<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 25, 1998.
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. 15 [X]
AND/OR
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 16 [X]
(CHECK APPROPRIATE BOX OR BOXES)
------------------------
MERRILL LYNCH FEDERAL SECURITIES TRUST
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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:
<TABLE>
<S> <C>
COUNSEL FOR THE FUND:
BROWN & WOOD LLP MICHAEL J. HENNEWINKEL, ESQ.
ONE WORLD TRADE CENTER MERRILL LYNCH ASSET MANAGEMENT, L.P.
NEW YORK, NEW YORK 10048 P.O. BOX 9011
ATTENTION: THOMAS R. SMITH, JR. PRINCETON, NEW JERSEY 08543-9011
</TABLE>
------------------------
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.
------------------------
TITLE OF SECURITIES BEING REGISTERED: Shares of Beneficial Interest, par value
$.10 per share.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
PROSPECTUS
NOVEMBER 25, 1998
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 12.
------------------------
Pursuant to the Merrill Lynch Select Pricing(SM) 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 Pricing(SM) 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 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 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 Pricing(SM) System"
on page 4.
Shares may be purchased directly from Merrill Lynch Funds Distributor (the
"Distributor"), a division of Princeton Funds Distributor, Inc. ("PFD"), P.O.
Box 9081, Princeton, New Jersey 08543-9081 [(609) 282-2800], or from securities
dealers that 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, and for participants in certain fee-based
programs the minimum initial purchase is $250 and the minimum subsequent
purchase is $50. Merrill Lynch may charge its customers a processing fee
(presently $5.35) for confirming purchases and repurchases. Purchases and
redemptions made directly through Financial Data Services, Inc. ("FDS" or the
"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 November 25, 1998 (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 Commission maintains a Web site
(http://www.sec.gov) that contains the Statement of Additional Information,
material incorporated by reference and other information regarding the Fund. The
Statement of Additional Information is hereby incorporated by reference into
this Prospectus.
------------------------
FUND ASSET MANAGEMENT -- MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR -- DISTRIBUTOR
<PAGE> 3
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:
Shareholder Servicing Costs(i)........ 0.16% 0.18% 0.18% 0.16%
Other................................. 0.06% 0.06% 0.07% 0.06%
------ ------------------ ------- -----
Total Other Expenses........... 0.22% 0.24% 0.25% 0.22%
------ ------------------ ------- -----
TOTAL FUND OPERATING EXPENSES........... 0.68% 1.45% 1.51% 0.93%
------ ------------------ ------- -----
------ ------------------ ------- -----
</TABLE>
- ---------------
(a) Class A shares are sold to a limited group of investors including certain
retirement plans and participants in certain fee-based programs. See
"Purchase of Shares -- Initial Sales Charge Alternatives -- Class A and
Class D Shares" -- page 25 and "Shareholder Services -- Fee-Based
Programs" -- page 38.
(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 28.
(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 25.
(footnotes continued on next page)
2
<PAGE> 4
(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 that
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 certain fee-based programs. A 0.75% sales
charge for 401(k) purchases over $1,000,000 will apply. See "Shareholder
Services -- Fee-Based Programs" -- page 38.
(e) The CDSC may be modified in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" -- page 38.
(f) The CDSC may be waived in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" -- page 38.
(g) See "Management of the Fund -- Management and Advisory Arrangements" -- page
21.
(h) See "Purchase of Shares -- Distribution Plans" -- page 31.
(i) See "Management of the Fund -- Transfer Agency Services" -- page 23.
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 Total 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.............................................. $47 $61 $76 $121
Class B.............................................. $55 $66 $79 $174
Class C.............................................. $25 $48 $82 $180
Class D.............................................. $49 $68 $89 $150
An investor would pay the following expenses on the same
$1,000 investment assuming no redemption at the end of
the period:
Class A.............................................. $47 $61 $76 $121
Class B.............................................. $15 $46 $79 $174
Class C.............................................. $15 $48 $82 $180
Class D.............................................. $49 $68 $89 $150
</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 $5.35) for confirming purchases and repurchases.
Purchases and redemptions made directly through the Fund's transfer agent are
not subject to the processing fee. See "Purchase of Shares" and "Redemption of
Shares."
