<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 20, 1996.
SECURITIES ACT FILE NO. 2-92366
INVESTMENT COMPANY ACT FILE NO. 811-4077
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. [_]
POST-EFFECTIVE AMENDMENT NO. 13 [X]
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT
OF 1940 [X]
AMENDMENT NO. 14 [X]
(CHECK APPROPRIATE BOX OR BOXES)
----------------
MERRILL LYNCH FEDERAL SECURITIES TRUST
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
800 SCUDDERS MILL ROAD 08536
PLAINSBORO, NEW JERSEY (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (609) 282-2800
ARTHUR ZEIKEL
MERRILL LYNCH FEDERAL SECURITIES TRUST
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
----------------
COPIES TO:
Counsel for the Fund: PHILIP L. KIRSTEIN, ESQ.
FUND ASSET
BROWN & WOOD LLP
ONE WORLD TRADE CENTER MANAGEMENT, L.P.
NEW YORK, NEW YORK 10048 P.O. BOX 9011
ATTENTION: THOMAS R. SMITH, JR. PRINCETON, NEW JERSEY 08543-9011
----------------
IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE (CHECK
APPROPRIATE BOX)
[X] immediately upon filing pursuant to paragraph (b)
[_] on (date) pursuant to paragraph (b)
[_] 60 days after filing pursuant to paragraph (a)(1)
[_] on (date) pursuant to paragraph (a)(1)
[_] 75 days after filing pursuant to paragraph (a)(2)
[_] on (date) pursuant to paragraph (a)(2) of rule 485.
IF APPROPRIATE, CHECK THE FOLLOWING BOX:
[_] this post-effective amendment designates a new effective
date for a previously filed post-effective amendment.
THE REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OF ITS SHARES OF
BENEFICIAL INTEREST UNDER THE SECURITIES ACT OF 1933 PURSUANT TO RULE 24f-2
UNDER THE INVESTMENT COMPANY ACT OF 1940. THE NOTICE REQUIRED BY SUCH RULE FOR
THE REGISTRANT'S MOST RECENT FISCAL YEAR WAS FILED ON OCTOBER 22, 1996.
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PROPOSED
PROPOSED MAXIMUM
AMOUNT OF MAXIMUM AGGREGATE AMOUNT OF
TITLE OF SECURITIES SHARES BEING OFFERING PRICE OFFERING REGISTRATION
BEING REGISTERED REGISTERED PER UNIT PRICE(1) FEE
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Shares of Beneficial Interest
(par value $.10 per share)...... 94,433,707 $9.97 $329,997 $100
- ---------------------------------------------------------------------------------------------
</TABLE>
- -------------------------------------------------------------------------------
(1) The calculation of the maximum aggregate offering price is made pursuant
to Rule 24e-2 under the Investment Company Act of 1940.
(2) The total amount of securities redeemed or repurchased during Registrant's
previous fiscal year was 94,400,608 Shares of Beneficial Interest.
(3) None of the Shares described in (2) above have been used for reduction
pursuant to Rule 24e-2(a) or Rule 24f-2(c) under the Investment Company
Act of 1940 in previous filings during Registrant's current fiscal year.
(4) 94,400,608 of the Shares redeemed during Registrant's previous fiscal year
are being used for the reduction of the registration fee in this amendment
to the Registration Statement.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
MERRILL LYNCH FEDERAL SECURITIES TRUST
REGISTRATION STATEMENT ON FORM N-1A
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
N-1A ITEM NO. LOCATION
------------- --------
PART A
<C> <S> <C>
Item 1. Cover Page.............. Cover Page
Item 2. Synopsis................ Not Applicable
Item 3. Condensed Financial
Information............ Financial Highlights
Item 4. General Description of
Registrant............. Investment Objective and Policies;
Additional Information
Item 5. Management of the Fund.. Fee Table; Management of the Fund;
Portfolio Transactions;
Inside Back Cover Page
Item 5A. Management's Discussion
of Fund Performance.... Not Applicable
Item 6. Capital Stock and Other
Securities............. Cover Page; Additional Information
Item 7. Purchase of Securities
Being Offered.......... Cover Page; Fee Table; Merrill Lynch Select
Pricing/SM/ System; Purchase of Shares;
Shareholder Services; Additional
Information; Inside Back Cover Page
Item 8. Redemption or
Repurchase............. Fee Table; Merrill Lynch Select Pricing/SM/
System; Purchase of Shares; Redemption of
Shares
Item 9. Pending Legal
Proceedings............ Not Applicable
PART B
Item 10. Cover Page.............. Cover Page
Item 11. Table of Contents....... Back Cover Page
Item 12. General Information and
History................ Not Applicable
Item 13. Investment Objectives
and Policies........... Investment Objective and Policies
Item 14. Management of the Fund.. Management of the Fund
Item 15. Control Persons and
Principal Holders of
Securities............. Management of the Fund
Item 16. Investment Advisory and
Other Services......... Management of the Fund; Purchase of Shares;
General Information
Item 17. Brokerage Allocation and
Other Services......... Portfolio Transactions and Brokerage
Item 18. Capital Stock and Other
Securities............. General Information
Item 19. Purchase, Redemption and
Pricing of Securities
Being Offered.......... Purchase of Shares; Redemption of Shares;
Determination of Net Asset Value;
Shareholder Services
Item 20. Tax Status.............. Dividends, Distributions and Taxes
Item 21. Underwriters............ Purchase of Shares
Item 22. Calculation of
Performance Data....... Performance Data
Item 23. Financial Statements.... Financial Statements
</TABLE>
PART C
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
PROSPECTUS
DECEMBER 20, 1996
MERRILL LYNCH FEDERAL SECURITIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
---------------
Merrill Lynch Federal Securities Trust (the "Fund") is a mutual fund seeking
a high current return through investments in U.S. Government and Government
agency securities, including Government National Mortgage Association ("GNMA")
mortgage-backed certificates and other mortgage-backed government securities.
The Fund may seek to enhance its return through the use of certain portfolio
strategies involving options and to hedge its portfolio through the use of
options and futures transactions. The Fund will declare dividends daily and pay
them monthly from its net investment income. The Fund's current return consists
of interest, premiums from expired call and put options, any short-term gains
from sales of portfolio securities on exercise of options or otherwise, and any
gains from closing purchase or sale transactions. There can be no assurance
that the investment objective of the Fund will be realized. For more
information on the Fund's investment objective and policies, please see
"Investment Objective and Policies" on page 10.
Pursuant to the Merrill Lynch Select PricingSM System, the Fund offers four
classes of shares, each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. As a
result of the implementation of the Merrill Lynch Select PricingSM System,
Class A shares of the Fund outstanding prior to October 21, 1994, have been
redesignated Class D shares. The Class A shares offered by this Prospectus
differ from the Class A shares offered prior to October 21, 1994, in many
respects, including sales charges, exchange privilege and the classes of
persons to whom such shares are offered. See "Merrill Lynch Select PricingSM
System" on page 4.
Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9081, Princeton, New Jersey 08543-9081 [(609)
282-2800], or from securities dealers which have entered into selected dealer
agreements with the Distributor including Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch"). The minimum initial purchase is $1,000 and the
minimum subsequent purchase is $50, except that for retirement plans the
minimum initial purchase is $100 and the minimum subsequent purchase is $1.
Merrill Lynch may charge its customers a processing fee (presently $4.85) for
confirming purchases and repurchases. Purchases and redemptions directly
through the Fund's transfer agent are not subject to the processing fee. See
"Purchase of Shares" and "Redemption of Shares".
---------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
---------------
This Prospectus is a concise statement of information about the Fund that is
relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated December 20, 1996 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission (the
"Commission") and is available, without charge, by calling or by writing the
Fund at the above telephone number or address. The Statement of Additional
Information is hereby incorporated by reference into this Prospectus.
---------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(a) CLASS B(b) CLASS C CLASS D
---------- ------------------------------- -------- -------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION
EXPENSES:
Maximum Sales Charge
Imposed on Purchases
(as a percentage of
offering price)....... 4.00%(c) None None 4.00%(c)
Sales Charge Imposed
on Dividend
Reinvestments......... None None None None
Deferred Sales Charge
(as a percentage of
original purchase
price or redemption
proceeds, whichever
is lower)............. None(d) 4.00% during the first year, 1.0% for None(d)
decreasing 1.0% annually one year(f)
thereafter to 0.0% after the
fourth year(e)
Exchange Fee........... None None None None
ANNUAL FUND OPERATING
EXPENSES (AS A
PERCENTAGE OF AVERAGE
NET ASSETS)
Management Fees(g)..... 0.46% 0.46% 0.46% 0.46%
12b-1 Fees(h):
Account Maintenance
Fees................ None 0.25% 0.25% 0.25%
Distribution Fees.... None 0.50% 0.55% None
(Class B shares convert to
Class D shares automatically
after approximately ten years
and cease being subject to
distribution fees)
Other Expenses:
Custodial Fees....... 0.02% 0.02% 0.02% 0.02%
Shareholder Servicing
Costs(i)............ 0.12% 0.14% 0.13% 0.12%
Other................ 0.02% 0.02% 0.02% 0.02%
---- ---- ---- ----
Total Other 0.16% 0.18% 0.17% 0.16%
Expenses.......... ---- ---- ---- ----
TOTAL FUND OPERATING 0.62% 1.39% 1.43% 0.87%
EXPENSES.............. ==== ==== ==== ====
</TABLE>
- --------
(a) Class A shares are sold to a limited group of investors including certain
retirement plans and certain participants in fee-based programs. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class
D Shares"--page 23 and "Shareholder Services--Fee-Based Programs"--page
35.
(b) Class B shares convert to Class D shares automatically approximately ten
years after initial purchase. See "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares"--page 25.
2
<PAGE>
(c) Reduced for purchases of $25,000 and over, and waived for purchases of
Class A shares by certain retirement plans in connection with certain fee-
based programs. Class A or Class D purchases of $1,000,000 or more may not
be subject to an initial sales charge. See "Purchase of Shares--Initial
Sales Charge Alternatives--Class A and Class D Shares"--page 23.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more which
are not subject to an initial sales charge may instead be subject to a
CDSC of 1.0% of amounts redeemed within the first year after purchase.
Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder Services--
Fee-Based Programs"--page 35.
(e) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder Services--
Fee-Based Programs"--page 35.
(f) The CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder Services--
Fee-Based Programs"--page 35.
(g) See "Management of the Fund--Management and Advisory Arrangements"--page
20.
(h) See "Purchase of Shares--Distribution Plans"--page 29.
(i) See "Management of the Fund--Transfer Agency Services"--page 21.
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID
FOR THE PERIOD OF:
-------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses
on a $1,000 investment including the maximum
$40.00 initial sales charge (Class A and
Class D shares only) and assuming (1) the To-
tal Fund Operating Expenses for each class
set forth on page 2, (2) a 5% annual return
throughout the periods and (3) redemption at
the end of the period:
Class A..................................... $46 $59 $73 $114
Class B..................................... $54 $64 $76 $167
Class C..................................... $25 $45 $78 $171
Class D..................................... $49 $67 $86 $143
An investor would pay the following expenses
on the same $1,000 investment assuming no re-
demption at the end of the period:
Class A..................................... $46 $59 $73 $114
Class B..................................... $14 $44 $76 $167
Class C..................................... $15 $45 $78 $171
Class D..................................... $49 $67 $86 $143
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The Example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Securities and Exchange Commission regulations. THE EXAMPLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR ANNUAL RATES OF
RETURN AND ACTUAL EXPENSES AND ANNUAL RATES OF RETURN MAY BE MORE OR LESS THAN
THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE. Class B and Class C shareholders
who hold their shares for an extended period of time may pay more in Rule 12b-
1 distribution fees than the economic equivalent of the maximum front-end
sales charges permitted under the Conduct Rules of the National Association of
Securities Dealers, Inc. (the "NASD"). Merrill Lynch may charge its customers
a processing fee (presently $4.85) for confirming purchases and repurchases.
Purchases and redemptions directly through the Fund's transfer agent are not
subject to the processing fee. See "Purchase of Shares" and "Redemption of
Shares".
3
<PAGE>
MERRILL LYNCH SELECT PRICINGSM SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
PricingSM System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D
are sold to investors choosing the initial sales charge alternatives, and
shares of Class B and Class C are sold to investors choosing the deferred
sales charge alternatives. The Merrill Lynch Select Pricing SM System is used
by more than 50 registered investment companies advised by Merrill Lynch Asset
Management, L.P. ("MLAM") or its affiliate, Fund Asset Management, L.P. ("FAM"
or the "Manager"). Funds advised by MLAM or FAM which use the Merrill Lynch
Select Pricing SM System are referred to herein as "MLAM-advised mutual
funds".
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The deferred sales charges, distribution and account maintenance fees that are
imposed on Class B and Class C shares, as well as the account maintenance fees
that are imposed on the Class D shares, are imposed directly against those
classes and not against all assets of the Fund and, accordingly, such charges
do not affect the net asset value of any other class or have any impact on
investors choosing another sales charge option. Dividends paid by the Fund for
each class of shares are calculated in the same manner at the same time and
will differ only to the extent that account maintenance and distribution fees
and any incremental transfer agency costs relating to a particular class are
borne exclusively by that class. Each class has different exchange privileges.
See "Shareholder Services--Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The distribution-
related revenues paid with respect to a class will not be used to finance the
distribution expenditures of another class. Sales personnel may receive
different compensation for selling different classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing SM System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing SM System that the investor
believes is most beneficial under his or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase
of Shares".
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION CONVERSION
CLASS SALES CHARGE(/1/) FEE FEE FEATURE
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/)(/3/)
- ---------------------------------------------------------------------------------------------
B CDSC for a period of 4 0.25% 0.50% B shares convert to D
years, at a rate of 4.0% during shares automatically
the first year, decreasing 1.0% after approximately ten
annually to 0.0%(/4/) years(/5/)
- ---------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(/6/) 0.25% 0.55% No
- ---------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales
charge(/3/) 0.25% No No
- ---------------------------------------------------------------------------------------------
</TABLE>
4
<PAGE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. Contingent deferred sales charges ("CDSCs") are
imposed if the redemption occurs within the applicable CDSC time period.
The charge will be assessed on an amount equal to the lesser of the
proceeds of redemption or the cost of the shares being redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares--Eligible Class A
Investors".
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class
A shares by certain retirement plans in connection with certain fee-based
programs. Class A and Class D share purchases of $1,000,000 or more may
not be subject to an initial sales charge but instead may be subject to a
1.0% CDSC if redeemed within one year. Such CDSC may be waived in
connection with redemptions to fund participation in certain fee-based
programs. A 0.75% sales charge for 401(k) purchases over $1,000,000 will
apply. See "Class A" and "Class D" below.
(4) Such CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and the conversion
and holding periods for certain retirement plans are modified. Also, Class
B shares of certain other MLAM-advised mutual funds into which exchanges
may be made have an eight-year conversion period. If Class B shares of the
Fund are exchanged for Class B shares of another MLAM-advised mutual fund,
the conversion period applicable to the Class B shares acquired in the
exchange will apply, and the holding period for the shares exchanged will
be tacked onto the holding period for the shares acquired.
(6) The CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs.
Class A:
Class A shares of the Fund incur an initial sales charge when they
are purchased and bear no ongoing distribution or account
maintenance fees. Class A shares of the Fund are offered to a
limited group of investors and also will be issued upon
reinvestment of dividends on outstanding Class A shares of the
Fund. Eligible investors include certain retirement plans and
participants in certain fee-based programs. In addition, Class A
shares of the Fund will be offered to directors and employees of
Merrill Lynch & Co., Inc. ("ML & Co.") and its subsidiaries (the
term "subsidiaries", when used herein with respect to ML & Co.,
includes FAM, MLAM and certain other entities directly or
indirectly wholly-owned and controlled by ML & Co.) and their
directors and employees, and to members of the Boards of MLAM-
advised mutual funds. The maximum initial sales charge is 4.00%,
which is reduced for purchases of $25,000 and over and waived for
purchases by certain retirement plans and participants in
connection with certain fee-based programs. Purchases of
$1,000,000 or more may not be subject to an initial sales charge
but if the initial sales charge is waived, such purchases may be
subject to a 1.0% CDSC if the shares are redeemed within one year
after purchase. Such CDSC may be waived in connection with
redemptions to fund participation in certain fee-based programs.
Sales charges also are reduced under a right of accumulation which
takes into account the investor's holdings of all classes of all
MLAM-advised mutual funds. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares".
Class B:
Class B shares do not incur a sales charge when they are
purchased, but they are subject to an ongoing account maintenance
fee of 0.25%, an ongoing distribution fee of 0.50% of the Fund's
average net assets attributable to the Class B shares and a CDSC
if they are redeemed within four years of purchase. Such CDSC may
be modified in connection with redemptions to fund certain fee-
based programs. Approximately ten years after issuance, Class B
shares will convert automatically into Class D shares of the Fund,
which are subject to an account maintenance fee but no
distribution fee; Class B shares of certain other MLAM-advised
mutual funds into which exchanges may be made convert into Class D
shares automatically after approximately eight years. If Class B
shares of the Fund are exchanged for Class B
5
<PAGE>
shares of another MLAM-advised mutual fund, the conversion period
applicable to the Class B shares acquired in the exchange will
apply, and the holding period for the shares exchanged will be
tacked onto the holding period for the shares acquired. Automatic
conversion of Class B shares into Class D shares will occur at
least once a month on the basis of the relative net asset values
of the shares of the two classes on the conversion date, without
the imposition of any sales load, fee or other charge. Conversion
of Class B shares to Class D shares will not be deemed a purchase
or sale of the shares for Federal income tax purposes. Shares
purchased through reinvestment of dividends on Class B shares also
will convert automatically to Class D shares. The conversion
period for dividend reinvestment shares, and the conversion and
holding periods for certain retirement plans are modified as
described under "Purchase of Shares--Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B
Shares to Class D Shares".
Class C:
Class C shares do not incur a sales charge when they are
purchased, but they are subject to an ongoing account maintenance
fee of 0.25% and an ongoing distribution fee of 0.55% of the
Fund's average net assets attributable to Class C shares. Class C
shares are also subject to a CDSC if they are redeemed within one
year of purchase. Such CDSC may be waived in connection with
redemptions to fund participation in certain fee-based programs.
Although Class C shares are subject to a 1.0% CDSC for only one
year (as compared to four years for Class B), Class C shares have
no conversion feature and, accordingly, an investor that purchases
Class C shares will be subject to distribution fees that will be
imposed on Class C shares for an indefinite period subject to
annual approval by the Fund's Board of Directors and regulatory
limitations.
Class D:
Class D shares incur an initial sales charge when they are
purchased and are subject to an ongoing account maintenance fee of
0.25% of the Fund's average net assets attributable to Class D
shares. Class D shares are not subject to an ongoing distribution
fee or any CDSC when they are redeemed. Purchases of $1,000,000 or
more may not be subject to an initial sales charge but if the
initial sales charge is waived, such purchases may be subject to a
CDSC of 1.0% if the shares are redeemed within one year after
purchase. Such CDSC may be waived in connection with redemptions
to fund participation in certain fee-based programs. The schedule
of initial sales charges and reductions for Class D shares is the
same as the schedule for Class A shares, except that there is no
waiver for purchases in connection with certain fee-based
programs. Class D shares also will be issued upon conversion of
Class B shares as described above under "Class B". See "Purchase
of Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares".
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing SM System that the investor believes is most beneficial under his or
her particular circumstances.
Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class
A shares rather than Class D shares because there is an account maintenance
fee imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative
particularly attractive
6
<PAGE>
because similar sales charge reductions are not available with respect to the
deferred sales charges imposed in connection with purchases of Class B or Class
C shares. Investors not qualifying for reduced initial sales charges who expect
to maintain their investment for an extended period of time also may elect to
purchase Class A or Class D shares, because over time the accumulated ongoing
account maintenance and distribution fees on Class B or Class C shares may
exceed the initial sales charge and, in the case of Class D shares, the account
maintenance fee. Class A, Class B, Class C and Class D share holdings will
count toward a right of accumulation which may qualify the investor for reduced
initial sales charges on new initial sales charge purchases. In addition, the
ongoing Class B and Class C account maintenance and distribution fees will
cause Class B and Class C shares to have higher expense ratios, pay lower
dividends and have lower total returns than the initial sales charge shares.
The ongoing Class D account maintenance fees will cause Class D shares to have
a higher expense ratio, pay lower dividends and have a lower total return than
Class A shares.
Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the
benefit of putting all of the investor's dollars to work from the time the
investment is made. The deferred sales charge alternatives may be particularly
appealing to investors who do not qualify for a reduction in initial sales
charges. Both Class B and Class C shares are subject to ongoing account
maintenance fees and distribution fees; however, the ongoing account
maintenance and distribution fees potentially may be offset to the extent any
return is realized on the additional funds initially invested in Class B or
Class C shares. In addition, Class B shares will be converted into Class D
shares of the Fund after a conversion period of approximately eight years, and
thereafter investors will be subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be the most advantageous to have all of their funds invested initially and
intend to hold their shares for an extended period of time. Investors in Class
B shares should take into account whether they intend to redeem their shares
within the CDSC period and, if not, whether they intend to remain invested
until the end of the conversion period and thereby take advantage of the
reduction in ongoing fees resulting from the conversion into Class D shares.
Other investors, however, may elect to purchase Class C shares if they
determine that it is advantageous to have all of their assets invested
initially and they are uncertain as to the length of time they intend to hold
their assets in MLAM-advised mutual funds. Although Class C shareholders are
subject to a shorter CDSC period at a lower rate, they forgo the Class B
Conversion feature, making their investment subject to account maintenance and
distribution fees for an indefinite period of time. In addition, while both
Class B and Class C distribution fees are subject to the limitations on asset-
based sales charges imposed by the NASD, the Class B distribution fees are
further limited under a voluntary waiver of asset-based sales charges. See
"Purchase of Shares--Limitations on the Payment of Deferred Sales Charges".
7
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in conjunction
with the annual audits of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements and the independent
auditors' report thereon for the fiscal year ended August 31, 1996, are
included in the Statement of Additional Information. Further information about
the performance of the Fund is contained in the Fund's most recent annual
report to shareholders which may be obtained, without charge, by calling or by
writing the Company at the telephone number or address on the front cover of
this Prospectus.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements.
<TABLE>
<CAPTION>
CLASS A CLASS B
---------------------- ----------------------------------------------------------
FOR THE FOR THE
PERIOD PERIOD
FOR THE OCTOBER 21, DECEMBER 23,
YEAR ENDED 1994+ TO FOR THE YEAR ENDED AUGUST 31, 1991+ TO
AUGUST 31, AUGUST 31, -------------------------------------------- AUGUST 31,
1996++ 1995++ 1996++ 1995++ 1994 1993 1992
---------- ----------- -------- ---------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
INCREASE
(DECREASE) IN NET
ASSET VALUE:
PER SHARE
OPERATING
PERFORMANCE:
Net asset value,
beginning of
period........... $ 9.61 $ 9.16 $ 9.61 $ 9.41 $ 10.14 $ 9.92 $ 9.92
-------- -------- -------- ---------- ---------- ---------- ----------
Investment
income--net...... .64 .58 .57 .60 .48 .52 .44
Realized and unrealized gain(loss)
on investments--
net.............. (.21) .45 (.21) .20 (.73) .22 --
-------- -------- -------- ---------- ---------- ---------- ----------
Total from
investment
operations....... .43 1.03 36 .80 (.25) .74 .44
-------- -------- -------- ---------- ---------- ---------- ----------
Less dividends and
distributions:
Investment
income--net...... (.64) (.58) (.57) (.60) (.48) (.52) (.44)
Realized gain on
investments--net. -- -- -- -- -- -- --
-------- -------- -------- ---------- ---------- ---------- ----------
Total dividends
and
distributions.... (.64) (.58) (.57) (.60) (.48) (.52) (.44)
-------- -------- -------- ---------- ---------- ---------- ----------
Net asset value,
end of period.... $ 9.40 $ 9.61 $ 9.40 $ 9.61 $ 9.41 $ 10.14 $ 9.92
======== ======== ======== ========== ========== ========== ==========
TOTAL INVESTMENT
RETURN:**
Based on net asset
value per share.. 4.55% 11.56%# 3.72% 8.91% (2.55)% 7.80% 4.54%#
======== ======== ======== ========== ========== ========== ==========
RATIOS TO AVERAGE
NET ASSETS:
Expenses.......... .62% .64%* 1.39% 1.41% 1.33 % 1.30% 1.33%*
======== ======== ======== ========== ========== ========== ==========
Investment
income--net...... 6.64% 7.21%* 5.87% 6.39% 4.90 % 5.27% 6.45%*
======== ======== ======== ========== ========== ========== ==========
SUPPLEMENTAL DATA:
Net assets, end of
period
(in thousands)... $231,651 $223,237 $924,885 $1,262,985 $1,497,358 $2,151,917 $1,921,893
======== ======== ======== ========== ========== ========== ==========
Portfolio
turnover......... 204.14% 260.34% 204.14% 260.34% 322.68 % 224.35% 230.83%
======== ======== ======== ========== ========== ========== ==========
<CAPTION>
CLASS C
----------------------
FOR THE
PERIOD
FOR THE OCTOBER 21,
YEAR ENDED 1994+ TO
AUGUST 31, AUGUST 31,
1996++ 1995++
---------- -----------
<S> <C> <C>
INCREASE
(DECREASE) IN NET
ASSET VALUE:
PER SHARE
OPERATING
PERFORMANCE:
Net asset value,
beginning of
period........... $ 9.61 $ 9.16
---------- -----------
Investment
income--net...... .56 .51
Realized and unrealized gain(loss)
on investments--
net.............. (.21) .45
---------- -----------
Total from
investment
operations....... .35 .96
---------- -----------
Less dividends and
distributions:
Investment
income--net...... (.56) (.51)
Realized gain on
investments--net. -- --
---------- -----------
Total dividends
and
distributions.... (.56) (.51)
---------- -----------
Net asset value,
end of period.... $ 9.40 $ 9.61
========== ===========
TOTAL INVESTMENT
RETURN:**
Based on net asset
value per share.. 3.67% 10.80%#
========== ===========
RATIOS TO AVERAGE
NET ASSETS:
Expenses.......... 1.43% 1.47%*
========== ===========
Investment
income--net...... 5.82% 6.28%*
========== ===========
SUPPLEMENTAL DATA:
Net assets, end of
period
(in thousands)... $22,672 $15,621
========== ===========
Portfolio
turnover......... 204.14% 260.34%
========== ===========
</TABLE>
- --------
+ Commencement of Operations.
++ Based on average outstanding shares for the period.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
8
<PAGE>
<TABLE>
<CAPTION>
CLASS D
- -------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31,
- -------------------------------------------------------------------------------------------------------------------
1996++ 1995++ 1994 1993 1992 1991 1990 1989 1988 1987
- -------- -------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 9.61 $ 9.41 $ 10.14 $ 9.92 $ 9.66 $ 9.28 $ 9.28 $ 9.15 $ 9.27 $ 10.19
- -------- -------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
.62 .64 .52 .57 .70 .81 .86 .87 .84 .80
(.21) .20 (.73) .22 .26 .38 -- .13 (.12) (.56)
- -------- -------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
.41 .84 (.21) .79 .96 1.19 .86 1.00 .72 .24
- -------- -------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(.62) (.64) (.52) (.57) (.70) (.81) (.86) (.87) (.84) (.80)
-- -- -- -- -- -- -- -- -- (.36)
- -------- -------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(.62) (.64) (.52) (.57) (.70) (.81) (.86) (.87) (.84) (1.16)
- -------- -------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
$ 9.40 $ 9.61 $ 9.41 $ 10.14 $ 9.92 $ 9.66 $ 9.28 $ 9.28 $ 9.15 $ 9.27
======== ======== ========== ========== ========== ========== ========== ========== ========== ==========
4.28% 9.48% (2.06)% 8.35% 10.16% 13.40% 9.61% 11.48% 8.02% 2.83%
======== ======== ========== ========== ========== ========== ========== ========== ========== ==========
.87% .89% .83 % .79% .80% .78% .77% .74% .69% .61%
======== ======== ========== ========== ========== ========== ========== ========== ========== ==========
6.39% 6.91% 5.41 % 5.80% 7.17% 8.62% 9.19% 9.49% 9.18% 8.26%
======== ======== ========== ========== ========== ========== ========== ========== ========== ==========
$942,388 $976,161 $1,356,979 $1,836,100 $2,048,037 $2,230,619 $2,353,328 $2,751,814 $3,533,843 $5,717,570
======== ======== ========== ========== ========== ========== ========== ========== ========== ==========
204.14% 260.34% 322.68 % 224.35% 230.83% 311.04% 324.74% 363.53% 292.68% 205.21%
======== ======== ========== ========== ========== ========== ========== ========== ========== ==========
</TABLE>
9
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek a high current return through
investments in U.S. Government and Government agency securities, including GNMA
mortgage-backed certificates and other mortgage-backed government securities.
This investment objective is a fundamental policy of the Fund which may not be
changed without a vote of a majority of the outstanding shares of the Fund. The
Fund may seek to enhance its return through the use of certain portfolio
strategies involving options and to hedge its portfolio through the use of
options and futures transactions. The hedging strategies are intended to reduce
volatility in the net asset value of Fund shares. The Fund's portfolio
strategies are not fundamental policies and may be modified by the Trustees of
the Fund without the approval of the Fund's shareholders.
The portfolio securities in which the Fund may invest are marketable
securities issued or guaranteed by the United States Government, by various
agencies of the United States Government and by various instrumentalities which
have been established or sponsored by the United States Government ("U.S.
Government securities"). Certain of these obligations, including U.S. Treasury
bills, notes and bonds and securities of GNMA and the Federal Housing
Administration ("FHA"), are issued or guaranteed by the U.S. Government and
supported by the full faith and credit of the United States. Other U.S.
Government securities are issued or guaranteed by Federal agencies or
government-sponsored enterprises and are not direct obligations of the United
States but involve sponsorship or guarantees by Government agencies or
enterprises. These obligations include securities that are supported by the
right of the issuer to borrow from the Treasury, such as obligations of Federal
Home Loan Banks, and securities that are supported only by the credit of the
instrumentality, such as Federal National Mortgage Association ("FNMA") bonds.
Because the U.S. Government is not obligated to provide support to its
instrumentalities, the Fund will invest in obligations issued by these
instrumentalities where the Fund is satisfied that the credit risk with respect
to the issuers is minimal. In addition, the Fund may invest up to 5% of its
assets in obligations issued or guaranteed by the International Bank for
Reconstruction and Development, an international organization of which the
United States is a member country.
The Fund has authority to invest in all U.S. Government securities. It is
anticipated that under certain circumstances as described below, a significant
portion of its portfolio of U.S. Government securities may consist of GNMA
mortgage-backed certificates ("GNMA Certificates") and other U.S. Government
securities representing ownership interests in mortgage pools. For a
description of GNMA Certificates and other eligible securities representing
interests in mortgage pools, see "GNMA Certificates and Other Mortgage-Backed
Government Securities" below. Determinations as to the types of U.S. Government
securities held by the Fund will be made by the Manager. The Manager's
decisions will be based on, among other factors, the relative yields of the
various types of U.S. Government securities, its assessment of future interest
rate patterns and the desirability of holding U.S. Government securities on
which it may write covered options, as described below.
The Fund is not limited as to the maturities of its portfolio investments and
may take full advantage of the entire range of maturities offered by U.S.
Government securities. The Manager may adjust the average maturity of the
Fund's portfolio from time to time, depending on its assessment of the relative
yields available on securities of different maturities and its assessment of
future interest rate patterns. Thus, at various times the average maturity of
the portfolio may be relatively short (from under one year to five years, for
example) and at other times may be relatively long (over 10 years, for
example).
