SIT MUTUAL FUNDS II INC, 497, 1998-12-07

SIT MUTUAL FUNDS II INC
497, 1998-12-07

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PART B

STATEMENT OF ADDITIONAL INFORMATION

SIT MONEY MARKET FUND, INC.
SIT U.S. GOVERNMENT SECURITIES FUND, INC.
SIT BOND FUND
SIT TAX-FREE INCOME FUND
SIT MINNESOTA TAX-FREE INCOME FUND
4600 Norwest Center, 90 S. 7th Street
Minneapolis, Minnesota 55402-4130
612-334-5888
800-332-5580

This Statement of Additional Information is not a prospectus. It should be read
in conjunction with the Funds' prospectus which may be obtained from the Funds
without charge by contacting the Funds at 4600 Norwest Center, 90 S. 7th Street,
Minneapolis, Minnesota 55402-4130. Telephone: (612) 334-5888 or (800) 332-5580.
The date of this Statement of Additional Information is August 1, 1998, as
supplemented on December 7, 1998, and it is to be used with the Funds'
prospectus dated August 1, 1998.

TABLE OF CONTENTS

Page
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ADDITIONAL INVESTMENT RESTRICTIONS
Money Market Fund......................................................... 2
U.S. Government Securities Fund........................................... 3
Bond Fund................................................................. 3
Tax-Free Income Fund...................................................... 4
Minnesota Tax-Free Income Fund............................................ 5
All Funds................................................................. 5
DIVERSIFICATION.............................................................. 5
SECURITIES IN WHICH THE THE MONEY MARKET FUND MIGHT INVEST................... 6
SECURITIES IN WHICH THE BOND FUND MIGHT INVEST............................... 7
SECURITIES IN WHICH MINNESOTA TAX-FREE INCOME FUND MIGHT INVEST.............. 8
COMMON INVESTMENTS........................................................... 9
COMPUTATION OF NET ASSET VALUE............................................... 17
CALCULATION OF PERFORMANCE DATA.............................................. 18
REDEMPTION-IN-KIND........................................................... 19
MANAGEMENT................................................................... 19
INVESTMENT ADVISER........................................................... 21
DISTRIBUTOR.................................................................. 23
BROKERAGE.................................................................... 23
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES.......................... 24
TAXES........................................................................ 25
FINANCIAL STATEMENTS......................................................... 28
OTHER INFORMATION............................................................ 28
LIMITATION OF DIRECTOR LIABILITY............................................. 28
APPENDIX A - BOND AND COMMERCIAL PAPER RATINGS............................... 29
APPENDIX B - MUNICIPAL BOND RATINGS.......................................... 31

<PAGE>

ADDITIONAL INVESTMENT RESTRICTIONS
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The investment objectives, policies and restrictions of the Funds are set forth
in the Prospectus. Certain additional investment information is set forth below.
All capitalized terms not defined herein have the same meanings as set forth in
the Prospectus. In addition to the restrictions in the prospectus, each Fund is
subject to other restrictions which are fundamental and may not be changed
without shareholder approval. Shareholder approval, as defined in the Investment
Company Act of 1940, means the lesser of the vote of (a) 67% of the shares of a
Fund at a meeting where more than 50% of the outstanding shares of the Fund are
present in person or by proxy or (b) more than 50% of the outstanding shares of
a Fund. A percentage limitation must be met at the time of investment and a
later deviation resulting from a change in values or net assets will not be a
violation.

MONEY MARKET FUND
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The Money Market Fund is subject to the following restrictions which are
fundamental. The Fund will not:
1. Concentrate more than 25% of the value of its net assets in any one
industry. Water, communications, electric and gas utilities shall each be
considered a separate industry. Banks shall be categorized as commercial
banks and savings and loan institutions, and each category shall be
considered a separate industry. As to finance companies, the following
categories will be considered separate industries: 1) captive automobile
finance companies; 2) captive equipment finance companies; 3) captive
retail finance companies; 4) consumer loan companies; 5) diversified
finance companies; and 6) captive oil finance companies. This limitation
does not apply to obligations issued by the U.S. government or its agencies
or instrumentalities;
2. Purchase securities of any issuer (other than obligations of, or guaranteed
by, the U.S. Government or its agencies or instrumentalities), if, as a
result, more than 5% of the Fund's net assets would be invested in
securities of such issuer. This restriction is limited to 75% of the Fund's
net assets.
3. Purchase more than 10% of any voting class of securities of any issuer;
4. Invest more than 10% of the Fund's net assets in securities of companies
which have (with their predecessors) a record of less than five years of
continuous operations;
5. Purchase or retain the securities of any issuer if, in total, the holdings
of all officers and directors of the Fund and of its investment adviser,
who individually own beneficially more than 0.5% of such securities,
represent more than 5% of the issuer's securities;
6. Borrow money, except temporarily in emergency or extraordinary situations
and then not for the purpose of purchase of investments, and not in excess
of 33-1/3% of the Fund's total net assets;
7. Lend money to others except through the purchase of debt obligations
(including repurchase agreements) of the type which the Fund is permitted
to purchase;
8. Except as part of a merger, consolidation, acquisition or reorganization,
invest more than 5% of the value of its total assets in the securities of
any one investment company or more than 10% of the value of its total
assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting
securities of any one investment company;
9. Purchase on margin or sell short except to obtain short-term credit as may
be necessary for the clearance of transactions;
10. Invest for the purpose of controlling management of any company;
11. Underwrite the securities of other issuers;
12. Invest in commodities or commodity futures contracts or in real estate,
although it may invest in securities which are secured by real estate and
securities of issuers which invest or deal in real estate;
13. Invest in exploration or development for oil, gas or other minerals,
although it may invest in the securities of issuers which invest in or
sponsor such programs;
14. Purchase common stocks, preferred stocks, warrants, other equity
securities, state bonds, municipal bonds, or industrial revenue bonds;
15. Issue senior securities as defined in the Investment Company Act of 1940;
or
16. Invest more than 15% of its net assets collectively in all types of
illiquid securities.

The following investment restrictions of the Fund are not fundamental and may be
changed by the Board of Directors of the Fund. The Fund will:

<PAGE>

1. Not invest more than 10% of its net assets collectively in all types of
illiquid securities;
2. Comply with all requirements of Rule 2a-7 under the Investment Company Act
of 1940, as such rule may be amended from time to time;
3. Not invest more than 5% of its net assets in any one issuer other than as
permitted pursuant to Rule 2a-7 under the Investment Company Act of 1940,
as such rule may be amended from time to time; or
4. Not pledge, mortgage, hypothecate or otherwise encumber the Fund's assets
except to the extent necessary to secure permitted borrowings.

U.S. GOVERNMENT SECURITIES FUND
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The U.S. Government Securities Fund is subject to the following restrictions
which are fundamental. The Fund will not:
1. Purchase securities of any issuer except securities issued, guaranteed or
insured by the U.S. government, its agencies or instrumentalities;
2. Have any limitation with regard to concentration for the purchase of
obligations issued or guaranteed by the U.S. government, its agencies or
instrumentalities;
3. Invest in commodities, commodity contracts or interest rate future
contracts; or purchase or sell real estate, although it may purchase and
sell securities of companies which deal in real estate and may purchase and
sell securities which are secured by interests in real estate;
4. Make loans except by purchasing publicly distributed debt securities such
as bonds, debentures and similar obligations;
5. Purchase on margin or sell short except to obtain short-term credit as may
be necessary for the clearance of transactions;
6. Invest in repurchase agreements;
7. Borrow money, except temporarily in emergency or extraordinary situations
and then not for the purchase of investments and not in excess of 33 1/3%
of the Fund's total net assets;
8. Underwrite the securities of other issuers;
9. Invest in securities subject to legal or contractual restrictions on resale
or securities which are otherwise illiquid;
10. Invest in exploration or development for oil, gas or other minerals; or
11. Issue senior securities as defined in the Investment Company Act of 1940.

The following investment restriction of the Fund is not fundamental and may be
changed by the Board of Directors of the Fund. The Fund will not:
1. Pledge, mortgage, hypothecate or otherwise encumber the Fund's assets
except to the extent necessary to secure permitted borrowings; or
2. Invest more than 5% of the value of its total assets in the securities of
any one investment company or more than 10% of the value of its total
assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting
securities of any one investment company, except a.) as part of a merger,
consolidation, acquisition, or reorganization or b.) in a manner consistent
with the requirements of an exemptive order issued to the Fund and/or the
Adviser by the Securities and Exchange Commission.

BOND FUND
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The Fund is subject to the following restrictions which are fundamental. The
Fund will not:
1. Invest in real estate (including real estate limited partnerships),
although it may invest in securities which are secured by or represent
interests in real estate;
2. Purchase or sell commodities or commodity contracts, provided that this
restriction does not apply to financial futures contracts or options
thereon;
3. Make loans except by purchase of debt obligations (including repurchase
agreements) in which it may invest consistent with its investment policies;
4. Underwrite securities of other issuers except to the extent that, in
connection with the disposition of its portfolio investments, it may be
deemed to be an underwriter under federal securities laws;
5. Borrow money, except temporarily in emergency or extraordinary situations
and then not for the purchase of investments and not in excess of 33 1/3%
of the Fund's total net assets;
6. Issue senior securities as defined in the Investment Company Act of 1940;
or

<PAGE>

7. Invest more than 25% of its assets in a single industry except with regard
to the purchase of obligations issued or guaranteed by the U.S. government,
its agencies or instrumentalities.

The following investment restrictions of the Fund are not fundamental and may be
changed by the Board of Directors of the Fund. The Fund will not:
1. Purchase on margin or sell short except to obtain short-term credit as may
be necessary for the clearance of transactions and it may make margin
deposits in connection with futures contracts;
2. Invest more than 5% of the value of its total assets in the securities of
any one investment company or more than 10% of the value of its total
assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting
securities of any one investment company, except a.) as part of a merger,
consolidation, acquisition, or reorganization or b.) in a manner consistent
with the requirements of an exemptive order issued to the Fund and/or the
Adviser by the Securities and Exchange Commission;
3. Write put options;
4. Invest more than 15% of its net assets collectively in all types of
illiquid securities;
5. Invest in more than 10% of the outstanding voting securities of any one
issuer;
6. Invest in oil, gas or other mineral leases, rights or royalty contracts,
although it may invest in securities of companies investing in the
foregoing; or
7. Pledge, mortgage, hypothecate or otherwise encumber the Fund's assets
except to the extent necessary to secure permitted borrowings.

TAX-FREE INCOME FUND
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The Tax-Free Income Fund is subject to the following restrictions which are
fundamental. The Fund will not:
1. Purchase on margin or sell short except to obtain short-term credit as may
be necessary for the clearance of transactions and it may make margin
deposits in connection with futures contracts;
2. Invest in real estate, although it may invest in securities which are
secured by or represent interests in real estate;
3. Purchase or sell commodities or commodity contracts, provided that this
restriction does not apply to index futures contracts, interest rate
futures contracts or options on interest rate futures contracts for
hedging;
4. Make loans except by purchase of debt obligations (including repurchase
agreements) in which it may invest consistent with its investment policies;
5. Underwrite securities of other issuers except to the extent that, in
connection with the disposition of its portfolio investments, it may be
deemed to be an underwriter under federal securities laws;
6. Write put or call options;
7. Issue senior securities as defined in the Investment Company Act of 1940;
8. Invest in more than 10% of the outstanding voting securities of any one
issuer;
9. Invest more than 15% of its net assets collectively in all types of
illiquid securities; or
10. Borrow money, except temporarily in emergency or extraordinary situations
and then not for the purchase of investments and not in excess of 33 1/3%
of the Fund's total net assets.

The following investment restrictions of the Fund are not fundamental and may be
changed by the Board of Directors of the Fund. The Fund will not:
1. Invest in oil, gas or other mineral leases, rights or royalty contracts,
although it may invest in securities of companies investing in the
foregoing;
2. Invest more than 5% of the value of its total assets in the securities of
any one investment company or more than 10% of the value of its total
assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting
securities of any one investment company, except a.) as part of a merger,
consolidation, acquisition, or reorganization or b.) in a manner consistent
with the requirements of an exemptive order issued to the Fund and/or the
Adviser by the Securities and Exchange Commission;
3. Invest for the purpose of exercising control or management;
4. Invest more than 5% of its net assets in foreign securities, provided that
the Fund may invest without limitation in tax-exempt securities issued by
U.S. territorial possessions; or
5. Pledge, mortgage, hypothecate or otherwise encumber the Fund's assets
except to the extent necessary to secure permitted borrowings.

<PAGE>

MINNESOTA TAX-FREE INCOME FUND
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The Fund is subject to the following restrictions which are fundamental. The
Fund will not:
1. Invest in real estate, although it may invest in securities which are
secured by or represent interests in real estate;
2. Purchase or sell commodities or commodity contracts, provided that this
restriction does not apply to index futures contracts, interest rate
futures contracts or options on interest rate futures contracts for
hedging;
3. Make loans except by purchase of debt obligations (including repurchase
agreements) in which it may invest consistent with its investment policies;
4. Underwrite securities of other issuers except to the extent that, in
connection with the disposition of its portfolio investments, it may be
deemed to be an underwriter under federal securities laws;
5. Borrow money, except temporarily in emergency or extraordinary situations
and then not for the purchase of investments and not in excess of 33 1/3%
of the Fund's total net assets;
6. Issue senior securities as defined in the Investment Company Act of 1940;
or
7. Invest more than 25% of its assets in the securities of issuers in any
single industry, except that the Fund may invest without limitation in
housing.

