan or
depositing distributions and redemptions in the bank account indicated by the
voided check or deposit slip accompanying the shareholder's election and/or by
depositing the shareholder's distributions in the Van Kampen Merritt fund
account indicated. A shareholder also agrees that neither the Fund, the Transfer
Agent or NFDS will be liable for any loss, liability, cost or expense arising
out of any request, including any fraudulent request. This service may be
amended or terminated at any time by the Transfer Agent or by the Fund at any
time.
REINSTATEMENT PRIVILEGE. A shareholder who has redeemed Class A Shares or
Class B Shares may, within 120 days, repurchase Class A Shares of the Fund, or
Shares of other Van Kampen Merritt mutual funds distributed by the Distributor,
in an amount of at least $500 and not exceeding the redemption proceeds
received, at a purchase price equal to the net asset value next determined after
the reinstatement request is received by the Transfer Agent or the Distributor.
A Class C Shareholder who has redeemed shares of the Fund may repurchase Class C
Shares of the Fund, or shares of other Van Kampen Merritt mutual funds
distributed by the Distributor with credit given for any contingent deferred
sales charge paid upon such redemption.
Exercising the reinstatement privilege will not affect the character of any
gain or loss realized on the redemption for federal income tax purposes, except
that if the redemption resulted in a loss, the reinstatement may result in the
loss being disallowed under the "wash sale" rules.
TAX SHELTERED RETIREMENT PLANS. Shares of the Fund are available for purchase
in connection with certain types of tax-sheltered retirement plans, including:
- Individual Retirement Accounts (IRA's) for individuals.
- Simplified Employee Pension Plans (SEP's) for employees.
- Qualified plans for self-employed individuals.
- Qualified corporate pension and profit-sharing plans for employees.
The purchase of shares of the Fund may be limited by the plans' provisions and
does not itself establish such plans. A reduced minimum initial investment,
available for purchase of Class A Shares, Class B Shares and Class C Shares only
in connection with a tax-sheltered retirement plan is $250.
IRA's are available for individuals under age 70 1/2 whether or not they are
active participants in any other tax-qualified employer plan. Generally,
individuals who are not active participants in a tax- qualified employer plan
may deduct from gross income their IRA contributions which do not exceed 100% of
compensation received during a year or $2,000 ($2,250 for a spousal account),
whichever is less. If an employee or the employee's spouse is an active
participant in a tax-qualified employer plan the IRA deduction is phased out
above certain income levels. Individuals may, however, make non-deductible
contributions to their IRA up to the lesser of 100% of annual compensation or
$2,000 ($2,250 for a spousal account) without being subject to an excise tax on
excessive contributions.
All contributions to an IRA made to the Fund through a broker must be settled
by April 15 in any year in order to be deemed a valid contribution for the
preceding year. Contributions made directly to the Fund via
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the mail must be postmarked by April 15 in any year in order to be deemed a
valid contribution for the preceding year. Generally, earnings on investments
held in an IRA are not taxable until withdrawn. Subject to certain exceptions,
substantial tax penalties apply to withdrawals before age 59 1/2. A request for
distributions from an IRA for which State Street Bank and Trust Company acts as
custodian must be made in writing.
A SEP is a retirement program established by an employer (including
individuals) for the benefit of its eligible employees. Generally, any employee
who has attained age 21, worked for the employer during three of the past five
years and earned a specified amount from the employer in the current year will
be eligible to participate. Under a SEP, each participant establishes an IRA to
which the sponsoring employer makes annual calendar year contributions.
Generally, these contributions cannot exceed the lesser of $30,000 or 15% of the
participant's compensation for the year. A participating employee may also make
his or her IRA contribution to the same account. Generally, earnings on accounts
held in an IRA established pursuant to a SEP are not taxable until withdrawn.
Subject to certain exceptions, substantial tax penalties apply to withdrawals
before age 59 1/2.
Shares of the Fund may also be purchased by all types of employer sponsored
tax-qualified retirement plans which allow for investments in mutual funds. A
standardized Van Kampen Merritt plan is available through securities brokers,
dealers, financial intermediaries, the Fund or the Distributor for employers
(including individuals) who desire to start or amend a retirement plan. The form
of this standardized plan has been determined to be "qualified" under the
Internal Revenue Code. An employer may use this prototype to establish a profit
sharing plan, a money purchase pension plan or both for its eligible employees.