10
<PAGE>
In as much as the Fund invests in fixed-income securities, it is important to
note that the Fund's net asset value may fall when interest rates rise and rise
when interest rates fall. In general, fixed-income securities with longer
maturities will be subject to greater volatility resulting from interest rate
fluctuations than will fixed-income securities with shorter maturities. In as
much as the Fund invests in mortgage-backed securities, however, it is also
important to note that the Fund's net asset value may also fall when interest
rates fall to the extent the Fund's holdings expose the Fund to losses from
prepayment risk. See "GNMA Certificates and Other Mortgage-Backed Government
Securities" below.
GNMA CERTIFICATES AND OTHER MORTGAGE-BACKED GOVERNMENT SECURITIES
GNMA Certificates are mortgage-backed securities of the modified pass-through
type, which means that both interest and principal payments (including
prepayments) are passed through monthly to the holder of the Certificate. The
National Housing Act provides that the full faith and credit of the United
States is pledged to the timely payment of principal and interest by GNMA of
amounts due on these GNMA Certificates. Each Certificate evidences an interest
in a specific pool of mortgage loans insured by the FHA or the Farmers Home
Administration or guaranteed by the Veterans Administration ("VA"). GNMA is a
wholly-owned corporate instrumentality of the United States within the
Department of Housing and Urban Development.
The average life of GNMA Certificates varies with the maturities of the
underlying mortgage instruments, which have maximum maturities of 30 years. The
average life may be substantially less than the original maturity of the
mortgage pools underlying the securities as a result of prepayments or
refinancing of such mortgages. Such prepayments are passed through to the
registered holder with the regular monthly payments of principal and interest.
In addition, GNMA offers a pass-through security backed by adjustable-rate
mortgages. As prepayment rates vary widely, it is not possible to predict
accurately the average life of a particular pool. The actual yield of each GNMA
Certificate is influenced by the prepayment experience of the mortgage pool
underlying the certificate.
In addition to GNMA Certificates, the Fund may invest in mortgage-backed
securities issued by FNMA and by the Federal Home Loan Mortgage Corporation
("FHLMC"). FNMA, a federally-chartered and privately-owned corporation, issues
pass-through securities and certificates representing an interest in a pool of
FNMA pass-through securities which are guaranteed as to payment of principal
and interest by FNMA. FHLMC, a corporate instrumentality of the United States,
issues participation certificates which represent an interest in mortgages from
FHLMC's portfolio and securities representing an interest in a pool of FHLMC
participation certificates. FHLMC guarantees the timely payment of interest and
the ultimate collection of principal. As is the case with GNMA Certificates,
the actual maturity of and realized yield on particular FNMA and FHLMC
mortgage-backed securities will vary based on the prepayment experience of the
underlying pool of mortgages. Securities guaranteed by FNMA and FHLMC are not
backed by the full faith and credit of the United States.
Mortgage-backed U.S. Government securities typically provide a higher
potential for current income than other types of U.S. Government securities;
however, U.S. Treasury bills, notes and bonds typically provide a higher
potential for capital appreciation than mortgage-backed securities.
Payments of principal of and interest on mortgage-backed securities are made
more frequently than are payments on conventional debt securities. In addition,
holders of mortgage-backed securities may receive
11
<PAGE>
unscheduled payments of principal at any time representing prepayments on the
underlying mortgage loans or financial assets. Such prepayments may usually be
made by the related obligor without penalty. Prepayment rates are affected by
changes in prevailing interest rates and numerous other economic, geographic,
social and other factors. Changes in the rate of prepayments will generally
affect the yield to maturity of the security. Moreover, when the holder of the
security attempts to reinvest prepayments or even the scheduled payments of
principal and interest, it may receive a rate of interest which is higher or
lower than the rate on the mortgage-backed securities originally held. To the
extent that mortgage-backed securities are purchased at a premium, mortgage
foreclosures and principal prepayments may result in a loss to the extent of
the premium paid. If such securities are bought at a discount, both scheduled
payments of principal and unscheduled prepayments will increase current and
total returns and will accelerate the recognition of income which, when
distributed to shareholders, will be taxable as ordinary income.
OPTIONS AND FUTURES PORTFOLIO STRATEGIES
The Fund may seek to increase its return through the use of options on the
underlying securities and may hedge all or a portion of its portfolio
investments against fluctuations in interest rates through the use of options,
interest rate futures and options on interest rate futures. While the Fund's
use of hedging strategies is intended to reduce the volatility of the net asset
value of Fund shares, the Fund's net asset value will fluctuate. The Fund may
only engage in hedging activities from time to time and may not necessarily be
engaging in hedging activities when movements in interest rates occur.
Reference is made to the Statement of Additional Information for further
information concerning these strategies. There can be no assurance that the
Fund's hedging transactions will be effective.
Although certain risks are involved in options and futures transactions (as
discussed below in "Risk Factors in Options and Futures Transactions"), the
Manager believes that, because the Fund will write only covered options on
portfolio securities and engage in other options and futures transactions only
for hedging purposes, the options and futures portfolio strategies of the Fund
will not subject the Fund to the risks frequently associated with the
speculative use of options and futures transactions. Tax requirements may limit
the Fund's ability to engage in the hedging transactions and strategies
described below. See "Additional Information--Taxes".
The Fund is authorized to use certain strategies involving options and
futures. Such instruments, which may be regarded as derivatives, are referred
to collectively herein as "Strategic Instruments."
Options on Securities and Securities Indices. The Fund may invest in options
on individual securities, baskets of securities or particular measurements of
value or rate (an "index"), such as an index of the price of treasury
securities or an index representative of short-term interest rates.
Purchasing Options. The Fund is authorized to purchase put options on
securities held in its portfolio or securities indices the performance of which
is substantially replicated by securities held in its portfolio. When the Fund
purchases a put option, in consideration for an upfront payment (the "option
premium") the Fund acquires a right to sell to another party specified
securities owned by the Fund at a specified price (the "exercise price") on or
before a specified date (the "expiration date"), in the case of an option on
securities, or to receive from another party a payment based on the amount a
specified securities index declines below a
12
<PAGE>
specified level on or before the expiration date, in the case of an option on a
securities index. The purchase of a put option limits the Fund's risk of loss
in the event of a decline in the market value of the portfolio holdings
underlying the put option prior to the option's expiration date. If the market
value of the portfolio holdings associated with the put option increases rather
than decreases, however, the Fund will lose the option premium and will
consequently realize a lower return on the portfolio holdings than would have
been realized without the purchase of the put.
The Fund is also authorized to purchase call options on securities it intends
to purchase or securities indices the performance of which substantially
replicates the performance of the types of securities it intends to purchase.
When the Fund purchases a call option, in consideration for the option premium
the Fund acquires a right to purchase from another party specified securities
at the exercise price on or before the expiration date, in the case of an
option on securities, or to receive from another party a payment based on the
amount a specified securities index increases beyond a specified level on or
before the expiration date, in the case of an option on a securities index. The
purchase of a call option may protect the Fund from having to pay more for a
security as a consequence of increases in the market value for the security
during a period when the Fund is contemplating its purchase, in the case of an
option on a security, or attempting to identify specific securities in which to
invest in a market the Fund believes to be attractive, in the case of an option
on an index (an "anticipatory hedge"). In the event the Fund determines not to
purchase a security underlying a call option, however, the Fund may lose the
entire option premium.
The Fund is also authorized to purchase put or call options in connection
with closing out put or call options it has previously sold.
Writing Options. The Fund is authorized to write (i.e., sell) call options on
securities held in its portfolio or securities indices the performance of which
is substantially replicated by securities held in its portfolio. When the Fund
writes a call option, in return for an option premium the Fund gives another
party the right to buy specified securities owned by the Fund at the exercise
price on or before the expiration date, in the case of an option on securities,
or agrees to pay to another party an amount based on any gain in a specified
securities index beyond a specified level on or before the expiration date, in
the case of an option on a securities index. The Fund may write call options to
earn income, through the receipt of option premiums. In the event the party to
which the Fund has written an option fails to exercise its rights under the
option because the value of the underlying securities is less than the exercise
price, the Fund will partially offset any decline in the value of the
underlying securities through the receipt of the option premium. By writing a
call option, however, the Fund limits its ability to sell the underlying
securities, and gives up the opportunity to profit from any increase in the
value of the underlying securities beyond the exercise price, while the option
remains outstanding.
The Fund may also write put options on securities or securities indices. When
the Fund writes a put option, in return for an option premium the Fund gives
another party the right to sell to the Fund a specified security at the
exercise price on or before the expiration date, in the case of an option on a
security, or agrees to pay to another party an amount based on any decline in a
specified securities index below a specified level on or before the expiration
date, in the case of an option on a securities index. The Fund may write put
options to earn income, through the receipt of option premiums. In the event
the party to which the Fund has written an option fails to exercise its rights
under the option because the value of the underlying securities
13
<PAGE>
is greater than the exercise price, the Fund will profit by the amount of the
option premium. By writing a put option, however, the Fund will be obligated to
purchase the underlying security at a price that may be higher than the market
value of the security at the time of exercise as long as the put option is
outstanding, in the case of an option on a security, or make a cash payment
reflecting any decline in the index, in the case of an option on an index.
Accordingly, when the Fund writes a put option it is exposed to a risk of loss
in the event the value of the underlying securities falls below the exercise
price, which loss potentially may substantially exceed the amount of option
premium received by the Fund for writing the put option. The Fund will write a
put option on a security or a securities index only if the Fund would be
willing to purchase the security at the exercise price for investment purposes
(in the case of an option on a security) or is writing the put in connection
with trading strategies involving combinations of options--for example, the
sale and purchase of options with identical expiration dates on the same
security or index but different exercise prices (a technique called a
"spread").
The Fund is also authorized to sell call or put options in connection with
closing out call or put options it has previously purchased.
Other than with respect to closing transactions, the Fund will only write
call or put options that are "covered." A call or put option will be considered
covered if the Fund has segregated assets with respect to such option in the
manner described in "Risk Factors in Options and Futures" below. A call option
will also be considered covered if the Fund owns the securities it would be
required to deliver upon exercise of the option (or, in the case of option on a
securities index, securities which substantially replicate the performance of
such index) or owns a call option, warrant or convertible instrument which is
immediately exercisable for, or convertible into, such security.
Options on GNMA Certificates. The following information relates to unique
characteristics of options on GNMA Certificates. Since the remaining principal
balance of GNMA Certificates declines each month as a result of mortgage
payments, the Fund, as a writer of a GNMA call holding GNMA Certificates as
"cover" to satisfy its delivery obligation in the event of exercise, may find
that the GNMA Certificates it holds no longer have a sufficient remaining
principal balance for this purpose. Should this occur, the Fund will purchase
additional GNMA Certificates from the same pool (if obtainable) or other GNMA
Certificates in the cash market in order to maintain its "cover".
A GNMA Certificate held by the Fund to cover an option position in any but
the nearest expiration month may cease to represent cover for the option in the
event of a decline in the GNMA coupon rate at which new pools are originated
under the FHA/VA loan ceiling in effect at any given time. If this should
occur, the Fund will no longer be covered, and the Fund will either enter into
a closing purchase transaction or replace such Certificate with a certificate
which represents cover. When the Fund closes its position or replaces such
Certificate, it may realize an unanticipated loss and incur transaction costs.
Types of Options. The Fund may engage in transactions in options on
securities or securities indices on exchanges and in the over-the counter
("OTC") markets. In general, exchange-traded options have standardized exercise
prices and expiration dates and require the parties to post margin against
their obligations, and the performance of the parties' obligations in
connection with such options is guaranteed by
14
<PAGE>
the exchange or a related clearing corporation. OTC options have more flexible
terms negotiated between the buyer and the seller, but generally do not require
the parties to post margin and are subject to greater risk of counterparty
default. See "Additional Risk Factors of OTC Transactions" below.
Futures. The Fund may engage in transactions in futures and options thereon.
Futures are standardized, exchange-traded contracts which obligate a purchaser
to take delivery, and a seller to make delivery, of a specific amount of a
commodity at a specified future date at a specified price. No price is paid
upon entering into a futures contract. Rather, upon purchasing or selling a
futures contract the Fund is required to deposit collateral ("margin") equal to
a percentage (generally less than 10%) of the contract value. Each day
thereafter until the futures position is closed, the Fund will pay additional
margin representing any loss experienced as a result of the futures position
the prior day or be entitled to a payment representing any profit experienced
as a result of the futures position the prior day.
The sale of a futures contract limits the Fund's risk of loss through a
decline in the market value of portfolio holdings correlated with the futures
contract prior to the futures contract's expiration date. In the event the
market value of the portfolio holdings correlated with the futures contract
increases rather than decreases, however, the Fund will realize a loss on the
futures position and a lower return on the portfolio holdings than would have
been realized without the purchase of the futures contract.
The purchase of a futures contract may protect the Fund from having to pay
more for securities as a consequence of increases in the market value for such
securities during a period when the Fund was attempting to identify specific
securities in which to invest in a market the Fund believes to be attractive.
In the event that such securities decline in value or the Fund determines not
to complete an anticipatory hedge transaction relating to a futures contract,
however, the Fund may realize a loss relating to the futures position.
The Fund will limit transactions in futures and options on futures to
financial futures contracts (i.e., contracts for which the underlying commodity
is a currency or securities or interest rate index) purchased or sold for
hedging purposes (including anticipatory hedges). The Fund will further limit
transactions in futures and options on futures to the extent necessary to
prevent the Fund from being deemed a "commodity pool" under regulations of the
Commodity Futures Trading Commission.
Risk Factors in Options and Futures. Use of Strategic Instruments for hedging
purposes involves the risk of imperfect correlation in movements in the value
of the Strategic Instruments and the value of the instruments being hedged. If
the value of the Strategic Instruments moves more or less than the value of the
hedged instruments the Fund will experience a gain or loss which will not be
completely offset by movements in the value of the hedged instruments.
The Fund intends to enter into transactions involving Strategic Instruments
only if there appears to be a liquid secondary market for such instruments or,
in the case of illiquid instruments traded in OTC transactions, such
instruments satisfy the criteria set forth below under "Additional Risk Factors
of OTC Transactions." However, there can be no assurance that, at any specific
time, either a liquid secondary market will exist for a Strategic Instrument or
the Fund will otherwise be able to sell such instrument at an acceptable price.
It may therefore not be possible to close a position in a Strategic Instrument
without incurring substantial losses, if at all.
15
<PAGE>
Certain transactions in Strategic Instruments (e.g., futures transactions,
sales of put options) and other types of transactions in which the Fund may
engage (e.g., delayed delivery transactions, discussed below) may expose the
Fund to potential losses which exceed the amount originally invested by the
Fund in such instruments. When the Fund engages in such a transaction, the Fund
will deposit in a segregated account at its custodian liquid securities with a
value at least equal to the Fund's exposure, on a mark-to-market basis, to the
transaction (as calculated pursuant to requirements of the Commission). Such
segregation will ensure that the Fund has assets available to satisfy its
obligations with respect to the transaction, but will not limit the Fund's
exposure to loss.
Additional Risk Factors of OTC Transactions; Limitations on the Use of OTC
Strategic Instruments. Certain Strategic Instruments traded in OTC markets,
including OTC options, may be substantially less liquid than other instruments
in which the Fund may invest. The absence of liquidity may make it difficult or
impossible for the Fund to sell such instruments promptly at an acceptable
price. The absence of liquidity may also make it more difficult for the Fund to
ascertain a market value for such instruments. The Fund will therefore acquire
illiquid OTC instruments (i) if the agreement pursuant to which the instrument
is purchased contains a formula price at which the instrument may be terminated
or sold, or (ii) for which the Investment Adviser anticipates the Fund can
receive on each business day at least two independent bids or offers, unless a
quotation from only one dealer is available, in which case that dealer's
quotation may be used.
The staff of the Securities and Exchange Commission has taken the position
that purchased OTC options and the assets underlying written OTC options are
illiquid securities. The Fund has therefore adopted an investment policy
pursuant to which it will not purchase or sell OTC options (including OTC
options on futures contracts) if, as a result of such transactions, the sum of
the market value of OTC options currently outstanding which are held by the
Fund, the market value of the securities underlying OTC call options currently
outstanding which have been sold by the Fund and margin deposits on the Fund's
outstanding OTC options exceeds 15% of the total assets of the Fund, taken at
market value, together with all other assets of the Fund which are deemed to be
illiquid or are otherwise not readily marketable. However, if an OTC option is
sold by the Fund to a dealer in U.S. government securities recognized as a
"primary dealer" by the Federal Reserve Bank of New York and the Fund has the
unconditional contractual right to repurchase such OTC option at a
predetermined price, then the Fund will treat as illiquid such amount of the
underlying securities as is equal to the repurchase price less the amount by
which the option is "in-the-money" (i.e., current market value of the
underlying security minus the option's exercise price).
Because Strategic Instruments traded in OTC markets are not guaranteed by an
exchange or clearing corporation and generally do not require payment of
margin, to the extent that the Fund has unrealized gains in such instruments or
has deposited collateral with its counterparty the Fund is at risk that its
counterparty will become bankrupt or otherwise fail to honor its obligations.
The Fund will attempt to minimize the risk that a counterparty will become
bankrupt or otherwise fail to honor its obligations by engaging in transactions
in Strategic Instruments traded in OTC markets only with financial institutions
which have substantial capital or which have provided the Fund with a third-
party guaranty or other credit enhancement.
Additional Limitations on the Use of Strategic Instruments. The Fund may not
use any Strategic Instrument to gain exposure to an asset or type or class of
assets that it would be prohibited by its investment restrictions from
purchasing directly.
16
<PAGE>
OTHER INVESTMENT PRACTICES
When-Issued Securities and Delayed Delivery Transactions. The Fund may
purchase U.S. Government securities on a when-issued basis, and it may purchase
or sell U.S. Government securities for delayed delivery. These transactions
occur when securities are purchased or sold by the Fund with payment and
delivery taking place in the future to secure what is considered an
advantageous yield and price to the Fund at the time of entering into the
transaction.
Stripped Mortgage-Backed Securities. The Fund may invest in stripped
mortgage-backed securities ("SMBSs") issued by agencies or instrumentalities of
the United States. SMBSs are derivative multiclass mortgage-backed securities.
SMBS arrangements commonly involve two classes of securities that receive
different proportions of the interest and principal distributions on a pool of
mortgage assets. A common variety of SMBS is where one class (the principal-
only or PO class) receives some of the interest and most of the principal from
the underlying assets, while the other class (the interest-only or IO class)
receives most of the interest and the remainder of the principal. In the most
extreme case, the IO class receives all of the interest, while the PO class
receives all of the principal. While the Fund may purchase securities of a PO
class, it is more likely to purchase the securities of an IO class. The yield
to maturity of an IO class is extremely sensitive to the rate of principal
payments (including prepayments) on the related underlying assets, and a rapid
rate of principal payments in excess of that considered in pricing the
securities will have a material adverse effect on an IO security's yield to
maturity. If the underlying mortgage assets experience greater than anticipated
payments of principal, the Fund may fail to recoup fully its initial investment
in IOs. In addition, there are certain types of IOs which represent the
interest portion of a particular class as opposed to the interest portion of
the entire pool. The sensitivity of this type of IO to interest rate
fluctuations may be increased because of the characteristics of the principal
portion to which they relate. As a result of the above factors, the Fund
generally will purchase IOs only as a component of so-called "synthetic"
securities. This means that purchases of IOs will be matched with certain
purchases of other securities, such as POs, inverse floating rate CMOs or fixed
rate securities; as interest rates fall, presenting a greater risk of
unanticipated prepayments of principal, the negative effect on the Fund because
of its holdings of IOs should be diminished somewhat because of the increased
yield on the inverse floating rate CMOs or the increased appreciation on the
POs or fixed rate securities. IOs and POs are considered by the staff of the
Securities and Exchange Commission to be illiquid securities and, consequently,
the Fund will not invest in IOs or POs in an amount which, taken together with
the Fund's other investments in illiquid securities, exceeds 15% of the Fund's
net assets.
Short Sales. The Fund may from time to time make short sales. These
transactions will involve either short sales of securities retained in the
Fund's portfolio or securities which it has the right to acquire without the
payment of further consideration (a short sale "against the box").
Repurchase Agreements. The Fund may invest in U.S. Government securities
pursuant to repurchase agreements. Repurchase agreements may be entered into
only with a member bank of the Federal Reserve System or primary dealer in U.S.
Government securities or an affiliate thereof. Under such agreements, the
seller agrees, upon entering into the contract, to repurchase the security at a
mutually agreed upon time and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. The Fund may not invest in repurchase
agreements maturing in more than seven days if, as a result, more than 15% of
the Fund's net assets would be invested
17
<PAGE>
in illiquid securities, including such repurchase agreements. In the event of
default by the seller under a repurchase agreement, the Fund may suffer time
delays and incur costs or possible losses in connection with the disposal of
the collateral.
Lending of Portfolio Securities. The Fund may lend portfolio securities, with
a value not in excess of 33 1/3% of its total assets, to brokers, dealers and
financial institutions and receive collateral in cash or U.S. Government
securities which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. During the period of
the loan, the Fund receives the income on loaned securities and a loan fee and
thereby increases its yield.
Borrowing of Money. Except to the extent permitted by the Fund's investment
policies as set forth in its Prospectus and Statement of Additional
Information, the Fund may not borrow money to purchase portfolio securities.
However, the Fund may borrow from banks as a temporary measure for
extraordinary or emergency purposes or to meet redemptions in amounts not
exceeding 10% (taken at market value) of its total assets and pledge its assets
to secure such borrowings. The Fund will not purchase portfolio securities
while any borrowings are outstanding.
PORTFOLIO TRANSACTIONS
The U.S. Government securities in which the Fund invests are traded primarily
in the OTC market. Where possible, the Fund will deal directly with the dealers
who make a market in the securities involved except in those circumstances
where better prices and execution are available elsewhere. Such dealers usually
are acting as principal for their own account. On occasion, securities may be
purchased directly from the issuer. Such portfolio securities are generally
traded on a net basis and do not normally involve either brokerage commissions
or transfer taxes. Securities firms may receive brokerage commissions on
certain portfolio transactions, including options, futures and options on
futures transactions and the purchase and sale of underlying securities upon
exercise of options. The Fund has no obligation to deal with any broker in the
execution of transactions in portfolio securities. Under the Investment Company
Act, persons affiliated with the Fund are prohibited from dealing with the Fund
as a principal in the purchase and sale of securities unless a permissive order
allowing such transactions is obtained from the Commission. Affiliated persons
of the Fund may serve as its broker in transactions conducted on an exchange
and in over-the-counter transactions conducted on an agency basis.
INVESTMENT RESTRICTIONS
In addition to the investment policies described in this section, the Fund's
investment activities are subject to further restrictions that are described in
the Statement of Additional Information. Investment restrictions and policies
which are fundamental policies may not be changed without the approval of the
holders of a majority of the Fund's outstanding voting securities (which for
this purpose and under the Investment Company Act means the lesser of (a) 67%
of the shares represented at a meeting at which more than 50% of the
outstanding shares are represented or (b) more than 50% of the outstanding
shares). Among its fundamental policies, the Fund may not invest more than 25%
of its total assets, taken at market value at the time of each investment, in
the securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).
18
<PAGE>
Investment restrictions and policies that are non-fundamental policies may be
changed by the Board of Trustees without shareholder approval. As a non-
fundamental restriction, the Fund may not borrow amounts in excess of 10% of
its total assets, taken at market value, and then only from banks as a
temporary measure for extraordinary or emergency purposes such as the
redemption of Fund shares. As a non-fundamental policy, the Fund will not
invest in securities which cannot readily be resold because of legal or
contractual restrictions or which are not otherwise readily marketable,
including repurchase agreements maturing in more than seven days, if, regarding
all such securities, more than 15% of its total assets taken at market value
would be invested in such securities. Notwithstanding the foregoing, the Fund
may purchase without regard to this limitation securities that are not
registered under the Securities Act, but that can be offered and sold to
"qualified institutional buyers" under Rule 144A under the Securities Act,
provided that the Fund's Board of Trustees continuously determines, based on
the trading markets for the specific Rule 144A security, that it is liquid.
PORTFOLIO TURNOVER
The Manager will effect portfolio transactions without regard to holding
period, if, in its judgment, such transactions are advisable in light of a
change in circumstances in general market, economic or financial conditions. As
a result of its investment policies, the Fund may engage in a substantial
number of portfolio transactions. High portfolio turnover involves
correspondingly greater transaction costs in the form of dealer spreads and
brokerage commissions, which are borne directly by the Fund. See "Additional
Information--Taxes" and "Portfolio Transactions and Brokerage" in the Statement
of Additional Information.
MANAGEMENT OF THE FUND
TRUSTEES
The Trustees of the Fund consist of six individuals, five of whom are not
"interested persons" of the Fund as defined in the Investment Company Act. The
Trustees of the Fund are responsible for the overall supervision of the
operations of the Fund and perform the various duties imposed on the directors
of investment companies by the Investment Company Act.
The Trustees of the Fund are:
Arthur Zeikel*--President of the Manager and MLAM; President and Director
of Princeton Services, Inc. ("Princeton Services"); Executive Vice
President of ML & Co.; Director of the Distributor.
Joe Grills--Member of the Committee of Investment of Employee Benefit
Assets of the Financial Executives Institute ("CIEBA"); Member of CIEBA's
Executive Committee; Member of the Investment Advisory Committees of the
State of New York Common Retirement Fund and the Howard Hughes Medical
Institute; Director, Duke Management Company, LaSalle Street Fund and Kimco
Realty Corporation.
Walter Mintz--Special Limited Partner of Cumberland Associates
(investment partnership).
Robert S. Salomon, Jr.--Principal of STI Management (investment adviser).
19
<PAGE>
Melvin R. Seiden--Director of Silbanc Properties, Ltd. (real estate,
investments and consulting).
Stephen B. Swensrud--Chairman of Fernwood Advisers (financial
consultants).
- --------
*Interested person, as defined in the Investment Company Act, of the Fund.
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Manager acts as the investment adviser for the Fund and provides the Fund
with management services pursuant to an investment management agreement (the
"Management Agreement"). The Manager is owned and controlled by ML&Co., a
financial services holding company and the parent of Merrill Lynch. The Manager
or an affiliate, MLAM, acts as the investment adviser for more than 130
registered investment companies and provides investment advisory advice to
individuals and institutions. As of November 30, 1996, the Manager and MLAM had
a total of approximately $223.7 billion in investment company and other
portfolio assets under management.
Subject to the direction of the Trustees, the Manager is responsible for the
actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Manager. The Manager performs certain other
administrative services and provides all the office space, facilities,
equipment and necessary personnel for management of the Fund.
As compensation for its services, the Manager receives from the Fund at the
end of each month a fee at the annual rate of 0.50% of the portion of the
Fund's average daily net assets not exceeding $500 million, with a fee
reduction at several breakpoints for net assets in excess of $500 million.
Effective November 1, 1986, the Manager agreed to a further reduction in the
management fee by lowering the net asset level at which the minimum fee rate
would be charged, and effective November 22, 1991, the Management Agreement was
amended to incorporate this reduction in the management fee. For the fiscal
year ended August 31, 1996, the fee paid by the Fund to the Manager was
$10,650,590 (based upon average net assets of approximately $2.3 billion) and
the effective fee rate was .46%.
The Management Agreement obligates the Fund to pay certain expenses incurred
in its operations, including, among other things, the management fee, legal and
audit fees, unaffiliated Trustees' fees and expenses, registration fees,
custodian and transfer agency fees, accounting and pricing costs, and certain
of the costs of printing proxies, shareholder reports, prospectuses and
statements of additional information. Accounting services are provided to the
Fund by the Manager and the Fund reimburses the Manager for its costs in
connection with such services. For the fiscal year ended August 31, 1996, the
reimbursement for such services aggregated $286,168. For the fiscal year ended
August 31, 1996, the ratio of total expenses to average net assets was .62% for
Class A shares, 1.39% for Class B shares, 1.43% for Class C shares and .87% for
Class D shares.
Gregory Mark Maunz is primarily responsible for the day-to-day management of
the Fund's portfolio. Mr. Maunz is a Vice President of the Fund and has been a
Vice President of the Manager since 1985.
20
<PAGE>
CODE OF ETHICS
The Board of Trustees of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the Investment Company Act which incorporates the Code of
Ethics of the Manager (together, the "Codes"). The Codes significantly
restrict the personal investing activities of all employees of the Manager
and, as described below, impose additional, more onerous, restrictions on fund
investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are
designed to identify any substantive prohibition or limitation applicable to
the proposed investment. The substantive restrictions applicable to all
employees of the Manager include a ban on acquiring any securities in a "hot"
initial public offering and a prohibition from profiting on short-term trading
in securities. In addition, no employee may purchase or sell any security
which at the time is being purchased or sold (as the case may be), or to the
knowledge of the employee is being considered for purchase or sale, by any
fund advised by the Manager. Furthermore, the Codes provide for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within periods of trading by the Fund in the same (or equivalent) security (15
or 30 days depending upon the transaction).
TRANSFER AGENCY SERVICES
Merrill Lynch Financial Data Services, Inc. (the "Transfer Agent"), which is
a wholly-owned subsidiary of ML & Co., acts as the Fund's transfer agent
pursuant to a transfer agency, dividend disbursing agency and shareholder
servicing agency agreement (the "Transfer Agency Agreement"). Pursuant to the
Transfer Agency Agreement, the Transfer Agent is responsible for the issuance,
transfer and redemption of shares and the opening and maintenance of
shareholder accounts. Pursuant to the Transfer Agency Agreement, the Fund pays
the Transfer Agent a fee of $11.00 per Class A or Class D shareholder account
and $14.00 per Class B or Class C shareholder account and is entitled to
reimbursement for out-of-pocket expenses incurred by the Transfer Agent under
the Transfer Agency Agreement. For the fiscal year ended August 31, 1996, the
total fee paid by the Fund to the Transfer Agent pursuant to the Transfer
Agency Agreement was $2,914,724. At November 30, 1996, the Fund had 32,708
Class A shareholder accounts, 55,052 Class B shareholder accounts, 1,330 Class
C shareholder accounts and 64,284 Class D shareholder accounts. At this level
of accounts, the annual fee payable to the Transfer Agent would aggregate
approximately $1.9 million plus out-of-pocket expenses.
PURCHASE OF SHARES
The Distributor, an affiliate of both the Manager and Merrill Lynch, acts as
the distributor of the shares of the Fund. Shares of the Fund are offered
continuously for sale by the Distributor and other eligible securities dealers
(including Merrill Lynch). Shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase is $1,000 and the minimum subsequent purchase is $50,
except that for retirement plans the minimum initial purchase is $100 and the
minimum subsequent purchase is $1. Different minimums may apply to purchases
through the Merrill Lynch BlueprintSM Program. See "Purchase of Shares--
Merrill Lynch BlueprintSM Program" in the Statement of Additional Information.
21
<PAGE>
The Fund offers its shares in four classes at a public offering price equal
to the next determined net asset value per share plus sales charges imposed
either at the time of purchase or on a deferred basis depending upon the class
of shares selected by the investor under the Merrill Lynch Select Pricing SM
System, as described below. The applicable offering price for purchase orders
is based upon the net asset value of the Fund next determined after receipt of
the purchase orders by the Distributor. As to purchase orders received by
securities dealers prior to the close of business on the New York Stock
Exchange ("NYSE") (generally 4:00 p.m., New York time) which includes orders
received after the close of business on the previous day, the applicable
offering price will be based on the net asset value as of 15 minutes after the
close of business on the NYSE, on the day the orders are placed with the
Distributor, provided the orders are received by the Distributor prior to 30
minutes after the close of business on the NYSE on that day. If the purchase
orders are not received prior to 30 minutes after the close of business on the
NYSE on that day, such orders shall be deemed received on the next business
day. The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Distributor or the Fund.
Neither the Distributor nor the dealers are permitted to withhold placing
orders to benefit themselves by a price change. Merrill Lynch may charge its
customers a processing fee (presently $4.85) to confirm a sale of shares to
such customers. Purchases directly through the Transfer Agent are not subject
to the processing fee.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing SM System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the
amount of the purchase, the length of time the investor expects to hold the
shares and other relevant circumstances. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares
of Class B and Class C are sold to investors choosing the deferred sales
charge alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the
investment thereafter being subject to a CDSC and ongoing distribution fees. A
discussion of the factors that investors should consider in determining the
method of purchasing shares under the Merrill Lynch Select Pricing SM System
is set forth under "Merrill Lynch Select Pricing SM System" on page 4.