The following investment restrictions of the Fund are not fundamental and may be
changed by the Board of Directors of the Fund. The Fund will not:
1. Purchase on margin or sell short, except to obtain short-term credit as may
be necessary for the clearance of transactions and it may make margin
deposits in connection with futures contracts;
2. Invest more than 5% of the value of its total assets in the securities of
any one investment company or more than 10% of the value of its total
assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting
securities of any one investment company, except a.) as part of a merger,
consolidation, acquisition, or reorganization or b.) in a manner consistent
with the requirements of an exemptive order issued to the Fund and/or the
Adviser by the Securities and Exchange Commission;
3. Write put options;
4. Invest more than 5% of its net assets in foreign securities, provided that
the Fund may invest without limitation in tax-exempt securities issued by
U.S. territorial possessions;
5. Invest more than 15% of its net assets collectively in all types of
illiquid securities;
6. Invest in oil, gas or other mineral leases, rights or royalty contracts,
although it may invest in securities of companies investing in the
foregoing; or
7. Pledge, mortgage, hypothecate or otherwise encumber the Fund's assets
except to the extent necessary to secure permitted borrowings.

ALL FUNDS
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In October 1995 the shareholders of each Fund approved a change to each Fund's
fundamental investment restrictions and authorized each Fund to lend portfolio
securities to brokers, dealers and other financial institutions needing to
borrow securities to complete certain transactions. To date, the Funds have not
loaned securities, and neither the Funds nor the Adviser intend to lend
securities in the immediate future.

DIVERSIFICATION
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As a fundamental policy (in addition to the fundamental policies and
restrictions set forth in the Prospectus and this Statement of Additional
Information), each Fund (except Minnesota Tax-Free Income Fund) intends to
operate as a "diversified" management investment company, as defined in the
Investment Company Act of 1940, as amended. A "diversified" investment company
means a company which meets the following requirements: At least 75% of the
value of the company's total assets is represented by cash and cash items
(including receivables), "Government Securities", securities of other investment
companies, and other securities for the purposes of this calculation limited in
respect of any one issuer to an amount not greater in value than 5% of the value
of the total assets of such management company and to not more than 10% of the
outstanding voting securities of such issuer. "Government Securities" means
securities issued or guaranteed as to principal or interest by the United
States, or by a person controlled or supervised by and acting as an
instrumentality of the Government of the United States pursuant to authority
granted by the Congress of the United States; or certificates of deposit

<PAGE>

for any of the foregoing. Additionally, as set forth above, each of the Funds
has adopted certain restrictions that are more restrictive than the policies set
forth in this paragraph.

The Minnesota Tax-Free Income Fund is a nondiversified investment company as
defined in the 1940 Act which means that the Fund is not restricted by the
provisions of the 1940 Act with respect to diversification of its investments.
However, the Fund intends to comply with the diversification requirements
contained in the Internal Revenue Code of 1986. Accordingly, at the end of each
quarter of the Fund's taxable year (a) at least 50% of the market value of the
Fund's assets must be invested in cash, U.S. Government securities, the
securities of other regulated investment companies and other securities, with
such other securities of any one issuer limited for the purposes of this
calculation to an amount not greater than 5% of the value of the Fund's total
assets and not more than 10% of the outstanding voting securities of the issuer,
and (b) not more than 25% of the value of the Fund's total assets can be
invested in the securities of any one issuer (other than U.S. Government
securities). Since a relatively high percentage of the Fund's assets may be
invested in the obligations of a limited number of issuers, some of which may be
within the same economic sector, the Fund's portfolio securities may be more
susceptible to any single economic, political or regulatory occurrence than the
portfolio securities of diversified investment companies.

For purposes of such diversification, the identification of the issuer of
tax-exempt securities depends on the terms and conditions of the security. If a
State or a political subdivision thereof pledges its full faith and credit to
payment of a security, the State or the political subdivision, respectively, is
deemed the sole issuer of the security. If the assets and revenues of an agency,
authority or instrumentality of a State or a political subdivision thereof are
separate from those of the State or political subdivision and the security is
backed only by the assets and revenues of the agency, authority or
instrumentality, such agency, authority or instrumentality is deemed to be the
sole issuer. Moreover, if the security is backed only by revenues of an
enterprise of specific projects of the state, a political subdivision or agency,
authority or instrumentality, such as utility revenue bonds, and the full faith
and credit of the governmental unit is not pledged to the payment thereof, such
enterprise or specific project is deemed the sole issuer. If, however, in any of
the above cases, a state, political subdivision or some other entity guarantees
a security and the value of all securities issued or guaranteed by the guarantor
and owned by the Fund exceeds 10% of the value of the Fund's total assets, the
guarantee is considered a separate security and is treated as an issue of the
guarantor.

SECURITIES IN WHICH THE MONEY MARKET FUND MIGHT INVEST
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OBLIGATIONS OF BANKS
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Bank money instruments in which the Fund may invest include certificates of
deposit, including variable rate certificates of deposit, bankers' acceptances
and time deposits. "Bank" includes commercial banks, savings banks and savings
and loan associations. Certificates of deposit are generally short-term,
interest-bearing negotiable certificates issued by commercial banks or savings
and loan associations against funds deposited in the issuing institution.
Variable rate certificates of deposit are certificates of deposit on which the
interest rate is periodically adjusted prior to their stated maturity, usually
at 30, 90 or 180 day intervals ("coupon dates"), based upon a specified market
rate, which is tied to the then prevailing certificate of deposit rate, with
some premium paid because of the longer final maturity date of the variable rate
certificate of deposit. As a result of these adjustments, the interest rate on
these obligations may be increased or decreased periodically. Variable rate
certificates of deposit normally carry a higher interest rate than fixed rate
certificates of deposit with shorter maturities, because the bank issuing the
variable rate certificate of deposit pays the investor a premium as the bank has
the use of the investors' money for a longer period of time. Variable rate
certificates of deposit can be sold in the secondary market. In addition,
frequently banks or dealers sell variable rate certificates of deposit and
simultaneously agree, either formally or informally, to repurchase such
certificates, at the option of the purchaser of the certificate, at par on the
coupon dates. In connection with the Fund's purchase of variable rate certifies
of deposit, it may enter into formal or informal agreements with banks or
dealers allowing the Fund to resell the certificates to the bank or dealer, at
the Fund's option. If the agreement to repurchase is informal, there can be no
assurance that the Fund would always be able to resell such certificates. Before
entering into any such transactions governed by formal agreements, however, the
Fund will comply with the provisions of SEC Release 10666 which generally
provides that the repurchase agreement must be fully collateralized. With
respect to variable rate certificates of deposit maturing in 180 days or less
from the time of purchase with interest rates adjusted on a monthly cycle, the
Fund uses the period remaining until the next rate adjustment date for purposes
of determining the

<PAGE>

average weighted maturity of its portfolio. With respect to all variable rate
instruments not meeting the foregoing criteria, the Fund uses the remaining
period to maturity for purposes of determining the average weighted maturity of
its portfolio until such time as the Securities and Exchange Commission has
determined otherwise.

A banker's acceptance is a time draft drawn on a commercial bank by a borrower
usually in connection with an international commercial transaction (to finance
the import, export, transfer or storage of goods). The borrower is liable for
payment as well as the bank, which unconditionally guarantees to pay the draft
at its face amount on the maturity date. Most acceptances have maturities of six
months or less and are traded in secondary markets prior to maturity.

Both domestic banks and foreign branches of domestic banks are subject to
extensive, but different, governmental regulations which may limit both the
amount and types of loans which may be made and interest rates which may be
charged. In addition, the profitability of the banking industry is largely
dependent upon the availability and cost of funds for the purpose of financing
lending operations under prevailing short-term debt conditions. General economic
conditions, as well as exposure to credit losses arising from possible financial
difficulties of borrowers, also play an important part in the operations of the
banking industry.

As a result of federal and state laws and regulations, domestic banks are, among
other things, generally required to maintain specified levels of reserves,
limited in the amount which they can loan to a single borrower, and are subject
to other regulations designed to promote financial soundness. Since the
portfolio may contain securities of foreign banks and foreign branches of
domestic banks, the Fund may be subject to additional investment risks that are
different in some respects from those incurred by a fund that invests only in
debt obligations of domestic banks.

The Fund only purchases certificates of deposit from savings and loan
institutions which are members of the Federal Home Loan Bank and are insured by
the Federal Savings and Loan Insurance Corporation. Such savings and loan
associations are subject to regulation and examination. Unlike most savings
accounts, certificates of deposit held by the Fund do not benefit materially
from insurance either from the Federal Deposit Insurance Corporation or the
Federal Savings and Loan Insurance Corporation. Certificates of deposit of
foreign branches of domestic banks are not covered by such insurance and
certificates of deposit of domestic banks purchased by the Fund are generally in
denominations far in excess of the dollar limitations on insurance coverage.

COMMERCIAL PAPER AND OTHER CORPORATE DEBT SECURITIES
- --------------------------------------------------------------------------------
Short-term corporate debt instruments purchased by the Fund consist of
commercial paper (including variable amount master demand notes), which refers
to short-term, unsecured promissory notes issued by corporations to finance
short-term credit needs. Commercial paper is usually sold on a discount basis
and has a maturity at the time of issuance not exceeding nine months. Variable
amount master demand notes are demand obligations that permit the investment of
fluctuating amounts at varying market rates of interest pursuant to arrangements
between the issuer and a commercial bank acting as agent for the payees of such
notes, whereby both parties have the right to vary the amount of the outstanding
indebtedness of the notes.

The Fund may also invest in fixed interest rate non-convertible corporate debt
securities (i.e., bonds and debentures) with no more than 397 days remaining to
maturity at date of settlement.

SECURITIES IN WHICH THE BOND FUND MIGHT INVEST
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FOREIGN CURRENCY TRANSACTIONS
- --------------------------------------------------------------------------------
As discussed in the Prospectus, the Bond Fund may engage in foreign currency
exchange transactions in connection with the purchase and sale of its
investments. A forward foreign currency exchange contract involves an obligation
to purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract as agreed by the parties, at a
price set at the time of the contract. In the case of a cancelable forward
contract, the holder has the unilateral right to cancel the contract at maturity
by paying a specified fee. The contracts are traded in the interbank market
conducted directly between currency traders (usually large commercial banks) and
their customers. A forward contract generally has no deposit requirement, and no
commissions are charged at any stage for trades.

<PAGE>

Forward foreign currency exchange contracts differ from foreign currency futures
contracts in certain respects. For example, the maturity date of a forward
contract may be any fixed number of days from the date of the contract agreed
upon by the parties, rather than a predetermined date in any given month.
Forward contracts may be in any amounts agreed upon by the parties rather than
predetermined amounts. Also, forward foreign exchange contracts are traded
directly between currency traders so that no intermediary is required. A forward
contract generally requires no margin or other deposit.

At the maturity of a forward or futures contract, the Fund may either accept or
make delivery of the currency specified in the contract, or, at or prior to
maturity, enter into a closing transaction involving the purchase or sale of an
offsetting contract. Closing transactions with respect to forward contracts are
usually effected with the currency trader who is a party to the original forward
contract. Closing transactions with respect to futures contracts are affected on
a commodities exchange: a clearing corporation associated with the exchange
assumes responsibility for closing out such contracts.

Options on foreign currencies operate similarly to options on securities and are
traded primarily on the over-the-counter market, although options on foreign
currencies have recently been listed on several exchanges. Options traded on the
over-the-counter market are illiquid and it may not be possible for the Fund to
dispose of an option it has purchased or terminate its obligations under an
option it has written at a time when the Adviser believes it would be
advantageous to do so. Options on foreign currencies are affected by all of
those factors which influence foreign exchange rates and investments generally.

The value of a foreign currency option is dependent upon the value of the
foreign currency and the U.S. dollar and may have no relationship to the
investment merits of a foreign debt security. Because foreign currency
transactions occurring in the interbank market involve substantially larger
amounts than those that may be involved in the use of foreign currency options,
investors may be disadvantaged by having to deal in an odd-lot market (generally
consisting of transactions of less than $1 million) for the underlying foreign
currencies at prices that are less favorable than for round lots. There is no
systematic reporting of last sale information for foreign currencies and there
is no regulatory requirement that quotations available through dealers or other
market sources be provided on a timely basis. Available quotation information is
generally representative of very large transactions in the interbank market and
thus may not reflect relatively smaller transactions (less than $1 million)
where rates may be less favorable. The interbank market in foreign currencies in
a global, around-the-clock market. To the extent that the U.S. options markets
are closed while the markets for the underlying currencies remain open,
significant price and rate movements may take place in the underlying markets
that cannot be reflected in the options markets.

Although foreign exchange dealers do not charge a fee for currency conversions,
they do realize a profit based upon the difference between prices at which they
are buying and selling various currencies. Thus, a dealer may offer to sell a
foreign currency to the Bond Fund at one rate, while offering a lesser rate of
exchange should the Fund desire to resell that currency to the dealer.