The cost for the use of the prototype plan is $50, and there are no annual fees.
The adopting employer determines within the prescribed limits the eligibility
standards, rate of contributions and other significant provisions of the
prototype plan. The Distributor, as sponsor of this prototype plan, reserves the
right to amend such plan from time to time to assure its continued qualification
under the Internal Revenue Code or for other reasons. Employers adopting this
prototype plan will be bound by such amendments.
Investors considering establishing a retirement plan or purchasing shares of
the Fund in connection with a retirement plan should consult with their attorney
or tax advisor with respect to plan requirements and tax aspects pertaining to
them.
B-37
<PAGE> 62
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
The Board of Trustees and Shareholders of
Van Kampen Merritt U.S. Government Fund
We have audited the accompanying statement of assets and liabilities of Van
Kampen Merritt U.S. Government Fund (the "Fund"), including the portfolio of
investments, as of December 31, 1994, and the related statement of operations
for the year then ended, the statement of changes in net assets for each of the
two years in the period then ended, and the financial highlights for each of the
periods presented. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1994, by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Van
Kampen Merritt U.S. Government Fund as of December 31, 1994, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended, and the financial highlights for each of
the periods presented, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Chicago, Illinois
January 31, 1995
B-38
<PAGE> 63
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Portfolio of Investments
December 31, 1994
- --------------------------------------------------------------------------------
Par
Amount
(000) Description Coupon Maturity Market Value
- ---------------------------------------------------------------------------
Mortgage-Backed Securities 124.4%
<S> <C> <C> <C> <C>
$ 1,554 FHLMC ....................... 10.250% 11/01/09 $ 1,632,666
417 FHLMC ....................... 11.250 09/01/15 448,450
1 FHLMC ....................... 8.000 01/01/19 557
23,000 FHLMC <F3> .................. 8.000 01/15/21 22,258,940
60,308 FHLMC ....................... 8.500 Various 59,138,499
28,665 FHLMC ....................... 10.000 Various 30,053,451
15,086 FHLMC ....................... 10.000 Various 15,746,191
45,436 FHLMC ....................... 11.000 Various 48,686,509
6,891 FHLMC (Seasoned) ............ 8.500 01/01/16 6,843,267
15,061 FHLMC REMIC #106G PAC ....... 8.250 12/15/20 14,512,780
16,723 FHLMC REMIC #127D PAC ....... 6.000 05/15/20 15,508,218
10,894 FHLMC REMIC #1350G PAC ...... 7.500 08/15/19 10,000,365
17,373 FHLMC REMIC #14B PAC ........ 9.000 12/15/19 17,208,557
13,550 FHLMC REMIC #163E PAC ....... 6.000 01/15/21 11,527,527
30,326 FHLMC REMIC #165K PAC <F3> .. 6.500 09/15/21 25,932,976
32,376 FHLMC REMIC #181E PAC ....... 7.000 08/15/21 28,378,211
44,820 FHLMC REMIC #79C PAC ........ 8.600 10/15/05 43,860,572
17,025 FHLMC REMIC #89D ............ 9.000 02/15/21 16,905,107
23,277 FHLMC REMIC #92G PAC ........ 7.000 11/15/20 20,079,189
13,124 FHLMC REMIC #97G PAC ........ 9.250 11/15/05 13,128,101
57 FNMA ........................ 12.500 03/01/15 63,482
3,737 FNMA ........................ 13.000 06/01/15 4,140,352
8,898 FNMA ........................ 8.500 07/01/19 8,805,797
4,334 FNMA ........................ 9.500 05/01/20 4,460,900
146,972 FNMA ........................ 6.500 Various 129,379,760
230,256 FNMA ........................ 7.000 Various 209,098,002
945,814 FNMA <F2> ................... 7.500 Various 883,730,583
68,897 FNMA ........................ 8.000 Various 66,118,788
13,840 FNMA ........................ 8.500 Various 13,610,304
8,365 FNMA ........................ 9.000 Various 8,412,213
12,570 FNMA ........................ 10.500 Various 13,394,656
14,675 FNMA ........................ 11.000 Various 15,853,413