Each Class A, Class B, Class C and Class D share of the Fund represents
identical interests in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The deferred sales charges, distribution and account maintenance fees that are
imposed on Class B and Class C shares, as well as the account maintenance fees
that are imposed on Class D shares, are imposed directly against those classes
and not against all assets of the Fund and, accordingly, such charges do not
affect the net asset value of any other class or have any impact on investors
choosing another sales charge option. Dividends paid by the Fund for each
class of shares are calculated in the same manner at the same time and differ
only to the extent that account maintenance and distribution fees and any
incremental transfer agency costs relating to a particular class are borne
exclusively by that class. Class B, Class C and Class D shares each have
exclusive voting rights with respect to the Rule 12b-1 distribution plan
adopted with respect to such class pursuant to which account maintenance
and/or distribution fees are paid. See "Distribution Plans" below. Each class
has different exchange privileges. See "Shareholder Services--Exchange
Privilege".
22
<PAGE>
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in
that the sales charges applicable to each class provide for the financing of
the distribution of the shares of the Fund. The distribution-related revenues
paid with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised
that only Class A and Class D shares may be available for purchase through
securities dealers, other than Merrill Lynch, which are eligible to sell
shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing SM System.
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION CONVERSION
CLASS SALES CHARGE(/1/) FEE FEE FEATURE
- ---------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/), (/3/)
- ---------------------------------------------------------------------------------------
B CDSC for periods of 4 years, 0.25% 0.50% B shares convert to D
at a rate of 4.0% during the shares automatically
first year, decreasing 1.0% after approximately ten
annually to 0.0%(/4/) years(/5/)
- ---------------------------------------------------------------------------------------
C 1.0% CDSC for one year(/6/) 0.25% 0.55% No
- ---------------------------------------------------------------------------------------
D Maximum 4.00% initial sales 0.25% No No
charge(/3/)
- ---------------------------------------------------------------------------------------
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs may be imposed if the redemption occurs
within the applicable CDSC time period. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of
the shares being redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors".
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class
A shares by certain retirement plans in connection with certain fee-based
programs. Class A and Class D share purchases of $1,000,000 or more may
not be subject to an initial sales charge but, if the initial sales charge
is waived, may be subject to a 1.0% CDSC for one year. A .75% sales charge
for 401(k) purchases over $1,000,000 will apply.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and the conversion
and holding periods for certain retirement plans are modified. Also, Class
B shares of certain other MLAM-advised mutual funds into which exchanges
may be made have an eight-year conversion period. If Class B shares of the
Fund are exchanged for Class B shares of another MLAM-advised mutual fund,
the conversion period applicable to the Class B shares acquired in the
exchange will apply, and the holding period for the shares exchanged will
be tacked onto the holding period for the shares acquired.
(6) The CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
Investors choosing the initial sales charge alternatives who are eligible to
purchase Class A shares should purchase Class A shares rather than Class D
shares because there is an account maintenance fee imposed on Class D shares.
23
<PAGE>
The public offering price of Class A and Class D shares for purchasers
choosing the initial sales charge alternative is the next determined net asset
value plus varying sales charges (i.e., sales loads), as set forth below.
<TABLE>
<CAPTION>
SALES CHARGE SALES CHARGE AS DISCOUNT TO
AS PERCENTAGE PERCENTAGE* OF SELECTED DEALERS
OF OFFERING THE NET AMOUNT AS PERCENTAGE OF
AMOUNT OF PURCHASE PRICE INVESTED THE OFFERING PRICE
- ------------------ ------------- --------------- ------------------
<S> <C> <C> <C>
Less than $25,000............. 4.00% 4.17% 3.75%
$25,000 but less than $50,000. 3.75 3.90 3.50
$50,000 but less than
$100,000..................... 3.25 3.36 3.00
$100,000 but less than
$250,000..................... 2.50 2.56 2.25
$250,000 but less than
$1,000,000................... 1.50 1.52 1.25
$1,000,000 and over**......... 0.00 0.00 0.00
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D share
purchases of $1,000,000 or more and on Class A share purchases in connection
with certain fee-based programs. If the sales charge is waived in connection
with a purchase of $1,000,000 or more, such purchases may be subject to a
CDSC of 1.0% if the shares are redeemed within one year after purchase. Such
CDSC may be waived in connection with redemptions to fund participation in
certain fee-based programs. A sales charge of 0.75% will be charged on
purchases of $1,000,000 or more of Class A or Class D shares by certain
employer-sponsored retirement or savings plans.
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and
Class D shares of the Fund will receive a concession equal to most of the
sales charge, they may be deemed to be underwriters under the Securities Act
of 1933, as amended (the "Securities Act").
For the fiscal year ended August 31, 1996, the Fund sold 11,032,271 Class A
shares for aggregate net proceeds of $105,977,427. The gross sales charges for
the sale of these shares were $7,828 of which $548 was received by the
Distributor and $7,280 was received by Merrill Lynch. During such fiscal year,
the Distributor received no CDSCs with respect to redemptions within one year
after purchase of Class A shares purchased subject to a front-end sales charge
waiver. For the fiscal year ended August 31, 1996, the Fund sold 24,780,817
Class D shares for aggregate net proceeds of $222,390,773. The gross sales
charges for the sale of Class D shares of the Fund for the year were $190,726,
of which $20,058 and $170,668 were received by the Distributor and Merrill
Lynch, respectively. During such fiscal year, the Distributor received no
CDSCs with respect to redemptions within one year after purchase of Class D
shares purchased subject to a front-end sales charge waiver.
Eligible Class A Investors. Class A shares are offered to a limited group of
investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Certain employer sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class A shares at net
asset value provided such plans meet the required minimum number of eligible
employees or required amount of assets advised by MLAM or any of its
affiliates. Class A shares are available at net asset value to corporate
warranty insurance reserve fund programs provided that the program has $3
million or more initially invested in MLAM-advised mutual funds. Also eligible
to purchase Class A shares at net asset value are participants in certain
investment programs including TMA SM Managed Trusts to which Merrill Lynch
Trust Company provides discretionary trustee services, collective investment
trusts for which Merrill Lynch Trust Company serves as trustee and certain
purchases made in connection with certain fee-based programs. In addition,
Class A shares will be offered at net asset value to Merrill Lynch & Co., Inc.
and its subsidiaries and their directors and employees and to members of the
Boards of MLAM-advised investment companies, including the Fund. Certain
persons
24
<PAGE>
who acquired shares of certain MLAM-advised closed-end funds in their initial
offerings who wish to reinvest the net proceeds from a sale of their closed-end
fund shares of common stock in shares of the Fund also may purchase Class A
shares of the Fund if certain conditions set forth in the Statement of
Additional Information are met (for closed-end funds that commenced operations
prior to October 21, 1994). In addition, Class A shares of the Fund and certain
other MLAM-advised mutual funds are offered at net asset value to shareholders
of Merrill Lynch Senior Floating Rate Fund, Inc. and, if certain conditions set
forth in the Statement of Additional Information are met, to shareholders of
Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch High Income
Municipal Bond Fund, Inc. who wish to reinvest the net proceeds from a sale of
certain of their shares of common stock pursuant to a tender offer conducted by
such funds in shares of the Fund and certain other MLAM-advised mutual funds.
Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges
also may be reduced under a Right of Accumulation and a Letter of Intention.
Class A shares are offered at net asset value to certain eligible Class A
investors as set forth above under "Eligible Class A Investors". See
"Shareholder Services--Fee-Based Programs".
Class A and Class D shares are offered at net asset value to Employee Access
AccountsSM available through qualified employers which provide employer-
sponsored retirement and savings plans that are eligible to purchase such
shares at net asset value. Subject to certain conditions Class A and Class D
shares are offered at net asset value to shareholders of Merrill Lynch Strategy
Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund, Inc., and Class A
shares are offered at net asset value to shareholders of Merrill Lynch Senior
Floating Rate Fund, Inc., who wish to reinvest in shares of the Fund the net
proceeds from a sale of certain of their shares of common stock, pursuant to
tender offers conducted by those funds.
Class D shares are offered at net asset value without sales charge to an
investor who has a business relationship with a Merrill Lynch Financial
Consultant, if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.
Class D shares are offered with reduced sales charges and, in certain
circumstances, at net asset value, to participants in the Merrill Lynch
Blueprint SM Program.
Additional information concerning these reduced initial sales charges is set
forth in the Statement of Additional Information.
DEFERRED SALES CHARGE ALTERNATIVES--CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in MLAM-advised mutual funds.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net
asset value per share without the imposition of a sales charge at the time of
purchase. As discussed below, Class B shares are subject to a four year CDSC,
while Class C shares are subject only to a one year 1.0% CDSC. On the other
hand, approximately ten years after Class B shares are issued, such Class B
shares, together with shares issued upon dividend reinvestment with respect to
those
25
<PAGE>
shares, are automatically converted into Class D shares of the Fund and
thereafter will be subject to lower continuing fees. See "Conversion of Class B
Shares to Class D Shares" below. Both Class B and Class C shares are subject to
an account maintenance fee of 0.25% of net assets and Class B shares are
subject to a distribution fee of 0.50% of net assets and Class C shares are
subject to a distribution fee of 0.55% of net assets as discussed below under
"Distribution Plans".
Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below.
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution-related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for
selling Class B and Class C shares, from the dealer's own funds. The
combination of the CDSC and the ongoing distribution fee facilitates the
ability of the Fund to sell the Class B and Class C shares without a sales
charge being deducted at the time of purchase. Approximately ten years after
issuance, Class B shares will convert automatically into Class D shares of the
Fund, which are subject to an account maintenance fee but no distribution fee;
Class B shares of certain other MLAM-advised mutual funds into which exchanges
may be made convert into Class D shares automatically after approximately eight
years. If Class B shares of the Fund are exchanged for Class B shares of
another MLAM-advised mutual fund, the conversion period applicable to the Class
B shares acquired in the exchange will apply, and the holding period for the
shares exchanged will be tacked onto the holding period for the shares
acquired.
Imposition of the CDSC and the distribution fee on Class B and Class C shares
is limited by the NASD asset-based sales charge rule. See "Limitations on the
Payment of Deferred Sales Charges" below. The proceeds from the ongoing account
maintenance fee are used to compensate Merrill Lynch for providing continuing
account maintenance activities. Class B shareholders of the Fund exercising the
exchange privilege described under "Shareholder Services--Exchange Privilege"
will continue to be subject to the Fund's CDSC schedule if such schedule is
higher than the CDSC schedule relating to the Class B shares acquired as a
result of the exchange.
Contingent Deferred Sales Charges--Class B Shares. Class B shares which are
redeemed within four years after purchase may be subject to a CDSC at the rates
set forth below charged as a percentage of the dollar amount subject thereto.
The charge will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed. Accordingly, no CDSC will
be imposed on increases in net asset value above the initial purchase price. In
addition, no CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions. For the fiscal year ended August 31,
1996, the Distributor received CDSCs of $1,283,799 with respect to redemption
of Class B shares, all of which were paid to Merrill Lynch.
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<PAGE>
The following table sets forth rates of the Class B CDSC:
<TABLE>
<CAPTION>
CLASS B CDSC AS A
PERCENTAGE OF
YEAR SINCE PURCHASE DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
------------------- -----------------
<S> <C>
0-1..................................................... 4.00%
1-2..................................................... 3.00%
2-3..................................................... 2.00%
3-4..................................................... 1.00%
4 and thereafter........................................ 0.00%
</TABLE>
In determining whether a CDSC is applicable to a redemption, the calculation
will be determined in the manner that results in the lowest possible rate being
charged. Therefore, it will be assumed that the redemption is first of shares
held for over four years or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the four-year
period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of
shares from a shareholder's account to another will be assumed to be made in
the same order as a redemption.
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares through dividend reinvestment. If at such time the investor
makes his first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to the CDSC because of dividend reinvestment. With respect to the
remaining 40 shares, the CDSC is applied only to the original cost of $10 per
share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of 2.0% (the
applicable rate in the third year after purchase) for shares purchased on or
after October 21, 1994.
The Class B CDSC is waived on redemptions of shares in connection with
certain post-retirement withdrawals from Individual Retirement Account ("IRA")
or other retirement plans or following the death or disability (as defined in
the Internal Revenue Code of 1986, as amended (the "Code")) of a shareholder.
The Class B CDSC also is waived on redemptions of shares by certain eligible
401(a) and eligible 401(k) plans and in connection with certain group plans
placing orders through the Merrill Lynch BlueprintSM Program. The CDSC is also
waived for any Class B shares which are purchased by an eligible 401(k) or
eligible 401(a) plan and are rolled over into a Merrill Lynch or Merrill Lynch
Trust Company custodied IRA and held in such account at the time of redemption
and for any Class B shares that were acquired and held at the time of
redemption in an Employee Access AccountSM available through employers
providing eligible 401(k) plans. The Class B CDSC also is waived for any Class
B shares which are purchased by a Merrill Lynch rollover IRA that was funded by
a rollover from a terminated 401(k) plan managed by the MLAM Private Portfolio
Group and held in such account at the time of redemption. Additional
information concerning the waiver of the Class B CDSC is set forth in the
Statement of Additional Information. The terms of the CDSC may be modified in
connection with redemptions to fund participation in certain fee-based
programs. See "Shareholder Services--Fee-Based Programs."
Contingent Deferred Sales Charges--Class C Shares. Class C shares which are
redeemed within one year after purchase may be subject to a 1.0% CDSC charged
as a percentage of the dollar amount subject thereto.
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<PAGE>
The charge will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed. Accordingly, no Class C
CDSC will be imposed on increases in net asset value above the initial purchase
price. In addition, no Class C CDSC will be assessed on shares derived from
reinvestment of dividends or capital gains distributions. No Class C CDSC will
be assessed in connection with redemption to fund participation in certain fee-
based programs. See "Shareholder Services--Fee-Based Programs."
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest
possible rate being charged. Therefore, it will be assumed that the redemption
is first of shares held for over one year or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the one-year period. The charge will not be applied to dollar amounts
representing an increase in the net asset value since the time of purchase. A
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
For the fiscal year ended August 31, 1996, the Distributor received CDSCs of
$37,766 with respect to redemption of Class C shares, all of which were paid to
Merrill Lynch.
Conversion of Class B Shares to Class D Shares. After approximately ten years
(the "Conversion Period"), Class B shares will be converted automatically into
Class D shares of the Fund. Class D shares are subject to an ongoing account
maintenance fee of 0.25% of net assets but are not subject to the distribution
fee that is borne by Class B shares. Automatic conversion of Class B shares
into Class D shares will occur at least once each month (on the "Conversion
Date") on the basis of the relative net asset values of the shares of the two
classes on the Conversion Date, without the imposition of any sales load, fee
or other charge. Conversion of Class B shares to Class D shares will not be
deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class
D shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert
approximately ten years after initial purchase. If, during the Conversion
Period, a shareholder exchanges Class B shares with an eight-year Conversion
Period for Class B shares with a ten-year Conversion Period, or vice versa, the
Conversion Period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked onto
the holding period for the shares acquired.
28
<PAGE>
The Conversion Period is modified for shareholders who purchased Class B
shares through certain retirement plans which qualified for a waiver of the
CDSC normally imposed on purchases of Class B shares ("Class B Retirement
Plans"). When the first share of any MLAM-advised mutual fund purchased by a
Class B Retirement Plan has been held for ten years (i.e., ten years from the
date the relationship between MLAM-advised mutual funds and the Class B
Retirement Plan was established), all Class B shares of all MLAM-advised mutual
funds held in that Class B Retirement Plan will be converted into Class D
shares of the appropriate funds. Subsequent to such conversion, that Class B
Retirement Plan will be sold Class D shares of the appropriate funds at net
asset value.
The Conversion Period also may be modified for retirement plan investors who
participate in certain fee-based programs. See "Shareholder Services--Fee-Based
Programs".
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the Investment Company Act (each a
"Distribution Plan") with respect to the account maintenance and/or
distribution fees paid by the Fund to the Distributor with respect to such
classes. The Class B and Class C Distribution Plans provide for the payment of
account maintenance fees and distribution fees, and the Class D Distribution
Plan provides for the payment of account maintenance fees.
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rate of 0.25% of the average daily net assets of the Fund attributable to
shares of the relevant class in order to compensate the Distributor and Merrill
Lynch (pursuant to a sub-agreement) in connection with account maintenance
activities.
The Distribution Plans for Class B and Class C shares provide that the Fund
also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rates of 0.50%
and 0.55%, respectively, of the average daily net assets of the Fund
attributable to the shares of the relevant class in order to compensate the
Distributor and Merrill Lynch (pursuant to a sub-agreement) for providing
shareholder and distribution services, and bearing certain distribution-related
expenses of the Fund, including payments to financial consultants for selling
Class B and Class C shares of the Fund. The Distribution Plans relating to
Class B and Class C shares are designed to permit an investor to purchase Class
B and Class C shares through dealers without the assessment of an initial sales
charge and at the same time permit the dealer to compensate its financial
consultants in connection with the sale of the Class B and Class C shares. In
this regard, the purpose and function of the ongoing distribution fees and the
CDSC are the same as those of the initial sales charge with respect to the
Class A and Class D shares of the Fund in that the deferred sales charges
provide for the financing of the distribution of the Fund's Class B and Class C
shares.
For the fiscal year ended August 31, 1996, the Fund paid the Distributor
$8,505,832 pursuant to the Class B Distribution Plan (based on average net
assets subject to such Class B Distribution Plan of approximately $1.1
billion), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class B shares. For the fiscal year ended August 31, 1996, the Fund paid the
Distributor $162,070 pursuant to the Class C Distribution Plan (based on
average
29
<PAGE>
net assets subject to such Class C Distribution Plan of approximately $20.1
million), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class C shares. For the fiscal year ended August 31, 1996, the Fund paid the
Distributor $2,400,905 pursuant to the Class D Distribution Plan (based on
average net assets subject to such Class D Distribution Plan of approximately
$955.1 million), all of which was paid to Merrill Lynch for providing account
maintenance activities in connection with Class D shares.
At November 30, 1996, the net assets of the Fund subject to the Class B
Distribution Plan aggregated approximately $865.4 million. At this asset level,
the annual fee payable pursuant to the Class B Distribution Plan would
aggregate approximately $6.5 million. At November 30, 1996, the net assets of
the Fund subject to the Class C Distribution Plan aggregated approximately
$24.7 million. At this asset level, the annual fee payable pursuant to the
Class C Distribution Plan would aggregate approximately $198,000. At
November 30, 1996, the net assets of the Fund subject to the Class D
Distribution Plan aggregated approximately $965.4 million. At this asset level,
the annual fee payable pursuant to the Class D Distribution Plan would
aggregate approximately $2.4 million.
The payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred, and accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the Distributor on-related revenues and expenses is
presented to the Directors for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information is presented annually as of December 31 of each year on
a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated accrual basis, revenues consist of
the account maintenance fees, distribution fees, the CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and marketing expenses, corporate
overhead and interest expense. On the direct expense and revenue/cash basis,
revenues consist of the account maintenance fees, distribution fees and CDSCs,
and the expenses consist of financial consultant compensation.
As of August 31, 1996, direct cash revenues for the period since commencement
of operations of Class B shares exceeded direct cash expenses by $103,036,735
(11.14% of Class B net assets at that date). As of December 31, 1995, the fully
allocated accrual expenses incurred by the Distributor and Merrill Lynch with
respect to Class B shares for the period since commencement of operations
exceeded fully allocated accrual revenues for such period by approximately
$243,000 (.02% of Class B net assets at that date). Similar fully allocated
accrual data for Class C shares is not presented because prior revenues and
expenses for the period from October 21, 1994 (commencement of operations) to
December 31, 1995 are de minimus. As of August 31, 1996, direct cash expenses
for the period since commencement of operations of Class C shares exceeded
direct cash revenues by $41,212 (.0033% of Class C net assets at that date).
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee
and the CDSC borne by the Class B shares and Class C shares but not the account
maintenance fee. The maximum sales charge rule is applied separately to each
class. As applicable to the Fund, the maximum sales charge rule limits the
aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C
30
<PAGE>
shares (computed separately) (defined to exclude shares issued pursuant to
dividend reinvestments and exchanges) plus (2) interest on the unpaid balance
for the respective class, computed separately, at the prime rate plus 1% (the
unpaid balance being the maximum amount payable minus amounts received from the
payment of the distribution fee and the CDSC). In connection with the Class B
shares, the Distributor has voluntarily agreed to waive interest charges on the
unpaid balance in excess of 0.50% of eligible gross sales. Consequently, the
maximum amount payable to the Distributor (referred to as the "voluntary
maximum") in connection with the Class B shares is 6.75% of eligible gross
sales. The Distributor retains the right to stop waiving the interest charges
at any time. To the extent payments would exceed the voluntary maximum, the
Fund will not make further payments of the distribution fee with respect to the
Class B shares and any CDSC will be paid to the Fund rather than to the
Distributor, however, the Fund will continue to make payments of the account
maintenance fee. In certain circumstances the amount payable pursuant to the
voluntary maximum may exceed the amount payable under the NASD formula. In such
circumstances payments in excess of the amount payable under the NASD formula
will not be made.
----------------
The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the Directors of the Fund will approve the continuance of the Distribution
Plans from year to year. However, the Distributor intends to seek annual
continuation of the Distribution Plans. In their review of the Distribution
Plans, the Directors will be asked to take into consideration expenses incurred
in connection with the account maintenance and/or distribution of each class of
shares separately. The initial sales charges, the account maintenance fee, the
distribution fee and/or the CDSCs received with respect to one class will not
be used to subsidize the sale of shares of another class. Payments of the
distribution fee on Class B shares will terminate upon conversion of those
Class B shares into Class D shares as set forth under "Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares to Class
D Shares".
REDEMPTION OF SHARES
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset
value per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC which may be applicable, there will be no
charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their holdings will receive on
redemption all dividends reinvested through the date of redemption. The value
of shares at the time of redemption may be more or less than the shareholder's
cost, depending on the market value of the securities held by the Fund at such
time.
REDEMPTION
A shareholder wishing to redeem shares may do so by tendering the shares
directly to the Transfer Agent, Merrill Lynch Financial Data Services, Inc.,
P.O. Box 45289, Jacksonville, Florida 32232-5289. Redemption requests delivered
other than by mail should be delivered to Merrill Lynch Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting
31
<PAGE>
redemption. Proper notice of redemption in the case of shares for which
certificates have been issued may be accomplished by a written letter as noted
above accompanied by certificates for the shares to be redeemed. Redemption
requests should not be sent to the Fund. The redemption request requires the
signature(s) of all persons in whose name(s) the shares are registered, signed
exactly as his (their) name(s) appear(s) on the Transfer Agent's register or on
the certificate, as the case may be. The signature(s) on the redemption request
must be guaranteed by an "eligible guarantor institution" (including, for
example, Merrill Lynch branch offices and certain other financial institutions)
as such is defined in Rule 17Ad-15 under the Securities Exchange Act of 1934,
as amended, the existence and validity of which may be verified by the Transfer
Agent through the use of industry publications. Notarized signatures are not
sufficient. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority. For shareholders redeeming directly with the Transfer Agent,
payments will be mailed within seven days of receipt of a proper notice of
redemption.
At various times the Fund may be requested to redeem shares for which it has
not yet received good payment. The Fund may delay or cause to be delayed the
mailing of a redemption check until such time as good payment (e.g., cash or
certified check drawn on a United States bank) has been collected for the
purchase of such shares. Normally, this delay will not exceed 10 days.
REPURCHASE
The Fund also will repurchase shares through a shareholder's listed
securities dealer. The Fund will normally accept orders to repurchase shares by
wire or telephone from dealers for their customers at the net asset value next
computed after receipt of the order by the dealer, provided that the request
for repurchase is received by the dealer prior to the close of business on the
NYSE (generally, 4:00 P.M., New York time) on the day received and is received
by the Fund from such dealer not later than 30 minutes after the close of
business on the NYSE on the same day. Dealers have the responsibility of
submitting such repurchase requests to the Fund not later than 30 minutes after
the close of business on the NYSE in order to obtain that day's closing price.
The foregoing repurchase arrangements are for the convenience of shareholders
and do not involve a charge by the Fund (other than any applicable CDSC).
Securities firms that do not have selected dealer agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Fund. Merrill Lynch may charge its
customers a processing fee (presently, $4.85) to confirm a repurchase of
shares. Repurchases directly through the Transfer Agent are not subject to the
processing fee. The Fund reserves the right to reject any order for repurchase,
which right of rejection might adversely affect shareholders seeking redemption
through the repurchase procedure. However, a shareholder whose order for
repurchase is rejected by the Fund may redeem shares as set forth above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a one-
time privilege to reinstate their accounts by purchasing Class A or Class D
shares, as the case may be, of the Fund at net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by
32
<PAGE>
sending a notice of exercise along with a check for the amount to be reinstated
to the Transfer Agent within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. Alternatively, the
reinstatement privilege may be exercised through the investor's Merrill Lynch
Financial Consultant within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. The reinstatement will
be made at the net asset value per share next determined after the notice of
reinstatement is received and cannot exceed the amount of the redemption
proceeds.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services and investment plans
described below which are designed to facilitate investment in shares of the
Fund. Certain of such services are not available to investors who place
purchase orders for the Fund through the Merrill Lynch BlueprintSM Program.
Full details as to each of such services, copies of the various plans described
below and instructions as to how to participate in the various services or
plans, or to change options with respect thereto, can be obtained from the Fund
by calling the telephone number on the cover page hereof or from the
Distributor or Merrill Lynch. Certain of these services are available only to
U.S. investors. Included in the Fund's shareholder services are the following:
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends and long-term capital gain distributions. The statements will also
show any other activity in the account since the preceding statement.
Shareholders will receive separate transaction confirmations for each purchase
or sale transaction other than automatic investment purchases and the
reinvestments of ordinary income dividends and long-term capital gain
distributions. Shareholders may make additions to their Investment Account at
any time by mailing a check directly to the Transfer Agent. Shareholders may
also maintain their accounts through Merrill Lynch. Upon the transfer of shares
out of a Merrill Lynch brokerage account, an Investment Account in the
transferring shareholder's name will be opened automatically, without charge,
at the Transfer Agent. Shareholders considering transferring their Class A or
Class D shares from Merrill Lynch to another brokerage firm or financial
institution should be aware that, if the firm to which the Class A or Class D
shares are to be transferred will not take delivery of shares of the Fund, a
shareholder either must redeem the Class A or Class D shares (paying any
applicable CDSC) so that the cash proceeds can be transferred to the account at
the new firm or such shareholder must continue to maintain an Investment
Account at the Transfer Agent for those Class A or Class D shares. Shareholders
interested in transferring their Class B or Class C shares from Merrill Lynch
and who do not wish to have an Investment Account maintained for such shares at
the Transfer Agent may request their new brokerage firm to maintain such shares
in an account registered in the name of the brokerage firm for the benefit of
the shareholder at the Transfer Agent. If the new brokerage firm is willing to
accommodate the shareholder in this manner, the shareholder must request that
he or she be issued certificates for his or her shares and then must turn the
certificates over to the new firm for re-registration as described in the
preceding sentence. Shareholders considering transferring a tax-deferred
retirement account such as an individual retirement account from Merrill Lynch
to another brokerage firm or financial institution should be aware that, if the
firm to which the retirement account is to
33
<PAGE>
be transferred will not take delivery of shares of the Fund, a shareholder
must either redeem the shares (paying any applicable contingent deferred sales
charge) so that the cash proceeds can be transferred to the account at the new
firm, or such shareholder must continue to maintain a retirement account at
Merrill Lynch for those shares.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other MLAM-advised mutual funds. There is currently no
limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated in accordance
with the rules of the Securities and Exchange Commission.
Under the Merrill Lynch Select Pricing SM System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-
advised mutual fund if the shareholder holds any Class A shares of the second
fund in his or her account in which the exchange is made at the time of the
exchange or is otherwise eligible to purchase Class A shares of the second
fund. If the Class A shareholder wants to exchange Class A shares for shares
of a second MLAM-advised mutual fund, and the shareholder does not hold Class
A shares of the second fund in his or her account at the time of the exchange
and is not otherwise eligible to acquire Class A shares of the second fund,
the shareholder will receive Class D shares of the second fund as a result of
the exchange. Class D shares also may be exchanged for Class A shares of a
second MLAM-advised mutual fund at any time as long as, at the time of the
exchange, the shareholder holds Class A shares of the second fund in the
account in which the exchange is made or is otherwise eligible to purchase
Class A shares of the second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously
paid on the Class A or Class D shares being exchanged and the sales charge
payable at the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares are exchangeable with shares of the same
class of other MLAM-advised mutual funds.
Shares of the Fund which are subject to a CDSC are exchangeable on the basis
of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares
of the Fund is "tacked" to the holding period for the newly acquired shares of
the other fund.
Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares
are held in a money market fund, however, will not count toward satisfaction
of the holding period requirement for reduction of any CDSC imposed on such
shares, if any, and, with respect to Class B shares, toward satisfaction of
the Conversion Period.
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<PAGE>
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the MLAM-advised mutual fund from
which the exchange has been made.
Exercise of the exchange is treated as a sale of the exchanged shares and a
purchase of the acquired shares for Federal income tax purposes. For further
information, see "Shareholder Services--Exchange Privilege" in the Statement of
Additional Information.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND DISTRIBUTIONS
All dividends and capital gains distributions are reinvested automatically in
full and fractional shares of the Fund at the net asset value per share next
determined on the payable date of such dividends or distributions. A
shareholder may at any time, by written notification or by telephone call (1-
800-MER-FUND) to the Transfer Agent, elect to have subsequent dividends or both
dividends and capital gains distributions, paid in cash, rather than
reinvested, in which event payment will be mailed on or about the payment date.
Cash payments can also be directly deposited to the shareholder's bank account.
No CDSC will be imposed on redemption of shares issued as a result of the
automatic reinvestment of dividends or capital gains distributions.
SYSTEMATIC WITHDRAWAL PLANS
A Class A or Class D shareholder may elect to receive systematic withdrawal
payments from his Investment Account in the form of payments by check or
through automatic payment by direct deposit to his bank account on either a
monthly or quarterly basis. A Class A or Class D shareholder whose shares are
held within a CMA(R), CBA(R) or Retirement Account may elect to have shares
redeemed on a monthly, bimonthly, quarterly, semiannual or annual basis through
the Systematic Redemption Program, subject to certain conditions.
AUTOMATIC INVESTMENT PLANS
Regular additions of Class A, Class B, Class C or Class D shares may be made
to an investor's Investment Account by prearranged charges of $50 or more to
his or her regular bank account. Investors who maintain CMA(R) or CBA(R)
accounts may arrange to have periodic investments made in the Fund in their
CMA(R) or CBA(R) accounts or in certain related accounts in amounts of $100 or
more through the CMA(R) or CBA(R) Automated Investment Program.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives for
securities transactions (each referred to in this paragraph as a "Program"),
may permit the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the Conversion Period applicable to the deposited shares.
35
<PAGE>
Termination of participation in a Program may result in the redemption of
shares held therein or the automatic exchange thereof to another class at net
asset value, which may be shares of a money market fund. In addition, upon
termination of participation in a Program, shares that have been held for less
than specified periods within such Program may be subject to a fee based upon
the current value of such shares. These Programs also generally prohibit such
shares from being transferred to another account at Merrill Lynch, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance
fees) in order for the investment not to be subject to Program fees. Additional
information regarding a specific Program (including charges and limitations on
transferability applicable to shares that may be held in such Program) is
available in such Program's client agreement and from Merrill Lynch Investor
Services at (800) MER-FUND (637-3863).