SECURITIES IN WHICH THE MINNESOTA TAX-FREE INCOME FUND MIGHT INVEST
- --------------------------------------------------------------------------------

SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN MINNESOTA TAX-EXEMPT OBLIGATIONS
- --------------------------------------------------------------------------------
As described in the Prospectus relating to the Minnesota Tax-Free Income Fund,
except during temporary defensive periods, this Fund will invest primarily in
Minnesota tax-exempt obligations, which include obligations of the State of
Minnesota or a political subdivision, municipality, agency or instrumentality of
the State of Minnesota. This Fund therefore is susceptible to political,
economic and regulatory factors affecting issuers of Minnesota tax-exempt
obligations. The following information provides only a brief summary of the
complex factors affecting the financial situation in Minnesota. This information
is derived from sources that are generally available to investors and is based
in part on information obtained from various state and local agencies in
Minnesota. It should be noted that the creditworthiness of obligations issued by
local Minnesota issuers may be unrelated to the creditworthiness of obligations
issued by the State of Minnesota, and that there is no obligation on the part of
Minnesota to make payment on such local obligations in the event of death.

Minnesota's constitutionality prescribed fiscal period is a biennium, and
Minnesota operates on a biennial budget basis. Legislative appropriations for
each biennium are prepared and adopted during the final legislative session of
the immediately

<PAGE>

preceding biennium. Prior to each fiscal year of a biennium, Minnesota's
Department of Finance allots a portion of the applicable biennial appropriation
to each agency or other entity for which an appropriation has been made. An
agency or other entity may not expend moneys in excess of its allotment. If
revenues are insufficient to balance total available resources and expenditures,
Minnesota's Commissioner of Finance, with the approval of the Governor, is
required to reduce allotments to the extent necessary to balance expenditures
and forecasted available resources for the then current biennium. The Governor
may prefer legislative action when a large reduction in expenditures appears
necessary, and if Minnesota's legislature is not in session the Governor is
empowered to convene a special session.

Diversity and a significant natural resource base are two important
characteristics of the Minnesota economy. Generally, the structure of the
State's economy parallels the structure of the United States economy as a whole.
There are, however, employment concentrations in durable goods and non-durable
goods manufacturing, particularly industrial machinery, instruments and
miscellaneous, food, paper and related industries, and printing and publishing.
During the period from 1980 to 1990, overall employment growth in Minnesota
lagged behind national employment growth, in large part due to declining
agricultural employment. The rate of non-farm employment growth in Minnesota
exceeded the rate of national growth, however, in the period of 1990 to 1996.
Minnesota continues to have one of the lowest unemployment rates in the nation.
Since 1980, Minnesota per capita income generally has remained above the
national average.

The State relies heavily on a progressive individual income tax and a retail
sales tax for revenue, which results in a fiscal system that is sensitive to
economic conditions. Frequently in recent years, legislation had been required
to eliminate projected budget deficits by raising additional revenue, reducing
expenditures, including aids to political subdivisions and higher education,
reducing the State's budget reserve, imposing a sales tax on purchases by local
governmental units, and making other budgetary adjustments. The Minnesota
Department of Finance February 1998 Forecast projected that, under then current
laws, the State would complete its current biennium June 30, 1999 with a $1
billion surplus, plus a $350 million cash flow account balance, plus a $522
million budget reserve. The 1998 Legislature, however, adopted various tax cuts,
spending increases, and other budgetary changes. As a result, the Department of
Finance now estimates that the State will complete the June 30, 1999 biennium
with an unrestricted balance of approximately $35 million, plus a $350 million
cash flow account balance, plus a $613 million budget reserve. Total General
Fund expenditures and transfers for the biennium are projected to be $21.5
billion. The State is party to a variety of civil actions that could adversely
affect the State's General Fund. In addition, substantial portions of State and
local revenues are derived from federal expenditures, and reductions in federal
aid to the State and its political subdivisions and other federal spending cuts
may have substantial adverse effects on the economic and fiscal condition of the
State and its local governmental units. Risks are inherent in making revenue and
expenditure forecasts. Economic or fiscal conditions less favorable than those
reflected in State budget forecasts may create additional budgetary pressures.

State grants and aids represent a large percentage of the total revenue of
cities, towns, counties and school districts in Minnesota, but generally the
State has no obligation to make payments on local obligations in the event of a
default. Even with respect to revenue obligations, no assurance can be given
that economic or other fiscal difficulties and the resultant impact on State and
local government finances will not adversely affect the ability of the
respective obligors to make timely payment of the principal and interest on
Minnesota Municipal Bonds that are held by the Fund or the value or
marketability of such obligations.

Recent Minnesota tax legislation and possible future changes in federal and
State income tax laws, including rate reductions, could adversely affect the
value and marketability of Minnesota Tax-exempt Obligations that are held by the
Minnesota Tax-Free Income Fund. See "Taxes - Minnesota Income Taxation," in the
Prospectus.

COMMON INVESTMENTS
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MORTGAGE-BACKED SECURITIES
- --------------------------------------------------------------------------------
The mortgage-backed securities in which the Bond Fund and U.S. Government
Securities Fund invest provide funds for mortgage loans made to residential home
buyers. These include securities which represent interests in pools of mortgage
loans made by lenders such as savings and loan institutions, mortgage banks,
commercial banks and insurance companies.

<PAGE>

Pools of mortgage loans are assembled for sale to investors such as the Funds by
various private, governmental and government-related organizations.

Interests in pools of mortgage-backed securities differ from other forms of debt
securities, which normally provide for periodic payment of interest in fixed
amounts with principal payments at maturity or specified call dates.
Mortgage-backed securities provide monthly payments which consist of both
interest and principal payments to the investor. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on their
residential mortgage loans, net of any fees paid to the issuer or guarantor of
such securities. Additional payments are caused by repayments of principal
resulting from the sale of the underlying residential property, refinancing or
foreclosure, net of fees or costs which may be incurred. Some mortgage-backed
securities, i.e., GNMA's, are described as "modified pass-through." These
securities entitle the holders to receive all interest and principal payments
owed on the mortgages in the pool, net of certain fees, regardless of whether or
not the mortgagors actually make the payments.

The principal government guarantor of mortgage-backed securities is the
Government National Mortgage Association ("GNMA"). GNMA is a wholly-owned U.S.
government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
government, the timely payment of principal and interest on securities issued by
approved institutions and backed by pools of FHA-insured or VA-guaranteed
mortgages.

Residential mortgage loans are pooled by the Federal Home Loan Mortgage
Corporation ("FHLMC"). FHLMC is a corporate instrumentality of the U.S.
government and was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. Its stock is owned by
the twelve Federal Home Loan Banks. FHLMC issues Participation Certificates
("PC's") which represent interest in mortgages from FHLMC's national portfolio.
FHLMC guarantees the timely payment of interest and ultimate collection of
principal, however, PC's are not backed by the full faith and credit of the U.S.
government.

The Federal National Mortgage Association ("FNMA") is a government sponsored
corporation owned entirely by private stockholders. It is subject to general
regulation by the Secretary of Housing and Urban Development. FNMA purchases
residential mortgages from a list of approved seller/servicers which include
state and federally-chartered savings and loan associations, mutual savings
banks, commercial banks and credit unions and mortgage banks. Pass-through
securities issued by FNMA are guaranteed as to timely payment of principal and
interest by FNMA, but are not backed by the full faith and credit of the U.S.
government.

The Federal Housing Administration ("FHA") was established by Congress in 1934
under the National Housing Act. A major purpose of the Act was to encourage the
flow of private capital into residential financing on a protected basis. FHA is
authorized to insure mortgage loans, primarily those related to residential
housing. FHA does not make loans and does not plan or build housing. FHA Project
Pools are pass-through securities representing undivided interests in pools of
FHA-insured multi-family project mortgage loans.

The Funds may purchase securities which are insured but not issued or guaranteed
by the U.S. government, its agencies or instrumentalities. An example of such a
security is a housing revenue bond (the interest on which is subject to federal
taxation) issued by a state and insured by an FHA mortgage loan. The Funds have
not purchased this type of security and have no current intent to do so. This
type of mortgage is insured by FHA pursuant to the provisions of Section
221(d)(4) of the National Housing Act of 1934, as amended. After a mortgagee
files a claim for insurance benefits, FHA will pay insurance benefits up to 100%
of the unpaid principal amount of the mortgage (generally 70% of the amount is
paid within six months of the claim and the remainder within the next six
months). The risks associated with this type of security are the same as other
mortgage securities -- prepayment and/or redemption prior to maturity, loss of
premium (if paid) if the security is redeemed prior to maturity and fluctuation
in principal value due to an increase or decrease in interest rates.

The average life of pass-through pools varies with the maturities of the
underlying mortgage instruments. In addition, the pool's term may be shortened
by unscheduled or early payments of principal and interest on the underlying
mortgages. The

<PAGE>

occurrence of mortgage prepayment is affected by factors including the level of
interest rates, general economic conditions, the location and age of the
mortgage and other social and demographic conditions.

As prepayment rates of individual pools vary widely, it is not possible to
accurately predict the average life of a particular pool. Mortgage pass-through
securities which receive regular principal payments have an average life less
than their maturity. The average life of mortgage pass-through investments will
typically vary from 1 to 18 years.

Yields on pass-through mortgage-backed securities are typically quoted based on
the maturity of the underlying instruments and the associated average life
assumption. Actual prepayment experience may cause the yield to differ from the
assumed average life yield. The compounding effect from reinvestments of monthly
payments received by the Fund will increase the yield to shareholders.

MANUFACTURED HOME LOANS
- --------------------------------------------------------------------------------
The U.S. Government Securities Fund and the Bond Fund invest in
GNMA manufactured home loan pass-through securities. Manufactured home loans are
fixed-rate loans secured by a manufactured home unit. In certain instances the
loan may be collateralized by a combination of a manufactured home unit and a
developed lot of land upon which the unit can be placed. Manufactured home loans
are generally not mortgages, however, because of the structural and operational
similarities with mortgage backed pass-through securities and the role of GNMA,
industry practice often groups the securities within the spectrum of GNMA
mortgage backed pass-through securities for listing purposes. Manufactured home
loans have key characteristics different from mortgage backed securities
including different prepayment rates. Prepayment rates tend to fluctuate with
interest rates and other economic variables. Manufactured home loan prepayment
rates generally tend to be less volatile than the prepayment rates experienced
by mortgage backed securities. See the above discussion regarding mortgage
backed securities.

OTHER ASSET-BACKED SECURITIES
- --------------------------------------------------------------------------------
The Bond Fund may invest in asset-backed securities that are backed by consumer
credit such as automobile receivables, consumer credit card receivables,
utilities, and home equity loans.

COLLATERALIZED MORTGAGE OBLIGATIONS (CMO)
- --------------------------------------------------------------------------------
The Funds, except the Money Market Fund, may invest in CMOs. CMOs are hybrid
instruments with characteristics of both mortgage-backed bonds and mortgage
pass-through securities. CMOs are commonly referred to as derivative securities.
Similar to a bond, interest and prepaid principal on a CMO is paid, in most
cases, semiannually. CMOs may be collateralized by whole mortgage loans, but are
more typically collateralized by portfolios of mortgage pass-through securities
guaranteed by GNMA, FHLMC, or FNMA. CMOs are structured into multiple classes,
each bearing a different stated maturity. Monthly payments of principal,
including prepayments, are first returned to investors holding the shortest
maturity class; investors holding the longer maturity classes receive principal
only after the first class has been retired. CMOs that are issued or guaranteed
by the U.S. Government or by any of its agencies or instrumentalities will be
considered U.S. Government securities by the Funds, while other CMOs, even if
collateralized by U.S. Government securities, will have the same status as other
privately issued securities for purposes of applying each Fund's diversification
tests.

In a typical CMO transaction, a corporation ("issuer") issues multiple series
("A, B, C, Z") of CMO bonds ("Bonds"). Proceeds of the Bond offering are used to
purchase mortgage instruments or mortgage pass-through certificates
("Collateral"). The Collateral is pledged to a third party trustee as security
for the Bonds. Principal and interest payments from the Collateral are used to
pay principal on the bonds in the order A, B, C, Z. The Series A, B, and C Bonds
all bear current interest. Interest on the Series Z Bond is accrued and added to
principal and a like amount is paid as principal on the Series A, B, or C Bond
currently paid off. When the Series A, B, and C Bonds are paid in full, interest
and principal on the Series Z Bond begin to be paid currently. With some CMOs,
the issuer serves as a conduit to allow loan originators (primarily builders or
savings and loan associations) to borrow against their loan portfolios.

MUNICIPAL LEASES
- --------------------------------------------------------------------------------
The Minnesota Tax-Free Income Fund and the Tax-Free Income Fund may invest up to
25% of their net assets in municipal lease obligations issued by state and local
governments or authorities to finance the acquisition of equipment and
facilities.

<PAGE>

Municipal leases may take the form of a lease, an installment purchase contract,
a conditional sales contract or a participation certificate in any of the above.
In determining leases in which the Funds will invest, the Adviser will carefully
evaluate the outstanding credit rating of the issuer (and the probable secondary
market acceptance of such credit rating). Additionally, the Adviser may require
that certain municipal lease obligations be issued or backed by a letter of
credit or put arrangement with an independent financial institution.

Municipal leases frequently have special risks not normally associated with
general obligation or revenue bonds. The constitutions and statutes of all
states contain requirements that the state or a municipality must meet to incur
debt. These often include voter referendum, interest rate limits and public sale
requirements. Leases and installment purchase or conditional sale contracts
(which normally provide for title to the leased asset to pass eventually to the
governmental issuer) have evolved as a means for governmental issuers to acquire
property and equipment without meeting the constitutional and statutory
requirements for the issuance of debt. The debt-issuance limitations are deemed
to be inapplicable because of the inclusion in many leases or contracts of
"nonappropriation" clauses that provide that the governmental issuer has no
obligation to make future payments under the lease or contract unless money is
appropriated for such purpose by the appropriate legislative body on a yearly or
other periodic basis.