2,341 FNMA ........................ 11.500 Various 2,548,187
4,326 FNMA #28- Interest Only ..... 8.500 01/01/18 1,508,800
3,164 FNMA #7- Interest Only ...... 8.500 04/01/17 1,067,826
14,231 FNMA (Seasoned) ............. 9.000 Various 14,381,504
15,000 FNMA REMIC #93-4HB PAC ....... 11.000 01/25/19 16,149,600
14,245 FNMA REMIC #89-49C PAC ...... 8.900 11/25/17 14,276,944
18,323 FNMA REMIC #89-63E .......... 9.400 06/25/12 18,409,982
11,900 FNMA REMIC #89-85D PAC ...... 7.600 05/25/18 11,669,735
11,900 FNMA REMIC #89-94G PAC ...... 7.500 12/25/19 10,911,467
16,957 FNMA REMIC #89-97C .......... 9.000 01/25/15 16,983,609
18,085 FNMA REMIC #90-12G PAC ...... 4.500 02/25/20 12,763,670
</TABLE>
See Notes to Financial Statements
B-39
<PAGE> 64
<TABLE>
<CAPTION>
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------------
Portfolio of Investments (Continued)
December 31, 1994
- --------------------------------------------------------------------------------------
Par
Amount
(000) Description Coupon Maturity Market Value
- --------------------------------------------------------------------------------------
Mortgage-Backed Securities (Continued)
<S> <C> <C> <C> <C>
$5,843 FNMA REMIC #90-43C .................. 9.500% 09/25/18 $5,854,638
20,517 FNMA REMIC #90-71H PAC .............. 8.500 06/25/20 20,057,009
13,674 FNMA REMIC #90-97E PAC .............. 7.000 08/25/19 13,203,099
5,697 GNMA ................................ 11.500 Various 6,266,997
148,051 GNMA ................................ 7.000 Various 132,919,924
374,285 GNMA ................................ 7.500 Various 347,377,550
351,018 GNMA ................................ 8.000 Various 335,766,698
313 GNMA ................................ 8.000 Various 300,899
76,922 GNMA ................................ 8.500 Various 75,815,396
155 GNMA ................................ 8.500 Various 152,645
829,113 GNMA <F3> ........................... 9.000 Various 836,616,596
340,335 GNMA ................................ 9.000 Various 344,054,754
89,179 GNMA ................................ 9.500 Various 92,048,098
22,921 GNMA ................................ 10.000 Various 24,109,723
32,593 GNMA ................................ 10.500 Various 34,843,523
3,303 GNMA ................................ 11.000 Various 3,598,755
3,560 GNMA ................................ 12.000 Various 3,971,609
3,806 GNMA ................................ 12.500 Various 4,285,340
2,494 GNMA ................................ 13.000 Various 2,833,376
1,180 GNMA GPM ............................ 12.250 Various 1,322,434
297 GNMA II ............................. 8.500 Various 290,125
12,214 GNMA II ............................. 10.500 Various 12,828,330
7,127 GNMA II ............................. 11.000 Various 7,632,559
3,096 GNMA II ............................. 11.500 Various 3,346,999
3,131 GNMA II ............................. 12.000 Various 3,422,928
1,798 GNMA II ............................. 12.500 Various 1,983,528
---------------
4,194,493,239
U.S. Treasury Securities 6.2% ---------------
15,000 U.S. T- Bonds <F3> ................... 13.125 5/15/01 18,938,850
15,000 U.S. T- Bonds <F3> ................... 13.750 8/15/04 20,870,400
45,000 U.S. T- Bonds <F3> ................... 14.000 11/15/11 65,580,750
40,000 U.S. T- Bonds <F3> ................... 12.000 8/15/13 53,225,600
50,000 U.S. T- Notes ....................... 7.500 12/31/96 49,843,500
----------
208,459,100
-----------
Total Long-Term Investments 130.6%
(Cost $4,565,413,344) <F1> ........................................... 4,402,952,339
Liabilities in Excess of Other Assets (30.6%) ....................... (1,030,753,830)
----------------
Net Assets 100% ..................................................... $3,372,198,509
----------------
<FN>
<F1> At December 31, 1994, cost for federal income tax purposes is $4,565,413,344; the aggregate
gross unrealized appreciation is $26,598,905 and the aggregate gross unrealized depreciation is
$189,059,910, resulting in net unrealized depreciation on investments of $162,461,005.