3
<PAGE> 5
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) 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 that 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
CDSCs, 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 CDSCs and distribution fees with respect to the Class B and Class C
shares in that the sales charges and distribution fees 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
4
<PAGE> 6
particular circumstances. More detailed information as to each class of shares
is set forth under "Purchase of Shares."
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
<S> <C> <C> <C> <C>
A Maximum 4.00% initial No No No
sales charge(2)(3)
B CDSC for a period of 4 years, 0.25% 0.50% B shares convert to D shares
at a rate of 4.0% during the automatically after
first year, decreasing 1.0% approximately ten years(5)
annually to 0.0%(4)
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. 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
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 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 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 of 4.00%, 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
5
<PAGE> 7
connection with certain fee-based programs. A 0.75% sales charge for
401(k) purchases over $1,000,000 will apply. Sales charges also are
reduced under a right of accumulation that 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 Class B shares, as well as a CDSC if they are redeemed
within four years of purchase. Such CDSC may be modified in connection
with 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 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
1.0% CDSC if they are redeemed within one year after purchase. Such
CDSC may be waived in connection with certain fee-based programs.
Although Class C shares are subject to a CDSC for only one year (as
compared to four years for Class B shares), 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 Trustees 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. The maximum initial sales charge of 4.00% is reduced
for purchases of $25,000 and over. 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 certain fee-based programs. A 0.75% sales
charge for 401(k) purchases over $1,000,000 will apply. 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 by retirement plans and participants in connection with
certain fee-based programs.
6
<PAGE> 8
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 because similar sales charge reductions are not available with
respect to the CDSCs 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 that 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 ten 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 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> 9
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 for the fiscal
year ended August 31, 1998, and the independent auditors' report thereon, appear
in the annual report of the Fund for the fiscal year ended August 31, 1998, (the
"Annual Report") and are incorporated by reference in the Statement of
Additional Information. Further information about the performance of the Fund is
contained in the Annual Report which may be obtained, without charge, by calling
or by writing the Fund 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
--------------------------------------------
FOR THE
PERIOD
FOR THE YEAR OCTOBER 21,
ENDED AUGUST 31, 1994+ TO
------------------------------ AUGUST 31,
1998 1997 1996++ 1995++
-------- -------- -------- -----------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 9.64 $ 9.40 $ 9.61 $ 9.16
-------- -------- -------- --------
Investment income -- net.................................... .60 .64 .64 .58
Realized and unrealized gain(loss) on investments -- net.... .16 .24 (.21) .45
-------- -------- -------- --------
Total from investment operations............................ .76 .88 .43 1.03
-------- -------- -------- --------
Less dividends from investment income -- net................ (.60) (.64) (.64) (.58)
-------- -------- -------- --------
Net asset value, end of period.............................. $ 9.80 $ 9.64 $ 9.40 $ 9.61
======== ======== ======== ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... 8.10% 9.66% 4.55% 11.56%#
======== ======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... .68% .65% .62% .64%*
======== ======== ======== ========
Investment income -- net.................................... 6.18% 6.73% 6.64% 7.21%*
======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $277,568 $278,103 $231,651 $223,237
======== ======== ======== ========
Portfolio turnover.......................................... 301.88% 349.05% 204.14% 260.34%
======== ======== ======== ========
</TABLE>
- ---------------
+ Commencement of Operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
8
<PAGE> 10
<TABLE>
<CAPTION>
CLASS B
------------------------------------------------------------------------------------
FOR THE
PERIOD
FOR THE YEAR ENDED DECEMBER 23,
AUGUST 31, 1991+ TO
--------------------------------------------------------------------- AUGUST 31,