In addition to the "nonappropriation" risk, municipal leases have additional
risk aspects because they represent a relatively new type of financing that has
not yet developed the depth of marketability associated with conventional bonds;
moreover, although the obligations will be secured by the leased equipment, the
disposition of the equipment in the event of non-appropriation or foreclosure
might, in some cases, prove difficult. In addition, in certain instances the
tax-exempt status of the obligations will not be subject to the legal opinion of
a nationally recognized "bond counsel," as is customarily required in larger
issues of municipal securities.

Municipal lease obligations, except in certain circumstances, are considered
illiquid by the staff of the Securities and Exchange Commission. Municipal lease
obligations held by a Fund will be treated as illiquid unless they are
determined to be liquid pursuant to guidelines established by the Fund's Board
of Directors. Under these guidelines, the Adviser will consider factors
including, but not limited to 1) whether the lease can be canceled, 2) what
assurance there is that the assets represented by the lease can be sold, 3) the
municipality's general credit strength (e.g. its debt, administrative, economic
and financial characteristics), 4) the likelihood that the municipality will
discontinue appropriating funding for the leased property because the property
is no longer deemed essential to the operations of the municipality (e.g. the
potential for an "event of non-appropriation"), and 5) the legal recourse in the
event of failure to appropriate.

MUNICIPAL NOTES
- --------------------------------------------------------------------------------
Municipal notes, which generally mature in three months to three years, are a
type of municipal security which may be purchased by the Minnesota Tax-Free Fund
and the Tax-Free Income Fund.

OBLIGATIONS OF, OR GUARANTEED BY, THE UNITED STATES GOVERNMENT, ITS AGENCIES OR
INSTRUMENTALITIES
- --------------------------------------------------------------------------------
Securities issued or guaranteed by the United States include a variety of
Treasury securities, which differ only in their interest rates, maturities and
dates of issuance. Treasury bills have a maturity of one year or less. Treasury
notes have maturities of one to ten years and Treasury bonds generally have
maturities of greater than ten years at the date of issuance. The prospectus
also refers to securities which are issued or guaranteed by agencies of the U.S.
government and various instrumentalities which have been established or
sponsored by the U.S. government. Except for U.S. Treasury securities, these
U.S. government obligations, even those which are guaranteed by federal agencies
or instrumentalities, may or may not be backed by the "full faith and credit" of
the United States. In the case of securities not backed by the full faith and
credit of the United States, the investor 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 United States itself in the event the agency
or instrumentality does not meet its commitment.

Some of the government agencies which issue or guarantee securities are the
Department of Housing and Urban Development, the Department of Health and Human
Services, the Government National Mortgage Association, the Farmers Home
Administration, the Department of Transportation, the Department of Defense and
the Department of Commerce. Instrumentalities which issue or guarantee
securities include the Export-Import Bank, the Federal Farm Credit System,

<PAGE>

Federal Land Banks, the Federal Intermediate Credit Bank, the Bank for
Cooperatives, Federal Home Loan Banks, the Federal National Mortgage Association
and the Federal Home Loan Mortgage Corporation. Instrumentalities of the U.S.
government which issue or guarantee securities which the Fund may purchase
include the Federal Farm Credit System, Federal Land Banks, the Federal
Intermediate Credit Bank, the Bank for Cooperatives, Federal Home Loan Banks,
FHLMC and the Student Loan Marketing Association. The U.S. Treasury is not
obligated by law to provide support to all U.S. government instrumentalities and
agencies, and the Funds will invest in securities which are not backed by the
full faith and credit of the U.S. Treasury issued by such instrumentalities and
agencies only when the Funds' Adviser determines that the credit risk with
respect to the instrumentality or agency issuing such securities does not make
its securities unsuitable investments for the Funds.

U.S. TREASURY INFLATION-PROTECTION SECURITIES
- --------------------------------------------------------------------------------
Inflation-protection securities are a new type of marketable book-entry security
issued by the United States Department of Treasury ("Treasury") with a nominal
return linked to the inflation rate in prices. Inflation-protection securities
are auctioned and issued on a quarterly basis on the 15th of January, April,
July, and October, beginning on January 15, 1997. Initially, they were issued as
10-year notes, with other maturities added thereafter. The index used to measure
inflation will be the non-seasonably adjusted U.S. City Average All Items
Consumer Price Index for All Urban Consumers ("CPI-U").

The value of the principal is adjusted for inflation, and every six months the
security will pay interest, which will be an amount equal to a fixed percentage
of the inflation-adjusted value of the principal. The final payment of principal
of the security will not be less than the original par amount of the security at
issuance.

The principal of the inflation-protection security is indexed to the
non-seasonally adjusted CPI-U. To calculate the inflation-adjusted principal
value for a particular valuation date, the value of the principal at issuance is
multiplied by the index ratio applicable to that valuation date. The index ratio
for any date is the ratio of the reference CPI applicable to such date to the
reference CPI applicable to the original issue date. Semiannual coupon interest
is determined by multiplying the inflation-adjusted principal amount by one-half
of the stated rate of interest on each interest payment date.

Inflation-adjusted principal or the original par amount, whichever is larger, is
paid on the maturity date as specified in the applicable offering announcement.
If at maturity the inflation-adjusted principal is less than the original
principal value of the security, an additional amount will be paid at maturity
so that the additional amount plus the inflation-adjusted principal equals the
original principal amount. Some inflation-protection securities may be stripped
into principal and interest components. In the case of a stripped security, the
holder of the stripped principal would receive this additional amount. The final
interest payment, however, will be based on the final inflation-adjusted
principal value, not the original par amount.

The reference CPI for the first day of any calendar month is the CPI-U for the
third preceding calendar month. (For example, the reference CPI for December 1
is the CPI-U reported for September of the same year, which is released in
October). The reference CPI for any other day of the month is calculated by a
linear interpolation between the reference CPI applicable to the first day of
the month and the reference CPI applicable to the first day of the following
month.

Any revisions the Bureau of Labor Statistics (or successor agency) makes to any
CPI-U number that had been previously released will not be used in calculations
of the value of outstanding inflation-protection securities. In the case that
the CPI-U for a particular month is not reported by the last day of the
following month, the Treasury will announce an index number based on the last
year-over-year CPI-U inflation rate available. Any calculations of the
Treasury's payment obligations on the inflation-protection security that need
that month's CPI-U number will be based on the index number that the Treasury
had announced. If the CPI-U is rebased to a different year, the Treasury will
continue to use the CPI-U series based on the base reference period in effect
when the security was first issued as long as that series continues to be
published. If the CPI-U is discontinued during the period the
inflation-protection security is outstanding, the Treasury will, in consultation
with

<PAGE>

the Bureau of Labor Statistics (or successor agency), determine an appropriate
substitute index and methodology for linking the discontinued series with the
new price index series. Determinations of the Secretary of the Treasury in the
regard are final.

Inflation-protection securities are held and transferred in either of two
book-entry systems: the commercial book-entry system (TRADES) and TREASURY
DIRECT. The securities are maintained and transferred at their original par
amount, i.e., not at their inflation-adjusted value. STRIPS components will be
maintained and transferred in TRADES at their value based on the original par
amount of the fully constituted security.

FUTURES CONTRACTS, OPTIONS AND OPTIONS ON FUTURES CONTRACTS
- --------------------------------------------------------------------------------
The Bond Fund, Minnesota Tax-Free Income Fund, and the Tax-Free Income Fund may
invest in interest rate futures contracts, index futures contracts and may buy
options on such contracts for the purpose of hedging its portfolio of fixed
income securities (and not for speculative purposes) against the adverse effects
of anticipated movements in interest rates. The U.S. Government Securities Fund
may buy and sell options on interest rate futures contracts and index futures
contracts for the purpose of hedging. As a result of entering into futures
contracts, no more than 10% of the Fund's (5% for Tax-Free Income Fund's) total
assets may be committed to margin.

Each Fund (except the Money Market Fund) may purchase exchange traded put and
call options on debt securities of an amount up to 5% of its net assets (10% for
Bond Fund) for the purpose of hedging. A put option (sometimes called a standby
commitment) gives the purchaser of the option, in return for a premium paid, the
right to sell the underlying security at a specified price during the term of
the option. The writer of the put option receives the premium and has the
obligation to buy the underlying securities upon exercise at the exercise price
during the option period. A call option (sometimes called a reverse standby
commitment) gives the purchaser of the option, in return for a premium, the
right to buy the security underlying the option at a specified exercise price at
any time during the term of the option. The writer of the call option receives
the premium and has the obligation at the exercise of the option, to deliver the
underlying security against payment of the exercise price during the option
period. A principal risk of standby commitments is that the writer of a
commitment may default on its obligation to repurchase or deliver the
securities.

An interest rate futures contract is an agreement to purchase or deliver an
agreed amount of debt securities in the future for a stated price on a certain
date. The Fund may use interest rate futures solely as a defense or hedge
against anticipated interest rate changes and not for speculation. The Fund
presently could accomplish a similar result to that which it hopes to achieve
through the use of futures contracts by selling debt securities with long
maturities and investing in debt securities with short maturities when interest
rates are expected to increase, or conversely, selling short-term debt
securities and investing in long-term debt securities when interest rates are
expected to decline. However, because of the liquidity that is often available
in the futures market, such protection is more likely to be achieved, perhaps at
a lower cost and without changing the rate of interest being earned by the Fund,
through using futures contracts.

DESCRIPTION OF FUTURES CONTRACTS. A futures contract sale creates an obligation
by the Fund, as seller, to deliver the type of financial instrument called for
in the contract at a specified future time for a stated price. A futures
contract purchase creates an obligation by the Fund, as purchaser, to take
delivery of the underlying financial instrument at a specified future time for a
stated price. The specific securities delivered or taken, respectively, at
settlement date, are not determined until at or near that date. The
determination is made in accordance with the rules of the exchange on which the
futures contract sale or purchase was made.

Although futures contracts by their terms call for actual delivery or acceptance
of securities, in most cases the contracts are closed out before the settlement
date without the making or taking of delivery. Closing out a futures contract
sale is effected by purchasing a futures contract for the same aggregate amount
of the specific type of financial instrument and the same delivery date. If the
price of the initial sale of the futures contract exceeds the price of the
offsetting purchase, the Fund is paid the difference and realizes a gain. If the
price of the offsetting purchase exceeds the price of the initial sale, the Fund
pays the difference and realizes a loss. Similarly, the closing out of a futures
contract purchase is effected by the Fund entering into a futures contract sale.
If the offsetting sale price exceeds the purchase price, the Fund realizes a
gain, and if the purchase price exceeds the offsetting sale price, the Fund
realizes a loss.

<PAGE>

The Funds are required to maintain margin deposits with brokerage firms through
which they enter into futures contracts. Margin balances will be adjusted at
least weekly to reflect unrealized gains and losses on open contracts. In
addition, the Funds will pay a commission on each contract, including offsetting
transactions.

Futures contracts are traded only on commodity exchanges--known as "contract
markets"--approved for such trading by the Commodity Futures Trading Commission
("CFTC"), and must be executed through a futures commission merchant or
brokerage firm which is a member of the relevant contract market. The CFTC
regulates trading activity on the exchanges pursuant to the Commodity Exchange
Act. The principal exchanges are the Chicago Board of Trade, the Chicago
Mercantile Exchange and the New York Futures Exchange. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership. The CFTC rules
provide that a mutual fund does not have to register a "commodity pool" if the
Fund uses commodity futures and options positions solely (1) for "bona fide
hedging" purposes (as that term is used in the rules and regulations of the
CFTC) or (2) for other purposes so long as aggregate initial margins and
premiums required in connection with non-hedging positions do not exceed five
percent of the liquidation value of the Fund's portfolio.

RISKS IN FUTURES CONTRACTS. One risk in employing futures contracts to protect
against cash market price volatility is the prospect that futures prices will
correlate imperfectly with the behavior of cash prices. The ordinary spreads
between prices in the cash and futures markets, due to differences in the
natures of those markets, are subject to distortions. First, all participants in
the futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements, investors may close
futures contracts through offsetting transactions which could distort the normal
relationship between the cash and futures markets. Second, the liquidity of the
futures market depends on participants entering into offsetting transactions
rather than making or taking delivery. To the extent participants decide to make
or take delivery, liquidity in the futures market could be reduced, thus
producing distortion. Third, from the point of view of speculators the deposit
requirements in the futures market are less onerous than margin requirements in
the securities market. Therefore, increased participation by speculators in the
futures market may cause temporary price distortions. Due to the possibility of
distortion, a correct forecast of general interest trends by the Adviser may
still not result in a successful transaction.

Another risk is that the Adviser would be incorrect in its expectation as to the
extent of various interest rate movements or the time span within which the
movements take place. Closing out a futures contract purchase at a loss because
of higher interest rates will generally have one or two consequences depending
on whether, at the time of closing out, the "yield curve" is normal (long-term
rates exceeding short-term). If the yield curve is normal, it is possible that
the Fund will still be engaged in a program of buying long-term securities.
Thus, closing out the futures contract purchase at a loss will reduce the
benefit of the reduced price of the securities purchased. If the yield curve is
inverted, it is possible that the Fund will retain its investments in short-term
securities earmarked for purchase of longer term securities. Thus, closing out
of a loss will reduce the benefit of the incremental income that the Fund will
experience by virtue of the high short-term rates.

RISKS OF OPTIONS. The use of options and options on interest rate futures
contracts also involves additional risk. Compared to the purchase or sale of
futures contracts, the purchase of call or put options and options on futures
contracts involves less potential risk to a Fund because the maximum amount at
risk is the premium paid for the options (plus transaction costs).