<F2> Securities purchased pursuant to a dollar roll transaction.
<F3> Assets segregated as collateral for dollar roll and reverse repurchase
transactions.
</TABLE>
See Notes to Financial Statements
B-40
<PAGE> 65
<TABLE>
<CAPTION>
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------
Statement of Assets and Liabilities
December 31, 1994
- --------------------------------------------------------------------------------
Assets:
<S> <C>
Investments, at Market Value (Cost $4,565,413,344) <F1>..................................... $4,402,952,339
Cash........................................................................................ 640
Receivables:
Interest.................................................................................... 33,959,021
Investments Sold............................................................................ 2,501,358
Fund Shares Sold............................................................................ 913,868
Other....................................................................................... 227,355
-----------------
Total Assets................................................................................ 4,440,554,581
-----------------
Liabilities:
Payables:
Investments Purchased....................................................................... 896,476,563
Reverse Repurchase Agreements <F4>.......................................................... 146,265,000
Income Distributions ....................................................................... 11,899,729
Fund Shares Repurchased..................................................................... 8,559,921
Investment Advisory Fee <F2>................................................................ 1,462,149
Accrued Expenses............................................................................ 3,692,710
-----------------
Total Liabilities........................................................................... 1,068,356,072
-----------------
Net Assets.................................................................................. $ 3,372,198,509
-----------------
Net Assets Consist of:
Paid in Surplus <F3>........................................................................ $ 4,057,915,563
Accumulated Undistributed Net Investment Income............................................. 766,993
Net Unrealized Depreciation on Investments.................................................. (162,461,005)
Accumulated Net Realized Loss on Investments................................................ (524,023,042)
-----------------
Net Assets.................................................................................. $ 3,372,198,509
-----------------
Maximum Offering Price Per Share:
Class A Shares:
Net asset value and redemption price per share (Based on net assets of $2,924,430,635
and 213,486,730 shares of beneficial interest issued and outstanding) <F3>.................. $ 13.70
Maximum sales charge (4.65%* of offering price)............................................. .67
-----------------
Maximum offering price to public............................................................ $ 14.37
-----------------
Class B Shares:
Net asset value and offering price per share (Based on net assets of $436,334,534 and
31,861,261 shares of beneficial interest issued and outstanding) <F3>....................... $ 13.69
-----------------
Class C Shares:
Net asset value and offering price per share (Based on net assets of $11,431,779 and
834,804 shares of beneficial interest issued and outstanding) <F3>.......................... $ 13.69
-----------------
Class D Shares:
Net asset value and offering price per share (Based on net assets of $1,561 and
114 shares of beneficial interest issued and outstanding) <F3>.............................. $ 13.69
-----------------
*On sales of $100,000 or more, the sales charge will be reduced. Effective January 16, 1995,
the maximum sales charge was changed to 4.75%.
</TABLE>
See Notes to Financial Statements
B-41
<PAGE> 66
<TABLE>
<CAPTION>
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------
Statement of Operations
For the Year Ended December 31, 1994
- --------------------------------------------------------------------------------
Investment Income:
<S> <C>
Interest.......................................................................................................... $ 312,095,070
Fee Income <F4>................................................................................................... 30,166,992
-----------------
Total Income...................................................................................................... 342,262,062
-----------------
Expenses:
Investment Advisory Fee <F2>...................................................................................... 18,897,359
Distribution (12b-1) and Service Fees (Allocated to Classes A, B, C and D of $6,434,233,
$4,715,679, $119,027 and $4, respectively) <F7> ............................................................... 11,268,943
Shareholder Services ............................................................................................. 5,134,959
Custody........................................................................................................... 2,105,364
Legal <F2>........................................................................................................ 319,000
Trustees Fees and Expenses <F2>................................................................................... 49,500
Other............................................................................................................. 508,386
-----------------
Total Operating Expenses.......................................................................................... 38,283,511
Interest Expense <F4>............................................................................................. 3,324,515
-----------------
Net Investment Income............................................................................................. $ 300,654,036
-----------------