1998 1997 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................. $ 9.63 $ 9.40 $ 9.61 $ 9.41 $ 10.14 $ 9.92 $ 9.92
-------- -------- -------- ---------- ---------- ---------- ----------
Investment income -- net.... .53 .57 .57 .60 .48 .52 .44
Realized and unrealized gain
(loss) on
investments -- net........ .16 .23 (.21) .20 (.73) .22 --
-------- -------- -------- ---------- ---------- ---------- ----------
Total from investment
operations................ .69 .80 .36 .80 (.25) .74 .44
-------- -------- -------- ---------- ---------- ---------- ----------
Less dividends from
investment income --net... (.53) (.57) (.57) (.60) (.48) (.52) (.44)
-------- -------- -------- ---------- ---------- ---------- ----------
Net asset value, end of
period.................... $ 9.79 $ 9.63 $ 9.40 $ 9.61 $ 9.41 $ 10.14 $ 9.92
======== ======== ======== ========== ========== ========== ==========
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share..................... 7.28% 8.71% 3.72% 8.91% (2.55)% 7.80% 4.54%#
======== ======== ======== ========== ========== ========== ==========
RATIOS TO AVERAGE NET
ASSETS:
Expenses.................... 1.45% 1.42% 1.39% 1.41% 1.33% 1.30% 1.33%*
======== ======== ======== ========== ========== ========== ==========
Investment income -- net.... 5.42% 5.98% 5.87% 6.39% 4.90% 5.27% 6.45%*
======== ======== ======== ========== ========== ========== ==========
SUPPLEMENTAL DATA:
Net assets, end of period
(in thousands)............ $627,818 $672,541 $924,885 $1,262,985 $1,497,358 $2,151,917 $1,921,893
======== ======== ======== ========== ========== ========== ==========
Portfolio turnover.......... 301.88% 349.05% 204.14% 260.34% 322.68% 224.35% 230.83%
======== ======== ======== ========== ========== ========== ==========
</TABLE>
- ---------------
+ Commencement of Operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
9
<PAGE> 11
<TABLE>
<CAPTION>
CLASS C
--------------------------------------------
FOR THE
PERIOD
FOR THE YEAR OCTOBER 21,
ENDED AUGUST 31, 1994+
--------------------------- TO AUGUST 31,
1998 1997 1996++ 1995++
------- ------- ------- --------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period....................... $ 9.63 $ 9.40 $ 9.61 $ 9.16
------- ------- ------- -------
Investment income -- net................................... .52 .56 .56 .51
Realized and unrealized gain(loss) on investments -- net... .16 .23 (.21) .45
------- ------- ------- -------
Total from investment operations........................... .68 .79 .35 .96
------- ------- ------- -------
Less dividends from investment income -- net............... (.52) (.56) (.56) (.51)
------- ------- ------- -------
Net asset value, end of period............................. $ 9.79 $ 9.63 $ 9.40 $ 9.61
======= ======= ======= =======
TOTAL INVESTMENT RETURN:**
Based on net asset value per share......................... 7.23% 8.66% 3.67% 10.80%#
======= ======= ======= =======
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................... 1.51% 1.47% 1.43% 1.47%*
======= ======= ======= =======
Investment income -- net................................... 5.35% 5.91% 5.82% 6.28%*
======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)................... $43,038 28,723 $22,672 $15,621
======= ======= ======= =======
Portfolio turnover......................................... 301.88% 349.05% 204.14% 260.34%
======= ======= ======= =======
</TABLE>
- ---------------
+ Commencement of Operations.
++ Based on average shares outstanding.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
10
<PAGE> 12
<TABLE>
<CAPTION>
CLASS D
--------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31,
--------------------------------------------------------------------------------
1998 1997 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 year.................. $ 9.63 $ 9.40 $ 9.61 $ 9.41 $ 10.14 $ 9.92 $ 9.66
-------- -------- -------- -------- ---------- ---------- ----------
Investment income-net...... .58 .62 .62 .64 .52 .57 .70
Realized and unrealized
gain (loss) on
investments-net.......... .16 .23 (.21) .20 (.73) .22 .26
-------- -------- -------- -------- ---------- ---------- ----------
Total from investment
operations............... .74 .85 .41 .84 (.21) .79 .96
-------- -------- -------- -------- ---------- ---------- ----------
Less dividends from
investment income-net.... (.58) (.62) (.62) (.64) (.52) (.57) (.70)
-------- -------- -------- -------- ---------- ---------- ----------
Net asset value, end of
year..................... $ 9.79 $ 9.63 $ 9.40 $ 9.61 $ 9.41 $ 10.14 $ 9.92
======== ======== ======== ======== ========== ========== ==========
TOTAL INVESTMENT RETURN:*
Based on net asset value
per share................ 7.84% 9.27% 4.28% 9.48% (2.06)% 8.35% 10.16%
======== ======== ======== ======== ========== ========== ==========
RATIOS TO AVERAGE NET
ASSETS:
Expenses................... .93% .90% .87% .89% .83% .79% .80%
======== ======== ======== ======== ========== ========== ==========
Investment income-net...... 5.94% 6.49% 6.39% 6.91% 5.41% 5.80% 7.17%
======== ======== ======== ======== ========== ========== ==========