The effective use of options strategies is dependent, among other things, upon
the Fund's ability to terminate options positions at a time when the Adviser
deems it desirable to do so. Although the Fund will enter into an option
position only if the Adviser believes that a liquid secondary market exists for
such option, there is no assurance that the Fund will be able to effect closing
transactions at any particular time or at an acceptable price. The Funds'
transactions involving options on futures contracts will be conducted only on
recognized exchanges.

The Funds' purchase or sale of put or call options and options on futures
contracts will be based upon predictions as to anticipated interest rates by the
Adviser, which could prove to be inaccurate. Even if the expectations of the
Adviser are correct, there may be an imperfect correlation between the change in
the value of the options and of the Funds' portfolio securities.

<PAGE>

The Funds, except the Money Market Fund, may purchase and sell put and call
options and options on interest rate futures contracts which are traded on a
United States exchange or board of trade as a hedge against changes in interest
rates, and will enter into closing transactions with respect to such options to
terminate existing positions. An interest rate futures contract provides for the
future sale by one party and the purchase by the other party of a certain amount
of a specific financial instrument (debt security) at a specified price, date,
time and place. An option on an interest rate futures contract, as contrasted
with the direct investment in such a contract, gives the purchaser the right, in
return for the premium paid, to assume a position in an interest rate futures
contract at a specified exercise price at any time prior to the expiration date
of the option. Options on interest rate futures contracts are similar to options
on securities, which give the purchaser the right, in return for the premium
paid, to purchase or sell securities.

A call option gives the purchaser of such option the right to buy, and obliges
its writer to sell, a specified underlying futures contract at a stated exercise
price at any time prior to the expiration date of the option. A purchaser of a
put option has the right to sell, and the writer has the obligation to buy, such
contract at the exercise price during the option period. Upon exercise of an
option, the delivery of the futures position by the writer of the option to the
holder of the option will be accompanied by delivery of the accumulated balance
in the writer's futures margin account, which represents the amount by which the
market price of the futures contract exceeds, in the case of a call, or is less
than, in the case of a put, the exercise price of the option on the futures
contract. If an option is exercised on the last trading day prior to the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and the closing
price of the interest rate futures contract on the expiration date. The
potential loss related to the purchase of an option on interest rate futures
contracts is limited to the premium paid for the option (plus transaction
costs). Because the value of the option is fixed at the point of sale, there are
no daily cash payments to reflect changes in the value of the underlying
contract; however, the value of the option does change daily and that change
would be reflected in the net asset values of the Fund.

PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS. The Funds (except the Money Market
Fund) may purchase put options on futures contracts if the Adviser anticipates a
rise in interest rates. Because the value of an interest rate or municipal bond
index futures contract moves inversely in relation to changes in interest rates,
a put option on such a contract becomes more valuable as interest rates rise. By
purchasing put options on futures contracts at a time when the Adviser expects
interest rates to rise, the Funds will seek to realize a profit to offset the
loss in value of its portfolio securities.

PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS. The Funds (except the Money
Market Fund) may purchase call options on futures contracts if the Adviser
anticipates a decline in interest rates. The purchase of a call option on an
interest rate or index futures contract represents a means of obtaining
temporary exposure to market appreciation at limited risk. Because the value of
an interest rate or index futures contract moves inversely in relation to
changes to interest rates, a call option on such a contract becomes more
valuable as interest rates decline. The Funds will purchase a call option on a
futures contract to hedge against a decline in interest rates in a market
advance when the Funds are holding cash. The Funds can take advantage of the
anticipated rise in the value of long-term securities without actually buying
them until the market is stabilized. At that time, the options can be liquidated
and the Funds' cash can be used to buy long-term securities.

The Funds expect that new types of futures contracts, options thereon, and put
and call options on securities and indexes may be developed in the future. As
new types of instruments are developed and offered to investors, the Adviser
will be permitted to invest in them provided that the Adviser believes their
quality is equivalent to the Funds' quality standards.

RISKS OF INVESTING IN HIGH YIELD SECURITIES
- --------------------------------------------------------------------------------
The Bond Fund and Minnesota Tax-Free Income Fund may each invest in high yield
securities or "junk bonds." Junk bonds are regarded as being predominantly
speculative as to the issuer's ability to make payments of principal and
interest. Investment in such securities involves substantial risk. Issuers of
junk bonds may be highly leveraged and may not have available to them more
traditional methods of financing. Therefore, the risks associated with acquiring
the securities of such issuers generally are greater than is the case with
higher rated securities. For example, during an economic downturn or a sustained
period of rising interest rates, issuers of junk bonds may be more likely to
experience financial stress, especially if such issuers are highly leveraged. In
addition, the market for junk bonds is relatively new and has not weathered a
major

<PAGE>

economic recession, and it is unknown what effects such a recession might have
on such securities. During such periods, such issuers may not have sufficient
cash flows to meet their interest payment obligations. The issuer's ability to
service its debt obligations also may be adversely affected by specific issuer
developments, or the issuer's inability to meet specific projected business
forecasts, or the unavailability of additional financing. The risk of loss due
to default by the issuer is significantly greater for the holders of junk bonds
because such securities may be unsecured and may be subordinated to the
creditors of the issuer. While most of the junk bonds in which the Funds may
invest do not include securities which, at the time of investment, are in
default or the issuers of which are in bankruptcy, there can be no assurance
that such events will not occur after a Fund purchases a particular security, in
which case the Fund may experience losses and incur costs. Junk bonds frequently
have call or redemption features that would permit an issuer to repurchase the
security from the Fund. If a call were exercised by the issuer during a period
of declining interest rates, the Fund likely would have to replace such called
security with a lower yielding security, thus decreasing the net investment
income to the Fund and dividends to shareholders.

Junk bonds tend to be more volatile than higher-rated fixed income securities,
so that adverse economic events may have a greater impact on the prices of junk
bonds than on higher-rated fixed income securities. Factors adversely affecting
the market value of such securities are likely to affect adversely the Fund's
net asset value. Like higher-rated fixed income securities, junk bonds generally
are purchased and sold through dealers who make a market in such securities for
their own accounts. However, there are fewer dealers in the junk bond market,
which may be less liquid than the market for higher-rated fixed income
securities, even under normal economic conditions. Also there may be significant
disparities in the prices quoted for junk bonds by various dealers. Adverse
economic conditions and investor perceptions thereof (whether or not based on
economic fundamentals) may impair the liquidity of this market and may cause the
prices the Fund receives for its junk bonds to be reduced. In addition, the Fund
may experience difficulty in liquidating a portion of its portfolio when
necessary to meet the Fund's liquidity needs or in response to a specific
economic event such as a deterioration in the creditworthiness of the issuer.
Under such conditions, judgment may play a greater role in valuing certain of
the Fund's portfolio securities than in the case of securities trading in a more
liquid market. In addition, the Fund may incur additional expenses to the extent
that it is required to seek recovery upon a default on a portfolio holding or to
participate in the restructuring of the obligation.

COMPUTATION OF NET ASSET VALUE
- --------------------------------------------------------------------------------

Net asset value is determined as of the close of the New York Stock Exchange on
each day that the exchange is open for business and on any other day on which
there is sufficient trading in a Fund's securities to materially affect the
Fund's net asset value per share. The customary national business holidays
observed by the New York Stock Exchange and on which the Funds are closed are:
New Year's Day, Martin Luther King Jr. Day, President's Day, Good Friday,
Memorial Day, July Fourth, Labor Day, Thanksgiving Day and Christmas Day. The
net asset value per share will not be determined on these national holidays.

On March 31, 1998 the net asset value and public offering price per share for
each Fund was calculated as follows:

Money Market Fund:
net assets ($43,110,774)
-------------
shares outstanding (43,113,793) = NAV per share = public offering
price per share ($1.00)

U.S. Government Securities Fund:
net assets ($103,868,216)
--------------
shares outstanding (9,767,850) = NAV per share = public offering
price per share ($10.63)

Bond Fund:
net assets ($10,706,251)
-------------
shares outstanding (1,067,125) = NAV per share = public offering
price per share ($10.03)

Tax-Free Income Fund:
net assets ($519,578,653)
--------------
shares outstanding (49,932,471) = NAV per share = public offering
price per share ($10.41)

<PAGE>

Minnesota Tax-Free Income Fund:
net assets ($143,633,670)
-------------
shares outstanding (13,697,612) = NAV per share = public offering
price per share ($10.49)

CALCULATION OF PERFORMANCE DATA
- --------------------------------------------------------------------------------

Advertisements and other sales literature for the Funds (other than Money Market
Fund) may refer to cumulative total return, average annual total return and
yield.

CUMULATIVE TOTAL RETURN. Total return means cumulative total return and is
calculated by finding the cumulative compounded rate of return over the period
indicated that would equate the initial amount invested to the ending redeemable
value, according to the following formula:

CTR = (ERV-P) X 100
-----
P
CTR = cumulative total return
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of such
period
P = initial payment of $1,000

This calculation assumes all dividends and capital gains distributions are
reinvested at net asset value on the appropriate reinvestment dates and includes
all recurring fees, such as investment advisory and management fees, charged to
all shareholder accounts.

AVERAGE ANNUAL TOTAL RETURN. Average annual total return is computed by finding
the average annual compounded rates of return over the periods indicated that
would equate the initial amount invested to the ending redeemable value,
according to the following formula:

P(1+T)n= ERV
P = a hypothetical initial payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of
such period.

YIELD. Yield is computed by dividing the net investment income per share (as
defined under Securities and Exchange Commission rules and regulations) earned
during the computation period by the maximum offering price per share on the
last day of the period, according to the following formula:

Yield = 2[( a - b + 1)6 - 1]
-------
cd
a = dividends and interest earned during the periods;
b = expenses accrued for the period (net of reimbursements);
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends; and
d = the maximum offering price per share on the last day of
the period.

The Funds' yields for the 30-day period ended March 31, 1998 were:

U.S. Government Securities Fund 5.61%
Bond Fund 5.43
Tax-Free Income Fund 4.70
Minnesota Tax-Free Income Fund 5.02

<PAGE>

CURRENT YIELD AND EFFECTIVE YIELD FOR MONEY MARKET FUND
- -------------------------------------------------------
CURRENT YIELD The Money Market Fund's current yield is based on a seven-day
period and is computed by determining the net change in value, exclusive of
capital changes, of a hypothetical account having a balance of one share at the
beginning of the period. This number is then divided by the price per share at
the beginning of the period to obtain the base period return, and then
multiplying the base period return by (365/7) with the resulting yield figure
carried to at least the nearest hundredth of one percent.

EFFECTIVE YIELD The Money Market Fund's effective yield is computed by using the
base period return as calculated above as follows:
Effective yield = [(Base period return + 1) 365/7 ] - 1

TAXABLE EQUIVALENT YIELD. The Tax-Free Income Fund and Minnesota Tax-Free Income
Fund may state a taxable equivalent yield which is computed by dividing that
portion of the yield of the Fund (as computed above) which is tax-exempt by one
minus a stated income tax rate and adding the product to that portion, if any,
of the yield of the Fund that is not tax-exempt. The taxable equivalent yield
for the Tax-Free Income Fund and Minnesota Tax-Free Income Fund assuming a 39.6%
marginal federal tax bracket and an 8.5% tax bracket for Minnesota residents
were 7.78% and 9.08% respectively, for the 30-day period ended March 31, 1998.

DISTRIBUTION RATE. The distribution rate is computed by dividing the net
investment income distributed to shareholders for a given period divided by a
Fund's average net asset value per share for that period, according to the
following formula:
Distribution Rate = a/b X 365 X 100
-----
c
a = net investment income distributed for the period;
b = number of days in the period;
c = average net asset value during the period;

The Funds' distribution rates for the 12-month period ended March 31, 1998 were:

U.S. Government Securities Fund 5.93%
Bond Fund 6.35
Tax-Free Income Fund 5.30
Minnesota Tax-Free Income Fund 5.31

As noted in the Prospectus, a Fund may advertise its relative performance as
compiled by outside organizations or refer to publications which have mentioned
its performance. The Adviser may refer to the following indices in
advertisements and other sales literature: Lehman Aggregate Bond Index, Lehman
5-Year Municipal Bond Index, Lehman Intermediate Bond Index.

REDEMPTION-IN-KIND
- --------------------------------------------------------------------------------

If the Adviser determines that existing conditions make cash payments
undesirable, redemption payments may be made in whole or in part in securities
or other financial assets, valued for this purpose as they are valued in
computing the NAV for a Fund's shares. Shareholders receiving securities or
other financial assets on redemption may realize a gain or loss for tax purposes
and will incur any costs of sale, as well as the associated inconveniences.

MANAGEMENT
- --------------------------------------------------------------------------------

The Sit Funds as a group (a total of 13 funds including the Bond Funds and Stock
Funds) pay each director, who is not also an officer, an annual total fee of
$12,000, $2,000 for each meeting attended, and provide reimbursement for travel
and other expenses. The names, addresses, principal occupations and other
affiliations of directors and officers of the Funds are given below. Except as
noted below, the business address of each officer and director is the same as
that of the Adviser - 4600 Norwest Center, Minneapolis, Minnesota.