PORTFOLIO TRANSACTIONS
The Fund has no obligation to deal with any dealer or group of dealers in the
execution of transactions in portfolio securities of the Fund. The securities
in which the Fund invests are normally purchased directly from the issuer or
from an underwriter or dealer in such securities. Where possible, the Fund
deals directly with the dealers who make a market in the securities involved
except in those circumstances where better prices and execution are available
elsewhere. It is the policy of the Fund to obtain the best net results in
conducting portfolio transactions, taking into account such factors as price
(including the applicable dealer spread), the size, type and difficulty of the
transactions involved, the firm's general execution and operations facilities,
and the firm's risk in positioning the securities involved and the provision of
supplemental investment research by the firm. While reasonably competitive
spreads or commissions are sought, the Fund will not necessarily be paying the
lowest spread or commission available. The portfolio securities of the Fund
generally are traded on a net basis and normally do not involve either
brokerage commissions or transfer taxes. The cost of portfolio securities
transactions of the Fund primarily consists of dealer or underwriter spreads.
Under the Investment Company Act, persons affiliated with the Fund, including
Merrill Lynch, are prohibited from dealing with the Fund as a principal in the
purchase and sale of securities unless such trading is permitted by an
exemptive order issued by the Commission. In addition, the Fund may not
purchase securities for the Fund from any underwriting syndicate of which
Merrill Lynch is a member except pursuant to procedures approved by the
Trustees of the Fund which comply with rules adopted by the Commission.
Affiliated persons of the Fund may serve as its broker in over-the-counter
transactions conducted for the Fund on an agency basis only.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
yield, for various specified time periods, in advertisements or information
furnished to present or prospective shareholders. Average annual total return
and yield are computed separately for Class A, Class B, Class C and Class D
shares in accordance with formulas specified by the Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital
36
<PAGE>
gains or losses on portfolio investments over such periods) that would equate
the initial amount invested to the redeemable value of such investment at the
end of each period. Average annual total return will be computed assuming all
dividends and distributions are reinvested and taking into account all
applicable recurring and nonrecurring expenses, including any CDSC that would
be applicable to a complete redemption of the investment at the end of the
specified period such as in the case of Class B and Class C shares and the
maximum sales charge in the case of Class A and Class D shares. Dividends paid
by the Fund with respect to all shares, to the extent any dividends are paid,
will be calculated in the same manner at the same time on the same day and will
be in the same amount, except that account maintenance fees and distribution
charges and any incremental transfer agency costs relating to each class of
shares will be borne exclusively by that class. The Fund may include
performance data for all classes of shares of the Fund in any advertisement or
information including performance data of the Fund.
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return
calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return and (2) the maximum applicable sales
charges will not be included with respect to annual or annualized rates of
return calculations. Aside from the effect on the performance data calculations
of including or excluding the maximum applicable sales charges, actual annual
or annualized total return data generally will be lower than average annual
total return data since the average annual rates of return reflect compounding;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time. In advertisements distributed to investors whose
purchases are subject to waiver of the CDSC in the case of Class B and Class C
shares (such as investors in certain retirement plans) or to reduced sales load
in the case of Class A and Class D shares, the performance data may take into
account the reduced, and not the maximum, sales charges or may not take into
account the CDSC and therefore may reflect greater total return since, due to
the reduced sales charges, a lower amount of expenses may be deducted. See
"Purchase of Shares". The Fund's total return may be expressed either as a
percentage or as a dollar amount in order to illustrate such total return on a
hypothetical $1,000 investment in the Fund at the beginning of each specified
period.
Yield quotations for each class will be computed based on a 30-day period by
dividing (a) the net income based on the yield of each security earned during
the period by (b) the average daily number of shares outstanding in each class
during the period that were entitled to receive dividends multiplied by the
maximum offering price/net asset value per share of that class on the last day
of the period. The yield for the 30-day period ended August 31, 1996 was 6.42%
for Class A shares, 5.91% for Class B shares, 5.86% for Class C shares and
6.18% for Class D shares.
Total return and yield figures are based on the Fund's historical performance
and are not intended to indicate future performance. The Fund's total return
and yield will vary depending on market conditions, the securities comprising
the Fund's portfolio, the Fund's operating expenses and the amount of realized
and unrealized net capital gains or losses during the period. The value of an
investment in the Fund will fluctuate and an investor's shares, when redeemed,
may be worth more or less than their original cost.
On occasion, the Fund may compare its performance to the Standard & Poor's
500 Composite Stock Price Index, the Dow Jones Industrial Average or
performance data published by Lipper Analytical Services,
37
<PAGE>
Inc., Morningstar Publications, Inc., Money Magazine, U.S. News & World Report,
Business Week, CDA Investment Technology, Inc., Forbes Magazine, Fortune
Magazine or other industry publications. In addition, from time to time the
Fund may include the Fund's risk adjusted performance ratings assigned by
Morningstar Publications, Inc. in advertising or supplemental sales literature.
As with other performance data, performance comparisons should not be
considered representative of the Fund's relative performance for any future
period. In addition, from time to time the Fund may include its risk-adjusted
performance ratings assigned by Morningstar Publications, Inc. in advertising
or supplemental sales literature.
TAXES
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue
Code of 1986, as amended (the "Code"). If it so qualifies, the Fund (but not
its shareholders) will not be subject to Federal income tax on the part of its
net ordinary income and net realized capital gains which it distributes to
Class A, Class B, Class C and Class D shareholders ("shareholders"). The Fund
intends to distribute substantially all of such income.
Dividends paid by the Fund from its ordinary income or from an excess of net
short-term capital gains over net long-term capital losses (together referred
to hereafter as "ordinary income dividends") are taxable to shareholders as
ordinary income. Distributions made from an excess of net long-term capital
gains over net short-term capital losses (including gains or losses from
certain transactions in futures and options) ("capital gain dividends") are
taxable to shareholders as long-term capital gains, regardless of the length of
time the shareholder has owned Fund shares. Any loss upon the sale or exchange
of Fund shares held for six months or less, however, will be treated as long-
term capital loss to the extent of any capital gain dividends received by the
shareholder. Distributions in excess of the Fund's earnings and profits will
first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset).
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Not later than 60 days after the close of its
taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any ordinary income dividends or capital gain
dividends. Distributions by the Fund, whether from ordinary income or capital
gains, generally will not be eligible for the dividends received deduction
allowed to corporations under the Code. If the Fund pays a dividend in January
which was declared in the previous October, November or December to
shareholders of record on a specified date in one of such months, then such
dividend will be treated for tax purposes as being paid by the Fund and
received by its shareholders on December 31 of the year in which such dividend
was declared.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult
their own tax advisers concerning the applicability of the United States
withholding tax.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding").
38
<PAGE>
Generally, shareholders subject to backup withholding will be those for whom no
certified taxpayer identification number is on file with the Fund or who, to
the Fund's knowledge, have furnished an incorrect number. When establishing an
account, an investor must certify under penalty of perjury that such number is
correct and that such investor is not otherwise subject to backup withholding.
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the Class
D shares acquired will be the same as such shareholder's basis in the Class B
shares converted, and the holding period of the acquired Class D shares will
include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will be
reduced (or the gain increased) to the extent any sales charge paid to the Fund
on the exchanged Shares reduces any sales charge such shareholder would have
owed upon the purchase of the new shares in the absence of the exchange
privilege. Instead, such sales charge will be treated as an amount paid for the
new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
The Fund may make investments that produce taxable income which is not
matched by a corresponding receipt of cash or an offsetting loss deduction.
Such investments would include obligations that have original issue discount,
accrue negative amortization or are subordinated in the mortgage-backed
securities structure. Such taxable income would be treated as income earned by
the Fund and would be subject to the distribution requirements of the Code.
Because such income may not be matched by a corresponding receipt of cash by
the Fund or an offsetting loss deduction, the Fund may be required to dispose
of other securities to be able to make distributions to shareholders. The Fund
intends to make sufficient and timely distributions to shareholders so as to
qualify for the special tax treatment afforded RICs at all times.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Certain states exempt from state income taxation dividends paid by RICs which
are derived from interest on U.S. Government obligations. State law varies as
to whether dividend income attributable to U.S. Government obligations is
exempt from state income tax. In general, state law does not consider income
derived from mortgage-backed securities to be income attributable to U.S.
Government obligations.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors
should consider applicable foreign taxes in their evaluation of an investment
in the Fund.
39
<PAGE>
ADDITIONAL INFORMATION
DIVIDENDS AND DISTRIBUTIONS
It is the Fund's intention to distribute all its net investment income.
Dividends from such net investment income will be declared daily prior to the
determination of net asset value on that day and paid monthly. Shares will
accrue dividends as long as they are issued and outstanding. Shares are issued
and outstanding as of the settlement date of a purchase order to the settlement
date of a redemption order. All net realized long-term capital gains and short-
term capital gains, if any, will be distributed to the Fund's shareholders at
least annually.
The per share dividends and distributions on each class of shares will be
reduced as a result of any account maintenance, distribution and transfer
agency fees applicable to that class. See "Additional Information--
Determination of Net Asset Value" below.
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined by
the Manager once daily as of 15 minutes after the close of business on the NYSE
(generally, 4:00 P.M., New York time) on each day during which the NYSE is open
for trading. The net asset value is computed by dividing the sum of the value
of the securities held by the Fund plus any cash or other assets (including
interest accrued but not yet received) minus all liabilities (including accrued
expenses) by the total number of shares outstanding at such time rounded to the
nearest cent. Expenses, including the fees payable to the Manager and any
account maintenance and/or distribution fees payable to the Distributor, are
accrued daily. The per share net asset value of Class A shares generally will
be higher than the per share net asset value of shares of the other classes,
reflecting the daily expense accruals of the account maintenance, distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares and the daily expense accruals of the account maintenance fees
applicable with respect to Class D shares; moreover, the per share net asset
value of Class D shares generally will be higher than the per share net asset
value of Class B and Class C shares, reflecting the daily expense accruals of
the distribution and higher transfer agency fees applicable with respect to
Class B and Class C shares. It is expected, however, that the per share net
asset value of the two classes will tend to converge (although not necessarily
meet) immediately after the payment of dividends or distributions, which will
differ by approximately the amount of the expense accrual differentials between
the classes.
Portfolio securities which are traded on stock exchanges are valued at the
last sale price (regular way) as of the close of business on the day the
securities are being valued, or, lacking any sales, at the last available bid
price. Securities traded in the OTC market are valued at the last available bid
price in the OTC market prior to the time of valuation. Portfolio securities
which are traded both in the OTC market and on a stock exchange are valued
according to the broadest and most representative market. Other investments,
including futures contracts and related options, are stated at market value.
Securities and assets for which market quotations are not readily available are
valued at fair value as determined in good faith by or under the
40
<PAGE>
direction of the Trustees of the Fund. The Fund employs Merrill Lynch
Securities Pricing Service ("MLSPS"), an affiliate of the Manager, to provide
securities prices for the Fund. During the fiscal year ended August 31, 1996,
the Fund made payments of $2,330 to MLSPS for such service.
ORGANIZATION OF THE FUND
The Fund was organized on July 20, 1984 under the laws of the Commonwealth of
Massachusetts and is a business entity commonly known as a "Massachusetts
business trust." It is a diversified, open-end investment company. The Fund is
authorized to issue an unlimited number of shares of beneficial interest of
different classes, par value $.10 per share. As of the date of this Prospectus,
the shares of the Fund are divided into four classes, designated Class A, Class
B, Class C and Class D shares. All shares represent an interest in the same
assets of the Fund and are identical in all respects except that Class B, Class
C and Class D shares bear certain expenses related to the account maintenance
fee relating to such shares and Class B and Class C shares bear certain
expenses related to the distribution of such shares. Each class has exclusive
voting rights with respect to matters relating to account maintenance and
distribution expenditures, as applicable. See "Purchase of Shares". The Fund
has received an order from the Commission permitting the issuance and sale of
multiple classes of shares of beneficial interest. The Trustees of the Fund may
classify and reclassify the shares of the Fund into additional classes of
shares of beneficial interest at a future date.
The Declaration of Trust does not require that the Fund hold an annual
meeting of shareholders. However, the Fund will be required to call special
meetings of shareholders in accordance with the requirements of the Investment
Company Act to seek approval of new management and advisory arrange-ments, of a
material increase in distribution fees or of a change in the fundamental
policies, objectives or restrictions of the Fund. The Fund also would be
required to hold a special shareholders' meeting to elect new Trustees at such
time as less than a majority of the Trustees holding office have been elected
by shareholders. The Declaration of Trust provides that a shareholders' meeting
may be called for any reason at the request of 10% of the outstanding shares of
the Fund or by a majority of the Trustees.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Prospectus.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts the shareholder should notify in writing:
Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
41
<PAGE>
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this
please call your Merrill Lynch financial consultant or Merrill Lynch Financial
Data Services, Inc. at 800-637-3863.
----------------
The Declaration of Trust establishing the Fund, dated July 20, 1984, a copy
of which, together with all amendments thereto (the "Declaration"), is on file
in the office of the Secretary of the Commonwealth of Massachusetts, provides
that the name "Merrill Lynch Federal Securities Trust" refers to the Trustees
under the Declaration collectively as Trustees, but not as individuals or
personally; and no Trustee, shareholder, officer, employer or agent of the Fund
shall be held to any personal liability, nor shall resort be had to their
private property for the satisfaction of any obligation or claim of the Fund
but the "Trust Property" only shall be liable.
42
<PAGE>
MERRILL LYNCH FEDERAL SECURITIES TRUST--AUTHORIZATION FORM (PART 1)
- -------------------------------------------------------------------------------
NOTE: THIS FORM MAY NOT BE USED FOR PURCHASES THROUGH THE MERRILL LYNCH
BLUEPRINT SM PROGRAM. YOU MAY REQUEST A MERRILL LYNCH BLUEPRINT SM
PROGRAM APPLICATION BY CALLING (800) 637-3766.
- -------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
[_] Class A shares [_] Class B shares [_] Class C shares [_] Class D shares
of Merrill Lynch Federal Securities Trust and establish an Investment Account
as described in the Prospectus. In the event that I am not eligible to
purchase Class A shares, I understand that Class D shares will be purchased.
Basis for establishing an Investment Account:
A. I enclose a check for $............ payable to Merrill Lynch Financial
Data Services, Inc. as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next to
be determined after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the Right of Accumulation as outlined in the Statement of
Additional Information: Please list all funds. (Use a separate sheet of
paper if necessary.)
1. .................................. 4. ..................................
2. .................................. 5. ..................................
3. .................................. 6. ..................................
Name...........................................................................
First Name Initial Last Name
Name of Co-Owner (if any)......................................................
First Name Initial Last Name
Address........................................................................
................................................. Date........................
(Zip Code)
Occupation........................... Name and Address of Employer ........
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owner, a joint tenancy with rights of survivorship will be
presumed unless otherwise specified.)
- -------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
Ordinary Income Dividends Long-Term Capital Gains
Select [_] Reinvest Select [_] Reinvest
One: [_] Cash One: [_] Cash
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: [_] CHECK
OR [_] DIRECT DEPOSIT TO BANK ACCOUNT
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by
direct deposit to my bank account and, if necessary, debit entries and
adjustments for any credit entries made to my account in accordance with the
terms I have selected on the Merrill Lynch Federal Securities Trust
Authorization Form.
SPECIFY TYPE OF ACCOUNT (CHECK ONE) [_] CHECKING [_] SAVINGS
Name on your account ..........................................................
Bank Name .....................................................................
Bank Number ...................... Account Number ............................
Bank Address ..................................................................
I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE WRITTEN
NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
Signature of Depositor ........................................................
Signature of Depositor ............................... Date...................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED
CHECK MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD
ACCOMPANY THIS APPLICATION.
- -------------------------------------------------------------------------------
43
<PAGE>
MERRILL LYNCH FEDERAL SECURITIES TRUST--AUTHORIZATION FORM (PART 1) --
(CONTINUED)
3. SOCIAL SECURITY OR TAXPAYER IDENTIFICATION NUMBER
[_][_][_][_][_][_][_][_][_]
Social Security Number or Taxpayer Identification Number
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security Number or Taxpayer Identification Number and (2)
that I am not subject to backup withholding (as discussed under "Additional
Information--Taxes") either because I have not been notified that I am subject
thereto as a result of a failure to report all interest or dividends, or the
Internal Revenue Service ("IRS") has notified me that I am no longer subject
thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDER-REPORTING AND
IF YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS
BEEN TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS
CERTIFICATION TO OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
- -------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
Dear Sir/Madam:
..................., 19......
Date of Initial Purchase
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch Federal Securities Trust or any other investment company with an initial
sales charge or deferred sales charge for which Merrill Lynch Funds
Distributor, Inc. acts as distributor over the next 13 month period which will
equal or exceed:
[_] $25,000 [_] $50,000 [_] $100,000 [_] $250,000 [_] $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Merrill Lynch Federal Securities
Trust Prospectus.
I agree to the terms and conditions of this Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc. my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch Federal Securities Trust held as security.
By .................................. .....................................
Signature of Owner Signature of Co-Owner
(If registered in joint names, both must
sign)
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
(1) Name............................. (2) Name.............................
Account Number....................... Account Number.......................
- -------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp.
- - - We hereby authorize Merrill Lynch
Funds Distributor, Inc. to act as
our agent in connection with
transactions under this
authorization form and agree to
notify the Distributor of any
purchases or sales made under a
Letter of Intention, Automatic
Investment Plan or Systematic
Withdrawal Plan. We guarantee the
- - - shareholder's signature.
This form when completed should be .................................
mailed to: Dealer Name and Address
Merrill Lynch Federal Securities Trust By ..............................
c/o Merrill Lynch Financial Data Authorized Signature of Dealer
Services, Inc.
P.O. Box 45289 [_][_][_] [_][_][_][_].............
Jacksonville, FL 32232-5289 Branch-Code F/C No. F/C Last Name
[_][_][_] [_][_][_][_][_]
Dealer's Customer A/C No.
44
<PAGE>
MERRILL LYNCH FEDERAL SECURITIES TRUST--AUTHORIZATION FORM (PART 2)
- -------------------------------------------------------------------------------
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL PLAN OR THE
AUTOMATIC INVESTMENT PLAN ONLY.
- -------------------------------------------------------------------------------
1. ACCOUNT REGISTRATION
Name of Owner...................... [_][_][_][_][_][_][_][_][_]
Name of Co-Owner (if any).......... Social Security No. or
Taxpayer Identification
Number
Address............................ Account Number ....................
(if existing account)
...................................
- -------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND D SHARES ONLY (See terms and
conditions in the Statement of Additional Information)
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for
quarterly, of [_] Class A or [_] Class D shares in Merrill Lynch Federal
Securities Trust, at cost or current offering price. Withdrawals to be made
either (check one) [_] Monthly on the 24th day of each month, or [_] Quarterly
on the 24th day of March, June, September and December. If the 24th falls on a
weekend or holiday, the next succeeding business day will be utilized. Begin
systematic withdrawal on . . . . . . . . . .(month) or as soon as possible
thereafter.
SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE): [_] $______
or [_] ___% of the current value of [_] Class A or [_] Class D shares in the
account.
SPECIFY WITHDRAWAL METHOD: [_] check or [_] direct deposit to bank account
(check one and complete part (a) or (b) below):
DRAW CHECKS PAYABLE (CHECK ONE)
(a)I hereby authorize payment by check
[_] as indicated in Item 1.
[_] to the order of..........................................................
Mail to (check one)
[_] the address indicated in Item 1.
[_] Name (Please Print)......................................................
Address .......................................................................
..........................................................................
Signature of Owner................................ Date..................
Signature of Co-Owner (if any)............................................
(B) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO BANK ACCOUNT AND (IF
NECESSARY) DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING
OR TERMINATING THIS SERVICE.
Specify type of account (check one): [_] checking [_] savings
Name on your Account...........................................................
Bank Name......................................................................
Bank Number........................ Account Number............................
Bank Address...................................................................
...............................................................................
Signature of Depositor................................. Date..................
Signature of Depositor.........................................................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID"
OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS APPLICATION.
45
<PAGE>
- -------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ("ACH") debit on my checking account as described
below each month to purchase: (choose one)
[_] Class A shares [_] Class B shares [_] Class C shares [_] Class D shares
of Merrill Lynch Federal Securities Trust, subject to the terms set forth
below. In the event that I am not eligible to purchase Class A shares, I
understand that Class D shares will be purchased.
MERRILL LYNCH FINANCIAL DATA AUTHORIZATION TO HONOR CHECKS OR ACH
SERVICES, INC. DEBITS DRAWN BY MERRILL LYNCH
FINANCIAL DATA SERVICES, INC.
You are hereby authorized to draw
checks an ACH debit each month on my To...............................Bank
bank account for investment in (Investor's Bank)
Merrill Lynch Federal Securities
Trust, as indicated below: Bank Address.........................
Amount of each check or ACH debit
$................................. City...... State...... Zip Code......
Account Number ...................
Please date and invest ACH debits on As a convenience to me, I hereby
the 20th of each month beginning request and authorize you to pay and
charge to my account ACH debits
..................................... drawn on my account by and payable
to Merrill Lynch Financial Data
................(month) Services, Inc., I agree that your
rights in respect to each such debit
or as soon as possible thereafter. shall be the same as if it were a
I agree that you are drawing these check drawn on you and signed
ACH debits voluntarily at my request personally by me. This authority is
and that you shall not be liable for to remain in effect until revoked by
any loss arising from any delay in me in writing. Until you receive
preparing or failure to prepare any such notice, you shall be fully
such debit. If I change banks or protected in honoring any such
desire to terminate or suspend this debit. I further agree that if any
program, I agree to notify you such debit be dishonored, whether
promptly in writing. I hereby with or without cause and whether
authorize you to take any action to intentionally or inadvertently, you
correct erroneous ACH debits of my shall be under no liability.
bank account or purchases of fund
shares including liquidating shares ............ .....................
of the Fund and credit my bank Date Signature of
account. I further agree that if a Depositor
debit is not honored upon
presentation, Merrill Lynch Financial ............ .....................
Data Services, Inc. is authorized to Bank Signature of Depositor
discontinue immediately the Automatic Account (If joint account,
Investment Plan and to liquidate Number both must sign)
sufficient shares held in my account
to offset the purchase made with the
dishonored debit.
............ .....................
Date Signature of
Depositor
......................
Signature of Depositor
(If joint account,
both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" SHOULD ACCOMPANY THIS APPLICATION.
46
<PAGE>
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
The Bank of New York
90 Washington Street
12th Floor
New York, New York 10286
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 3224-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540
COUNSEL
Brown & Wood LLP
One World Trade Center
New York, New York 10048-0557
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESEN-
TATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION WITH THE
OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMA-
TION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY
THE FUND, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
-------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fee Table.................................................................. 2
Merrill Lynch Select PricingSM System...................................... 4
Financial Highlights....................................................... 8
Investment Objective and Policies.......................................... 10
GNMA Certificates and Other Mortgage-Backed Government Securities......... 11
Options and Futures Portfolio Strategies.................................. 12
Other Investment Practices................................................ 17
Portfolio Transactions.................................................... 18
Investment Restrictions................................................... 18
Portfolio Turnover........................................................ 19
Management of the Fund..................................................... 19
Trustees.................................................................. 19
Management and Advisory Arrangements...................................... 20
Code of Ethics............................................................ 21
Transfer Agency Services.................................................. 21
Purchase of Shares......................................................... 21
Initial Sales Charge Alternatives--
Class A and Class D Shares.............................................. 23
Deferred Sales Charge Alternatives--
Class B and Class C Shares.............................................. 25
Distribution Plans........................................................ 29
Limitations on the Payment of Deferred
Sales Charges........................................................... 30
Redemption of Shares....................................................... 31
Redemption................................................................ 31
Repurchase................................................................ 32
Reinstatement Privilege--
Class A and Class D Shares.............................................. 32
Shareholder Services....................................................... 33
Investment Account........................................................ 33
Exchange Privilege........................................................ 34
Automatic Reinvestment of Dividends and Distributions..................... 35
Systematic Withdrawal Plans............................................... 35
Automatic Investment Plans................................................ 35
Fee-Based Programs........................................................ 35
Portfolio Transactions..................................................... 36
Performance Data........................................................... 36
Taxes...................................................................... 38
Additional Information..................................................... 40
Dividends and Distributions............................................... 40
Determination of Net Asset Value.......................................... 40
Organization of the Fund.................................................. 41
Shareholder Inquiries..................................................... 41
Shareholder Reports....................................................... 41
Authorization Form......................................................... 43
</TABLE>
Code #10259-1296
[LOGO] MERRILL LYNCH
MERRILL LYNCH
FEDERAL SECURITIES TRUST
[ART]
PROSPECTUS
DECEMBER 20, 1995
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This propsectus should be retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
- -----------------------------------
MERRILL LYNCH FEDERAL SECURITIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
Merrill Lynch Federal Securities Trust (the "Fund") is a mutual fund seeking
a high current return through investments in U.S. Government and Government
agency securities, including Government National Mortgage Association ("GNMA")
mortgage-backed certificates and other mortgage-backed government securities.
The Fund may seek to enhance its return through the use of certain portfolio
strategies involving options and to hedge its portfolio through the use of
options and futures transactions. The Fund will declare dividends daily and pay
them monthly from its net investment income. The Fund's current return consists
of interest, premiums from its expired call and put options, any short-term
gains from sales of portfolio securities on exercise of options or otherwise,
and any gains from closing purchase or sale transactions. There can be no
assurance that the investment objective of the Fund will be realized.
----------------
Pursuant to the Merrill Lynch Select PricingSM System, the Fund offers four
classes of shares each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances.
----------------
This Statement of Additional Information of the Fund is not a prospectus and
should be read in conjunction with the Prospectus of the Fund, dated December
20, 1996 (the "Prospectus"), which has been filed with the Securities and
Exchange Commission (the "Commission") and can be obtained, without charge, by
calling or by writing the Fund at the above telephone number or address. This
Statement of Additional Information has been incorporated by reference into the
Prospectus.
----------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
----------------
The date of this Statement of Additional Information is December 20, 1996
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek a high current return through
investments in U.S. Government and Government agency securities ("U.S.
Government securities"), including GNMA mortgage-backed certificates, and other
mortgage-backed government securities. Reference is made to "Investment
Objective and Policies" in the Prospectus for a discussion of the investment
objective and policies of the Fund.
While the Fund has authority to invest in all U.S. Government securities, it
is anticipated that under certain market conditions, a significant portion of
its portfolio of U.S. Government securities may consist of GNMA mortgage-backed
certificates ("GNMA Certificates") and other U.S. Government securities
representing ownership interests in mortgage pools. The Fund is authorized to
acquire all types of U.S. Government securities representing ownership
interests in mortgage pools which are presently issued or which may be issued
in the future. In this regard, GNMA recently began offering a pass-through
security backed by adjustable-rate mortgages. These securities bear interest at
a rate which is adjusted either quarterly or annually. The prepayment
experience of the mortgages underlying these securities may vary from that for
fixed-rate mortgages. These securities are eligible for purchase by the Fund.
Portfolio Turnover. Fund Asset Management, L.P. (the "Manager" or "FAM" )
will effect portfolio transactions without regard to any holding period if, in
its judgment, such transactions are advisable in light of a change in general
market, economic or financial conditions. For the fiscal years ended August 31,
1995 and 1996 the Fund's portfolio turnover rates were 260.34% and 204.14%,
respectively. A high rate of portfolio turnover results in correspondingly
greater transaction costs in the form of dealer spreads and brokerage
commissions which are borne directly by the Fund. The Fund is subject to the
Federal income tax requirement that less than 30% of the Fund's gross income be
derived from gains from the sale or other disposition of securities held for
less than three months. See "Dividends, Distributions and Taxes--Taxes".
INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental investment
policies and restrictions. The fundamental policies and restrictions set forth
below may not be changed without the approval of the holders of a majority of
the Fund's outstanding voting securities (which for this purpose means the
lesser of (a) 67% of the shares represented at a meeting at which more than 50%
of the outstanding shares are represented or (b) more than 50%of the
outstanding shares). Unless otherwise provided, all references to the assets of
the fund below are in terms of current market value. The Fund may not:
1. Make any investment inconsistent with the Fund's classification as a
diversified company under the Investment Company Act.
2. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).
3. Make investments for the purpose of exercising control or management.
4. Purchase or sell real estate, except that, to the extent permitted by
applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
2
<PAGE>
5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Prospectus and this
Statement of Additional Information, as they may be amended from time to
time.
6. Issue senior securities to the extent such issuance would violate
applicable law.
7. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) the Fund may borrow up
to an additional 5% of its total assets for temporary purposes, (iii) the
Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (iv) the Fund
may purchase securities on margin to the extent permitted by applicable
law. The Fund may not pledge its assets other than to secure such
borrowings or, to the extent permitted by the Fund's investment policies as
set forth in its Prospectus and Statement of Additional Information, as
they may be amended from time to time, in connection with hedging
transactions, short sales, when-issued and forward commitment transactions
and similar investment strategies.
8. Underwriter securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended, (the "Securities Act") in selling portfolio securities.
9. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
b. Make short sales of securities or maintain a short position, except to
the extent permitted by applicable law. The Fund currently does not intend
to engage in short sales, except short sales "against the box."
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Trustees of the Fund has otherwise determined
to be liquid pursuant to applicable law.
d. Notwithstanding fundamental investment restriction (7) above, borrow
money or pledge its assets except that the Fund may borrow from a bank as a
temporary measure for extraordinary or emergency purposes or to meet
redemptions in amounts not exceeding 10% (taken at the market value) of its
total assets and pledge its assets to secure such borrowings. (For the
purpose of this restriction, collateral arrangements with respect to the
writing of options, interest rate futures contracts, options on interest
rate futures contracts, and collateral arrangements with respect to initial
and variation margin are not
3
<PAGE>
deemed to be a pledge of assets and neither such arrangements nor the
purchase or sale of futures or related options are deemed to be the
issuance of a senior security.)
The staff of the Commission has taken the position that purchased over-the-
counter ("OTC") options and the assets used as cover for written OTC options
are illiquid securities to the extent set forth under "Investment Objective and
Policies--Options and Futures Portfolio Strategies" in the Prospectus.
Because of the affiliation of the Manager with the Fund, the Fund is
prohibited from engaging in certain transactions involving the Manager's
affiliate, Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch")
or its affiliates except for brokerage transactions permitted under the
Investment Company Act involving only usual and customary commissions or
transactions pursuant to an exemptive order under the Investment Company Act.
See "Portfolio Transactions and Brokerage". Without such an exemptive order,
the Fund is prohibited from engaging in portfolio transactions with Merrill
Lynch or its affiliates acting as principal and from purchasing securities in
public offerings which are not registered under the Securities Act of 1933 in
which such firm or any of its affiliates participate as an underwriter or
dealer.
The Trustees have established the policy that the Fund will not purchase or
retain the securities of any issuer, if those individual officers, directors
and Trustees of the Fund, Merrill Lynch Asset Management, L.P. ("MLAM") or any
affiliate thereof each owning beneficially more than one-half of 1% of the
securities of such issuer own in the aggregate more than 5% of the securities
of such issuer. Portfolio securities of the Fund may not be purchased from,
sold or loaned to the Manager or its affiliates or any of their directors,
general partners, officers or employees, acting as principal.
The Fund has adopted a policy pursuant to which it will not write any covered
put options on U.S. Government securities if as a result the Fund would then
have more than 50% of its total assets (taken at market value) subject to being
invested upon the exercise of put options. This policy may be amended without
the approval of the Fund's shareholders.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
Information about the Trustees and executive officers of the Fund, including
their ages and their principal occupations for at least the last five years are
set forth below. Unless otherwise noted, the address of each executive officer
and Trustee is P.O. Box 9011, Princeton, New Jersey 08543-9011.
Arthur Zeikel(64)--President and Trustee(1)(2)--President of the Manager
(which term as used herein includes its corporate predecessors) since 1977;
President of MLAM (which term as used herein includes its corporate
predecessors) since 1977; President and Director of Princeton Services, Inc.
("Princeton Services") since 1993; Executive Vice President of Merrill Lynch &
Co., Inc. ("ML & Co.") since 1990; Director of Merrill Lynch Funds Distributor,
Inc. (the "Distributor") since 1977.