SUPPLEMENTAL DATA:
Net assets, end of year (in
thousands)............... $866,013 $927,756 $942,388 $976,161 $1,356,979 $1,836,100 $2,048,037
======== ======== ======== ======== ========== ========== ==========
Portfolio turnover......... 301.88% 349.05% 204.14% 260.34% 322.68% 224.35% 230.83%
======== ======== ======== ======== ========== ========== ==========
<CAPTION>
CLASS D
------------------------------------
FOR THE YEAR ENDED AUGUST 31,
------------------------------------
1991 1990 1989
---------- ---------- ----------
<S> <C> <C> <C>
INCREASE (DECREASE) IN NET
ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning
of year.................. $ 9.28 $ 9.28 $ 9.15
---------- ---------- ----------
Investment income-net...... .81 .86 .87
Realized and unrealized
gain (loss) on
investments-net.......... .38 -- .13
---------- ---------- ----------
Total from investment
operations............... 1.19 .86 1.00
---------- ---------- ----------
Less dividends from
investment income-net.... (.81) (.86) (.87)
---------- ---------- ----------
Net asset value, end of
year..................... $ 9.66 $ 9.28 $ 9.28
========== ========== ==========
TOTAL INVESTMENT RETURN:*
Based on net asset value
per share................ 13.40% 9.61% 11.48%
========== ========== ==========
RATIOS TO AVERAGE NET
ASSETS:
Expenses................... .78% .77% .74%
========== ========== ==========
Investment income-net...... 8.62% 9.19% 9.49%
========== ========== ==========
SUPPLEMENTAL DATA:
Net assets, end of year (in
thousands)............... $2,230,619 $2,353,328 $2,751,814
========== ========== ==========
Portfolio turnover......... 311.04% 324.74% 363.53%
========== ========== ==========
</TABLE>
- ---------------
+ Based on average shares outstanding.
* Total investment returns exclude the effects of sales loads.
11
<PAGE> 13
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 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). 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
12
<PAGE> 14
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).
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
may 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.
13
<PAGE> 15
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 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 correlated to 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
14
<PAGE> 16
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
correlates with 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 correlated with 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 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
15
<PAGE> 17
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 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 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 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
16
<PAGE> 18
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 security 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.
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.
17
<PAGE> 19
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.
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
18
<PAGE> 20
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 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
19
<PAGE> 21
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).
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.
20
<PAGE> 22
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
"non-affiliated" 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* -- Chairman of the Manager and its affiliate MLAM;
Chairman and Director of Princeton Services, Inc. ("Princeton Services");
Executive Vice President of ML & Co.
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, the Howard Hughes Medical
Institute and the Virginia Retirement System; Director and Vice Chairman,
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); Trustee of the Common Fund.
MELVIN R. SEIDEN -- Director of Silbanc Properties, Ltd. (real
estate, investments and consulting).
STEPHEN B. SWENSRUD -- Chairman of Fernwood Advisors (investment
adviser); Principal of Fernwood Associates (financial consultant).
- ---------------
* 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 and investment advisory 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 Merrill Lynch Asset Management Group (which includes the
Investment
21
<PAGE> 23
Adviser) acts as the investment adviser to more than 100 registered investment
companies and provides investment advisory advice to individuals and
institutions. As of October 1998, the Asset Management Group had a total of
approximately $483 billion in investment company and other portfolio assets
under management. This amount includes assets managed for certain affiliates of
the Manager.
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 average daily 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 average daily 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, 1998, the fee paid by the Fund to the
Manager was $8,536,593 (based upon average daily net assets of approximately
$1.8 billion).