Realized and Unrealized Gain/Loss on Investments:
Net Realized Gain/Loss on Investments:
Proceeds from Sales............................................................................................... $ 11,923,735,360
Cost of Securities Sold........................................................................................... (12,105,017,302)
-----------------
Net Realized Loss on Investments (Including realized loss on closed and expired option and futures transactions
of $11,942,581 and $5,200,635, respectively)................................................................... (181,281,942)
-----------------
Net Unrealized Appreciation/Depreciation on Investments:
Beginning of the Period........................................................................................... 169,269,531
End of the Period ................................................................................................ (162,461,005)
-----------------
Net Unrealized Depreciation on Investments During the Period..................................................... (331,730,536)
-----------------
Net Realized and Unrealized Loss on Investments................................................................... $ (513,012,478)
-----------------
Net Decrease in Net Assets from Operations........................................................................ $ (212,358,442)
-----------------
</TABLE>
See Notes to Financial Statements
B-42
<PAGE> 67
<TABLE>
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------
Statement of Changes in Net Assets
For the Years Ended December 31, 1994 and 1993
- --------------------------------------------------------------------------------
<CAPTION>
Year Ended Year Ended
December 31, 1994 December 31, 1993
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
From Investment Activities:
Operations:
Net Investment Income....................................................... $ 300,654,036 $ 316,003,802
Net Realized Loss on Investments............................................ (181,281,942) (45,902,032)
Net Unrealized Appreciation/Depreciation on Investments During the Period... (331,730,536) 23,557,010
----------------- -----------------
Change in Net Assets from Operations ....................................... (212,358,442) 293,658,780
Distributions from Net Investment Income*................................... (299,974,780) (315,942,680)
----------------- -----------------
Net Change in Net Assets from Investment Activities......................... (512,333,222) (22,283,900)
----------------- -----------------
From Capital Transactions <F3>:
Proceeds from Shares Sold................................................... 225,736,668 734,098,330
Net Asset Value of Shares Issued Through Dividend Reinvestment.............. 146,031,506 153,470,193
Cost of Shares Repurchased.................................................. (625,132,457) (402,171,672)
----------------- -----------------
Net Change in Net Assets from Capital Transactions.......................... (253,364,283) 485,396,851
----------------- -----------------
Total Increase/Decrease in Net Assets....................................... (765,697,505) 463,112,951
Net Assets:
Beginning of the Period..................................................... 4,137,896,014 3,674,783,063
----------------- -----------------
End of the Period (Including undistributed net investment income of
$766,993 and $87,737, respectively)......................................... $ 3,372,198,509 $ 4,137,896,014
----------------- -----------------
</TABLE>
<TABLE>
<CAPTION>
Year Ended Year Ended
*Distributions by Class December 31, 1994 December 31, 1993
- -------------------------------------------------------------------------------
<S> <C> <C>
Distributions from Net Investment Income:
Class A Shares .......................... $ (265,263,650) $ (295,036,236)
Class B Shares .......................... (33,862,695) (20,776,787)
Class C Shares .......................... (848,319) (129,657)
Class D Shares .......................... (116) -0-
----------------- -----------------
$ (299,974,780) $ (315,942,680)
----------------- -----------------
</TABLE>
See Notes to Financial Statements
B-43
<PAGE> 68
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------
Notes to Financial Statements
December 31, 1994
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
Van Kampen Merritt U.S. Government Fund (the "Fund") is organized as a sub-trust
of Van Kampen Merritt U.S. Government Trust (the "Trust"), a Massachusetts
business trust and is registered as a diversified open-end management investment
company under the Investment Company Act of 1940, as amended. The Fund commenced
investment operations on May 31, 1984. On August 24, 1992, the Fund commenced
distribution of Class B shares. The distribution of the Fund's Class C shares,
which were initially introduced as Class D shares and subsequently renamed Class
C shares on March 7, 1994, commenced on August 13, 1993. The distribution of the
Fund's fourth class of shares, Class D shares, commenced on March 14, 1994.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
A.Security Valuation-Investments are stated at value using market quotations or,
if such valuations are not available, estimates obtained from yield data
relating to instruments or securities with similar characteristics in accordance
with procedures established in good faith by the Board of Trustees. Short-term
securities with remaining maturities of less than 60 days are valued at
amortized cost.
B.Security Transactions-Security transactions are recorded on a trade date
basis. Realized gains and losses are determined on an identified cost basis.
The Fund may purchase and sell securities on a "when issued" and "delayed
delivery" basis, with settlement to occur at a later date. The value of the
security so purchased is subject to market fluctuations during this period. The
Fund will maintain, in a segregated account with its custodian, assets having
an aggregate value at least equal to the amount of the when issued or delayed
delivery purchase commitments until payment is made.