Joe Grills(61)--Trustee(2)--183 Soundview Lane, New Canaan, Connecticut
06840. Member of the Committee of Investment of Employee Benefit Assets of the
Financial Executives Institute ("CIEBA") since 1986; member of CIEBA's
Executive Committee since 1988 and its Chairman from 1991 to 1992; Assistant
Treasurer of International Business Machines Incorporated ("IBM") and Chief
Investment Officer of IBM
4
<PAGE>
Retirement Funds from 1986 until 1993; Member of the Investment Advisory
Committee of the State of New York Common Retirement Fund; Member of the
Investment Advisory Committee of the Howard Hughes Medical Institute; Director,
Duke Management Company since 1993; Director, LaSalle Street Fund since 1995;
Director, Kimco Realty Corporation since January 1997.
Walter Mintz(67)--Trustee(2)--1114 Avenue of the Americas, New York, New York
10036. Special Limited Partner of Cumberland Associates (investment
partnership) since 1982.
Robert S. Salomon, Jr. (60)--Trustee(2)(3)--106 Dolphin Cove Quay, Stamford,
Connecticut 06902. Principal of STI Management (investment adviser); Director,
Common Fund and the Norwalk Community Technical College Foundation; Chairman
and CEO of Salomon Brothers Asset Management from 1992 until 1995; Chairman of
Salomon Brothers equity mutual funds from 1992 until 1995; Director of Stock
Research and U.S. Equity Strategist at Salomon Brothers from 1975 until 1991.
Melvin R. Seiden(66)--Trustee(2)--780 Third Avenue, Suite 2502, New York, New
York 10017. Director of Silbanc Properties, Ltd. (real estate, investments and
consulting) since 1987; Chairman and President of Seiden & de Cuevas, Inc.
(private investment firm) from 1964 to 1987.
Stephen B. Swensrud(63)--Trustee(2)--24 Federal Street, Suite 400, Boston,
Massachusetts 02110. Chairman of Fernwood Advisers (financial consultants).
Terry K. Glenn(56)--Executive Vice President(1)(2)--Executive Vice President
of the Manager and MLAM since 1983; Executive Vice President and Director of
Princeton Services since 1993; President of the Distributor since 1986 and
Director thereof since 1991; Director of Financial Data Services, Inc. since
1985.
Jeffrey B. Hewson(45)--Vice President(1)(2)--Vice President of MLAM since
1989 and Portfolio Manager of the Manager since 1985; Senior Consultant, Price
Waterhouse from 1981 to 1985.
Gregory Mark Maunz(44)--Vice President(1)(2)--Vice President of MLAM since
1985 and Portfolio Manager since 1984.
Donald C. Burke(36)--Vice President(1)(2)--Vice President and Director of
Taxation of MLAM since 1990; employee of Deloitte & Touche LLP from 1982 to
1990.
Gerald M. Richard(47)--Treasurer(1)(2)--Senior Vice President and Treasurer
of the Manager and MLAM since 1984; Senior Vice President and Treasurer of
Princeton Services since 1993; Vice President and Treasurer of the Distributor
since 1981 and 1984, respectively.
Ira P. Shapiro(33)--Secretary(1)(2)--Attorney associated with the Manager and
MLAM since 1993; Prior to 1993 Mr. Shapiro was an attorney in private practice.
- --------
(1) Interested person, as defined in the Investment Company Act, of the Fund.
(2) Such Trustee or officer is a director, officer or member of the advisory
board of one or more investment companies for which the Manager or MLAM
acts as investment adviser or manager.
(3) On January 17, 1996, Robert S. Saloman, Jr. was elected a Trustee of the
Fund to fill the vacancy created by the retirement of Harry Woolf who
retired as a Trustee, effective December 31, 1995, pursuant to the Fund's
retirement policy.
5
<PAGE>
As of November 30, 1996, the officers and Trustees of the Fund as a group (12
persons) owned an aggregate of less than 1% of the outstanding shares of common
stock of ML & Co. and owned an aggregate of less than 1% of the outstanding
shares of the Fund.
The Fund pays each Trustee not affiliated with the Manager a fee of $4,000
per year plus $1,000 per board meeting attended together with such Trustee's
actual out-of-pocket expenses relating to attendance at board meetings, and
each member of its Audit Committee, which consists of all of the non-affiliated
Trustees, $4,000 per year plus $750 per meeting attended. Fees and expenses
paid to the unaffiliated Trustees aggregated $80,471 for the fiscal year ended
August 31, 1996.
The following table sets forth for the fiscal year ended August 31, 1996
compensation paid by the Fund to the non-interested Trustees and for the
calendar year ended December 31, 1995, the aggregate compensation paid by all
registered investment companies (including the Fund) advised by the Manager and
its affiliate, MLAM ("MLAM/FAM-Advised Funds") to the non-interested Trustees:
<TABLE>
<CAPTION>
PENSION OR
RETIREMENT AGGREGATE
BENEFITS COMPENSATION
ACCRUED FROM FUND AND
COMPENSATION AS PART OF MLAM/FAM-ADVISED
FROM THE FUND FUNDS PAID TO
TRUSTEE FUND EXPENSE TRUSTEE/DIRECTOR(A)
- ------- ------------ ---------- -------------------
<S> <C> <C> <C>
Joe Grills.......................... $15,000 None $153,883
Walter Mintz........................ 15,000 None 153,883
Robert S. Salomon, Jr.(2)........... 17,833 None --
Melvin R. Seiden.................... 15,000 None 153,883
Stephen B. Swensrud................. 13,250 None 161,883
Harry Woolf......................... 1,750 None 153,883
</TABLE>
- --------
(1) The Trustees serve on the boards of MLAM/FAM-Advised Funds as follows: Joe
Grills (18 registered investment companies consisting of 38 portfolios),
Walter Mintz (18 registered investment companies consisting of 38
portfolios), Robert S. Salomon (18 registered investment companies
consisting of 38 portfolios), Melvin R. Seiden (18 registered investment
companies consisting of 38 portfolios), Stephen B. Swensrud (20 registered
investment companies consisting of 49 portfolios), and Harry Woolf, prior
to his retirement, effective December 31, 1995, pursuant to the Fund's
retirement policy (18 registered investment companies consisting of 38
portfolios).
(2) Mr. Salomon was elected a Trustee of the Fund on January 17, 1996.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Fund--Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities held by the Fund may also be held by other funds or investment
advisory clients for which the Manager or MLAM acts as an adviser. Securities
may be held by, or be appropriate investments for, the Fund as well as other
clients of the Manager or MLAM. Because of different objectives or other
factors, a particular security may be bought for one or more clients when one
or more clients are selling the same security. If purchases or sales of
securities for the Fund or other funds for which they act as investment adviser
or for their advisory clients arise for consideration at or about the same
time, transactions in such securities will be made, insofar as feasible, for
the respective funds and clients in a manner deemed equitable
6
<PAGE>
to all. To the extent that transactions on behalf of more than one client of
the Manager or MLAM during the same period may increase the demand for
securities being purchased or the supply of securities being sold, there may be
an adverse effect on price.
The Fund has entered into an investment management agreement (the "Management
Agreement") with the Manager. Under the Management Agreement, the Manager
receives from the Fund at the end of each month a fee at the following annual
rates:
<TABLE>
<S> <C>
MANAGEMENT
FEE
----------
Portion of average daily value of net assets:
Not exceeding $500 million.................................... 0.500%
$500 million to $1 billion.................................... 0.475%
$1 billion to $1.5 billion.................................... 0.450%
$1.5 billion to $2 billion.................................... 0.425%
$2 billion to $2.5 billion.................................... 0.400%
$2.5 billion to $3.5 billion.................................. 0.375%
$3.5 billion to $5 billion.................................... 0.350%
$5 billion to $6.5 billion.................................... 0.325%
Exceeding $6.5 billion........................................ 0.300%
</TABLE>
For the fiscal year ended August 31, 1995, the fee paid by the Fund to the
Manager was $11,490,071 (based upon average net assets of approximately $2.6
billion) and the effective fee rate was .44%. For the fiscal year ended August
31, 1996, the fee paid by the Fund to the Manager was $10,650,590 (based upon
average net assets of approximately $2.3 billion), and the effective fee rate
was .46%.
The Management Agreement obligates the Manager to provide investment advisory
services and to pay all compensation of and furnish office space for officers
and employees of the Fund connected with investment and economic research,
trading and investment management of the Fund, as well as the fees of all
Trustees of the Fund who are affiliated persons of ML & Co. The Fund pays all
other expenses incurred in the operation of the Fund, including, among other
things, taxes, expenses for legal and auditing services, costs of printing
proxies, shareholder reports, prospectuses and statements of additional
information (except to the extent paid by the Distributor), charges of the
Fund's custodian and transfer agent, expenses of redemption of shares,
Commission fees, expenses of registering the shares under Federal or state
laws, fees and expenses of unaffiliated Trustees, accounting and pricing costs
(including the daily calculation of net asset value), insurance, interest,
brokerage costs, litigation and other extraordinary or nonrecurring expenses,
and other expenses properly payable by the Fund. The Distributor will pay the
promotional expenses of the Fund incurred in connection with the offering of
shares of the Fund. Certain expenses of the Distributor will be financed by the
Fund pursuant to Distribution Plans in compliance with Rule 12b-1 under the
Investment Company Act. See "Purchase of Shares--Distribution Plans".
The Manager is a limited partnership, the partners of which are ML & Co. and
Princeton Services, Inc. ML & Co. and Princeton Services are "controlling
persons" of the Manager as defined under the Investment
7
<PAGE>
Company Act because of their ownership of its voting securities or their power
to exercise a controlling influence over its management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Management Agreement will remain in effect from year to year if approved
annually (a) by the Trustees of the Fund or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees who are not parties
to such contract or interested persons (as defined in the Investment Company
Act) of any such party. Such agreement is not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party
thereto or by the vote of the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
ALTERNATIVE SALES ARRANGEMENTS
The Fund issues four classes of shares under the Merrill Lynch Select
PricingSM System: shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives, and shares of Class B and Class C are
sold to investors choosing the deferred sales charge alternatives. Each Class
A, Class B, Class C and Class D share of the Fund represents an identical
interest in the investment portfolio of the Fund and has the same rights,
except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
Class B, Class C and Class D shares each have exclusive voting rights with
respect to the Rule 12b-1 distribution plan adopted with respect to such class
pursuant to which account maintenance and/or distribution fees are paid. Each
class has different exchange privileges. See "Shareholder Services--Exchange
Privilege".
The Merrill Lynch Select PricingSM System is used by more than 50 registered
investment companies advised by the Manager or its affiliate, MLAM. Funds
advised by the Manager or MLAM which utilize the Merrill Lynch Select
Pricing SM System are referred to herein as "MLAM-advised mutual funds".
The Fund has entered into separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the "Distribution Agreements"). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the
offering of each class of shares of the Fund. After the prospectuses,
statements of additional information and periodic reports have been prepared,
set in type and mailed to shareholders, the Distributor pays for the printing
and distribution of copies thereof used in connection with the offering to
dealers and investors. The Distributor also pays for other supplementary sales
literature and advertising costs. The Distribution Agreements are subject to
the same renewal requirements and termination provisions as the Management
Agreement described above.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
As a result of the implementation of the Merrill Lynch Select Pricing SM
System, Class A shares of the Fund outstanding prior to October 21, 1994, have
been redesignated Class D shares. The Class A shares
8
<PAGE>
currently being offered differ from the Class A shares offered prior to October
21, 1994 in many respects, including sales charges, exchange privilege and the
classes of persons to whom such shares are offered. During the fiscal year
ended August 31, 1994, the Fund sold 14,555,924 of its Class A shares for
aggregate net proceeds to the Fund of $141,925,143. The gross sales charges for
the sale of shares of the Fund for that year were $711,103, of which $51,423
and $659,680 were received by the Distributor and Merrill Lynch, respectively.
For the period October 21, 1994 (commencement of operations) to August 31,
1995, the Fund sold 30,530,411 of its new Class A shares for aggregate net
proceeds of $282,054,026. The gross sales charges for the sale of those shares
during that period were $19,143, of which $1,123 and $18,020 were received by
the Distributor and Merrill Lynch, respectively. For the fiscal year ended
August 31, 1996, the Fund sold 11,032,271 of its Class A shares for aggregate
net proceeds to the Fund of $105,977,427. The gross sales charges for the sale
of shares of the Fund during that year were $7,828, of which $548 and $7,280
were received by the Distributor and Merrill Lynch, respectively. During the
fiscal year ended August 31, 1995, the Fund sold 4,559,726 of its Class D
shares (including redesignated Class A shares) for aggregate net proceeds to
the Fund of $42,599,935. The gross sales charges for the sale of those shares
during that year were $271,995, of which $23,539 and $248,456 were received by
the Distributor and Merrill Lynch, respectively. During the fiscal year ended
August 31, 1996 the Fund sold 24,780,817 of its Class D shares for aggregate
net proceeds to the Fund of $222,390,773. The gross sales charges for the sale
of those shares during that year were $190,726, of which $20,058 and $170,668
were received by the Distributor and Merrill Lynch, respectively.
The term "purchase" as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children
under the age of 21 years purchasing shares for his or their own account and
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account (including a pension, profit-sharing
or other employee benefit trust created pursuant to a plan qualified under
Section 401 of the Internal Revenue Code of 1986, as amended (the "Code"))
although more than one beneficiary is involved. The term "purchase" also
includes purchases by any "company", as that term is defined in the Investment
Company Act, but does not include purchases by any such company which has not
been in existence for at least six months or which has no purpose other than
the purchase of shares of the Fund or shares of other registered investment
companies at a discount; provided, however, that it shall not include purchases
by any group of individuals whose sole organizational nexus is that the
participants therein are credit cardholders of a company, policyholders of an
insurance company, customers of either a bank or broker-dealer or clients of an
investment adviser. The term "purchase" also includes purchases by employee
benefit plans not qualified under Section 401 of the Code, including purchases
by employees or by employers on behalf of employees, by means of a payroll
deduction plan or otherwise, of shares of the Fund. Purchases by such a company
or non-qualified employee benefit plan will qualify for the quantity discounts
discussed above only if the Fund and the Distributor are able to realize
economies of scale in sales effort and sales related expense by means of the
company, employer or plan making the Fund's Prospectus available to individual
investors or employees and forwarding investments by such persons to the Fund
and by any such employer or plan bearing the expense of any payroll deduction
plan.
Closed-End Fund Investment Option. Class A shares of the Fund and other MLAM-
advised mutual funds ("Eligible Class A Shares") are offered at net asset value
to shareholders of certain closed-end funds
9
<PAGE>
advised by MLAM or the Investment Adviser who purchased such closed-end fund
shares prior to October 21, 1994 (the date the Merrill Lynch Select Pricing SM
System commenced operations) and wish to reinvest the net proceeds from a sale
of their closed-end fund shares of common stock in Eligible Class A or Class D
Shares, if the conditions set forth below are satisfied. Alternatively,
closed-end fund shareholders who purchased such shares on or after October 21,
1994 and wish to reinvest the net proceeds from a sale of their closed-end
fund shares are offered Class A shares (if eligible to buy Class A shares) or
Class D shares of the Fund and other MLAM-advised mutual funds ("Eligible
Class D Shares"), if the following conditions are met. First, the sale of the
closed-end fund shares must be made through Merrill Lynch, and the net
proceeds therefrom must be immediately reinvested in Eligible Class A or Class
D Shares. Second, the closed-end fund shares must either have been acquired in
the initial public offering or be shares representing dividends from shares of
common stock acquired in such offering. Third, the closed-end fund shares must
have been continuously maintained in a Merrill Lynch securities account.
Fourth, there must be a minimum purchase of $250 to be eligible for the
investment option.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund,
Inc. will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond
Fund, Inc. will receive Class D shares of the Fund, except that shareholders
already owning Class A shares of the Fund will be eligible to purchase
additional Class A shares pursuant to this option, if such additional Class A
shares will be held in the same account as the existing Class A shares and the
other requirements pertaining to the reinvestment privilege are met. In order
to exercise this investment option, a shareholder of one of the above-
referenced continuously offered closed-end funds (an "eligible fund") must
sell his or her shares of common stock of the eligible fund (the "eligible
shares") back to the eligible fund in connection with a tender offer conducted
by the eligible fund and reinvest the proceeds immediately in the designated
class of shares of the Fund. This investment option is available only with
respect to eligible shares as to which no Early Withdrawal Charge or CDSC
(each as defined in the eligible fund's prospectus) is applicable. Purchase
orders from eligible fund shareholders wishing to exercise this investment
option will be accepted only on the day that the related tender offer
terminates and will be effected at the net asset value of the designated class
of the Fund on such day.
REDUCED INITIAL SALES CHARGES
Right of Accumulation. The reduced sales charges are applicable through a
right of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value
or cost, whichever is higher, of the purchaser's combined holdings of all
classes of shares of the Fund and of other MLAM-advised mutual funds. For any
such right of accumulation to be made available, the Distributor must be
provided at the time of purchase, by the purchaser or the purchaser's
securities dealer, with sufficient information to permit confirmation of
qualification, and acceptance of the purchase order is subject to such
confirmation. The right of accumulation may be amended or terminated at any
time. Shares held in the name of a nominee or custodian under pension, profit-
sharing, or other employee benefit plans may not be combined with other shares
to qualify for the right of accumulation.
10
<PAGE>
Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class A or Class D shares of the Fund or any
other MLAM-advised mutual funds made within a thirteen-month period starting
with the first purchase pursuant to a Letter of Intention in the form provided
in the Prospectus. The Letter of Intention is available only to investors
whose accounts are maintained at the Fund's transfer agent. The Letter of
Intention is not available to employee benefit plans for which Merrill Lynch
provides plan--participant recordkeeping services. The Letter of Intention is
not a binding obligation to purchase any amount of Class A or Class D shares;
however its execution will result in the purchaser paying a lower sales charge
at the appropriate quantity purchase level. A purchase not originally made
pursuant to a Letter of Intention may be included under a subsequent Letter of
Intention executed within 90 days of such purchase if the Distributor is
informed in writing of this intent within such 90-day period. The value of
Class A or Class D shares of the Fund and of other MLAM-advised mutual funds
presently held, at cost or maximum offering price (whichever is higher), on
the date of the first purchase under the Letter of Intention, may be included
as a credit toward the completion of such Letter. If the total amount of
shares purchased does not equal the amount stated in the Letter of Intention
(minimum of $25,000), the investor will be notified and must pay, within 20
days of the expiration of such Letter, the difference between the sales charge
on the Class A or Class D shares purchased at the reduced rate and the sales
charge applicable to the shares actually purchased through the Letter. Class A
or Class D shares equal to five percent of the intended amount will be held in
escrow during the thirteen-month period (while registered in the name of the
purchaser) for this purpose. The first purchase under the Letter of Intention
must be at least five percent of the dollar amount of such Letter. If a
purchase during the term of such Letter would otherwise be subject to a
further reduced sales charge based on the right of accumulation, the purchaser
will be entitled on that purchase and subsequent purchases to that further
reduced percentage sales charge, but there will be no retroactive reduction of
the sales charges on any previous purchase. The value of any shares redeemed
or otherwise disposed of by the purchaser prior to termination or completion
of the Letter of Intention will be deducted from the total purchases made
under such Letter. An exchange from a MLAM-advised money market fund into the
Fund that creates a sales charge will count toward completing a new or
existing Letter of Intention from the Fund.
Merrill Lynch Blueprint SM Program. Class A and Class D shares of the Fund
are offered to participants in the Merrill Lynch Blueprint SM Program
("Blueprint"). Blueprint is directed to small investors, group IRAs and
participants in certain affinity groups such as credit unions, trade
associations and benefit plans. Investors placing orders to purchase Class A
or Class D shares of the Fund through Blueprint will acquire the Class A or
Class D shares at net asset value plus a sales charge calculated in accordance
with the Blueprint sales charge schedule (i.e., up to $5,000 at 3.5% and
$5,000.01 or more at the standard sales charge rates disclosed in the
Prospectus). Class A and Class D shares of the Fund are offered at net asset
value plus a sales charge of 1/2 of 1% for corporate or group IRA programs
placing orders to purchase their Class A or Class D shares through Blueprint.
Services available to investors placing orders for Class A or Class D shares
through Blueprint, including exchange privileges, may differ from those
available to other investors in Class A or Class D shares.
Class A and Class D shares are offered at net asset value to Blueprint
participants through the Merrill Lynch Directed IRA Rollover Program ("IRA
Rollover Program") available from Merrill Lynch Business Financial Services, a
business unit of Merrill Lynch. The IRA Rollover Program is available to
custodian rollover assets from Employer Sponsored Retirement and Savings Plans
(as defined below) whose Trustee and/or Plan Sponsor has entered into a
Merrill Lynch Directed IRA Rollover Program Service Agreement.
11
<PAGE>
Orders for purchases and redemptions of Class A or Class D shares of the
Fund may be grouped for execution purposes which, in some circumstances, may
involve the execution of such orders two business days following the day such
orders are placed. The minimum initial purchase is $100, with a $50 minimum
for subsequent purchases through Blueprint. There are no minimum initial or
subsequent purchase requirements for participants who are part of an automatic
investment plan. Additional information concerning purchases through
Blueprint, including any annual fees and transaction charges, is available
from Merrill Lynch, Pierce, Fenner & Smith Incorporated, The BlueprintSM
Program, P.O. Box 30441, New Brunswick, New Jersey 08989-0441.
Employee Access Accounts SM. Class A or Class D shares are offered at net
asset value to Employee Access Accounts SM available through qualified
employers that provide employer sponsored retirement or savings plans that are
eligible to purchase such shares at net asset value. The initial minimum for
such accounts is $500, except that the initial minimum for shares purchased
for such accounts pursuant to the Automatic Investment Program is $50.
Purchase Privilege of Certain Persons. Directors of the Fund, members of the
Boards of other MLAM-advised investment companies, directors and employees of
Merrill Lynch & Co., Inc. and its subsidiaries, (the term "subsidiaries", when
used herein with respect to Merrill Lynch & Co., Inc., includes FAM, MLAM and
certain other entities directly or indirectly wholly-owned and controlled by
Merrill Lynch & Co., Inc.), and their directors and employees and any trust,
pension, profit-sharing or other benefit plan for such persons may purchase
Class A shares of the Fund at net asset value.
Class D shares of the Fund will be offered at net asset value, without a
sales charge, to an investor who has a business relationship with a financial
consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that
he or she will purchase Class D shares of the Fund with proceeds from a
redemption of a mutual fund that was sponsored by the financial consultant's
previous firm and was subject to a sales charge either at the time of purchase
or on a deferred basis; and second, the investor also must establish that such
redemption had been made within 60 days prior to the investment in the Fund,
and the proceeds from the redemption had been maintained in the interim in
cash or a money market fund.
Class D shares of the Fund are also offered at net asset value, without a
sales charge, to an investor who has a business relationship with a Merrill
Lynch Financial Consultant and who has invested in a mutual fund sponsored by
a non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied: first, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares
of such other fund were subject to a sales charge either at the time of
purchase or on a deferred basis; and second, such purchase of Class D shares
must be made within 90 days after notice.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Merrill Lynch
Financial Consultant and who has invested in a mutual fund for which Merrill
Lynch has not served as a selected dealer if the following conditions are
satisfied: first, the investor must advise Merrill Lynch that it will purchase
Class D shares of the Fund with proceeds from the redemption of such shares of
other mutual funds and that such shares have been outstanding for a period of
12
<PAGE>
no less than six months; and second, such purchase of Class D shares must be
made within 60 days after the redemption and the proceeds from the redemption
must be maintained in the interim in cash or a money market fund.
TMA SM Managed Trusts. Class A shares are offered to TMA SM Managed Trusts
to which Merrill Lynch Trust Company provides discretionary trustee services
at net asset value.
Acquisition of Certain Investment Companies. The public offering price of
Class D shares of the Fund may be reduced to the net asset value per Class D
share in connection with the acquisition of the assets of or merger or
consolidation with a personal holding company or a public or private
investment company. The value of the assets or company acquired in a tax-free
transaction may be adjusted in appropriate cases to reduce possible adverse
tax consequences to the Fund which might result from an acquisition of assets
having net unrealized appreciation which is disproportionately higher at the
time of acquisition than the realized or unrealized appreciation of the Fund.
The issuance of Class D shares for consideration other than cash is limited to
bona fide reorganizations, statutory mergers or other acquisitions of
portfolio securities which (i) meet the investment objectives and policies of
the Fund; (ii) are acquired for investment and not for resale (subject to the
understanding that the disposition of the Fund's portfolio securities shall at
all times remain within its control); and (iii) are liquid securities, the
value of which is readily ascertainable, which are not restricted as to
transfer either by law or liquidity of market (except that the Fund may
acquire through such transactions restricted or illiquid securities to the
extent the Fund does not exceed the applicable limits on acquisition of such
securities set forth under "Investment Objective and Policies" herein).
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be
needed in obtaining such investments.
EMPLOYER-SPONSORED RETIREMENT OR SAVINGS PLANS AND CERTAIN OTHER ARRANGEMENTS
Certain employer-sponsored retirement or savings plans and certain other
arrangements may purchase Class A or Class D shares at net asset value, based
on the number of employees eligible to participate in the plan, the aggregate
amount invested by the plan in specified investments and/or the services
provided by Merrill Lynch to the plan. Certain other plans may purchase Class
B shares with a waiver of the contingent deferred sales charge ("CDSC") upon
redemption, based on similar criteria. Such Class B shares will convert into
Class D shares approximately ten years after the plan purchases the first
share of any MLAM-advised mutual fund. Minimum purchase requirements may be
waived or varied for such plans. Additional information regarding purchases by
employer-sponsored retirement or savings plans and certain other arrangements
is available toll-free from Merrill Lynch Business Financial Services at (800)
237-7777.
DISTRIBUTION PLANS
Reference is made to "Purchase of Shares--Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
Investment Company Act (each a "Distribution Plan") with respect to the
account maintenance and/or distribution fees paid by the Fund to the
Distributor with respect to such classes.
Payments of the account maintenance fees and/or distribution fees are
subject to the provisions of Rule 12b-1 under the Investment Company Act.
Among other things, each Distribution Plan provides that the Distributor shall
provide and the Directors shall review quarterly reports of the disbursement
of the account
13
<PAGE>
maintenance fees and/or distribution fees paid to the Distributor. In their
consideration of each Distribution Plan, the Directors must consider all
factors they deem relevant, including information as to the benefits of the
Distribution Plan to the Fund and its related class of shareholders. Each
Distribution Plan further provides that, so long as the Distribution Plan
remains in effect, the selection and nomination of Directors who are not
"interested persons" of the Fund, as defined in the Investment Company Act (the
"Independent Directors"), shall be committed to the discretion of the
Independent Directors then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the Independent Directors concluded that there is a
reasonable likelihood that such Distribution Plan will benefit the Fund and its
related class of shareholders. Each Distribution Plan can be terminated at any
time, without penalty, by the vote of a majority of the Independent Directors
or by the vote of the holders of a majority of the outstanding related class of
voting securities of the Fund. A Distribution Plan cannot be amended to
increase materially the amount to be spent by the Fund without the approval of
the related class of shareholders, and all material amendments are required to
be approved by the vote of the Directors, including a majority of the
Independent Directors who have no direct or indirect financial interest in such
Distribution Plan, cast in person at a meeting called for that purpose. Rule
12b-1 further requires that the Fund preserve copies of each Distribution Plan
and any report made pursuant to such plan for a period of not less than six
years from the date of such Distribution Plan or such report, the first two
years in an easily accessible place.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the National
Association of Securities Dealers, Inc. ("NASD") imposes a limitation on
certain asset-based sales charges such as the distribution fee and the CDSC
borne by the Class B and Class C shares but not the account maintenance fee.
The maximum sales charge rule is applied separately to each class. As
applicable to the Fund, the maximum sales charge rule limits the aggregate of
distribution fee payments and CDSCs payable by the Fund to (1) 6.25% of
eligible gross sales of Class B shares and Class C shares, computed separately
(defined to exclude shares issued pursuant to dividend reinvestments and
exchanges), plus (2) interest on the unpaid balance for the respective class,
computed separately, at the prime rate plus 1% (the unpaid balance being the
maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances payment
in excess of the amount payable under the NASD formula will not be made.
14
<PAGE>
The following table sets forth comparative information as of August 31,
1996, with respect to the Class B and Class C shares of the Fund indicating
the maximum allowable payments that can be made under the NASD maximum sales
charge rule and, with respect to Class B shares, the Distributor's voluntary
maximum.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF AUGUST 31, 1996
----------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
ALLOWABLE AMOUNTS FEE AT
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT NET
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
--------- --------- ---------- ------- -------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Class B
Under NASD Rule As
Adopted................ 4,698,441 293,653 204,353 498,006 140,952 357,054 4,624
Under Distributor's
Voluntary Waiver....... 4,698,441 293,653 23,492 317,145 140,952 176,193 4,624
Class C
Under NASD Rule As
Adopted................ 33,352 2,084 182 2,266 186 2,080 125
</TABLE>
- --------
(1) Purchase price of all eligible Class B shares sold since December 23, 1991
(commencement of operations) and all eligible Class C shares sold since
October 21, 1994 (commencement of operations) other than shares acquired
through dividend reinvestment and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1%, as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals. Of the
distribution fee payments made with respect to Class B shares prior to
July 6, 1993, under a prior plan at a 0.75% rate, 0.50% of average daily
net assets has been treated as a distribution fee and 0.25% of average
daily net assets has been deemed to have been a service fee and not
subject to the NASD maximum sales charge rule. See "Purchase of Shares--
Distribution Plans" in the Prospectus.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any contingent deferred sales
charge payments) is amortizing the unpaid balance. No assurance can be
given that payments of the distribution fee will reach either the NASD
maximum or, with respect to the Class B shares, the voluntary maximum.
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended only for any period during which trading on the
NYSE is restricted as determined by the Commission or such Exchange is closed
(other than customary weekend and holiday closings), for any period during
which an emergency exists, as defined by the Commission, as a result of which
disposal of portfolio securities or determination of the net asset value of
the Fund is not reasonably practicable, and for such other periods as the
Commission may by order permit for the protection of shareholders of the Fund.
15
<PAGE>
The value of shares at the time of redemption may be more or less than the
shareholder's cost, depending on the market value of the securities held by the
Fund at such time.
DEFERRED SALES CHARGE--CLASS B AND CLASS C SHARES
As discussed in the Prospectus under "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares", while Class B shares redeemed
within four years of purchase are subject to a CDSC under most circumstances,
the charge is waived on redemptions of Class B shares in connection with
certain post-retirement withdrawals from IRA or other retirement plans or on
redemptions of Class B shares following the death or disability of a Class B
shareholder. Redemptions for which the waiver applies are: (a) any partial or
complete redemption in connection with a tax-free distribution following
retirement under a tax-deferred retirement plan or attaining age 59 1/2 in the
case of an IRA or other retirement plan or part of a series of equal periodic
payments (not less frequently than annually) made for the life (or life
expectancy), or any redemption resulting from the tax-free return of an excess
contribution to an IRA; or (b) any partial or complete redemption following the
death or disability (as defined in the Code) of a Class B shareholder
(including one who owns the Class B shares as joint tenant with his or her
spouse), provided the redemption is requested within one year of the death or
initial determination of disability. For the fiscal years ended August 31,
1994, 1995 and 1996 the Distributor received CDSCs of $4,398,541, $2,992,727
and $1,283,799, respectively, with respect to redemptions of Class B shares,
all of which were paid to Merrill Lynch. For the period October 21, 1994
(commencement of operations) to August 31, 1995, and for the fiscal year ended
August 31, 1996, the Distributor received CDSCs of $6,138 and $37,766,
respectively, with respect to redemptions of Class C shares, all of which were
paid to Merrill Lynch.