The Fund has entered into a management agreement with the Manager (the
"Management Agreement"). 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,
1998, the reimbursement for such services aggregated $254,086. For the fiscal
year ended August 31, 1998, the ratio of total expenses to average net assets
was 0.68% for Class A shares, 1.45% for Class B shares, 1.51% for Class C shares
and 0.93% 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 Senior Vice President of the Fund since
1997 and has been a First Vice President of the Manager since 1997 and Vice
President of the Manager from 1985 to 1997.
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 that 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,
22
<PAGE> 24
no employee may purchase or sell any security that 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
The Transfer Agent, which is a 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 Transfer
Agent receives a fee of up to $11.00 per Class A or Class D account and up to
$14.00 per Class B or Class C account and is entitled to reimbursement for
certain transaction charges and out-of-pocket expenses incurred by the Transfer
Agent under the Transfer Agency Agreement. Additionally, a $.20 monthly closed
account charge will be assessed on all accounts which close during the calendar
year. Application of this fee will commence the month following the month the
account is closed. At the end of the calendar year, no further fees will be due.
For purposes of the Transfer Agent Agreement, the term "account" includes a
shareholder account maintained directly by the Transfer Agent and any other
account representing the beneficial interest of a person in the relevant share
class on a recordkeeping system, provided the recordkeeping system is maintained
by a subsidiary of ML & Co. For the fiscal year ended August 31, 1998, the total
fee paid by the Fund to the Transfer Agent was $3,012,806.
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 (i) for retirement plans the minimum initial purchase is $100 and
the minimum subsequent purchase is $1, and (ii) for shareholders who are
participants in certain fee-based programs, the minimum initial purchase is $250
and the minimum subsequent purchase is $50. Different minimums may apply to
purchases through the Merrill Lynch Blueprint(SM) Program. See "Purchase of
Shares -- Merrill Lynch Blueprint(SM) Program" in the Statement of Additional
Information.
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 the NYSE closes at 4:00 p.m., Eastern 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, if the purchase orders are not
23
<PAGE> 25
received prior to 30 minutes after the close of business on the NYSE, 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
$5.35) to confirm a sale of shares to such customers. Purchases made 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
CDSCs, 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 (except
that Class B shareholders may vote upon any material changes to expenses charged
under the Class D Distribution Plan). See "Distribution Plans" below. 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 Class A and Class D shares are the same as those
of the CDSCs and distribution fees with respect to Class B and Class C shares in
that the sales charges and distribution fees 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, that are eligible
to sell shares.
24
<PAGE> 26
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
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
<S> <C> <C> <C> <C>
A Maximum 4.00% initial No No No
sales charge(2)(3)
B CDSC for periods of 4 years, 0.25% 0.50% B shares convert to D shares
at a rate of 4.0% during the automatically after
first year, decreasing 1.0% approximately ten years(5)
annually to 0.0%(4)
C 1.0% CDSC for one year(6) 0.25% 0.55% No
D Maximum 4.00% initial 0.25% No No
sales 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 and participants in connection with
certain fee-based programs. Certain 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 certain fee-based programs. A 0.75% sales charge
for 401(k) purchases over $1,000,000 will apply.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and the conversion
and holding periods for certain retirement plans and certain fee-based
programs were 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 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.
25
<PAGE> 27
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 certain Class A and Class D
purchases of $1,000,000 or more and on Class A share purchases by
participants 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 1.0% CDSC if the shares are redeemed within one
year after purchase. Such CDSC may be waived in connection with certain
fee-based programs. 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. 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"). The proceeds from the account maintenance
fees are used to compensate the Distributor and Merrill Lynch (pursuant to a
sub-agreement) for providing continuing account maintenance activities.
For the fiscal year ended August 31, 1998, the Fund sold 13,202,465 Class A
shares for aggregate net proceeds of $128,750,132. The gross sales charges for
the sale of these shares were $7,978 of which $979 was received by the
Distributor and $6,999 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, 1998, the Fund sold 12,691,687
Class D shares for aggregate net proceeds of $123,584,021. The gross sales
charges for the sale of Class D shares of the Fund for the year were $124,274,
of which $10,481 and $113,793 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
26
<PAGE> 28
MLAM or any of its affiliates. Class A shares are available at net asset value
to corporate warranty insurance reserve fund programs and U.S. branches of
foreign banking institutions provided that the program or branch 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 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 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."