C.Investment Income-Interest income is recorded on an accrual basis. Original
issue discounts on securities purchased are amortized over the expected life of
each applicable security.
D.Federal Income Taxes-It is the Fund's policy to comply with the requirements
of the Internal Revenue Code applicable to regulated investment companies and
to distribute substantially all of its taxable income to its shareholders.
Therefore, no provision for federal income taxes is required.
The Fund intends to utilize provisions of the federal income tax laws which
allow it to carry a realized capital loss forward for eight years following the
year of loss and offset such losses against any future realized capital gains.
At December 31, 1994, the Fund had an accumulated capital loss carry forward for
tax purposes of $524,023,042. Of this amount, $74,101,929, $157,069,720,
$50,594,575, $6,272,412, $8,800,432, $45,902,032 and $181,281,942 will expire on
December 31, 1995, 1996, 1997, 1998, 2000, 2001 and 2002, respectively.
E.Distribution of Income and Gains-The Fund declares daily and pays monthly
dividends from net investment income. Net realized gains, if any, are
distributed annually. Distributions from net realized gains for book purposes
may include short-term capital gains, which are included as ordinary income for
tax purposes.
2.Investment Advisory Agreement and Other Transactions with Affiliates
Under the terms of the Fund's Investment Advisory Agreement, Van Kampen American
Capital Investment Advisory Corp. (the "Adviser") will provide investment advice
and facilities to the Fund for an annual fee payable monthly as follows:
<TABLE>
<CAPTION>
Average Net Assets % Per Annum
- ----------------------------------
<S> <C>
First $500 million... .550 of 1%
Next $500 million.... .525 of 1%
Next $2 billion...... .500 of 1%
Next $2 billion...... .475 of 1%
Next $2 billion...... .450 of 1%
Next $2 billion...... .425 of 1%
Thereafter........... .400 of 1%
</TABLE>
Certain legal expenses are paid to Skadden, Arps, Slate, Meagher & Flom, counsel
to the Fund, of which a trustee of the Fund is an affiliated person.
For the year ended December 31, 1994, the Fund recognized expenses of
approximately $1,898,000 representing Van Kampen American Capital Distributors,
Inc.'s or its affiliates' ("VKAC") cost of providing accounting, legal,
portfolio pricing and certain shareholder services to the Fund.
Certain officers and trustees of the Fund are also officers and directors of
VKAC. The Fund does not compensate its officers or trustees who are officers of
VKAC.
The Fund has implemented deferred compensation and retirement plans for its
Trustees. Under the deferred compensation plan, Trustees may elect to defer all
or a portion of their compensation to a later date. The retirement plan covers
those Trustees who are not officers of VKAC.
At December 31, 1994, VKAC owned 105, 100 and 100 shares of Classes B, C and D,
respectively.
B-44
<PAGE> 69
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------
Notes to Financial Statements (Continued)
December 31, 1994
- --------------------------------------------------------------------------------
3. Capital Transactions
The Fund has outstanding four classes of common shares, Classes A, B, C and D.
There are an unlimited number of shares of each class without par value
authorized. At December 31, 1994, paid in surplus aggregated $3,537,006,303,
$507,798,545, $13,109,002 and $1,713 for Classes A, B, C and D, respectively.