Merrill Lynch BlueprintSM Program. Class B shares are offered to certain
participants in the BlueprintSM program. Blueprint is directed to small
investors, group IRAs and participants in certain affinity groups such as trade
associations and credit unions. Class B shares of the Fund are offered through
Blueprint only to members of certain affinity groups. The CDSC is waived in
connection with purchase orders placed through Blueprint by members of such
affinity groups. Services, including the exchange privilege, available to Class
B investors through Blueprint, however, may differ from those available to
other investors in Class B shares. Orders for purchases and redemptions of
Class B shares of the Fund will be grouped for execution purposes which, in
some circumstances, may involve the execution of such orders two business days
following the day such orders are placed. The minimum initial purchase is $100,
with a $50 minimum for subsequent purchases through Blueprint. There is no
minimum initial or subsequent purchase requirement for investors who are part
of a Blueprint automatic investment plan. Additional information concerning
these Blueprint programs, including any annual fees or transaction charges, is
available from Merrill Lynch, Pierce, Fenner & Smith Incorporated, The
BlueprintSM Program, P.O. Box 30441, New Brunswick, New Jersey 08989-0441.
PORTFOLIO TRANSACTIONS
Reference is made to "Investment Objective and Policies--Other Investment
Policies and Practices--Portfolio Transactions" in the Prospectus.
Subject to policies established by the Trustees of the Fund, the Manager is
responsible for the execution of the Fund's portfolio transactions. The Fund
has no obligation to deal with any broker or group of brokers
16
<PAGE>
in the execution of transactions in portfolio securities. Orders for
transactions in portfolio securities are placed for the Fund with a number of
brokers and dealers, including Merrill Lynch. In placing orders, it is the
policy of the Fund to obtain the most favorable net results, taking into
account various factors, including price (including the applicable brokerage
commissions or dealer spread), size of the transaction and difficulty of
execution. Where practicable, the Manager surveys a number of brokers and
dealers in connection with proposed portfolio transactions and selects the
broker or dealer which offers the Fund best price and execution or other
services which are of benefit to the Fund. Securities firms also may receive
brokerage commissions on transactions including covered call options written by
the Fund and the sale of underlying securities upon the exercise of such
options. In addition, consistent with the Rules of Fair Practice of the
National Association of Securities Dealers, Inc. and the policies established
by the Fund's Trustees, the Manager may consider sales of shares of the Fund as
a factor in the selection of brokers or dealers to execute portfolio
transactions for the Fund.
The Fund does not use any particular broker or dealer, and brokers who
provide supplemental investment research to the Manager may receive orders for
transactions by the Fund. Such supplemental research services ordinarily
consist of assessments and analyses of the business or prospects of a company,
industry or economic sector. Information so received will be in addition to and
not in lieu of the services required to be performed by the Manager under the
Management Agreement with the Fund. The expenses of the Manager will not
necessarily be reduced as a result of the receipt of such supplemental
information, and the Manager may use such information in servicing its other
accounts. Whether or not a particular broker-dealer sells shares of the Fund
neither qualifies nor disqualifies such broker-dealer to execute transactions
for the Fund.
The U.S. Government securities in which the Fund invests are traded primarily
in the OTC market. Transactions in the OTC market are generally principal
transactions with dealers and the costs of such transactions involve dealer
spreads rather than brokerage commissions. With respect to OTC transactions,
the Fund, where possible, deals directly with the dealers who make a market in
the securities involved except in those circumstances where better prices and
execution are available elsewhere. Under the Investment Company Act, persons
affiliated with the Fund are prohibited from dealing with the Fund as a
principal in the purchase and sale of securities. Since transactions in the OTC
market usually involve transactions with dealers acting as principals for their
own account, affiliated persons of the Fund, including Merrill Lynch, may not
serve as the Fund's dealer in connection with such transactions. However,
affiliated persons of the Fund may serve as its broker in transactions
conducted on an exchange or OTC transactions conducted on an agency basis. The
Fund may not purchase securities from any underwriting syndicate of which
Merrill Lynch is a member, except pursuant to procedures adopted by the
Trustees of the Fund which comply with rules adopted by the Commission.
The Trustees of the Fund have considered the possibility of recapturing for
the benefit of the Fund brokerage commissions, dealer spreads and other
expenses of possible portfolio transactions, such as underwriting commissions,
by conducting such portfolio transactions through affiliated entities,
including Merrill Lynch. For example, brokerage commissions received by Merrill
Lynch could be offset against the management fee paid by the Fund to the
Manager. After considering all factors deemed relevant, the Trustees made a
determination not to seek such recapture. The Trustees will reconsider this
matter from time to time.
For the fiscal years ended August 31, 1995 and 1996, respectively, the Fund
paid no brokerage commissions.
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Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the national securities exchanges from executing exchange
transactions for their affiliates and institutional accounts which they manage
unless the member (i) has obtained prior express authorization from the account
to effect such transactions, (ii) at least annually furnishes the account with
the aggregate compensation received by the member in effecting such
transactions, and (iii) complies with any rules the Commission has prescribed
with respect to the requirements of clauses (i) and (ii). To the extent Section
11(a) would apply to Merrill Lynch acting as a broker for the Fund in any of
its portfolio transactions executed on any such securities exchange of which it
is a member, appropriate consents have been obtained from the Fund and annual
statements as to aggregate compensation will be provided to the Fund.
DETERMINATION OF NET ASSET VALUE
Reference is made to "Additional Information--Determination of Net Asset
Value" in the Prospectus concerning the determination of net asset value.
The net asset value of the shares of all classes of the Fund is determined by
the Manager once daily, Monday through Friday, as of 15 minutes after the close
of business on the NYSE (generally, 4:00 P.M., New York time), on each day the
NYSE is open for trading. The NYSE is not open on New Year's Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day. The net asset value per share is computed by dividing the
sum of the value of the securities held by the Fund plus any cash or other
assets minus all liabilities by the total number of shares outstanding at such
time, rounded to the nearest cent. Expenses, including the management fees and
any account maintenance and/or distribution fees, are accrued daily. The per
share net asset value of the Class B, Class C and Class D shares generally will
be lower than the per share net asset value of the Class A shares reflecting
the daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to the Class B and Class C shares
and the daily expense accruals of the account maintenance fees applicable with
respect to the Class D shares; moreover, the per share net asset value of Class
B and Class C shares generally will be lower than the per share net asset value
of Class D shares, reflecting the daily expense accruals of the distribution
fees and higher transfer agency fees applicable with respect to Class B and
Class C shares of the Fund. It is expected, however, that the per share net
asset value of the four classes will tend to converge (although not necessarily
meet) immediately after the payment of dividends or distributions, which will
differ by approximately the amount of the expense accrual differential between
the classes.
Portfolio securities which are traded on stock exchanges are valued at the
last sale price (regular way) as of the close of business on the day the
securities are being valued, or, lacking any sales, at the last available bid
price. Securities traded in the OTC market are valued at the last available bid
price in the OTC market prior to the time of valuation. Portfolio securities
which are traded both in the OTC market and on a stock exchange are valued
according to the broadest and most representative market. Other investments,
including futures contracts and related options, are stated at market value.
Securities and assets for which market quotations are not readily available are
valued at fair value as determined in good faith by or under the direction of
the Trustees of the Fund. The Fund employs Merrill Lynch Securities Pricing
Service ("MLSPS"), an affiliate of the Manager, to provide securities prices
for the Fund.
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Securities and assets for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of the Trustees of the Fund. Such variations and procedures will be reviewed
periodically by the Trustees.
Generally, trading in U.S. Government securities is substantially completed
each day at various times prior to 4:15 P.M., New York time. The values of such
securities used in computing the net asset value of the Fund's shares are
determined as of such times. Occasionally, events affecting the values of such
securities may occur between the times at which they are determined and the
time the Fund determines its net asset value which will not be reflected in the
computation of the Fund's net asset value. If events materially affecting the
value of such securities occur during such period, then these securities will
be valued at their fair value as determined in good faith by the Trustees.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services summarized below which are
designed to facilitate investment in its shares. Certain of such services are
not available to investors who place orders for the Company's shares through
the Merrill Lynch BlueprintSM Program. Full details as to each of such services
and copies of the various plans described below and instructions as to how to
participate in the various services or plans, or how to change options with
respect thereto, can be obtained from the Fund, the Distributor or Merrill
Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends and capital gain distributions. The statements will also show any
other activity in the account since the preceding statement. Shareholders will
receive separate transaction confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gain distributions. A
shareholder may make additions to his or her Investment Account at any time by
mailing a check directly to the Transfer Agent.
Share certificates are issued only for full shares and only upon the specific
request of a shareholder. Issuance of certificates representing all or only
part of the full shares in an Investment Account may be requested by a
shareholder directly from the Transfer Agent. Shareholders considering
transferring their Class A or Class D shares from Merrill Lynch to another
brokerage firm or financial institution should be aware that, if the firm to
which the Class A or Class D shares are to be transferred will not take
delivery of shares of the Fund, a shareholder either must redeem the Class A or
Class D shares (paying any applicable CDSC) so that the cash proceeds can be
transferred to the account at the new firm or such shareholder must continue to
maintain an Investment Account at the Transfer Agent for those Class A or Class
D shares. Shareholders interested in transferring their Class B or Class C
shares from Merrill Lynch and who do not wish to have an Investment Account
maintained for such shares at the transfer agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder at the Transfer Agent.
Shareholders considering transferring a tax-deferred
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retirement account such as an individual retirement account from Merrill Lynch
to another brokerage firm or financial institution should be aware that, if the
firm to which the retirement account is to be transferred will not take
delivery of shares of the Fund, a shareholder must either redeem the shares
(paying any applicable CDSC) so that the cash proceeds can be transferred to
the account at the new firm, or such shareholder must continue to maintain a
retirement account at Merrill Lynch for those shares.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if (s)he is an eligible Class A investor as
described in the Prospectus) or Class B, Class C or Class D shares at the
applicable public offering price either through the shareholder's securities
dealer, or by mail directly from the Transfer Agent, acting as agent for such
securities dealer. Voluntary accumulation can also be made through a service
known as the Automatic Investment Plan whereby the Fund is authorized through
pre-authorized checks or automated clearing house debits of $50 or more to
charge the regular bank account of the shareholder on a regular basis to
provide systematic additions to the Investment Account of such shareholder.
Investors whose shares of the Fund are held within a CMA (R) or CBA (R) account
may arrange to have periodic investments made in the Fund, in their CMA (R) or
CBA (R) accounts or in certain related accounts in the amount of $100 or more
($1 for retirement accounts) through the CMA (R) or CBA (R) Automated
Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will
automatically be reinvested in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund, as of the close of
business on the payment date of the dividend or distribution. Shareholders may
elect in writing to receive either their dividends or capital gains
distributions, or both, in cash, in which event payment will be mailed or
direct deposited on or about the payment date.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-800-MER-FUND) that they no longer wish to have their dividends
and/or distributions reinvested in shares of the Fund or vice versa and,
commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS--CLASS A AND CLASS D SHARES
A Class A or Class D shareholder may elect to make systematic withdrawals
from an Investment Account in the form of payments by check or through
automatic payment by direct deposit to such shareholder's bank account on
either a monthly or quarterly basis as provided below. Quarterly withdrawals
are available for shareholders who have acquired Class A or Class D shares of
the Fund having a value, based on cost or the current offering price, of $5,000
or more, and monthly withdrawals for shareholders with Class A or Class D
shares with such a value of $10,000 or more.
At the time of each withdrawal payment, sufficient Class A or Class D shares
are redeemed from those on deposit in the shareholder's account to provide the
withdrawal payment specified by the shareholder. The
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shareholder may specify either a dollar amount or a percentage of the value of
his Class A or Class D shares. Redemptions will be made at net asset value as
determined as of 15 minutes after the close of business of the NYSE (generally,
4:00 P.M., New York time) on the 24th day of each month or the 24th day of the
last month of each quarter, whichever is applicable. If the NYSE is not open
for business on such date, the Class A or Class D shares will be redeemed at
the close of business on the following business day. The check for the
withdrawal payment will be mailed or the direct deposit of the withdrawal
payment will be made on the next business day following redemption. When a
shareholder is making systematic withdrawals, dividends and distributions on
all Class A or Class D shares in the Investment Account are reinvested
automatically in Fund Class A or Class D shares. A shareholder's systematic
withdrawal plan may be terminated at any time, without charge or penalty, by
the shareholder, the Fund, the Transfer Agent or the Distributor. Withdrawal
payments should not be considered as dividends, yield or income. Each
withdrawal is a taxable event. If periodic withdrawals continuously exceed
reinvested dividends, the shareholder's original investment may be
correspondingly reduced. Purchases of additional Class A or Class D shares
concurrent with withdrawals are ordinarily disadvantageous to the shareholder
because of sales charges and tax liabilities. The Fund will not knowingly
accept purchase orders for Class A shares of the Fund from investors who
maintain a systematic withdrawal plan unless such purchase is equal to at least
one year's scheduled withdrawals or $1,200, whichever is greater. Periodic
investments may not be made into an Investment Account in which the shareholder
has elected to make systematic withdrawals.
A Class A or Class D shareholder whose shares are held within a CMA (R),
CBA (R) or Retirement Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA (R)/CBA (R)
Systematic Redemption Program. The minimum fixed dollar amount redeemable is
$25. The proceeds of systematic redemptions will be posted to the shareholder's
account five business days after the date the shares are redeemed. Monthly
systematic redemptions will be made at net asset value on the first Monday of
each month, bimonthly systematic redemptions will be made at net asset value on
the first Monday of every other month, and quarterly, semiannual or annual
redemptions are made at net asset value on the first Monday of months selected
at the shareholder's option. If the first Monday of the month is a holiday, the
redemption will be processed at net asset value on the next business day. The
CMA (R)/CBA (R) Systematic Redemption Program is not available if Fund shares
are being purchased within the account pursuant to the Automatic Investment
Program. For more information on the CMA (R)/CBA (R) Systematic Redemption
Program, eligible shareholders should contact their Merrill Lynch Financial
Consultant.
RETIREMENT PLANS
Self-directed IRA's and other retirement plans are available from Merrill
Lynch. Under these plans, investments may be made in the Fund and certain of
the other mutual funds sponsored by Merrill Lynch as well as in other
securities. Merrill Lynch charges an initial establishment fee and an annual
custodial fee for each account. Information with respect to these plans is
available upon request from Merrill Lynch. The minimum initial purchase to
establish any such plan is $250 and the minimum subsequent purchase is $1
(except that the minimum initial purchase through Blueprint is $100).
Capital gains and ordinary income received in each of the plans referred to
above are exempt from Federal taxation until distributed from the plans.
Investors considering participation in any such plan should review specific tax
laws relating thereto and should consult their attorneys or tax advisors with
respect to the establishment and maintenance of any such plan.
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EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds listed below. Under the Merrill
Lynch Select Pricing SM System, Class A shareholders may exchange Class A
shares of the Fund for Class A shares of a second MLAM-advised mutual fund if
the shareholder holds any Class A shares of the second fund in his account in
which the exchange is made at the time of the exchange or is otherwise
eligible to purchase Class A shares of the second fund. If the Class A
shareholder wants to exchange Class A shares for shares of a second MLAM-
advised mutual fund but does not hold Class A shares of the second fund in his
or her account at the time of the exchange and is not otherwise eligible to
acquire Class A shares of the second fund, the shareholder will receive Class
D shares of the second fund as a result of the exchange. Class D shares also
may be exchanged for Class A shares of a second MLAM-advised mutual fund at
any time as long as, at the time of the exchange, the shareholder holds Class
A shares of the second fund in the account in which the exchange is made or is
otherwise eligible to purchase Class A shares of the second fund. Class B,
Class C and Class D shares are exchangeable with shares of the same class of
other MLAM-advised mutual funds. For purposes of computing the CDSC that may
be payable upon a disposition of the shares acquired in the exchange, the
holding period for the previously owned shares of the Fund is "tacked" to the
holding period of the newly acquired shares of the other Fund as more fully
described below. Class A, Class B, Class C and Class D shares also are
exchangeable for shares of certain MLAM-advised money market funds
specifically designated below as available for exchange by holders of Class A,
Class B, Class C or Class D shares. Shares with a net asset value of at least
$100 are required to qualify for the exchange privilege, and any shares
utilized in an exchange must have been held by the shareholder for at least 15
days. It is contemplated that the exchange privilege may be applicable to
other new mutual funds whose shares may be distributed by the Distributor.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of another MLAM-advised mutual
fund ("new Class A or Class D shares") are transacted on the basis of relative
net asset value per Class A or Class D share, respectively, plus an amount
equal to the difference, if any, between the sales charge previously paid on
the outstanding Class A or Class D shares and the sales charge payable at the
time of the exchange on the new Class A or Class D shares. With respect to
outstanding Class A or Class D shares as to which previous exchanges have
taken place, the "sales charge previously paid" shall include the aggregate of
the sales charge paid with respect to such Class A or Class D shares in the
initial purchase and any subsequent exchange. Class A or Class D shares issued
pursuant to dividend reinvestment are sold on a no-load basis in each of the
funds offering Class A or Class D shares. For purposes of the exchange
privilege, Class A and Class D shares acquired through dividend reinvestment
shall be deemed to have been sold with a sales charge equal to the sales
charge previously paid on the Class A or Class D shares on which the dividend
was paid. Based on this formula, Class A and Class D shares of the Fund
generally may be exchanged into the Class A or Class D shares of the other
funds or into shares of the Class A and Class D money market funds with a
reduced or without a sales charge.
In addition, each of the funds with Class B and Class C shares outstanding
("outstanding Class B or Class C shares") offers to exchange its Class B or
Class C shares for Class B or Class C shares, respectively, ("new Class B or
Class C shares"), of another MLAM-advised mutual fund on the basis of relative
net asset value per Class B or Class C share, without the payment of any CDSC
that might otherwise be due on redemption of the outstanding shares. Class B
shareholders of the Fund exercising the exchange privilege will continue to be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule
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relating to the new Class B shares acquired through use of the exchange
privilege. In addition, Class B shares of the Fund acquired through use of the
exchange privilege will be subject to the Fund's CDSC schedule if such schedule
is higher than the CDSC schedule relating to the Class B shares of the fund
from which the exchange has been made. For purposes of computing the sales
charge that may be payable on a disposition of the new Class B or Class C
shares, the holding period for the outstanding Class B or Class C shares is
"tacked" to the holding period of the new Class B or Class C shares. For
example, an investor may exchange Class B shares of the Fund for those of
Merrill Lynch Special Value Fund, Inc. ("Special Value Fund") after having held
the Fund Class B shares for two and a half years. The 2% CDSC that generally
would apply to a redemption would not apply to the exchange. Three years later
the investor may decide to redeem the Class B shares of Special Value Fund and
receive cash. There will be no CDSC due on this redemption, since by "tacking"
the two and a half year holding period of Fund Class B shares to the three year
holding period for the Special Value Fund Class B shares, the investor will be
deemed to have held the new Special Value Fund Class B shares for more than
five years.
Shareholders also may exchange shares of the Fund into shares of a money
market fund advised by the Manager or its affiliates, but the period of time
that Class B or Class C shares are held in a money market fund will not count
towards satisfaction of the holding period requirement for purposes of reducing
the CDSC or with respect to Class B shares, towards satisfaction of the
conversion period. However, shares of a money market fund which were acquired
as a result of an exchange for Class B or Class C shares of the Fund may, in
turn, be exchanged back into Class B or Class C shares, respectively, of any
fund offering such shares, in which event the holding period for Class B or
Class C shares of the fund will be aggregated with previous holding periods for
purposes of reducing the CDSC. Thus, for example, an investor may exchange
Class B shares of the Fund for shares of Merrill Lynch Institutional Fund
("Institutional Fund") after having held the Fund Class B shares for two and a
half years and three years later decide to redeem the shares of Institutional
Fund for cash. At the time of this redemption, the 2% CDSC that would have been
due had the Class B shares of the Fund been redeemed for cash rather than
exchanged for shares of Institutional Fund will be payable. If instead of such
redemption the shareholder exchanged such shares for Class B shares of a fund
which the shareholder continued to hold for an additional two and a half years,
any subsequent redemption would not incur a CDSC.
Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made.
To exercise the exchange privilege, shareholders should contact their Merrill
Lynch Financial Consultant, who will advise the Fund of the exchange, or, if
the exchange does not involve a money market fund, the shareholder may write to
the Transfer Agent requesting that the exchange be effected. Such letter must
be signed exactly as the account is registered with signatures guaranteed by an
"eligible guarantor institution" as such is defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, as amended, the existence and validity of
which may be verified by the Transfer Agent through the use of industry
publications. Shareholders of the Fund, and shareholders of the other funds
described above with shares for which certificates have not been issued, may
exercise the exchange privilege by wire through their securities dealers. The
Fund reserves the right to require a properly completed Exchange Application.
The exchange privilege may be modified or terminated in accordance with the
rules of the Commission. The Fund reserves the right to limit the number of
times an investor may exercise the exchange privilege. Certain funds may
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suspend the continuous offering of their shares to the general public at any
time and may thereafter resume such offering from time to time. The exchange
privilege is available only to U.S. shareholders in states where the exchange
legally may be made.
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute all of its net investment income. Dividends
from such net investment income will be declared daily prior to the
determination of net asset value on that day and paid monthly. Net investment
income for dividend purposes consists of interest earned less expenses of the
Fund accrued for that dividend period. Shares will accrue dividends as long as
they are issued and outstanding. Shares are issued and outstanding as of the
settlement date of a purchase order to the settlement date of a redemption
order. All net realized long-term capital gains and short-term capital gains,
if any, will be distributed to the Fund's shareholders at least annually.
See "Shareholder Services--Automatic Reinvestment of Dividends and Capital
Gains Distributions" for information concerning the manner in which dividends
and distributions may be automatically reinvested in shares of the Fund.
Shareholders may elect in writing to receive any such dividends or
distributions, or both, in cash. Dividends and distributions are taxable to
shareholders as discussed below whether they are reinvested in shares of the
Fund or received in cash. The per share dividends and distributions on Class B
and Class C shares will be lower than the per share dividends and distributions
on Class A and Class D shares as a result of the account maintenance,
distribution and higher transfer agency fees applicable with respect to the
Class B and Class C shares; similarly, the per share dividends and
distributions on Class D shares will be lower than the per share dividends and
distributions on Class A shares as a result of the account maintenance fees
applicable with respect to the Class D shares. See "Determination of Net Asset
Value".
TAXES
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. If it so
qualifies, the Fund (but not its shareholders) will not be subject to Federal
income tax on the part of its net ordinary income and net realized capital
gains which it distributes to Class A, Class B, Class C and Class D
shareholders (together, the "shareholders"). The Fund intends to distribute
substantially all of such income.
Dividends paid by the Fund from its ordinary income or from an excess of net
short-term capital gains over net long-term capital losses (together referred
to hereafter as "ordinary income dividends") are taxable to shareholders as
ordinary income. Distributions made from an excess of net long-term capital
gains over net short-term capital losses (including gains or losses from
certain transactions in futures and options) ("capital gain dividends") are
taxable to shareholders as long-term capital gains, regardless of the length of
time the shareholder has owned Fund shares. Any loss upon the sale or exchange
of Fund shares held for six months or less will be treated as long-term capital
loss to the extent of any capital gain dividends received by the shareholder.
Distributions in excess of the Fund's earnings and profits will first reduce
the adjusted tax basis of a holder's shares and, after such adjusted tax basis
is reduced to zero, will constitute capital gains to such holder (assuming the
shares are held as a capital asset).
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Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Not later than 60 days after the close of its
taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any ordinary income dividends or capital gain
dividends. Distributions by the Fund, whether from ordinary income or capital
gains, generally will not be eligible for the dividends received deduction
allowed to corporations under the Code. If the Fund pays a dividend in January
which was declared in the previous October, November or December to
shareholders of record on a specified date in one such month, then such
dividend will be treated for tax purposes as being paid by the Fund and
received by its shareholders on December 31 of the year in which the dividend
was declared.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% United States withholding tax under
the existing provisions of the Code applicable to foreign individuals and
entities unless a reduced rate of withholding or a withholding exemption is
provided under applicable treaty law. Nonresident shareholders are urged to
consult their own tax advisers concerning the applicability of the United
States withholding tax.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that such investor is
not otherwise subject to backup withholding.
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the Class
D shares acquired will be the same as such shareholder's basis in the Class B
shares converted, and the holding period of the acquired Class D shares will
include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of acquiring
such shares, then the loss the shareholder can recognize on the exchange will
be reduced (or the gain increased) to the extent any sales charge paid to the
Fund on the exchanged shares reduces any sales charge such shareholder would
have owed upon the purchase of the new shares in the absence of the exchange
privilege. Instead, such sales charge will be treated as an amount paid for the
new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. While the Fund intends to distribute its income
and capital gains in the manner necessary to minimize imposition of the 4%
excise tax, there can be no assurance that sufficient amounts of the Fund's
taxable income and capital gains will be distributed to avoid entirely the
imposition of the tax. In such event, the Fund will be liable for the tax only
on the amount by which it does not meet the foregoing distribution
requirements.
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TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may write (i.e., sell) covered call and covered put options on its
portfolio securities, purchase put and call options on securities, and engage
in transactions in financial futures and related options on such futures. In
general, unless an election is available to the Fund or an exception applies,
such options and futures contracts that are "Section 1256 contracts" will be
"marked to market" for Federal income tax purposes at the end of each taxable
year, i.e., each such option or futures contract will be treated as sold for
its fair market value on the last day of the taxable year, and any gain or loss
attributable to such contracts will be 60% long-term and 40% short-term capital
gain or loss. Application of these rules to Section 1256 contracts held by the
Fund may alter the timing and character of distributions to shareholders. The
mark-to-market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles", may affect the
taxation of the Fund's sales of securities and transactions in options, futures
and short sales of securities. Under Section 1092, the Fund may be required to
postpone recognition for tax purposes of losses incurred in certain sales of
securities and certain closing transactions in options, futures and short sales
of securities.
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other
disposition of securities held for less than three months. Accordingly, the
Fund may be restricted in effecting certain short sales of securities and
closing transactions within three months after entering into an option or
futures contract.
The Fund may make investments that produce taxable income which is not
matched by a corresponding receipt of cash or an offsetting loss deduction.
Such investments would include obligations that have original issue discount,
accrue negative amortization or are subordinated in the mortgage-backed
securities structure. Such taxable income would be treated as income earned by
the Fund and would be subject to the distribution requirements of the Code.
Because such income may not be matched by a corresponding receipt of cash by
the Fund or an offsetting loss deduction, the Fund may be required to dispose
of other securities to be able to make distributions to shareholders. The Fund
intends to make sufficient and timely distributions to shareholders so as to
qualify for the special tax treatment afforded RICs at all times and to
minimize imposition of the excise tax.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends also may be subject to state and
local taxes.
Certain states exempt from state income taxation dividends paid by RICs which
are derived from interest on U.S. Government obligations. State law varies as
to whether dividend income attributable to U.S. Government obligations is
exempt from state income tax. In general, state law does not consider income
derived from mortgage-backed securities to be income attributable to U.S.
Government obligations.
26
<PAGE>
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors
should consider applicable foreign taxes in their evaluation of an investment
in the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield, in advertisements or information
furnished to present or prospective shareholders. Total return and yield
figures are based on the Fund's historical performance and are not intended to
indicate future performance. Average annual total return and yield are
determined separately for Class A, Class B, Class C and Class D shares in
accordance with formulas specified by the Commission.
Average annual total return quotations for the specified periods are computed
by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A and Class D shares and the CDSC that would be applicable to a complete
redemption of the investment at the end of the specified period in the case of
Class B and Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) the rates of return calculated will not be average annual
rates, but rather, actual annual, annualized or aggregate rates and (2) the
maximum applicable sales charges will not be included with respect to annual or
annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of
return reflect compounding over a longer period of time. In addition, because
the Fund reduced the maximum applicable sales charge in 1988 from 6.25% to
4.00%, certain performance data also will be computed with the inclusion of the
lower sales charge. Such data generally will reflect higher rates of return
because a lower sales charge is deducted.
27
<PAGE>
Set forth below is total return information for the Class A, Class B, Class C
and Class D shares of the Fund for the periods indicated.
<TABLE>
<CAPTION>
CLASS D SHARES (FORMERLY
CLASS A SHARES** CLASS B SHARES* CLASS C SHARES** CLASS A SHARES)
-------------------------- -------------------------- -------------------------- -------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A VALUE OF A AS A VALUE OF A AS A VALUE OF A AS A VALUE OF A
PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END $1,000 AT THE END $1,000 AT THE END $1,000 AT THE END
PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD
------ ------------ ------------- ------------ ------------- ------------ ------------- ------------ ------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
One Year Ended
August 31,
1996........... 0.36% $1,003.60 (0.18)% $ 998.20 2.70% $1,027.00 0.11 % $1,001.10
Five Years Ended
August 31,
1996........... 5.08 % $1,281.20
Ten Years Ended
August 31,
1996........... 6.98 % $1,964.30
Class A and
Class C
Inception
(October 21,
1994) through
August 31,
1996........... 6.25% $1,119.60 7.72% $1,148.70
Class B
Inception
(December 23,
1991) to August
31, 1996....... 4.70 % $1,240.60
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<CAPTION>
YER ENDED AUGUST 31,A
- ---------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1996............ 4.55% $1,045.50 3.72 % $1,037.20 3.67% $1,036.70 4.28 % $1,042.80
1995............ 8.91 % $1,089.10 9.48 % $1,094.80
1994............ (2.55)% $ 974.50 (2.06)% $ 979.40
1993............ 7.80 % $1,078.00 8.35 % $1,083.50
1992............ 10.16 % $1,101.60
1991............ 13.40 % $1,134.00
1990............ 9.61 % $1,096.10
1989............ 11.48 % $1,114.80
1988............ 8.02 % $1,080.20
1987............ 2.43 % $1,024.30
1986............ 17.39 % $1,173.90
Class A and
Class C
Inception
(October 21,
1994) to
August 31,
1995........... 11.56% $1,115.60 10.80% $1,108.00
Class B
Inception
(December 23,
1991) to August
31, 1992....... 4.54 % $1,045.40
Class D
(formerly Class
A) Inception
(September 28,
1984) to
August 31,
1985........... 17.34 % $1,173.40
</TABLE>
(footnotes on following page)
28
<PAGE>
<TABLE>
<CAPTION>
CLASS D SHARES (FORMERLY
CLASS A SHARES** CLASS B SHARES* CLASS C SHARES** CLASS A SHARES)
-------------------------- -------------------------- -------------------------- --------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A VALUE OF A AS A VALUE OF A AS A VALUE OF A AS A VALUE OF A
PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END $1,000 AT THE END $1,000 AT THE END $1,000 AT THE END
PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD
------ ------------ ------------- ------------ ------------- ------------ ------------- ------------ -------------
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Class A and
Class C
Inception
(October 21,
1994) to
August 31,
1996........... 11.96% $1,119.60 14.87% $1,148.70
Class B
Inception
(December 23,
1991) to August
31, 1996....... 24.06% $1,240.60
Class D
(formerly Class
A) Inception
(September 28,
1984) to
August 31,
1996........... 170.55% $2,705.50
</TABLE>
- --------
* Information as to Class B shares is presented only for the period December
23, 1991 to August 31, 1996. Prior to December 23, 1991, no Class B shares
were publicly issued.
** Information as to Class A and Class C shares is presented only for the
period October 21, 1994 to August 31, 1996. Prior to October 21, 1994, no
new Class A or Class C shares were publicly issued.
In order to reflect the reduced sales charges in the case of Class A or
Class D shares, or the waiver of the contingent deferred sales charge in the
case of Class B or Class C shares applicable to certain investors, as
described under "Purchase of Shares" and "Redemption of Shares", respectively,
the total return data quoted by the Fund in advertisements directed to such
investors may take into account the reduced, and not the maximum, sales charge
and therefore may reflect greater total return since, due to the reduced sales
charges or the waiver of sales charges, a lower amount of expenses is
deducted.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust of the Fund permits the Trustees to issue an
unlimited number of full and fractional shares of beneficial interest, par
value $0.10 per share, of different classes and to divide or combine the
shares into a greater or lesser number of shares without thereby changing the
proportionate beneficial interests in the Fund. At the date of this Statement
of Additional Information, the shares of the Fund are divided into four
classes, designated Class A, Class B, Class C and Class D shares. Class A,
Class B, Class C and Class D shares represent interests in the same assets of
the Fund and have identical voting, dividend, liquidation and other rights and
the same terms and conditions except that the Class B, Class C and Class D
shares bear certain expenses related to the account maintenance and/or
distribution of such shares and have exclusive voting rights with respect to
matters relating to such account maintenance and/or distribution expenditures.