Provided applicable threshold requirements are met, either Class A or Class
D shares are offered at net asset value to Employee Access(SM) Accounts
available through authorized employers. 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.
27
<PAGE> 29
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,
which declines each year 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 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 average
daily net assets attributable to the shares of the relevant class and Class B
shares are subject to a distribution fee of 0.50% of average daily net assets
attributable to the Class B shares and Class C shares are subject to a
distribution fee of 0.55% of average daily net assets attributable to the Class
C shares as discussed below under "Distribution Plans." The proceeds from the
account maintenance fees are used to compensate the Distributor and Merrill
Lynch (pursuant to a sub-agreement) for providing continuing account maintenance
activities.
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) that are paid from the dealers own funds.
These expenses relate 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 such shares. 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. 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 that
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
28
<PAGE> 30
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,
1998, the Distributor received CDSCs of $675,960 with respect to redemption of
Class B shares, all of which were paid to Merrill Lynch. Additional CDSCs
payable to the Distributor may have been waived or converted to a contingent
obligation in connection with a shareholder's participation in certain fee-based
programs.
The following table sets forth rates of the Class B CDSC:
<TABLE>
<CAPTION>
CLASS B CDSC AS A
YEAR SINCE PERCENTAGE OF
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 certain
circumstances 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 Blueprint(SM)
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 Account(SM) available through
employers providing eligible 401(k) plans. The Class B CDSC also is waived for
any Class B shares that are purchased by a Merrill Lynch rollover IRA that was
funded by a rollover from a terminated 401(k) plan
29
<PAGE> 31
managed by the MLAM Private Portfolio Group and held in such account at the time
of redemption. The Class B CDSC also is waived for any Class B shares that are
purchased within qualifying Employee Access(SM) Accounts. 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
certain fee-based programs. See "Shareholder Services -- Fee-Based Programs."
Contingent Deferred Sales Charges -- Class C Shares. Class C shares that
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.
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. The Class C CDSC
may be waived in connection with certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs." For the fiscal year ended August 31, 1998, the
Distributor received CDSCs of $13,550 with respect to redemption of Class C
shares, all of which were paid to Merrill Lynch.
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.
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 average daily net assets attributable to the
Class D shares 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.
30
<PAGE> 32
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. See "Shareholder Services -- Exchange Privilege"
in the Statement of Additional Information.
The Conversion Period is modified for shareholders who purchased Class B
shares through certain retirement plans that 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
provides 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
31
<PAGE> 33
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, 1998, the Fund paid the Distributor
$4,652,983 pursuant to the Class B Distribution Plan (based on average net
assets subject to such Class B Distribution Plan of approximately $622.1
million), 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, 1998, the Fund paid the
Distributor $232,559 pursuant to the Class C Distribution Plan (based on average
daily net assets subject to such Class C Distribution Plan of approximately
$29.1 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, 1998, the Fund paid the
Distributor $2,248,302 pursuant to the Class D Distribution Plan (based on
average daily net assets subject to such Class D Distribution Plan of
approximately $901.8 million), all of which was paid to Merrill Lynch for
providing account maintenance activities in connection with Class D shares.
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, 1998, direct cash revenues for the period since
commencement of operations of Class B shares exceeded direct cash expenses by
$112,349,184 (17.90% of Class B net assets at that date). As of December 31,
1997, the fully allocated accrual revenues incurred by the Distributor and
Merrill Lynch with respect to Class B shares for the period since commencement
of operations exceeded fully allocated accrual expenses for such period by
approximately $7,990,000 (1.24% of Class B net assets at that date). As of
August 31, 1998, direct cash revenues for the period since commencement of
operations of Class C shares exceeded direct cash expenses by $417,382 (.97% of
Class C net assets at that date). As of December 31, 1997, the fully allocated
accrual expenses incurred by the Distributor and Merrill Lynch with respect to
Class C shares for the period since commencement of operations exceeded fully
allocated accrual revenues for such period by approximately $132,000 (.48% 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
32
<PAGE> 34
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 CDSCs). 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 that 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, without charge, by
tendering the shares directly to the Transfer Agent, Financial Data Services,
Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289. Redemption requests
delivered other than by mail should be delivered to 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 redemption. Proper notice of
redemption in the case of shares for which certificates have been issued may be
accomplished by a written
33
<PAGE> 35
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 term 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, the NYSE closes at 4:00 p.m., Eastern 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, $5.35) to confirm a repurchase of shares.