<PAGE>

<TABLE>
<CAPTION>
NAME & ADDRESS POSITION WITH THE FUNDS PRINCIPAL OCCUPATION DURING PAST 5 YEARS
- -------------- ----------------------- ----------------------------------------
<S> <C> <C>
Eugene C. Sit, CFA * Director and Chairman, CEO and CIO Sit Investment Associates, Inc.
Chairman (the "Adviser"); Chairman, CEO and CIO of Sit/Kim
International Investment Associates, Inc. ("Sit/Kim");
Director and Chairman of the Sit Funds and Director of
SIA Securities Corp. (the "Distributor")

Peter L. Mitchelson, CFA * Director and President and Director of the Adviser; Executive Vice
Vice Chairman President and Director of Sit/Kim; Director and Vice
Chairman of the Sit Funds and Director of the Distributor

Michael C. Brilley * Director, Senior Vice President, Senior Vice President and Senior Fixed Income Officer of
and Senior Portfolio Manager the Adviser

Melvin C. Bahle Director Emeritus Director Emeritus of the Sit Funds; Director of the Sit
#1 Muirfield Lane Funds until October, 1995; Financial consultant;
St. Louis, MO 63141 Director and/or Officer of several companies, foundations
and religious organizations

William E. Frenzel * Director Director of the Sit Funds; Advisory Director of the
1775 Massachusetts Ave. NW Adviser; Director of Sit/Kim; Senior Visiting Scholar
Washington, DC 20036 at the Brookings Institution; Former senior member
of Congress and a ranking member on the House Ways
and Means Committee and Vice Chairman of the House
Budget Committee

John E. Hulse Director Director of the Sit Funds; Director, Vice Chairman and
4303 Quail Run Lane Chief Financial Officer at Pacific Telesis Group until
Danville, CA 64506 June 1992; Trustee, Benild Religious & Charitable Trust;
Trustee, Pacific Gas & Electric Nuclear
Decommissioning Trust

Sidney L. Jones Director Director of the Sit Funds; Adjunct Faculty, Center for
8505 Parliament Drive Public Policy Education, The Brookings Institution;
Potomac, MD 20854 Visiting Research Associate in Economics at Carleton
College; Former Assistant Secretary for Economic Policy,
United States Department of the Treasury

Donald W. Phillips Director Director of the Sit Funds; President of Forstmann-Leff
111 West Jackson Blvd International, Inc.; Executive Vice President and Director
Chicago, IL 60606 of Equity Financial and Management Company until
1997; Chairman of Equity Institutional Investors, Inc.,
until 1997

Mary K. Stern, CFA President President of the Sit Mutual Funds; President of Mutual
Fund Group and Executive Vice President of Society
Bank, Cleveland, Ohio until 1994

Paul E. Rasmussen Vice President & Treasurer Vice President, Secretary and Controller for the Adviser
and Sit/Kim; Vice President and Treasurer of the Sit
Funds; President and Treasurer of the Distributor
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
NAME & ADDRESS POSITION WITH THE FUNDS PRINCIPAL OCCUPATION DURING PAST 5 YEARS
- -------------- ----------------------- ----------------------------------------
<S> <C> <C>
Debra A. Sit, CFA Vice President - Investments; Vice President - Investments of the Tax-Free Fund and
Assistant Treasurer Minnesota Tax-Free Fund and Assistant Treasurer of all
Funds

Bryce A. Doty, CFA Vice President - Investments Vice President - Investments of the U.S. Government
Securities Fund and Bond Fund; Head of the Public
Trading desk at Minnesota Mutual Life Insurance
Company until November, 1995

Paul J. Jungquist, CFA Vice President - Investments Vice President - Investments of the Money Market Fund

Michael P. Eckert Vice President Vice President - Mutual Fund Sales of the Adviser

Michael J. Radmer Secretary Secretary of the Sit Funds; Partner of the Funds' general
220 South Sixth Street counsel, Dorsey & Whitney, LLP
Minneapolis, MN
</TABLE>

* Directors who are deemed to be "interested persons" of the Funds as that
term is defined by the Investment Company Act of 1940. Messrs. Sit, Brilley
and Mitchelson are interested persons because they are officers of the
Adviser. Mr. Frenzel may be deemed to be an interested person because he is
an advisory director of the Adviser.

Ms. Debra Sit is the daughter of Eugene C. Sit.

INVESTMENT ADVISER
- --------------------------------------------------------------------------------

The Adviser (or an affiliate) has served as the investment adviser for each Fund
since the inception of each Fund.

TERMS COMMON TO ALL FUNDS' INVESTMENT MANAGEMENT AGREEMENTS
- --------------------------------------------------------------------------------
Each Fund's Investment Management Agreement provides that the Adviser will
manage the investment of the Fund's assets, subject to the applicable provisions
of the Fund's articles of incorporation, bylaws and current registration
statement (including, but not limited to, the investment objective, policies and
restrictions delineated in the Fund's current prospectus and Statement of
Additional Information), as interpreted from time to time by the Fund's Board of
Directors. Under each Agreement, the Adviser has the sole and exclusive
responsibility for the management of the Fund's investment portfolio and for
making and executing all investment decisions for the Fund. The Adviser is
obligated under each Agreement to report to the Fund's Board of Directors
regularly at such times and in such detail as the Board may from time to time
determine appropriate, in order to permit the Board to determine the adherence
of the Adviser to the Fund's investment policies. Each Agreement also provides
that the Adviser shall not be liable for any loss suffered by the Fund in
connection with the matters to which the Agreement relates, except losses
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.

Each Agreement provides that the Adviser shall, at its own expense, furnish all
office facilities, equipment and personnel necessary to discharge its
responsibilities and duties under the Agreement and that the Adviser will
arrange, if requested by the Fund, for officers or employees of the Adviser to
serve without compensation from the Fund as directors, officers or employees of
the Fund if duly elected to such positions by the shareholders or directors of
the Fund.

Each Agreement provides that it will continue in effect from year to year only
as long as such continuance is specifically approved at least annually by the
applicable Fund's Board of Directors or shareholders and by a majority of the
Board of Directors who are not "interested persons" (as defined in the 1940 Act)
of the Adviser or the Fund. The Agreement is terminable upon 60 days' written
notice by the Adviser or the Fund and will terminate automatically in the event
of its "assignment" (as defined in the 1940 Act).

<PAGE>

COMPENSATION AND ALLOCATION OF EXPENSES
- --------------------------------------------------------------------------------
Under each of the Fund's Investment Management Agreement, the Fund is obligated
to pay the Adviser a flat monthly fee, which is equal on an annual basis to
.80%, (except for the U.S. Government Securities Fund and Money Market Fund) of
the average daily net assets of each Fund. However, under each such Fund's
Agreement, the Adviser has agreed to bear all of the Fund's expenses, except for
extraordinary expenses (as designated by a majority of the Fund's disinterested
directors), interest, brokerage commissions and other transaction charges
relating to the investing activities of the Fund.

Under the current Investment Management Agreement for each of U.S. Government
Securities Fund and Money Market Fund, the Fund is obligated to pay the Adviser
a flat monthly fee (equal on an annual basis to 1.00% of the first $50 million
of average daily net assets and .80% of average daily net assets in excess of
$50 million for U.S. Government Securities Fund and equal on an annual basis to
.80% of the first $50 million of average daily net assets and .60% of average
daily net assets in excess of $50 million for Money Market Fund). However, under
each such Fund's current Agreement, the Adviser is obligated to bear all of the
Fund's expenses, except for extraordinary expenses (as designated by a majority
of the Fund's disinterested directors), interest, brokerage commissions and
other transaction charges relating to the investing activities of the Fund.

For the period October 1, 1993 through December 31, 1998 the Adviser has
voluntarily agreed to limit the management fee (and, thereby, all Fund expenses,
except those not payable by the Adviser as set forth above) of Government Fund
and Money Market Fund to .80% and .50% of average daily net assets per year,
respectively, and of Tax-Free Income Fund to .70% of the Fund's average daily
net assets in excess of $250 million and .60% of the Funds' daily net assets in
excess of $500 million. After December 31, 1998, this voluntary fee waiver may
be discontinued by the Adviser in its sole discretion.

On February 11, 1994 the Board of Directors changed the fiscal year end from
June 30 to March 31. Set forth below are the investment management fees paid by
each Fund, during the fiscal years ended March 31, 1998, 1997, 1996, and other
fees and expenses paid by the Funds during such years and fees and expenses of
the Funds waived or paid by the Adviser during such years:

<TABLE>
<CAPTION>
MONEY U.S. GOVT. TAX-FREE MN TAX-FREE
MARKET SECURITIES BOND INCOME INCOME
1998 FUND FUND FUND FUND FUND
- ---- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AVERAGE NET ASSETS $ 33,006,824 $ 87,324,414 $ 7,859,288 $ 421,148,441 $ 115,908,637
Investment Advisory Fees 263,629 797,954 62,780 3,365,321 926,184
Other Expenses
Expenses Waived (98,857) (100,000) 00 (171,504) 00
Net Fund Expenses 164,772 697,954 62,780 3,193,817 926,184
Ratio of expenses to average daily net assets .50% .80% .80% .76% .80%

1997
- ----
AVERAGE NET ASSETS $ 25,971,000 $ 57,925,388 $ 5,462,994 $ 296,175,655 $73,642,770.47
Investment Advisory Fees 208,145 564,216 43,801 2,374,577 590,061
Other Expenses
Expenses Waived (78,042) (99,999) 00 (46,819) 00
Net Fund Expenses 130,103 464,217 43,801 2,327,758 590,061
Ratio of expenses to average daily net assets .50% .80% .80% .79% .80%

1996
- ----
AVERAGE NET ASSETS $ 22,216,443 $ 44,538,307 $ 4,845,015 $ 265,004,492 $ 54,570,121
Investment Advisory Fees 178,297 445,304 38,803 2,123,785 436,992
Other Expenses
Expenses Waived (66,862) (88,625) 00 (15,540) 00
Net Fund Expenses 111,435 356,679 38,803 2,108,245 436,992
Ratio of expenses to average daily net assets .50% .80% .80% .80% .80%
</TABLE>

<PAGE>

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

Sit Mutual Funds II, Inc. (the "Company") on behalf of the Bond Fund, Minnesota
Tax-Free Income Fund, and the Tax-Free Income Fund; the U.S. Government
Securities Fund, and the Money Market Fund have entered into an Underwriting and
Distribution Agreement with SIA Securities Corp. ("Securities"), an affiliate of
the Adviser, pursuant to which Securities will act as each Fund's principal
underwriter. Securities will market each Fund's shares only to certain
institutional investors and all other sales of each Fund's shares will be made
by each Fund. The Adviser will pay all expenses of Securities in connection with
such services and Securities is otherwise not entitled to any other compensation
under the Underwriting and Distribution Agreement. Each Fund will incur no
additional fees in connection with the Underwriting and Distribution Agreement.

Pursuant to the Underwriting and Distribution Agreement, Securities has agreed
to act as the principal underwriter for each Fund in the sale and distribution
to the public of shares of each Fund, either through dealers or otherwise.
Securities has agreed to offer such shares for sale at all times when such
shares are available for sale and may lawfully be offered for sale and sold. The
Underwriting and Distribution Agreement is renewable from year to year if the
Fund's directors approve such agreement. The Fund or Securities can terminate
the Underwriting and Distribution Agreement at any time without penalty on 60
days' notice written notice to the other party. The Underwriting and
Distribution Agreement terminates automatically upon its assignment. In the
Underwriting and Distribution Agreement, Securities agrees to indemnify each
Fund against all costs of litigation and other legal proceedings and against any
liability incurred by or imposed on the Fund in any way arising out of or in
connection with the sale or distribution of each Fund's shares, except to the
extent that such liability is the result of information which was obtainable by
Securities only from persons affiliated with the Fund but not Securities.

BROKERAGE
- --------------------------------------------------------------------------------

Transactions on a stock exchange in equity securities will be executed primarily
through brokers that will receive a commission paid by the applicable Fund.
Fixed income securities, as well as equity securities traded in the
over-the-counter market, are generally traded on a "net" basis with dealers
acting as principals for their own accounts without a stated commission,
although the price of the security usually includes a profit to the dealer. In
underwritten fixed income and equity offerings, securities are purchased at a
fixed price that includes an amount of compensation to the underwriter,
generally referred to as the underwriter's selling concession or discount.
Certain of these securities may also be purchased directly from the issuer, in
which case neither commissions nor discounts are paid.

The Adviser selects and, where applicable, negotiates commissions with the
broker-dealers who execute the transactions for one or more of the Funds. The
primary criterion for the selection of a broker-dealer is the ability of the
broker-dealer, in the opinion of the Adviser to secure prompt execution of the
transactions on favorable terms, including the best price of the security, the
reasonableness of the commission and considering the state of the market at the
time. When consistent with these objectives, business may be placed with
broker-dealers who furnish investment research or services to the Adviser. Such
research or services include advice, both directly and in writing, as to the
value of securities, the advisability of investing in, purchasing or selling
securities, and the availability of securities, or purchasers or sellers of
securities. Such services also may include analyses and reports concerning
issues, industries, securities, economic factors and trends, portfolio strategy,
and the performance of accounts. This allows the Adviser to supplement its own
investment research activities and enables the Adviser to obtain the views and
information of individuals and research staffs of many different securities
firms prior to making investment decisions for the Funds. To the extent
portfolio transactions are effected with broker-dealers who furnish research
services to the Adviser, the Adviser receives a benefit, not capable of
valuation in dollar amounts, without providing any direct monetary benefit to
the applicable Funds from these transactions. The Adviser believes that most
research services they receive generally benefit several or all of the
investment companies and private accounts which they manage, as opposed to
solely benefiting one specific managed fund or account. Normally, research
services obtained through managed funds or accounts investing in common stocks
would primarily benefit the managed funds or accounts which invest in common
stock; similarly, services obtained from transactions in fixed income securities
would normally be of greater benefit to the managed funds or accounts which
invest in debt securities.