The Fund has received an order from the Commission permitting the issuance and
sale of multiple classes of shares of beneficial interest. The Board of
Trustees of the Fund may classify and reclassify the shares of the Fund into
additional classes at a future date.
29
<PAGE>
All shares of the Fund have equal voting rights, except that as noted above,
each class will have exclusive voting rights with respect to matters relating
to the expenses being borne solely by such class. Each issued and outstanding
share is entitled to one vote and to participate equally in dividends and
distributions declared by the Fund, and upon liquidation or dissolution each
share is entitled to receive its allocable share of the net assets of the Fund
remaining after satisfaction of outstanding liabilities, except that, as noted
above, expenses related to the distribution of each class will be borne solely
by such class. There normally will be no meetings of shareholders for the
purposes of electing Trustees unless and until such time as less than a
majority of the Trustees holding office have been elected by shareholders, at
which time the Trustees then in office will call a shareholders' meeting for
the election of Trustees. Shareholders may, in accordance with the terms of the
Declaration of Trust, cause a meeting of shareholders to be held for the
purpose of voting on the removal of Trustees. Also, the Fund will be required
to call a special meeting of shareholders in accordance with the requirements
of the Investment Company Act to seek approval of new management and advisory
arrangements, of a material increase in distribution fees or of a change in the
fundamental policies, objectives or restrictions of the Fund.
Shares of the Fund, when issued, will be fully paid and nonassessable, have
no preference, preemptive, exchange or similar rights, and will be freely
transferable. Redemption and conversion rights are discussed elsewhere herein
and in the Prospectus. Holders of shares of the Fund are entitled to redeem
their shares as set forth elsewhere herein and in the Prospectus. Shares do not
have cumulative voting rights and the holders of more than 50% of the shares of
the Fund voting for the election of Trustees can elect all of the Trustees if
they choose to do so and in such event the holders of the remaining shares
would not be able to elect any Trustees. No amendment may be made to the
Declaration of Trust without the affirmative vote of a majority of the
outstanding shares of the Fund.
COMPUTATION OF OFFERING PRICE PER SHARE
The offering price for Class A, Class B, Class C and Class D shares of the
Fund, based on the value of the Fund's net assets and number of shares
outstanding as of August 31, 1996, is set forth below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Net Assets.................. $231,651,242 $924,884,437 $22,672,290 $942,388,296
============ ============ =========== ============
Number of Shares Outstand-
ing........................ 24,644,296 98,404,386 2,412,552 100,269,823
============ ============ =========== ============
Net Asset Value Per Share
(net assets
divided by number of shares
outstanding)............... $ 9.40 $ 9.40 $ 9.40 $ 9.40
Sales Charge (Class A and
Class D shares:
4.00% of offering price
(4.17% of net
asset value per share))*... .39 ** ** .39
------------ ------------ ----------- ------------
Offering Price.............. $ 9.79 $ 9.40 $ 9.40 $ 9.79
============ ============ =========== ============
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge
is applicable.
** Class B and Class C shares are not subject to an initial sales charge but
may be subject to a CDSC upon redemption. See "Purchase of Shares--Deferred
Sales Charge Alternatives--Class B and Class C Shares" in the Prospectus and
"Redemption of Shares--Deferred Sales Charges--Class B and Class C Shares"
herein.
30
<PAGE>
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
been selected as the independent auditors of the Fund. The independent auditors
are responsible for auditing the financial statements of the Fund.
CUSTODIAN
The Bank of New York, 90 Washington Street, 12th Floor, New York, New York
10286, (the "Custodian") acts as the Custodian of the Fund's assets. The
Custodian is responsible for safeguarding and controlling the Fund's cash and
securities, handling the receipt and delivery of securities and collecting
interest on the Fund's investments.
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Fund's transfer agent (the
"Transfer Agent"). The Transfer Agent is responsible for the issuance, transfer
and redemption of shares and the opening, maintenance and servicing of
shareholder accounts. See "Management of the Fund--Transfer Agency Services" in
the Prospectus.
LEGAL COUNSEL
Brown & Wood LLP, One World Trade Center, New York, New York 10048-0557, is
counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on August 31 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio
and other information. An annual report, containing financial statements
audited by independent auditors, is sent to shareholders each year. After the
end of each year shareholders will receive Federal income tax information
regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the Securities and Exchange
Commission, Washington, D.C., under the Securities Act and the Investment
Company Act, to which reference is hereby made.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
To the knowledge of the Fund, no person or entity owned beneficially 5% or
more of the Fund's shares of beneficial interest on December 1, 1996.
31
<PAGE>
----------------
The Declaration of Trust establishing the Fund, dated July 20, 1984, a copy
of which, together with all amendments thereto (the "Declaration"), is on file
in the office of the Secretary of the Commonwealth of Massachusetts, provides
that the name "Merrill Lynch Federal Securities Trust" refers to the Trustees
under the Declaration collectively as Trustees, but not as individuals or
personally; and no Trustee, shareholder, officer, employee or agent of the Fund
shall be held to any personal liability, nor shall resort be had to their
private property for the satisfaction of any obligation or claim of the Fund,
but the "Trust Property" only shall be liable.
32
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Merrill Lynch Federal Securities Trust:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Merrill Lynch Federal Securities Trust as of
August 31, 1996, the related statements of operations for the year then ended
and changes in net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year
period then ended. These financial statements and the financial highlights are
the responsibility of the Trust's management. Our responsibility is to express
an opinion on these financial statements and the financial highlights based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at August
31, 1996 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
Federal Securities Trust as of August 31, 1996, the results of its operations,
the changes in its net assets, and the financial highlights for the respective
stated periods in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
October 7, 1996
33
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
Face Interest Maturity Value
Issue Amount Rate Date(s) (Note 1a)
US Government Obligations--11.51%
<S> <C> <C> <S> <C>
United States Treasury Notes $ 18,000,000 5.875 % 4/30/1998 $ 17,893,080
175,000,000 8.875 2/15/1999 184,488,500
42,000,000 6.375 5/15/1999 41,862,240
Total US Government Obligations (Cost--$242,073,555) 244,243,820
US Government Agency Mortgage-Backed Obligations*--87.22%
Federal Home Loan Mortgage Corporation 730 10.00 7/01/2019 791
Participation Certificates 18,828,343 10.50 9/01/2000-9/01/2020 20,646,408
4,497,534 11.00 8/01/2010-9/01/2020 4,988,035
3,749,462 11.50 10/01/1998-6/01/2020 4,202,884
1,708,827 12.00 7/01/1999-6/01/2020 1,945,380
3,929,674 12.50 10/01/1999-7/01/2019 4,536,297
5,137,772 13.00 8/01/1999-10/01/2015 6,003,127
Federal Home Loan Mortgage Corporation 432,643 6.00 4/01/2009 409,522
Participation Certificates--Gold Program 92,702,139 6.50 8/01/2010-6/01/2011 89,038,407
9,897,911 7.225(2) 11/01/1997 9,952,040
180,493,478 7.50 1/01/2020-7/01/2026 177,202,682
103,840,422 8.00 1/01/2007-6/01/2026 105,536,794
14,139,652 8.50 1/01/2025-7/01/2025 14,409,154
6,653,927 10.50 1/01/2020-12/01/2020 7,256,906
Federal Home Loan Mortgage Trust 134 2,352,315 9.00(1) 4/15/2022 650,556
Corporation REMICs** Trust 1220 106,720,856 10.00 2/15/2022 12,289,213
Federal National Mortgage 70,011,905 6.00 2/01/2026-5/01/2026 62,712,245
Association Mortgage-Backed 89,627,066 6.50 12/01/2008-8/01/2026 82,852,029
Securities 110,176,742 7.00 6/01/2007-5/01/2026 106,276,078
224,685,680 7.50 12/01/2007-8/01/2026 219,535,074
48,517,004 8.00 6/01/2006-1/01/2020 48,786,086
85,656,422 8.50 5/01/2010-11/01/2025 87,256,075
33,773,225 8.50(3) 7/15/2023 34,554,231
27,733,013 9.50 3/01/2020 29,552,992
15,736 10.50 9/01/2000 16,622
42,527,798 11.00 2/01/2011-11/01/2020 47,617,524
137,124 11.50 1/01/2015-6/01/2015 154,608
2,186,969 13.00 8/01/2010-6/01/2015 2,563,521
Federal National Mortgage 93-123-S 15,529,411 8.55156++ 7/25/2000 14,898,529
Association REMICs** 94-M4-A 24,631,410 9.03795 6/25/2023 25,224,103
Government National Mortgage 10,804,270 6.50 2/15/2026 9,933,122
Association Mortgage-Backed 101,042,740 7.00 4/15/2023-3/15/2026 95,840,321
Securities 296,171,633 7.50 1/15/2007-4/15/2026 289,479,465
154,466,723 8.00 5/15/2023-6/15/2026 154,582,980
10,465,750 8.50 2/15/2023-3/15/2026 10,684,798
62,548,298 10.00 12/15/2015-12/15/2021 68,508,918
317,728 10.50 10/15/2014-4/15/2021 352,875
871 11.00 1/15/2016 980
14,897 11.50 8/15/2013-4/15/2015 16,936
Total US Government Agency Mortgage-Backed Obligations (Cost--$1,872,478,881) 1,850,468,308
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (concluded)
Face Value
Amount Issue (Note 1a)
Repurchase Agreements***--4.17%
<C> <S> <C>
$88,500,000 Nikko Securities Co., purchased on 8/30/1996 to yield 5.26%
to 9/03/1996 $ 88,500,000
Total Repurchase Agreements (Cost--$88,500,000) 88,500,000
US Government & Agency Discount Obligations****--4.93%
Federal Home Loan Mortgage Corporation:
39,705,000 5.23% due 9/16/1996 39,630,013
45,000,000 5.23% due 9/17/1996 44,908,475
20,000,000 Federal National Mortgage Association, 5.18% due 9/18/1996 19,956,833
Total US Government & Agency Discount Obligations (Cost--$104,495,321) 104,495,321
<CAPTION>
Par Strike Callable
Value Price From
Options Purchased--0.09%
<S> <C> <S> <C> <S> <C>
Call Options $169,023,769 Federal Home Loan Mortgage
Purchased Corporation--Gold Program,
15-Year, 7% 100 August 1996 1,306,356
100,000,000 Government National Mortgage
Association,30-Year, 6%
Adjustable Rate Mortgage 100 10/20/1996(4) 130,000
32,000,000 United States Treasury Notes,
6.875% due 5/15/2006 98.156 9/11/1996(4) 475,008
Total Options Purchased (Cost--$3,929,420) 1,911,364
Total Investment (Cost--$2,311,477,177)--107.92% 2,289,618,813
Options Written--(0.04%)
Call Options 50,000,000 Government National Mortgage
Written Association, 30-Year, 8% 99 9/11/1996(4) (781,250)
Put Options 100,000,000 Government National Mortgage
Written Association, 30-Year, 6%
Adjustable Rate Mortgage 100 10/20/1996(4) (10,000)
Total Options Written (Premiums Received--$525,625) (791,250)
Total Investments, Net of Options Written (Cost--$2,310,951,552)--107.88% 2,288,827,563
Liabilities in Excess of Other Assets--(7.88%) (167,231,298)
---------------
Net Assets--100.00% $ 2,121,596,265
===============
<FN>
(1)Represents the interest only portion of a mortgage-backed
obligation.
(2)Represents balloon mortgages that amortize on a 30-year schedule
and have 5-year maturities.
(3)Federal Housing Administration/Veterans' Administration Mortgages
packaged by the Federal National Mortgage Association.
(4)Represents European call options callable only on notification
date.
++Adjustable Rate Security. The interest rate resets periodically
and inversely. The interest rate shown is the rate in effect as of
August 31, 1996.
*Mortgage-Backed Obligations are subject to principal paydowns as a
result of prepayments or refinancings of the underlying mortgage
instruments. As a result, the average life may be substantially less
than the original maturity.
**Real Estate Mortgage Investment Conduits (REMICs).
***Repurchase Agreements are fully collateralized by US Government &
Agency Obligations.
****Certain US Government & Agency Obligations are traded on a
discount basis; the interest rates shown are the discount rates paid
at the time of purchase by the Trust.
See Notes to Financial Statements.
</TABLE>
35
<PAGE>
FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of August 31, 1996
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$2,307,547,757) (Note 1a) $ 2,287,707,449
Call options purchased, at value (cost--$3,929,420)
(Notes 1a & 1c) 1,911,364
Cash 47,174
Receivables:
Securities sold $ 325,724,207
Interest 15,339,584
Beneficial interest sold 1,541,541
Principal paydowns 1,024,983
Extended deliveries 181,138 343,811,453
---------------
Prepaid registration fees and other assets (Note 1f) 132,409
---------------
Total assets 2,633,609,849
---------------
Liabilities: Call options written, at value (premiums received--$525,625)
(Notes 1a & 1c) 791,250
Payables:
Securities purchased (Note 1h) 499,363,732
Beneficial interest redeemed 6,491,120
Dividends to shareholders (Note 1g) 2,641,077
Investment adviser (Note 2) 891,943
Distributor (Note 2) 872,626 510,260,498
---------------
Accrued expenses and other liabilities 961,836
---------------
Total liabilities 512,013,584
---------------
Net Assets: Net assets $ 2,121,596,265
===============
Net Assets Class A Shares of beneficial interest, $0.10 par value,
Consist of: unlimited number of shares authorized $ 2,464,430
Class B Shares of beneficial interest, $0.10 par value,
unlimited number of shares authorized 9,840,439
Class C Shares of beneficial interest, $0.10 par value,
unlimited number of shares authorized 241,255
Class D Shares of beneficial interest, $0.10 par value,
unlimited number of shares authorized 10,026,982
Paid-in capital in excess of par 2,437,058,649
Accumulated realized capital losses on investments--net
(Note 5) (315,911,501)
Unrealized depreciation on investments--net (22,123,989)
---------------
Net assets $ 2,121,596,265
===============
Net Asset Value: Class A--Based on net assets of $231,651,242 and 24,644,296
shares of beneficial interest outstanding $ 9.40
===============
Class B--Based on net assets of $924,884,437 and 98,404,386
shares of beneficial interest outstanding $ 9.40
===============
Class C--Based on net assets of $22,672,290 and 2,412,552
shares of beneficial interest outstanding $ 9.40
===============
Class D--Based on net assets of $942,388,296 and 100,269,823
shares of beneficial interest outstanding $ 9.40
===============
See Notes to Financial Statements.
</TABLE>
36
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
Statement of Operations for the Year Ended August 31, 1996
<S> <S> <C>
Investment Interest and discount earned $ 170,261,306
Income Other 666,948
(Note 1e): ---------------
Total income 170,928,254
---------------
Expenses: Investment advisory fees (Note 2) 10,650,590
Account maintenance and distribution fees--Class B (Note 2) 8,505,832
Account maintenance fees--Class D (Note 2) 2,400,905
Transfer agent fees--Class B (Note 2) 1,527,866
Transfer agent fees--Class D (Note 2) 1,094,301
Custodian fees 426,340
Accounting services (Note 2) 286,168
Transfer agent fees--Class A (Note 2) 266,280
Printing and shareholder reports 186,751
Account maintenance and distribution fees--Class C (Note 2) 162,070
Professional fees 123,578
Registration fees (Note 1f) 108,434
Trustees' fees and expenses 80,471
Transfer agent fees--Class C (Note 2) 26,277
Other 59,131
---------------
Total expenses 25,904,994
---------------
Investment income--net 145,023,260
---------------
Realized & Realized gain on investments--net 17,428,212
Unrealized Change in unrealized appreciation/depreciation on investments--net (66,407,293)
Gain (Loss) on ---------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 96,044,179
(Notes 1c, 1e & 3): ===============
See Notes to Financial Statements.
</TABLE>
37
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
<CAPTION>
Statements of Changes in Net Assets
For the Year Ended August 31,
Increase (Decrease) in Net Assets: 1996 1995
<S> <S> <C> <C>
Operations: Investment income--net $ 145,023,260 $ 170,805,573
Realized gain (loss) on investments--net 17,428,212 (48,775,962)
Change in unrealized appreciation/depreciation on
investments--net (66,407,293) 92,170,478
--------------- ---------------
Net increase in net assets resulting from operations 96,044,179 214,200,089
--------------- ---------------
Dividends to Investment income--net:
Shareholders Class A (15,541,226) (12,352,715)
(Note 1g): Class B (66,689,844) (84,089,808)
Class C (1,181,094) (348,549)
Class D (61,490,784) (73,437,660)
--------------- ---------------
Net decrease in net assets resulting from dividends
to shareholders (144,902,948) (170,228,732)
--------------- ---------------
Beneficial Interest Net decrease in net assets derived from beneficial
Transactions interest transactions (307,548,996) (420,304,775)
(Notes 1i & 4): --------------- ---------------
Net Assets: Total decrease in net assets (356,407,765) (376,333,418)
Beginning of year 2,478,004,030 2,854,337,448
--------------- ---------------
End of year $ 2,121,596,265 $ 2,478,004,030
=============== ===============
See Notes to Financial Statements.
</TABLE>
38
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
<CAPTION>
Financial Highlights
Class A++++
The following per share data and ratios have been derived For the For the Period
from information provided in the financial statements. Year Ended Oct. 21, 1994++
August 31, to August 31,
Increase (Decrease) in Net Asset Value: 1996 1995
<S> <S> <C> <C>
Per Share Net asset value, beginning of period $ 9.61 $ 9.16
Operating --------------- ---------------
Performance: Investment income--net .64 .58
Realized and unrealized gain (loss) on investments--net (.21) .45
--------------- ---------------
Total from investment operations .43 1.03
--------------- ---------------
Less dividends from investment income--net (.64) (.58)
--------------- ---------------
Net asset value, end of period $ 9.40 $ 9.61
=============== ===============
Total Investment Based on net asset value per share 4.55% 11.56%+++
Return:** =============== ===============
Ratios to Average Expenses .62% .64%*
Net Assets: =============== ===============
Investment income--net 6.64% 7.21%*
=============== ===============
Supplemental Net assets, end of period (in thousands) $ 231,651 $ 223,237
Data: =============== ===============
Portfolio turnover 204.14% 260.34%
=============== ===============
<CAPTION>
Class B
The following per share data and ratios have been derived For the Period
from information provided in the financial statements. Dec. 23, 1991++
For the Year Ended August 31, to August 31,
Increase (Decrease) in Net Asset Value: 1996++++ 1995++++ 1994 1993 1992
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of
Operating period $ 9.61 $ 9.41 $ 10.14 $ 9.92 $ 9.92
Performance: ---------- ---------- ---------- ---------- ----------
Investment income--net .57 .60 .48 .52 .44
Realized and unrealized gain
(loss) on investments--net (.21) .20 (.73) .22 --
---------- ---------- ---------- ---------- ----------
Total from investment operations .36 .80 (.25) .74 .44
---------- ---------- ---------- ---------- ----------
Less dividends from investment
income--net (.57) (.60) (.48) (.52) (.44)
---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.40 $ 9.61 $ 9.41 $ 10.14 $ 9.92
========== ========== ========== ========== ==========
Total Investment Based on net asset value per share 3.72% 8.91% (2.55%) 7.80% 4.54%+++
Return:** ========== ========== ========== ========== ==========
Ratios to Average Expenses 1.39% 1.41% 1.33% 1.30% 1.33%*
Net Assets: ========== ========== ========== ========== ==========
Investment income--net 5.87% 6.39% 4.90% 5.27% 6.45%*
========== ========== ========== ========== ==========
Supplemental Net assets, end of period
Data: (in thousands) $ 924,885 $1,262,985 $1,497,358 $2,151,917 $1,921,893
========== ========== ========== ========== ==========
Portfolio turnover 204.14% 260.34% 322.68% 224.35% 230.83%
========== ========== ========== ========== ==========
<FN>
++Commencement of Operations.
++++Based on average shares outstanding for the period.
*Annualized.
**Total investment returns exclude the effects of sales loads.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
39
<PAGE>
FINANCIAL INFORMATION (concluded)
<TABLE>
<CAPTION>
Financial Highlights (concluded)
Class C++++
The following per share data and ratios have been derived For the For the Period
from information provided in the financial statements. Year Ended Oct. 21, 1994++
August 31, to August 31,
Increase (Decrease) in Net Asset Value: 1996 1995
<S> <S> <C> <C>
Per Share Net asset value, beginning of period $ 9.61 $ 9.16
Operating --------------- ---------------
Performance: Investment income--net .56 .51
Realized and unrealized gain (loss) on investments--net (.21) .45
--------------- ---------------
Total from investment operations .35 .96
--------------- ---------------
Less dividends from investment income--net (.56) (.51)
--------------- ---------------
Net asset value, end of period $ 9.40 $ 9.61
=============== ===============
Total Investment Based on net asset value per share 3.67% 10.80%+++
Return:** =============== ===============
Ratios to Average Expenses 1.43% 1.47%*
Net Assets: =============== ===============
Investment income--net 5.82% 6.28%*
=============== ===============
Supplemental Net assets, end of period (in thousands) $ 22,672 $ 15,621
Data: =============== ===============
Portfolio turnover 204.14% 260.34%
=============== ===============
<CAPTION>
The following per share data and ratios have been derived Class D
from information provided in the financial statements.
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 1996++++ 1995++++ 1994 1993 1992
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 9.61 $ 9.41 $ 10.14 $ 9.92 $ 9.66
Operating ---------- ---------- ---------- ---------- ----------
Performance: Investment income--net .62 .64 .52 .57 .70
Realized and unrealized gain
(loss) on investments--net (.21) .20 (.73) .22 .26
---------- ---------- ---------- ---------- ----------
Total from investment operations .41 .84 (.21) .79 .96
---------- ---------- ---------- ---------- ----------
Less dividends from investment
income--net (.62) (.64) (.52) (.57) (.70)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 9.40 $ 9.61 $ 9.41 $ 10.14 $ 9.92
========== ========== ========== ========== ==========
Total Investment Based on net asset value per share 4.28% 9.48% (2.06%) 8.35% 10.16%
Return:** ========== ========== ========== ========== ==========
Ratios to Average Expenses .87% .89% .83% .79% .80%
Net Assets: ========== ========== ========== ========== ==========
Investment income--net 6.39% 6.91% 5.41% 5.80% 7.17%
========== ========== ========== ========== ==========
Supplemental Net assets, end of year
Data: (in thousands) $ 942,388 $ 976,161 $1,356,979 $1,836,100 $2,048,037
========== ========== ========== ========== ==========
Portfolio turnover 204.14% 260.34% 322.68% 224.35% 230.83%
========== ========== ========== ========== ==========
<FN>
++Commencement of Operations.
++++Based on average shares outstanding for the period.
*Annualized.
**Total investment returns exclude the effects of sales loads.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
40
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch Federal Securities Trust (the "Trust") is registered
under the Investment Company Act of 1940 as a diversified, open-end
management investment company. The Trust offers four classes of
shares under the Merrill Lynch Select Pricing SM System. Shares of
Class A and Class D are sold with a front-end sales charge. Shares
of Class B and Class C may be subject to a contingent deferred sales
charge. All classes of shares have identical voting, dividend,
liquidation and other rights and the same terms and conditions,
except that Class B, Class C and Class D Shares bear certain
expenses related to the account maintenance of such shares, and
Class B and Class C Shares also bear certain expenses related to the
distribution of such shares. Each class has exclusive voting rights
with respect to matters relating to its account maintenance and
distribution expenditures. The following is a summary of significant
accounting policies followed by the Trust.
(a) Valuation of investments--Securities traded in the over-the-
counter market are valued at the last available bid price in the
over-the-counter market or on the basis of yield equivalents as
obtained from one or more dealers that make markets in the
securities. The Trust employs Merrill Lynch Securities Pricing
Service ("MLSPS"), an affiliate of Fund Asset Management, L.P.
("FAM"), to provide mortgage-backed securities prices for the Trust.
Options on US Government securities, which are traded on exchanges,
are valued at their last bid price in the case of options purchased
by the Trust and their last asked price in the case of options
written by the Trust. An option traded on the over-the-counter
market is valued at its last bid price or asked price as obtained
from one or more dealers that make markets in the securities.
Interest rate futures contracts and options thereon, which are
traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Securities with a remaining maturity of
sixty days or less are valued on an amortized cost basis, which
approximates market value. Securities and assets for which market
quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Trustees
of the Trust.
(b) Repurchase agreements--The Trust invests in US Government
securities pursuant to repurchase agreements with a member bank of
the Federal Reserve System or a primary dealer in US Government
securities. Under such agreements, the bank or primary dealer agrees
to repurchase the security at a mutually agreed upon time and price.
The Trust takes possession of the underlying securities, marks to
market such securities and, if necessary, receives additions to such
securities daily to ensure that the contract is fully
collateralized.
(c) Derivative financial instruments--The Trust may engage in
various portfolio strategies to seek to increase its return by
hedging its portfolio against adverse movements in the debt and
currency markets. Losses may arise due to changes in the value of
the contract or if the counterparty does not perform under the
contract.
* Futures contracts--The Trust may purchase or sell interest rate
futures contracts. Upon entering into a contract, the Trust deposits
and maintains as collateral such initial margins as required by the
exchange on which the transaction is effected. Pursuant to the
contract, the Trust agrees to receive from or pay to the broker an
amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Trust as unrealized gains or losses. When
the contract is closed, the Trust records a realized gain or loss
equal to the difference between the value of the contract at the
time it was opened and the value at the time is was closed.
* Options--The Trust is authorized to write and purchase call and
put options. When the Trust writes an option, an amount equal to the
premium received by the Trust is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option
written. When a security is purchased or sold through an exercise of
an option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Trust enters into a closing transaction), the Trust
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premiums paid or received).
Written and purchased options are non-income producing investments.
41
<PAGE>
(d) Income taxes--It is the Trust's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income (including amortization of
discount) and extended delivery fees are recognized on the accrual
basis. Realized gains and losses on security transactions are
determined on the identified cost basis.
(f) Prepaid registration fees--Prepaid registration fees are charged
to expense as the related shares are issued.
(g) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates.
(h) Dollar rolls--The Trust sells mortgage-backed securities for
delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type, coupon and maturity)
securities on a specific future date. The repurchase amount as of
August 31, 1996 was $61,612,358.
(i) Reclassification--Certain amounts have been reclassified as a
result of permanent book-tax differences.
2. Investment Advisory Agreement and
Transactions with Affiliates:
The Trust has entered into an Investment Advisory Agreement with
FAM. The general partner of FAM is Princeton Services, Inc. ("PSI"),
an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc.
("ML & Co."), which is the limited partner. The Trust has also
entered into a Distribution Agreement and Distribution Plans with
Merrill Lynch Funds Distributor, Inc. ("MLFD" or "Distributor"), a
wholly-owned subsidiary of Merrill Lynch Group, Inc.
FAM is responsible for the management of the Trust's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Trust. For such
services, the Trust pays a monthly fee based upon the average daily
value of the Trust's net assets at the following rate:
Portion of Average Daily Value of Net Assets: Rate
Not exceeding $500 million 0.500%
In excess of $500 million but not
exceeding $1 billion 0.475%
In excess of $1 billion but not
exceeding $1.5 billion 0.450%
In excess of $1.5 billion but not
exceeding $2 billion 0.425%
In excess of $2 billion but not
exceeding $2.5 billion 0.400%
In excess of $2.5 billion but not
exceeding $3.5 billion 0.375%
In excess of $3.5 billion but not
exceeding $5 billion 0.350%
In excess of $5 billion but not
exceeding $6.5 billion 0.325%
Exceeding $6.5 billion 0.300%
The Investment Advisory Agreement obligates FAM to reimburse the
Trust to the extent the Trust's expenses (excluding interest, taxes,
distribution fees, brokerage fees and commissions, and extraordinary
items) exceed 2.5% of the Trust's first $30 million of average daily
net assets, 2.0% of the next $70 million of average daily net
assets, and 1.5% of the average daily net assets in excess thereof.
FAM's obligation to reimburse the Trust is limited to the amount of
the management fee. No fee payment will be made to FAM during any
fiscal year which will cause such expenses to exceed the pro rata
expense limitation at the time of such payment.
Pursuant to the distribution plans (the "Distribution Plans")
adopted by the Trust in accordance with Rule 12b-1 under the
Investment Company Act of 1940, the Trust pays the Distributor
ongoing account maintenance and distribution fees. The fees are
accrued daily and paid monthly at annual rates based upon the
average daily net assets of the shares as follows:
Account Distribution
Maintenance Fee Fee
Class B 0.25% 0.50%
Class C 0.25% 0.55%
Class D 0.25% --
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), a subsidiary of ML & Co.,
also provides
42
<PAGE>
account maintenance and distribution services to the
Trust. The ongoing account maintenance fee compensates the
Distributor and MLPF&S for providing account maintenance services to
Class B, Class C and Class D shareholders. The ongoing distribution
fee compensates the Distributor and MLPF&S for providing shareholder
and distribution-related services to Class B and Class C
shareholders.
NOTES TO FINANCIAL STATEMENTS (concluded)
For the year ended August 31, 1996, MLFD earned underwriting
discounts and direct commissions and MLPF&S earned dealer
concessions on sales of the Trust's Class A and Class D Shares as
follows:
MLFD MLPF&S
Class A $ 548 $ 7,280
Class D $20,058 $170,668
For the year ended August 31, 1996, MLPF&S received contingent
deferred sales charges of $1,283,799 and $37,766 relating to
transactions in Class B and Class C Shares, respectively.
During the year ended August 31, 1996, the Trust paid MLSPS $2,330
for security price quotations to compute the net asset value of the
Trust.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-
owned subsidiary of ML & Co., is the Trust's transfer agent.
Accounting services are provided to the Trust by FAM at cost.
Certain officers and/or trustees of the Trust are officers and/or
directors of FAM, PSI, MLFD, MLPF&S, MLFDS, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended August 31, 1996 were $4,779,399,805 and
$5,066,445,637, respectively.
Net realized and unrealized gains (losses) as of August 31, 1996
were as follows:
Realized
Gains Unrealized
(Losses) Losses
Long-term investments $ 17,885,147 $(19,840,308)
Short-term investments (1,708) --
Options purchased (2,013,430) (2,018,056)
Options written 1,558,203 (265,625)
------------ ------------
Total $ 17,428,212 $(22,123,989)
============ ============
As of August 31, 1996, net unrealized depreciation for Federal
income tax purposes aggregated $35,589,527, of which $12,448,470
related to appreciated securities and $48,037,997 related to
depreciated securities. The aggregate cost of investments, including
options written and purchased, at August 31, 1996 for Federal income
tax purposes was $2,324,417,090.
Transactions in call options written for the year ended August 31,
1996 were as follows:
Face
Amount Premiums
Call Options Written Subject to Put Received
Outstanding put options
written, beginning of year -- --
Options written $317,500,000 $ 2,552,344
Options closed (50,000,000) (1,671,484)
Options expired (217,500,000) (365,235)
------------ ------------
Outstanding put options
written, end of year $ 50,000,000 $ 515,625
============ ============
Transactions in put options written for the year ended August 31,
1996 were as follows:
Face
Amount Premiums
Put Options Written Subject to Put Received
Outstanding put options
written, beginning of year $ 32,100,000 $ 300,938
Options written 100,000,000 10,000
Options closed (32,100,000) (300,938)
------------ ------------
Outstanding put options
written, end of year $100,000,000 $ 10,000
============ ============
4. Shares of Beneficial Interest:
Net decrease in net assets derived from beneficial interest
transactions was $307,548,996 and $420,304,775 for the years ended
August 31, 1996 and August 31, 1995, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 11,032,271 $105,977,427
Shares issued to shareholders
in reinvestment of dividends 213,992 2,055,029
------------ ------------
Total issued 11,246,263 108,032,456
Shares redeemed (9,834,489) (94,194,820)
------------ ------------
Net increase 1,411,774 $ 13,837,636
============ ============
43
<PAGE>
Class A Shares for the Period Dollar
Oct. 21, 1994++ to Aug. 31, 1995 Shares Amount
Shares sold 30,530,411 $282,054,026
Shares issued to shareholders
in reinvestment of dividends 455,652 4,239,634
------------ ------------
Total issued 30,986,063 286,293,660
Shares redeemed (7,753,541) (72,945,956)
------------ ------------
Net increase 23,232,522 $213,347,704
============ ============
[FN]
++Commencement of Operations.