For the year ended December 31, 1994, transactions were as follows:
<TABLE>
<CAPTION>
Shares Value
- ----------------------------------------------------------------
<S> <C> <C>
Sales:
Class A....................... 7,599,641 $ 112,208,814
Class B....................... 7,168,455 106,241,984
Class C....................... 498,458 7,284,166
Class D....................... 113 1,704
------------- -----------------
Total Sales................... 15,266,667 $ 225,736,668
------------- -----------------
Dividend Reinvestment:
Class A....................... 8,956,898 $ 129,070,604
Class B....................... 1,141,680 16,421,225
Class C....................... 37,661 539,668
Class D....................... 1 9
------------- -----------------
Total Dividend Reinvestment... 10,136,240 $ 146,031,506
------------- -----------------
Repurchases:
Class A....................... (36,347,230) $ (523,299,211)
Class B....................... (6,793,189) (97,347,991)
Class C....................... (317,931) (4,485,255)
Class D....................... -0- -0-
------------- -----------------
Total Repurchases............. (43,458,350) $ (625,132,457)
------------- -----------------
</TABLE>
At December 31, 1993, paid in surplus aggregated $3,819,026,096, $482,483,327
and $9,770,423 for Class A, B and C, respectively. For the year ended December
31, 1993, transactions were as follows:
<TABLE>
<CAPTION>
Shares Value
- ----------------------------------------------------------------
<S> <C> <C>
Sales:
Class A....................... 21,185,821 $ 337,931,085
Class B....................... 24,241,179 386,349,922
Class C....................... 619,586 9,817,323
------------- -----------------
Total Sales................... 46,046,586 $ 734,098,330
------------- -----------------
Dividend Reinvestment:
Class A....................... 8,970,749 $ 142,830,037
Class B....................... 665,206 10,557,661
Class C....................... 5,267 82,495
------------- -----------------
Total Dividend Reinvestment... 9,641,222 $ 153,470,193
------------- -----------------
Repurchases:
Class A....................... (24,095,621) $ (384,231,494)
Class B....................... (1,122,035) (17,810,783)
Class C....................... (8,237) (129,395)
------------- -----------------
Total Repurchases............. (25,225,893) $ (402,171,672)
------------- -----------------
</TABLE>
Class B, C and D shares are offered without a front end sales charge, but are
subject to a contingent deferred sales charge (CDSC). The CDSC will be imposed
on most redemptions made within six years of the purchase for Class B and one
year of the purchase for Classes C and D as detailed in the following schedule.
The Class B, C and D shares bear the expense of their respective deferred sales
arrangements, including higher distribution and service fees and incremental
transfer agency costs.
<TABLE>
<CAPTION>
Contingent Deferred
Sales Charge
Year of Redemption Class B Class C Class D
- ----------------------------------------------------
<S> <C> <C> <C>
First ................... 4.00% 1.00% 0.75%
Second .................. 3.75% None None
Third ................... 3.50% None None
Fourth .................. 2.50% None None
Fifth ................... 1.50% None None
Sixth ................... 1.00% None None
Seventh and Thereafter .. None None None
</TABLE>
For the year ended December 31, 1994, VKAC, as Distributor for the Fund,
received net commissions on sales of the Fund's Class A shares of approximately
$671,000 and CDSC on the redeemed shares of Classes B, C and D of approximately
$2,301,000. Sales charges do not represent expenses of the Fund.
4.Investment Transactions
Aggregate purchases and cost of sales, including principal paydowns and dollar
rolls, of investment securities, excluding short-term notes, for the year ended
December 31, 1994, were $11,787,022,614 and $12,105,017,302, respectively.
The Fund utilizes investment techniques called "dollar rolls," "forward
transactions" and reverse repurchase agreements for leverage purposes. In a
dollar roll, the Fund sells securities for delivery in the current month and
simultaneously contracts to repurchase, typically in 30 to 60 days,
substantially similar (same type, coupon and maturity) securities on a specified
future date from the same party at an agreed upon price which is less than the
sales price. The Fund is compensated by the difference between the current sales
price and the forward price for the future purchase.
In a forward transaction, the Fund purchases securities for delivery in the
current month and subsequently agrees to postpone delivery until the next
available delivery date, usually the next month. The Fund receives a fee as
compensation for postponing delivery. Fee income on these transactions is
recognized at the offsetting transaction's trade date for dollar rolls and the
date when settlement is postponed for forward transactions. At December 31,
1994, the Fund had open dollar roll and/or forward transactions with a market
value of $883.7 million and related assets segregated for these open purchases
of $884.8 million.
B-45
<PAGE> 70
Van Kampen Merritt U.S. Government Fund
- --------------------------------------------------------------------------------
Notes to Financial Statements (Continued)
December 31, 1994
- --------------------------------------------------------------------------------
In a reverse repurchase agreement the Fund sells securities and agrees to
repurchase them at a mutually agreed upon date and price. During the reverse
repurchase agreement period, the Fund continues to receive principal and
interest payments on these securities. The average daily balance of reverse
repurchase agreements during the period was approximately $73.3 million with an
average interest rate of 4.54%. At December 31, 1994, the interest rate in
effect for reverse repurchase agreements was 6.00%.