<PAGE>

The Adviser maintains an informal list of broker-dealers, which is used from
time to time as a general guide in the placement of Fund business, in order to
encourage certain broker-dealers to provide the Adviser with research services
which the Adviser anticipates will be useful to them in managing the Funds.
Because the list is merely a general guide, which is to be used only after the
primary criterion for the selection of broker-dealers (discussed above) has been
met, substantial deviations from the list are permissible and may be expected to
occur. The Adviser will authorize a Fund to pay an amount of commission for
effecting a securities transaction in excess of the amount of commission another
broker-dealer would have charged only if the Adviser determines in good faith
that such amount of commission is reasonable in relation to the value of the
brokerage and research services provided by such broker-dealer, viewed in terms
of either that particular transaction or the Adviser's overall responsibilities
with respect to the accounts as to which it exercises investment discretion.
Generally, a Fund pays commissions higher than the lowest commission rates
available.

Fund management does not currently anticipate that a Fund will effect brokerage
transactions in its portfolio securities with any broker-dealer affiliated
directly or indirectly with the Funds or the Adviser.

The Adviser has entered into agreements with Capital Institutional Services,
Inc. ("CIS"), and Lipper Analytical Securities Corporation ("LAS"), unaffiliated
registered broker-dealers located in Dallas and New York respectively. All
transactions placed with CIS and LAS are subject to the above criteria. CIS and
LAS provide the Adviser with a wide variety of economic, performance, and
investment research information.

Investment decisions for each Fund are made independently of those for other
clients of the Adviser, including the other Funds. When the Funds or clients
simultaneously engage in the purchase or sale of the same securities, the price
of the transactions is averaged and the amount allocated in accordance with a
formula deemed equitable to each Fund and client. In some cases, this system may
adversely affect the price paid or received by the Fund or the size of the
position obtainable. All trades will be transacted through U.S. based brokerage
firms and commercial banks. Brokerage commissions paid by the Funds for the
fiscal years ended March 31, 1998, 1997, 1996, 1995, and for the period July 1,
1993 through fiscal year end March 31, 1994:

<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Money Market Fund 0 0 0 0 0
U.S. Government Securities Fund $29,252 $2,891 $4,123 $1,000 $1,173
Bond Fund 1,069 1,214 1,936 195 113
Tax-Free Income Fund 77,251 0 0 0 5,370
Minnesota Tax-Free Income Fund 20,442 225 0 1,669 4,688
</TABLE>

CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
- --------------------------------------------------------------------------------

The following persons owned of record or beneficially 5% or more of the
respective Fund's outstanding shares as of April 29, 1998:

<TABLE>
<CAPTION>
Record Beneficially Of Record &
Person Only Only Beneficially
- ------ ------ ------------ ------------
<S> <C> <C> <C>
MONEY MARKET FUND
Bongards Creameries Cooperative
Attn: Matt Quade, 13200 County Road 51, Norwood, MN 5%

Christ Presbyterian Church
Building Fund, 6901 Normandale Road, Edina, MN 6%

Metropolitan Sports Facilities Commission
900 South 5th Street, Minneapolis, MN 17%

U.S. GOVERNMENT SECURITIES FUND
Charles Schwab & Company, Inc., Special Custody Account for
Benefit Cust, 101 Montgomery Street, San Francisco, CA 35%
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
Record Beneficially Of Record &
Person Only Only Beneficially
- ------ ------ ------------ ------------
<S> <C> <C> <C>
U.S. GOVERNMENT SECURITIES FUND
National Financial Services Corporation for
Benefit Cust, P.O. Box 3908, New York, NY 9%

BOND FUND
Charles Schwab & Company, Inc., Special Custody Account for
Benefit Cust, 101 Montgomery Street, San Francisco, CA 15%

Northern Trust Cust IRA Rollover for Benefit Cust, S. Walter Richey,
900 2nd Avenue S. Ste. 1800, Minneapolis, MN 9%

Northern Trust Cust IRA Rollover for Benefit Cust, Frank R. Zimmerman,
4291 Maitland Road, P.O. Box 87, Acme, MI 8%

Norwest Bank MN NA, Cust Victor C. Wallestad,
733 Marquette Avenue MS 0036, Minneapolis, MN 33%

TAX-FREE INCOME FUND
Charles Schwab & Company, Inc., Special Custody Account for
Benefit Cust, 101 Montgomery Street, San Francisco, CA 21%

National Financial Services Corporation for
Benefit Cust, P.O. Box 3908, New York, NY 6%

MINNESOTA TAX-FREE INCOME FUND
Charles Schwab & Company, Inc., Special Custody Account for
Benefit Cust, 101 Montgomery Street, San Francisco, CA 12%

Kenneth B. Heithoff
2015 James Avenue S., Minneapolis, MN 5%
</TABLE>

TAXES
- --------------------------------------------------------------------------------

The tax status of the Funds and the distributions which they may make are
summarized in the prospectus in the section entitled "Taxes." Each Fund intends
to fulfill the requirements of Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"), as a regulated investment company. If so
qualified, each Fund will not be liable for federal income taxes to the extent
it distributes its taxable income to its shareholders.

To qualify under Subchapter M for tax treatment as a regulated investment
company, each Fund must, among other things: (1) distribute to its shareholders
at least 90% of its investment company taxable income (as that term is defined
in the Code determined without regard to the deduction for dividends paid) and
90% of its net tax-exempt income; (2) derive at least 90% of its gross income
from dividends, interest, payments with respect to securities loans, gains from
the sale or other disposition of stock or securities, or other income derived
with respect to its business of investing in such stock, securities, or
currency, and (3) diversify its holdings so that, at the end of each fiscal
quarter of the Fund, (a) at least 50% of the market value of the Fund's assets
is represented by cash, cash items, United States Government securities and
securities of other regulated investment companies, and other securities, with
these other securities limited, with respect to any one issuer, to an amount no
greater than 5% of the Fund's total assets and no greater than 10% of the
outstanding voting securities of such issuer, and (b) not more than 25% of the
market value of the Fund's total assets is invested in the securities of any one
issuer (other than United States Government securities or securities of other
regulated investment companies).

<PAGE>

Each Fund is subject to a non-deductible excise tax equal to 4% of the excess,
if any, of the amount required to be distributed for each calendar year over the
amount actually distributed. In order to avoid the imposition of this excise
tax, each Fund must declare and pay dividends representing 98% of its net
investment income for that calendar year and 98% of its capital gains (both
long-term and short-term) for the twelve-month period ending October 31 of the
calendar year.

When shares of a Fund are sold or otherwise disposed of, the Fund shareholder
will realize a capital gain or loss equal to the difference between the purchase
price and the sale price of the shares disposed of, if, as is usually the case,
the Fund shares are a capital asset in the hands of the Fund shareholder. In
addition, pursuant to a special provision in the Code, if Fund shares with
respect to which a long-term capital gain distribution has been made are held
for six months or less, any loss on the sale or other disposition of such shares
will be a long-term capital loss to the extent of such long-term capital gain
distribution. Any loss on the sale or exchange of shares of the Tax-Free Income
Fund or the Minnesota Tax-Free Income Fund held for six months or less (although
regulations may reduce this time period to 31 days) will be disallowed for
federal income tax purposes to the extent of the amount of any exempt-interest
dividend received with respect to such shares. Certain deductions otherwise
allowable to financial institutions and property and casualty insurance
companies will be eliminated or reduced by reason of the receipt of certain
exempt-interest dividends.

Any loss on the sale or exchange of shares of a Fund generally will be
disallowed to the extent that a shareholder acquires or contracts to acquire
shares of the same Fund within 30 days before or after such sale or exchange.

Under the Code, interest on indebtedness incurred or continued to purchase or
carry shares of an investment company paying exempt-interest dividends, such as
the Tax-Free Income Fund or the Minnesota Tax-Free Income Fund, will not be
deductible by a shareholder in proportion to the ratio of exempt-interest
dividends to all dividends other than those treated as long-term capital gains.
Indebtedness may be allocated to shares of the Tax-Free Income Fund or the
Minnesota Tax-Free Income Fund even though not directly traceable to the
purchase of such shares. Federal law also restricts the deductibility of other
expenses allocable to shares of such Fund.

The Tax-Free Income Fund and the Minnesota Tax-Free Income Fund intend to take
all actions required under the Code to ensure that each Fund may pay
"exempt-interest dividends." Distributions of net interest income from
tax-exempt obligations that are designated by the Funds as exempt-interest
dividends are excludable from the gross income of the Funds' shareholders. The
Funds' present policy is to designate exempt-interest dividends annually. The
Funds will calculate exempt-interest dividends based on the average annual
method and the percentage of income designated as tax-exempt for any particular
distribution may be substantially different from the percentage of income that
was tax-exempt during the period covered by the distribution. Shareholders are
required for information purposes to report exempt-interest dividends and other
tax-exempt interest on their tax return. Distributions paid from other taxable
interest income and from any net realized short-term capital gains will be
taxable to shareholders as ordinary income, whether received in cash or in
additional shares.

For federal income tax purposes, an alternative minimum tax ("AMT") is imposed
on taxpayers to the extent that such tax exceeds a taxpayer's regular income tax
liability (with certain adjustments). Exempt-interest dividends attributable to
interest income on certain tax-exempt obligations issued after August 7, 1986 to
finance certain private activities are treated as an item of tax preference that
is included in alternative minimum taxable income for purposes of computing the
federal AMT for all taxpayers and the federal environmental tax on corporations.
The Tax-Free Income Fund and Minnesota Tax-Free Income Fund may each invest up
to 20% of its net assets in securities that generate interest that is treated as
an item of tax preference. In addition, a portion of all other tax-exempt
interest received by a corporation, including exempt-interest dividends, will be
included in adjusted current earnings and in earnings and profits for purposes
of determining the federal corporate AMT and the branch profits tax imposed on
foreign corporations under Section 884 of the Code.

Because liability for the AMT depends upon the regular tax liability and tax
preference items of a specific taxpayer, the extent, if any, to which any tax
preference items resulting from investment in the Tax-Free Income Fund or the
Minnesota Tax-Free Income Fund will be subject to the tax will depend upon each
shareholder's individual situation. For shareholders with substantial tax
preferences, the AMT could reduce the after-tax economic benefits of an
investment in the Tax-Free

<PAGE>

Income Fund or the Minnesota Tax-Free Income Fund. Each shareholder is advised
to consult his or her tax adviser with respect to the possible effects of such
tax preference items.

In addition, shareholders who are or may become recipients of Social Security
benefits should be aware that exempt-interest dividends are includable in
computing "modified adjusted gross income" for purposes of determining the
amount of Social Security benefits, if any, that is required to be included in
gross income. The maximum amount of Social Security benefits includable in gross
income is 85%.

The Tax Reform Act of 1986 imposed new requirements on certain tax-exempt bonds
which, if not satisfied, could result in loss of tax exemption for interest on
such bonds, even retroactively to the date of issuance of the bonds. Proposals
may be introduced before Congress in the future, the purpose of which will be to
further restrict or eliminate the federal income tax exemption for tax-exempt
securities. The Tax-Free Income Fund and the Minnesota Tax-Free Income Fund
cannot predict what additional legislation may be enacted that may affect
shareholders. The Funds will avoid investment in tax-exempt securities which, in
the opinion of the investment adviser, pose a material risk of the loss of tax
exemption. Further, if a tax-exempt security in a Fund's portfolio loses its
exempt status, the Fund will make every effort to dispose of such investment on
terms that are not detrimental to the Fund.

If the Funds invest in zero coupon obligations upon their issuance, such
obligations will have original issue discount in the hands of the Fund.
Generally, the original issue discount equals the difference between the "stated
redemption price at maturity" of the obligation and its "issue price" as those
terms are defined in the Code. If a Fund acquires an already issued zero coupon
bond from another holder, the bond will have original issue discount in the
Fund's hands, equal to the difference between the "adjusted issue price" of the
bond at the time a Fund acquires it (that is, the original issue price of the
bond plus the amount of original issue discount accrued to date) and its stated
redemption price at maturity. In each case, a Fund is required to accrue as
ordinary interest income a portion of such original issue discount even though
it receives no cash currently as interest payment on the obligation.
Furthermore, if a Fund invests in U.S. Treasury inflation-protection securities,
it will be required to treat as original issue discount any increase in the
principal amount of the securities that occurs during the course of its taxable
year. If a Fund purchases such inflation-protection securities that are issued
in stripped form either as stripped bonds or coupons, it will be treated as if
it had purchased a newly issued debt instrument having original issue discount.

Because each Fund is required to distribute substantially all of its net
investments income (including accrued original issue discount), a Fund investing
in either zero coupon bonds or U.S. Treasury inflation protection securities may
be required to distribute to shareholders an amount greater than the total cash
income it actually receives. Accordingly, in order to make the required
distributions, the Fund may be required to borrow or to liquidate securities.

The foregoing relates only to federal income taxation and is a general summary
of the federal tax law in effect as of the date of this Statement of Additional
Information.