Class B Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 16,843,373 $ 161,838,398
Shares issued to shareholders
in reinvestment of dividends 4,018,944 38,574,345
------------- -------------
Total issued 20,862,317 200,412,743
Automatic conversion of
shares (9,718,045) (107,029,876)
Shares redeemed (44,194,562) (408,856,018)
------------- -------------
Net decrease (33,050,290) $(315,473,151)
============= =============
Class B Shares for the Year Dollar
Ended August 31, 1995 Shares Amount
Shares sold 21,572,051 $ 201,569,458
Shares issued to shareholders
in reinvestment of dividends 5,141,582 47,944,155
------------- -------------
Total issued 26,713,633 249,513,613
Automatic conversion
of shares (142,436) (1,332,622)
Shares redeemed (54,176,662) (503,689,288)
------------- -------------
Net decrease (27,605,465) $(255,508,297)
============= =============
Class C Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 2,160,634 $ 20,825,991
Shares issued to shareholders
in reinvestment of dividends 75,534 723,024
------------ ------------
Total issued 2,236,168 21,549,015
Shares redeemed (1,449,722) (13,905,461)
------------ ------------
Net increase 786,446 $ 7,643,554
============ ============
Class C Shares for the Period Dollar
Oct. 21, 1994++ to Aug. 31, 1995 Shares Amount
Shares sold 1,942,998 $ 18,329,377
Shares issued to shareholders
in reinvestment of dividends 22,508 213,166
------------ ------------
Total issued 1,965,506 18,542,543
Shares redeemed (339,400) (3,229,586)
------------ ------------
Net increase 1,626,106 $ 15,312,957
============ ============
[FN]
++Commencement of Operations.
Class D Shares for the
Year Ended Dollar
August 31, 1996 Shares Amount
Shares sold 24,780,817 $ 222,390,773
Automatic conversion of
shares 9,718,045 107,029,876
Shares issued to shareholders
in reinvestment of dividends 3,084,645 29,564,190
------------- -------------
Total issued 37,583,507 358,984,839
Shares redeemed (38,921,835) (372,541,874)
------------- -------------
Net decrease (1,338,328) $ (13,557,035)
============= =============
Class D Shares for the
Year Ended Dollar
August 31, 1995 Shares Amount
Shares sold 4,559,726 $ 42,599,935
Automatic conversion of
shares 142,436 1,332,622
Shares issued to shareholders
in reinvestment of dividends 3,722,044 34,698,654
------------- -------------
Total issued 8,424,206 78,631,211
Shares redeemed (50,970,271) (471,652,190)
------------- -------------
Net decrease (42,546,065) $(393,020,979)
============= =============
As a result of implementation of the Merrill Lynch Select Pricing SM
System, Class A Shares of the Fund outstanding prior to October 21,
1994 were redesignated to Class D Shares. There were 119,438,530
shares redesignated amounting to $1,423,379,743.
5. Capital Loss Carryforward:
At August 31, 1996, the Trust had a net capital loss carryforward of
approximately $302,395,000, of which $68,370,000 expires in 1997,
$39,147,000 expires in 1998, $178,146,000 expires in 2003, and
$16,732,000 expires in 2004. This amount will be available to offset
like amounts of any future taxable gains. Expired capital loss
carryforward in the amount of $98,649,523 has been reclassified to
paid-in capital in excess of par.
44
<PAGE>
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45
<PAGE>
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46
<PAGE>
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47
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies......................................... 2
Investment Restrictions.................................................. 2
Management of the Fund.................................................... 4
Trustees and Officers.................................................... 4
Management and Advisory Arrangements..................................... 6
Purchase of Shares........................................................ 8
Alternative Sales Arrangements........................................... 8
Initial Sales Charge Alternatives--Class A and Class D Shares............ 8
Reduced Initial Sales Charges............................................ 10
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements........................................................... 13
Distribution Plans....................................................... 13
Limitations on the Payment of Deferred Sales Charges..................... 14
Redemption of Shares...................................................... 15
Deferred Sales Charge--Class B and Class C Shares........................ 16
Portfolio Transactions.................................................... 16
Determination of Net Asset Value.......................................... 18
Shareholder Services...................................................... 19
Investment Account....................................................... 19
Automatic Investment Plans............................................... 20
Automatic Reinvestment of Dividends and Capital Gains Distributions...... 20
Systematic Withdrawal Plans--Class A and Class D Shares.................. 20
Retirement Plans......................................................... 21
Exchange Privilege....................................................... 22
Dividends, Distributions and Taxes........................................ 24
Dividends and Distributions.............................................. 24
Taxes.................................................................... 24
Tax Treatment of Options and Futures Transactions......................... 26
Performance Data.......................................................... 27
General Information....................................................... 29
Description of Shares.................................................... 29
Computation of Offering Price Per Share.................................. 30
Independent Auditors..................................................... 31
Custodian................................................................ 31
Transfer Agent........................................................... 31
Legal Counsel............................................................ 31
Reports to Shareholders.................................................. 31
Additional Information................................................... 31
Security Ownership of Certain Beneficial Owners.......................... 32
Independent Auditors' Report.............................................. 33
Financial Statements...................................................... 34
</TABLE>
Code #10260-1296
[LOGO] MERRILL LYNCH
MERRILL LYNCH
FEDERAL SECURITIES TRUST
[ART]
STATEMENT OF
ADDITIONAL
INFORMATION
December 20, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE>
PART C. OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
(a) FINANCIAL STATEMENTS:
Contained in Part A:
Financial Highlights for each of the years in the ten-year period
ended August 31, 1996.
Contained in Part B:
Schedule of Investments as of August 31, 1996.
Statement of Assets and Liabilities as of August 31, 1996.
Statement of Operations for the year ended August 31, 1996.
Statements of Changes in Net Assets for each of the years in the
two-year period ended August 31, 1996.
Financial Highlights for each of the years in the five-year period
ended August 31, 1996.
(b) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <S>
1(a) --Declaration of Trust of the Registrant.(a)
(b) --Certification of amendment, dated December 20, 1991, to Declaration
of Trust.(a)
(c) --Instrument establishing Class A and Class B shares of the
Registrant.(a)
(d) --Certification of amendment, dated October 13, 1994, to Declaration
of Trust and Instrument establishing Class C and Class D shares of
the Registrant.(a)
2 --By-Laws of the Registrant.(a)
3 --None.
4 --Portions of the Declaration of Trust and By-Laws of the Registrant
defining the rights of holders of shares of the Registrant.(b)
5(a) --Management Agreement between the Registrant and Fund Asset Manage-
ment, Inc.(c)
(b) --Supplement to Management Agreement between Registrant and Fund Asset
Management, L.P.(d)
6(a) --Form of Class A Distribution Agreement between Registrant and Mer-
rill Lynch Funds Distributor, Inc.(d)
(b) --Class B Distribution Agreement between Registrant and Merrill Lynch
Funds Distributor,
Inc.(a)
(c) --Form of Class C Distribution Agreement between Registrant and Mer-
rill Lynch Funds Distributor, Inc. (including Selected Dealers
Agreement).(d)
(d) --Form of Class D Distribution Agreement between Registrant and Mer-
rill Lynch Funds Distributor, Inc. (including Selected Dealers
Agreement).(d)
7 --None.
8 --Custody Agreement between Registrant and The Bank of New York.(a)
9 --Transfer Agency, Dividend Disbursing Agency and Shareholder Servic-
ing Agency Agreement between the Registrant and Merrill Lynch Finan-
cial Data Services, Inc.(a)
10 --Opinion of Brown & Wood, counsel to Registrant.
11 --Consent of Deloitte & Touche LLP, independent auditors for Regis-
trant.
12 --None.
13 --Certificate of Fund Asset Management, Inc.(a)
14 --None.
</TABLE>
C-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <S>
15(a) --Amended and Restated Class B Distribution Plan of Registrant.(c)
(b) --Form of Class C Distribution Plan and Class C Distribution Plan Sub-
Agreement of Registrant.(d)
(c) --Form of Class D Distribution Plan and Class D Distribution Plan Sub-
Agreement of Registrant.(d)
16(a) --Schedule for computation of each performance quotation provided for
Class A shares in the Registration Statement in response to Item
22.(f)
(b) --Schedule for computation of each performance quotation provided for
Class B shares in the Registration Statement in response to Item
22.(a)
(c) --Schedule for computation of each performance quotation provided for
Class C shares in the Registration Statement in response to Item
22.(f)
(d) --Schedule for computation of each performance quotation provided for
Class D (formerly Class A) shares in the Registration Statement in
response to Item 22.(a)
17(a) --Financial Data Schedule for Class A Shares.
(b) --Financial Data Schedule for Class B Shares.
(c) --Financial Data Schedule for Class C Shares.
(d) --Financial Data Schedule for Class D Shares.
18 --Merrill Lynch Select PricingSM System Plan Pursuant to Rule 18f-3(e)
</TABLE>
- --------
(a) Refiled pursuant to the Electronic Data Gathering, Analysis and Retrieval
("EDGAR") phase-in requirements.
(b) Reference is made to Article II, Section 2.3 and Articles III, V, VI, VIII,
IX, X and XI of the Registrant's Declaration of Trust, filed as Exhibit
1(a) to Post-Effective Amendment No. 12 to the Registrant's Registration
Statement under the Securities Act of 1933, as amended (the "Registration
Statement"); and to Articles I, V and VI of the Registrant's By-Laws, filed
as Exhibit 2 to Post-Effective Amendment No. 12 to the Registration
Statement.
(c) Filed on December 23, 1993 as an Exhibit to the Registrant's Registration
Statement on Form N-1A under the Securities Act of 1933.
(d) Filed on October 21, 1994 as an Exhibit to the Registrant's Registration
Statement on Form N-1A under the Securities Act of 1933.
(e) Incorporated by reference to Post-Effective Amendment No. 13 to the
Registration Statement on Form N-1A of Merrill Lynch New York Municipal
Bond Fund of Merrill Lynch Multi-State Municipal Series Trust filed on
January 25, 1996.
(f) Filed on December 21, 1995 as an Exhibit to the Registrant's Registration
Statement on Form N-1A under the Securities Act of 1933.
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
The Registrant is not controlled by or under common control with any person.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES
<TABLE>
<CAPTION>
NUMBER OF
HOLDERS AT
NOVEMBER
TITLE OF CLASS 30, 1996
-------------- ----------
<S> <C>
Class A shares of beneficial interest, par value $0.10 per share..... 1,553
Class B shares of beneficial interest, par value $0.10 per share..... 54,786
Class C shares of beneficial interest, par value $0.10 per share..... 1,330
Class D shares of beneficial interest, par value $0.10 per share..... 63,853
</TABLE>
- --------
Note: The number of holders shown in the table includes holders of record plus
beneficial owners whose shares are held of record by Merrill Lynch, Pierce,
Fenner & Smith Incorporated.
C-2
<PAGE>
ITEM 27. INDEMNIFICATION
Section 5.3 of the Registrant's Declaration of Trust provides as follows:
"The Trust shall indemnify each of its Trustees, officers, employees, and
agents (including persons who serve at its request as directors, officers or
trustees of another organization in which it has any interest as a shareholder,
creditor or otherwise) against all liabilities and expenses (including amounts
paid in satisfaction of judgments, in compromise, as fines and penalties, and
as counsel fees) reasonably incurred by him in connection with the defense or
disposition of any action, suit or other proceeding, whether civil or criminal,
in which he may be involved or with which he may be threatened, while in office
or thereafter, by reason of his being or having been such a trustee, officer,
employee or agent, except with respect to any matter as to which he shall have
been adjudicated to have acted in bad faith, willful misfeasance, gross
negligence or reckless disregard of his duties; provided, however, that as to
any matter disposed of by a compromise payment by such person, pursuant to a
consent decree or otherwise, no indemnification either for said payment or for
any other expenses shall be provided unless the Trust shall have received a
written opinion from independent legal counsel approved by the Trustees to the
effect that if either the matter of willful misfeasance, gross negligence or
reckless disregard of duty, or the matter of good faith and reasonable belief
as to the best interest of the Trust, had been adjudicated, it would have been
adjudicated in favor of such person. The rights accruing to any Person under
these provisions shall not exclude any other right to which he may be lawfully
entitled; provided that no Person may satisfy any right of indemnity or
reimbursement granted herein or in Section 5.1 or to which he may be otherwise
entitled except out of the property of the Trust, and no shareholder shall be
personally liable to any Person with respect to any claim for indemnity or
reimbursement or otherwise. The Trustees may make advance payments in
connection with indemnification under this Section 5.3, provided that the
indemnified person shall have given a written undertaking to reimburse the
Trust in the event it is subsequently determined that he is not entitled to
such indemnification."
Insofar as the conditional advancing of indemnification moneys for actions
based upon the Investment Company Act of 1940 may be concerned, such payments
will be made only on the following conditions: (i) the advances must be limited
to amounts used, or to be used, for the preparation or presentation of a
defense to the action, including costs connected with the preparation of a
settlement; (ii) advances may be made only upon receipt of a written promise
by, or on behalf of, the recipient to repay that amount of the advance which
exceeds the amount to which it is ultimately determined that he is entitled to
receive from the Registrant by reason of indemnification; and (iii) (a) such
promise must be secured by a surety bond, other suitable insurance or an
equivalent form of security which assures that any repayments may be obtained
by the Registrant without delay or litigation, which bond, insurance or other
form of security must be provided by the recipient of the advance, or (b) a
majority of a quorum of the Registrant's disinterested, non-party Trustees, or
an independent legal counsel in a written opinion, shall determine, based upon
a review of readily available facts, that the recipient of the advance
ultimately will be found entitled to indemnification.
In Section 9 of the Class A, Class B, Class C and Class D shares Distribution
Agreements relating to the securities being offered hereby, the Registrant
agrees to indemnify the Distributor and each person, if any, who controls the
Distributor within the meaning of the Securities Act of 1933, against certain
types of civil liabilities arising in connection with the Registration
Statement or Prospectus.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to Trustees, officers and controlling
persons of the Registrant and the principal underwriter
C-3
<PAGE>
pursuant to the foregoing provisions or otherwise, the Registrant has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a Trustee, officer or controlling person of the Registrant and the
principal underwriter in connection with the successful defense of any action,
suit or proceeding) is asserted by such Trustee, officer or controlling person
or the principal underwriter in connection with the shares being registered,
the Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
Fund Asset Management, L.P. (the "Manager" or "FAM") acts as the investment
adviser for the following open-end investment companies: CBA Money Fund, CMA
Government Securities Fund, CMA Money Fund, CMA Multi-State Municipal Series
Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The Corporate Fund Accumulation
Program, Inc., Financial Institutions Series Trust, Merrill Lynch Basic Value
Fund, Inc., Merrill Lynch California Municipal Series Trust, Merrill Lynch
Corporate Bond Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc., Merrill
Lynch Federal Securities Trust, Merrill Lynch Funds for Institutions Series,
Merrill Lynch Multi-State Limited Maturity Municipal Series Trust, Merrill
Lynch Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond Fund,
Inc., Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Special Value Fund, Inc.,
Merrill Lynch World Income Fund, Inc. and The Municipal Fund Accumulation
Program, Inc.; and the following closed-end investment companies: Apex
Municipal Fund, Inc., Corporate High Yield Fund, Inc., Corporate High Yield
Fund II, Inc., Income Opportunities Fund 1999, Inc., Income Opportunities Fund
2000, Inc., Merrill Lynch Municipal Strategy Fund, Inc., MuniAssets Fund, Inc.,
MuniEnhanced Fund, Inc., MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest
Fund II, Inc., MuniVest California Insured Fund, Inc., MuniVest Florida Fund,
MuniVest Michigan Insured Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest
New York Insured Fund, Inc., MuniVest Pennsylvania Insured Fund, MuniYield
Arizona Fund, Inc., MuniYield California Fund, Inc., MuniYield California
Insured Fund, Inc., MuniYield California Insured Fund II, Inc., MuniYield
Florida Fund, MuniYield Florida Insured Fund, MuniYield Fund, Inc., MuniYield
Insured Fund, Inc., MuniYield Insured Fund II, Inc., MuniYield Michigan Fund,
Inc., MuniYield Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc.,
MuniYield New Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc.,
MuniYield New York Insured Fund II, Inc., MuniYield New York Insured Fund III,
Inc., MuniYield Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield
Quality Fund II, Inc., Senior High Income Portfolio, Inc., Taurus
MuniCalifornia Holdings, Inc., Taurus MuniNew York Holdings, Inc., and
Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM"), an affiliate of the Manager,
acts as investment adviser for the following open-end investment companies:
Merrill Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas
Income Fund, Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch
Asset Growth Fund, Inc., Merrill Lynch Asset Income Fund, Inc., Merrill Lynch
Balanced Fund for Investment and Retirement, Inc., Merrill Lynch Capital Fund,
Inc., Merrill Lynch Developing Capital Markets Fund, Inc., Merrill Lynch Dragon
Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch
C-4
<PAGE>
Fundamental Growth Fund, Inc., Merrill Lynch Fund For Tomorrow, Inc., Merrill
Lynch Global Allocation Fund, Inc., Merrill Lynch Global Bond Fund for
Investment and Retirement, Merrill Lynch Global Convertible Fund, Inc., Merrill
Lynch Global Holdings, Inc., Merrill Lynch Global Resources Trust, Merrill
Lynch Global SmallCap Fund, Inc., Merrill Lynch Global Utility Fund, Inc.,
Merrill Lynch Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill Lynch
Healthcare Fund, Inc., Merrill Lynch Institutional Intermediate Fund, Merrill
Lynch International Equity Fund, Merrill Lynch Latin America Fund, Inc.,
Merrill Lynch Middle East/Africa Fund, Inc., Merrill Lynch Municipal Series
Trust, Merrill Lynch Pacific Fund, Inc., Merrill Lynch Ready Assets Trust,
Merrill Lynch Retirement Series Trust, Merrill Lynch Series Fund, Inc., Merrill
Lynch Short-Term Global Income Fund, Inc., Merrill Lynch Strategic Dividend
Fund, Merrill Lynch Technology Fund, Inc., Merrill Lynch U.S. Treasury Money
Fund, Merrill Lynch U.S.A. Government Reserves, Merrill Lynch Utility Income
Fund, Inc. and Merrill Lynch Variable Series Funds, Inc., and for the following
closed-end investment companies: Convertible Holdings, Inc., Merrill Lynch High
Income Municipal Bond Fund, Inc. and Merrill Lynch Senior Floating Rate Fund,
Inc.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch
Funds for Institutions Series and Merrill Lynch Institutional Intermediate Fund
is One Financial Center, 15th Floor, Boston, Massachusetts 02111-2646. The
address of the Manager, MLAM and Princeton Services, Inc. ("Princeton
Services"), and Princeton Administrators, L.P. is also P.O. Box 9011,
Princeton, New Jersey 08543-9011. The address of Merrill Lynch Funds
Distributor, Inc. ("MLFD") is P.O. Box 9081, Princeton, New Jersey 08543-
9081.The address of Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") and Merrill Lynch & Co., Inc. ("ML&Co.") is North Tower,
World Financial Center, 250 Vesey Street, New York, New York 10281. The address
of the Fund's transfer agent, Merrill Lynch Financial Data Services, Inc.
("FDS"), is 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Set forth below is a list of each executive officer and partner of the
Manager indicating each business, profession, vocation or employment of a
substantial nature in which each such person or entity has been engaged since
September 1, 1992 for his own account or in the capacity of director, officer,
partner or trustee. In addition, Mr. Zeikel is President, Mr. Richard is
Treasurer and Mr. Glenn is Executive Vice President of all or substantially all
of the investment companies described in the preceding paragraph and also hold
the same positions with all or substantially all of the investment companies
advised by MLAM as they do with those advised by the Manager. Messrs. Glenn,
Giordano, Harvey, Kirstein, and Monagle are directors or officers of one or
more of such companies.
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS,
NAME MANAGER PROFESSION, VOCATION OR EMPLOYMENT
---- -------------------- ----------------------------------
<S> <C> <C>
ML & Co................. Limited Partner Financial Services Holding Company
Princeton Services, Inc.
("Princeton Services"). General Partner General Partner of MLAM
Arthur Zeikel........... President President and Director of MLAM; Presi-
dent and Director of Princeton Servic-
es; Director of the Distributor; Execu-
tive Vice President of ML & Co.
</TABLE>
C-5
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS,
NAME MANAGER PROFESSION, VOCATION OR EMPLOYMENT
---- -------------------- ----------------------------------
<S> <C> <C>
Terry K. Glenn.......... Executive Vice Presi- Executive Vice President of MLAM;
dent Executive Vice President and Director
of Princeton Services; President and
Director of the Distributor; Director
of FDS; President of Princeton
Administrators, Inc.
Vincent R. Giordano..... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Elizabeth Griffin....... Senior Vice President Senior Vice President of MLAM
Michael J. Hennewinkel.. Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Norman R. Harvey........ Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
N. John Hewitt.......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Philip L. Kirstein...... Senior Vice Senior Vice President, General Counsel
President, General and Secretary of MLAM; Senior Vice
Counsel and President, General Counsel, Director
Secretary and Secretary of Princeton Services;
Director of the Distributor
Ronald M. Kloss......... Senior Vice President Senior Vice President and Controller of
and Controller MLAM; Senior Vice President and
Controller of Princeton Services
Stephen M. M. Miller.... Senior Vice President Executive Vice President of Princeton
Administrators, L.P.
Joseph T. Monagle....... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Michael L. Quinn........ Senior Vice President Senior Vice President of FAM; Senior
Vice President of Princeton Services;
Managing Director and First Vice
President of Merrill Lynch, Pierce,
Fenner & Smith Incorporated
Gerald M. Richard....... Senior Vice President Senior Vice President and Treasurer of
and Treasurer MLAM; Senior Vice President and
Treasurer of Princeton Services; Vice
President and Treasurer of the
Distributor
Richard L. Rufener...... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services;
Vice President of the Distributor
</TABLE>
C-6
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS,
NAME MANAGER PROFESSION, VOCATION OR EMPLOYMENT
---- -------------------- ----------------------------------
<S> <C> <C>
Richard L. Reller....... Senior Vice President Senior Vice President of FAM; Senior
Vice President of Princeton Services
Ronald L. Welburn....... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Anthony Wiseman......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
</TABLE>
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) MLFD acts as the principal underwriter for the Registrant. MLFD acts as
the principal underwriter for each of the open-end investment companies
referred to in the first two paragraphs of Item 28 except CBA Money Fund, CMA
Government Securities Fund, CMA Money Fund, CMA Multi-State Municipal Series
Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, Convertible Holdings, Inc., The
Corporate Fund Accumulation Program, Inc., MuniAssets Fund, Inc. and The
Municipal Fund Accumulation Program,, Inc.; and MLFD also acts as the principal
underwriter for the following closed-end investment companies: Merrill Lynch
High Income Municipal Bond Fund, Inc. and Merrill Lynch Senior Floating Rate
Fund, Inc.
(b) Set forth below is information concerning each director and officer of
MLFD. The principal business address of each such person is P.O. Box 9081,
Princeton, New Jersey 08543-9081, except that the address of Messrs. Aldrich,
Crook, Brady, Breen, Fatseas and Wasel is One Financial Center, 15th Floor,
Boston, Massachusetts 02111-2646.
<TABLE>
<CAPTION>
(2) (3)
(1) POSITIONS AND OFFICES WITH POSITIONS AND OFFICES
NAME DISTRIBUTOR WITH REGISTRANT
- ---- -------------------------- ---------------------
<S> <C> <C>
Terry K. Glenn............ President and Director Executive Vice President
Arthur Zeikel............. Director President and Trustee
Phillip L. Kirstein....... Director None
William E. Aldrich........ Senior Vice President None
Robert W. Crook........... Senior Vice President None
Kevin P. Boman............ Vice President None
Michael J. Brady.......... Vice President None
William M. Breen.......... Vice President None
Mark A. DeSario........... Vice President None
James T. Fatseas.......... Vice President None
Debra W. Landsman-Yaros... Vice President None
Michelle T. Lau........... Vice President None
Gerald M. Richard......... Vice President and Treasurer Treasurer
Salvatore Venezia......... Vice President None
William Wasel............. Vice President None
Robert Harris............. Secretary None
</TABLE>
(c) Not applicable.
C-7
<PAGE>
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by Section
31(a) of the Investment Company Act of 1940 and the Rules thereunder will be
maintained at the offices of the Registrant, 800 Scudders Mill Road,
Plainsboro, New Jersey 08536 and its transfer agent, Merrill Lynch Financial
Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-
6484.
ITEM 31. MANAGEMENT SERVICES.
Other than as set forth under the caption "Management of the Fund--Management
and Advisory Arrangements" in the Prospectus constituting Part A of the
Registration Statement and under "Management of the Fund--Management and
Advisory Arrangements" in the Statement of Additional Information constituting
Part B of the Registration Statement, the Registrant is not a party to any
management related service contract.
ITEM 32. UNDERTAKINGS.
(a) Not applicable.
(b) Not applicable.
(c) Registrant undertakes to furnish to each person to whom a prospectus is
delivered with a copy of the Registrant's latest annual report to shareholders,
upon request and without charge.
C-8
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933 AND THE INVESTMENT
COMPANY ACT OF 1940, THE REGISTRANT CERTIFIES THAT IT MEETS ALL OF THE
REQUIREMENTS FOR EFFECTIVENESS OF THIS POST-EFFECTIVE AMENDMENT TO ITS
REGISTRATION STATEMENT PURSUANT TO RULE 485(B) UNDER THE SECURITIES ACT OF 1933
AND HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY
THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE TOWNSHIP OF PLAINSBORO, AND
STATE OF NEW JERSEY, ON THE 19TH DAY OF DECEMBER, 1996.
Merrill Lynch Federal Securities
Trust
(Registrant)
/s/ Arthur Zeikel
By: _________________________________
(Arthur Zeikel, President and
Trustee)
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION
STATEMENT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE CAPACITIES AND
ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Arthur Zeikel President and Trustee December 19, 1996
____________________________________ (Principal Executive
(Arthur Zeikel) Officer)
Gerald M. Richard* Treasurer (Principal
____________________________________ Financial and Accounting
(Gerald M. Richard) Officer)
Joe Grills* Trustee
____________________________________
(Joe Grills)
Walter Mintz* Trustee
____________________________________
(Walter Mintz)
Robert S. Salomon, Jr.* Trustee
____________________________________
(Robert S. Salomon, Jr.)
Stephen B. Swensrud* Trustee
____________________________________
(Stephen B. Swensrud)
Melvin R. Seiden* Trustee
____________________________________
(Melvin R. Seiden)
</TABLE>
December 19, 1996
*By: /s/ Arthur Zeikel
---------------------------
(Arthur Zeikel, Attorney-
in-Fact)
C-9
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10 --Opinion of Brown & Wood LLP, counsel to Registrant
11 --Consent of Deloitte & Touche LLP, independent auditors for
Registrant
17(a) --Financial Data Schedule for Class A Shares
17(b) --Financial Data Schedule for Class B Shares
17(c) --Financial Data Schedule for Class C Shares
17(d) --Financial Data Schedule for Class D Shares
</TABLE>
<PAGE>
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents fair and
accurate narrative descriptions of graphic and image material omitted from this
EDGAR Submission file due to ASCII-incompatibility and cross-references this
material to the location of each occurrence in the text.
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 1
<NAME> MERRILL LYNCH FEDERAL SECURITIES TRUST - CLASS A
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1996
<PERIOD-START> SEP-01-1995
<PERIOD-END> AUG-31-1996
<INVESTMENTS-AT-COST> 2310951552
<INVESTMENTS-AT-VALUE> 2288827563
<RECEIVABLES> 343811453
<ASSETS-OTHER> 179583
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 2632818599
<PAYABLE-FOR-SECURITIES> 499363732
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 11858602
<TOTAL-LIABILITIES> 511222334
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 2459631755
<SHARES-COMMON-STOCK> 24644296
<SHARES-COMMON-PRIOR> 23232522
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (315911501)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (22123989)
<NET-ASSETS> 231651242
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 170261306
<OTHER-INCOME> 666948
<EXPENSES-NET> (25904994)
<NET-INVESTMENT-INCOME> 145023260
<REALIZED-GAINS-CURRENT> 17428212
<APPREC-INCREASE-CURRENT> (66407293)
<NET-CHANGE-FROM-OPS> 96044179
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (15541226)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 11032271
<NUMBER-OF-SHARES-REDEEMED> (9834489)
<SHARES-REINVESTED> 213992
<NET-CHANGE-IN-ASSETS> (356407765)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (432109548)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 10650590
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 25904994
<AVERAGE-NET-ASSETS> 232437833
<PER-SHARE-NAV-BEGIN> 9.61
<PER-SHARE-NII> .64
<PER-SHARE-GAIN-APPREC> (.21)
<PER-SHARE-DIVIDEND> (.64)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 9.40
<EXPENSE-RATIO> .62
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 2
<NAME> MERRILL LYNCH FEDERAL SECURITIES TRUST - CLASS B
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1996
<PERIOD-START> SEP-01-1995
<PERIOD-END> AUG-31-1996
<INVESTMENTS-AT-COST> 2310951552
<INVESTMENTS-AT-VALUE> 2288827563
<RECEIVABLES> 343811453
<ASSETS-OTHER> 179583
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 2632818599
<PAYABLE-FOR-SECURITIES> 499363732
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 11858602
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<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
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<NAME> MERRILL LYNCH FEDERAL SECURITIES TRUST - CLASS C
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<NAME> MERRILL LYNCH FEDERAL SECURITIES TRUST - CLASS D
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<PAGE>
EXHIBIT 99.10
Brown & Wood LLP
One World Trade Center
New York, New York 10048
December 20, 1996
Merrill Lynch Federal Securities Trust
P.O. Box 9011
Princeton, New Jersey 08543-9011
Dear Sirs:
This opinion is furnished in connection with the registration by Merrill
Lynch Federal Securities Trust, a Massachusetts business trust (the "Trust"), of
94,433,707 shares of beneficial interest, par value $0.10 per share (the
"Shares"), of the Trust, under the Securities Act of 1933 pursuant to a
registration statement on Form N-1A (File No. 2-92366), as amended (the
"Registration Statement").
As counsel for the Trust, we are familiar with the proceedings taken by it
in connection with the authorization, issuance and sale of the Shares. In
addition, we have examined and are familiar with the Declaration of Trust of the
Trust, as amended, the By-Laws of the Trust and such other documents as we have
deemed relevant to the matters referred to in this opinion.
Based upon the foregoing, we are of the opinion that the Shares, upon
issuance and sale in the manner referred to in the Registration Statement for
consideration not less than the par value thereof, will be legally issued, fully
paid and nonassessable shares of beneficial interest, except that shareholders
of the Trust may under certain circumstances be held personally liable for the
Trust's obligations.
In rendering this opinion, we have relied as to matters of Massachusetts
law upon an opinion of Bingham, Dana & Gould rendered to the Trust.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Prospectus and
Statement of Additional Information constituting parts thereof.
Very truly yours,
/s/ Brown & Wood LLP
<PAGE>
Exhibit 99.11
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Federal Securities Trust:
We consent to the use in Post-Effective Amendment No. 13 to Registration
Statement No. 2-92366 of our report dated October 7, 1996 appearing in the
Statement of Additional Information, which is part of such Registration
Statement, and to the reference to us under the caption "Financial Highlights"
appearing in the Prospectus, which also is a part of such Registration
Statement.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Princeton, New Jersey
December 20, 1996