5.Derivative Financial Instruments
A derivative financial instrument in very general terms refers to a security
whose value is "derived" from the value of an underlying asset, reference rate
or index.
The Fund has a variety of reasons to use derivative instruments, such as to
attempt to protect the Fund against possible changes in the market value of its
portfolio and to manage the portfolio's effective yield, maturity and duration.
All of the Fund's portfolio holdings, including derivative instruments, are
marked to market each day with the change in value reflected in the unrealized
appreciation/depreciation on investments. Upon disposition, a realized gain or
loss is recognized accordingly, except for exercised option contracts where the
recognition of gain or loss is postponed until the disposal of the security
underlying the option contract. Summarized below are the specific types of
derivative financial instruments used by the Fund.
A. Option Contracts-An option contract gives the buyer the right, but not the
obligation to buy (call) or sell (put) an underlying item at a fixed exercise
price during a specified period. These contracts are generally used by the Fund
to manage the portfolio's effective maturity and duration.
Transactions in options for the year ended December 31, 1994, were as follows:
<TABLE>
<CAPTION>
Contracts Premium
- ---------------------------------------------------------------
<S> <C> <C>
Outstanding at December 31, 1993... 2,850 $ (5,233,170)
Options Written and
Purchased (Net).................... 34,948 (30,111,447)
Options Terminated in Closing
Transactions (Net)................. (35,048) 33,233,549
Options Expired (Net).............. (2,750) 2,111,068
--------- ---------------
Outstanding at December 31, 1994... -0- $ -0-
--------- ---------------
</TABLE>
B. Futures Contracts-A futures contract is an agreement involving the delivery
of a particular asset on a specified future date at an agreed upon price. The
Fund generally invests in futures on U.S. Treasury Bonds and typically closes
the contract prior to the delivery date. These contracts are generally used to
manage the portfolio's effective maturity and duration.
The fluctuation in market value of the contracts is settled daily through a cash
margin account. Realized gains and losses are recognized when the contracts are
closed or expire.
Transactions in futures, each with a par value of $100,000, for the year ended
December 31, 1994, were as follows:
<TABLE>
<CAPTION>
Contracts
- -----------------------------------------------
<S> <C>
Outstanding at December 31, 1993... -0-
Futures Opened..................... 5,809
Futures Closed..................... (5,809)
--------
Outstanding at December 31, 1994... -0-
--------
</TABLE>
6. Mortgage Backed Securities
A Mortgage Backed Security (MBS) is a pass-through security created by pooling
mortgages and selling participations in the principal and interest payments
received from borrowers. Most of these securities are guaranteed by federally
sponsored agencies--Government National Mortgage Association (GNMA), Federal
National Mortgage Association (FNMA) or Federal Home Loan Mortgage Corporation
(FHLMC). A Collateralized Mortgage Obligation (CMO) is a bond which is
collateralized by a pool of MBS's. The Fund also invests in REMIC's (Real Estate
Mortgage Investment Conduit) which are simply another form of CMO. These MBS
pools are divided into classes or tranches with each class having its own
characteristics. For instance, a PAC (Planned Amortization Class) is a specific
class of mortgages which over its life will generally have the most stable cash
flows and the lowest prepayment risk. A GPM (Graduated Payment Mortgage) is a
negative amortization mortgage where the payment amount gradually increases over
the life of the mortgage. The early payment amounts are not sufficient to cover
the interest due and, therefore, the unpaid interest is added to the principal,
thus increasing the borrower's mortgage balance.
An Interest Only security is another class of MBS representing ownership in the
cash flows of the interest payments made from a specified pool of MBS. The cash
flow on this instrument decreases as the mortgage principal balance is repaid by
the borrower.
7.Distribution and Service Plans
The Fund and its shareholders have adopted a distribution plan (the
"Distribution Plan") pursuant to Rule 12b-1 under the Investment Company Act of
1940 and a service plan (the "Service Plan," collectively the "Plans"). The
Plans govern payments for the distribution of the Fund's shares, ongoing
shareholder services and maintenance of shareholder accounts.
Annual fees under the Plans of up to .30% each of Class A and Class D shares and
1.00% each of Class B and Class C shares are accrued daily. Included in these
fees for the year ended December 31, 1994, are payments to VKAC of approximately
$4,583,300.
B-46