MINNESOTA INCOME TAXATION - MINNESOTA TAX-FREE INCOME FUND
- --------------------------------------------------------------------------------
Minnesota taxable net income is based generally on federal taxable income. The
portion of exempt-interest dividends paid by the Minnesota Tax-Free Income Fund
that is derived from interest on Minnesota tax exempt obligations is excluded
from the Minnesota taxable net income of individuals, estates and trusts,
provided that the portion of the exempt-interest dividends from such Minnesota
sources paid to all shareholders represents 95% or more of the exempt-interest
dividends paid by the Fund. The remaining portion of such dividends, and
dividends that are not exempt-interest dividends or capital gain dividends, are
included in the Minnesota taxable net income of individuals, estates and trusts,
except for dividends directly attributable to interest on obligations of the
U.S. government, its territories and possessions. Exempt-interest dividends are
not excluded from the Minnesota taxable income of corporations and financial
institutions. Dividends qualifying for federal income tax purposes as capital
gain dividends are to be treated by shareholders as long-term capital gains.
Minnesota has repealed the favorable treatment of long-term capital gains, while
retaining restrictions on the deductibility of capital losses. Exempt-interest
dividends attributable to interest on certain private activity bonds issued
after August 7, 1986 will be included in Minnesota alternative minimum taxable
income of individuals, estates and trusts for

<PAGE>

purposes of computing Minnesota's alternative minimum tax. Dividends generally
will not qualify for the dividends-received deduction for corporations and
financial institutions.

The 1995 Minnesota Legislature has enacted a statement of intent that interest
on obligations of Minnesota governmental units and Indian tribes be included in
net income of individuals, estates and trusts for Minnesota income tax purposes
if a court determines that Minnesota's exemption of such interest unlawfully
discriminates against interstate commerce because interest on obligations of
governmental issuers located in other states is so included. This provision
applies to taxable years that begin during or after the calendar year in which
any such court decision becomes final, irrespective of the date on which the
obligations were issued. Minnesota Tax-Free Income Fund is not aware of any
decision in which a court has held that a state's exemption of interest on its
own bonds or those of its political subdivisions or Indian tribes, but not of
interest on the bonds of other states or their political subdivisions or Indian
tribes, unlawfully discriminates against interstate commerce or otherwise
contravenes the United States Constitution. Nevertheless, the Fund cannot
predict the likelihood that interest on the Minnesota bonds held by the Fund
would become taxable under this Minnesota statutory provision.

FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------

The information contained in the financial statements and annual reports to
shareholders of the Funds is incorporated by reference in this Statement of
Additional Information.

OTHER INFORMATION
- --------------------------------------------------------------------------------

CUSTODIAN; COUNSEL; ACCOUNTANTS
- --------------------------------------------------------------------------------
The Northern Trust Co., 50 South LaSalle Street, Chicago, IL 60675 acts as
custodian of the Funds' assets and portfolio securities; Dorsey & Whitney LLP,
220 South Sixth Street, Minneapolis, Minnesota 55402, is the independent General
Counsel for the Funds; and KPMG Peat Marwick LLP, 4200 Norwest Center,
Minneapolis, Minnesota 55402, acts as the Funds' independent accountants.

LIMITATION OF DIRECTOR LIABILITY
- --------------------------------------------------------------------------------

Under Minnesota law, each director of the Funds owes certain fiduciary duties to
the Funds and to their shareholders. Minnesota law provides that a director
"shall discharge the duties of the position of director in good faith, in a
manner the director reasonably believes to be in the best interest of the
corporation, and with the care an ordinarily prudent person in a like position
would exercise under similar circumstances." Fiduciary duties of a director of a
Minnesota corporation include, therefore, both a duty of "loyalty" (to act in
good faith and act in a manner reasonably believed to be in the best interests
of the corporation) and a duty of "care" (to act with the care an ordinarily
prudent person in a like position would exercise under similar circumstances).
Minnesota law authorizes corporations to eliminate or limit the personal
liability of a director to the corporation or its shareholders for monetary
damages for breach of the fiduciary duty of "care". Minnesota law does not,
however, permit a corporation to eliminate or limit the liability of a director
(i) for any breach of the directors' duty of "loyalty" to the corporation or its
shareholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for authorizing a
dividend, stock repurchase or redemption or other distribution in violation of
Minnesota law or for violation of certain provisions of Minnesota securities
laws or (iv) for any transaction from which the director derived an improper
personal benefit. The Articles of Incorporation of the Company limit the
liability of directors to the fullest extent permitted by Minnesota statutes,
except to the extent that such liability cannot be limited as provided in the
Investment Company Act of 1940 (which Act prohibits any provisions which purport
to limit the liability of directors arising from such directors' willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of their role as directors).

Minnesota law does not eliminate the duty of "care" imposed upon a director. It
only authorizes a corporation to eliminate monetary liability for violations of
that duty. Minnesota law, further, does not permit elimination or limitation of
liability of "officers" to the corporation for breach of their duties as
officers (including the liability of directors who serve as officers for breach
of their duties as officers). Minnesota law does not permit elimination or
limitation of the availability of equitable relief, such as injunctive or
rescissionary relief. Further, Minnesota law does not permit elimination or
limitation of a

<PAGE>

director's liability under the Securities Act of 1933 or the Securities Exchange
Act of 1934, and it is uncertain whether and to what extent the elimination of
monetary liability would extend to violations of duties imposed on directors by
the Investment Company Act of 1940 and the rules and regulations adopted under
such Act.

The Funds are not required under Minnesota law to hold annual or periodically
scheduled meetings of shareholders. Minnesota corporation law provides for the
Board of Directors to convene shareholder meetings when it deems appropriate.
However, the Funds intend to hold meetings of shareholders annually. In
addition, if a regular meeting of shareholders has not been held during the
immediately preceding fifteen months, a shareholder or shareholders holding
three percent or more of the voting shares of the Funds may demand a regular
meeting of shareholders by written notice of demand given to the chief executive
officer or the chief financial officer of the Funds. Within ninety days after
receipt of the demand, a regular meeting of shareholders must be held at the
expense of the Funds. Irrespective of whether a regular meeting of shareholders
has been held during the immediately preceding fifteen months, in accordance
with Section 16(c) under the 1940 Act, the Board of Directors of the Funds shall
promptly call a meeting of shareholders for the purpose of voting upon the
question of removal of any director when requested in writing so to do by the
record holders of not less than 10 percent of the outstanding shares.
Additionally, the 1940 Act requires shareholder votes for all amendments to
fundamental investment policies and restrictions and for all investment advisory
contracts and amendments thereto. The Funds will assist in communications with
other shareholders as required by Section 16(c) of the 1940 Act.

<PAGE>

APPENDIX A
BOND AND COMMERCIAL PAPER RATINGS

BOND RATINGS
MOODY'S INVESTORS SERVICE, INC.
Rating Definition
------ ----------
Aaa Judged to be the best quality, carry the smallest degree of
investment risk
Aa Judged to be of high quality by all standards
A Possess many favorable investment attributes and are to be
considered as higher medium grade obligations
Baa Medium grade obligations. Lack outstanding investment
characteristics.
Ba Judged to have speculative elements. Protection of interest
and principal payments may be very moderate.
B Generally lack characteristics of a desirable investment.
Assurance of interest and principal payments over any long
period of time may be small.
Moody's also applies numerical indicators, 1, 2, and 3, to rating
categories Aa through Ba. The modifier 1 indicates that the security is
in the higher end of the rating category; the modifier 2 indicates a
mid-range ranking; and 3 indicates a ranking toward the lower end of the
category.

STANDARD & POOR'S CORPORATION
Rating Definition
------ ----------
AAA Highest grade obligations and possess the ultimate degree of
protection as to principal and interest
AA Also qualify as high grade obligations, and in the majority of
instances differ from AAA issues only in small degree
A Regarded as upper medium grade, have considerable investment
strength but are not entirely free from adverse effects of
changes in economic and trade conditions, interest and
principal are regarded as safe
BBB Considered investment grade with adequate capacity to pay
interest and repay principal.
BB Judged to be speculative with some inadequacy to meet timely
interest and principal payments.
B Has greater vulnerability to default than other speculative
grade securities. Adverse economic conditions will likely
impair capacity or willingness to pay interest and principal.

Standard & Poor's applies indicators "+", no character, and "-" to the
above rating categories AA through B. The indicators show relative
standing within the major rating categories.

FITCH IBCA
Rating Definition
------ ----------
AAA Highest credit quality with exceptional ability to pay
interest and repay principal
AA Investment grade and very high credit quality ability to pay
interest and repay principal is very strong, although not
quite as strong as AAA
A Investment grade with high credit quality. Ability to pay
interest and repay principal is strong.
BBB Investment grade and has satisfactory credit quality. Adequate
ability to pay interest and repay principal.
BB Considered speculative. Ability to pay interest and repay
principal may be affected over time by adverse economic
changes.
B Considered highly speculative. Currently meeting interest and
principal obligations, but probability of continued payment
reflects limited margin of safety.
+ and - indicators indicate the relative position within the rating
category, but are not used in AAA category.

DUFF & PHELPS CREDIT RATING CO.
Rating Definition
------ ----------
AAA Highest credit quality, risk factors are negligible
AA High credit quality with moderate risk
A Protection factors are average but adequate, however, risk
factors are more variable and greater in periods of economic
stress
BBB Below average protection factors, but still considered
sufficient for prudent investment
BB Below investment grade but likely to meet obligations when
due.
B Below investment grade and possessing risk that obligations
will not be met when due.

<PAGE>

+ and - indicators indicate the relative position within the rating
category, but are not used in AAA category.

COMMERCIAL PAPER RATINGS
MOODY'S
Commercial paper rated "Prime" carries the smallest degree of investment
risk. The modifiers 1, 2, and 3 are used to denote relative strength
within this highest classification.

STANDARD & POOR'S
The rating A-1 is the highest commercial paper rating assigned by
Standard & Poor's Corporation. The modifier "+" indicates that the
security is in the higher end of this rating category.

FITCH IBCA
F-1+ Exceptionally strong credit quality
F-1 Strong credit quality

DUFF & PHELPS
Category 1 (top grade):
Duff1+ Highest certainty of timely payment
Duff1 Very high certainty of timely payment
Duff1- High certainty of timely payment

<PAGE>

APPENDIX B
MUNICIPAL BOND, MUNICIPAL NOTE AND TAX-EXEMPT COMMERCIAL PAPER RATINGS

MUNICIPAL BOND RATINGS
STANDARD & POOR'S CORPORATION:
Rating Definition
------ ----------
AAA Highest rating; extremely strong security.
AA Very strong security; differs from AAA in only a small degree.
A Strong capacity but more susceptible to adverse economic
effects than two above categories.
BBB Adequate capacity but adverse economic conditions more likely
to weaken capacity.
Standard & Poor's applies indicators "+", no character, and "-" to the
above rating categories AA through B. The indicators show relative
standing within the major rating categories.

MOODY'S INVESTORS SERVICES, INC.:
Rating Definition
------ ----------
Aaa Best quality; carry the smallest degree of investment risk.
Aa High quality; margins of protection not quite as large as the
Aaa bonds.
A Upper medium grade; security adequate but could be susceptible
to impairment.
Baa Medium grade; neither highly protected nor poorly
secured--lack outstanding investment characteristics and
sensitive to changes in economic circumstances.
Moody's also applies numerical indicators, 1, 2, and 3, to rating
categories Aa through Ba. The modifier 1 indicates that the security is
in the higher end of the rating category; the modifier 2 indicates a
mid-range ranking; and 3 indicates a ranking toward the lower end of the
category.

FITCH IBCA:
Rating Definition
------ ----------
AAA Highest credit quality with exceptional ability to pay
interest and repay principal
AA Investment grade and very high credit quality ability to pay
interest and repay principal is very strong, although not
quite as strong as AAA
A Investment grade with high credit quality. Ability to pay
interest and repay principal is strong.
BBB Investment grade and has satisfactory credit quality. Adequate
ability to pay interest and repay principal.
BB Considered speculative. Ability to pay interest and repay
principal may be affected over time by adverse economic
changes.
B Considered highly speculative. Currently meeting interest and
principal obligations, but probability of continued payment
reflects limited margin of safety.
+ and - indicators indicate the relative position within the rating
category, but are not used in AAA category.

DUFF & PHELPS CREDIT RATING CO.:
Rating Definition
------ ----------
AAA Highest credit quality, risk factors are negligible
AA High credit quality with moderate risk
A Protection factors are average but adequate, however, risk
factors are more variable and greater in periods of economic
stress
BBB Below average protection factors, but still considered
sufficient for prudent investment
BB Below investment grade but likely to meet obligations when
due.
B Below investment grade and possessing risk that obligations
will not be met when due.
+ and - indicators indicate the relative position within the rating
category, but are not used in AAA category.

MUNICIPAL NOTE RATINGS
STANDARD & POOR'S CORPORATION:
Rating Definition
------ ----------
SP-1 Very strong or strong capacity to pay principal and interest.
Those issues determined to possess overwhelming safety
characteristics will be given a plus (+) designation.

<PAGE>

SP-2 Satisfactory capacity to pay principal and interest.

MOODY'S INVESTORS SERVICE, INC.:
Rating* Definition
------ ----------
MIG 1 Best quality
MIG 2 High quality
MIG 3 Favorable quality
MIG 4 Adequate quality

* A short-term issue having a demand feature, i.e., payment relying on
external liquidity and usually payable upon demand rather than fixed
maturity dates, is differentiated by Moody's with the use of the
symbols VMIG1 through VMIG4.

TAX-EXEMPT COMMERCIAL PAPER RATINGS
STANDARD & POOR'S CORPORATION:
Rating Definition
------ ----------
A-1+ Highest degree of safety.
A-1 Very strong degree of safety.

MOODY'S INVESTORS SERVICE, INC.:
Rating Definition
------ ----------
Prime 1(P-1) Superior capacity for repayment.