Repurchases made directly through the Fund's 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
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
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
34
<PAGE> 36
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 Blueprint(SM) 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 account such as an IRA 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 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.
35
<PAGE> 37
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other MLAM-advised mutual funds and Summit Cash Reserves
Fund ("Summit"), a Merrill Lynch-sponsored money market fund specifically
designated as available for exchange by holders of Class A, Class B, Class C and
Class D shares of 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 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
the 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 that 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 and Class D shares are exchangeable for Class A shares of, and
Class B and Class C shares are exchangeable for Class B shares of Summit. Class
A shares of Summit have an exchange privilege back into Class A or Class D
shares of MLAM-advised mutual funds; Class B shares of Summit have an exchange
privilege back into Class B or Class C shares of MLAM-advised mutual funds and,
in the event of such an exchange, the period of time that Class B shares of
Summit are held will count toward satisfaction of the holding period requirement
for purposes of reducing any CDSC and, with respect to Class B shares, toward
satisfaction of any Conversion Period. Class B shares of Summit will be subject
to a distribution fee at an annual rate of 0.75% of average daily net assets of
such Class B shares. This exchange privilege does not apply with respect to
certain Merrill Lynch fee-based programs, for which alternative exchange
arrangements may exist. Please see your Merrill Lynch Financial Consultant for
further information.
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Prior to October 12, 1998, exchanges from the Fund and other MLAM-advised
mutual funds into a money market fund were directed to certain Merrill
Lynch-sponsored money market funds other than Summit. Shareholders who exchanged
shares of a MLAM-advised mutual fund for shares of such other money market funds
and subsequently wish to exchange those money market fund shares for shares of
the Fund will be subject to the CDSC schedule applicable to such Fund shares, if
any. The holding period for those money market fund shares will not count toward
satisfaction of the holding period requirement for reduction of the CDSC imposed
on such shares, if any, and, with respect to Class B shares, toward satisfaction
of the Conversion Period. However, the holding period for Class B or Class C
shares received in exchange for such money market fund shares will be aggregated
with the holding period for the original shares for purposes of reducing the
CDSC or satisfying the Conversion Period.
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.
The exchange privilege is modified with respect to certain retirement plans
which participate in the MFA program. Such retirement plans may exchange Class
B, Class C or Class D shares that have been held for at least one year for Class
A shares of the same fund on the basis of relative net asset values in
connection with the commencement of participation in the MFA program, i.e., no
CDSC will apply. The one year holding period does not apply to shares acquired
through reinvestment of dividends. Upon termination of participation in the MFA
program, Class A shares will be re-exchanged for the class of shares originally
held. For purposes of computing any CDSC that may be payable upon redemption of
Class B or Class C shares so reacquired, or the Conversion Period for Class B
shares so reacquired, the holding period for the Class A shares will be "tacked"
to the holding period for the Class B or Class C shares originally held. The
Fund's exchange privilege is also modified with respect to purchases of Class A
and Class D shares by non-retirement plan investors under the MFA program.
First, the initial allocation of assets is made under the MFA program. Then, any
subsequent exchange under the MFA program of Class A or Class D shares of a
MLAM-advised mutual fund for Class A or Class D shares of the Fund will be made
solely on the basis of the relative net asset values of the shares being
exchanged. Therefore, there will not be a charge for any difference between the
sales charge previously paid on the shares of the other MLAM-advised mutual fund
and the sales charge payable on the shares of the Fund being acquired in the
exchange under the MFA program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS 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 to Merrill Lynch if the shareholder's
account is maintained by Merrill Lynch, or by written notification or by
telephone (1-800-MER-FUND) to the Transfer Agent, if the shareholder's account
is maintained with the Transfer Agent, elect to have subsequent dividends or
both dividends and capital gains distributions, paid in cash, rather than
reinvested, in
37
<PAGE> 39
which event payment will be mailed on or about the payment date (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares). The
Fund is not responsible for any failure of delivery to the shareholder's address
of record and no interest will accrue on amounts represented by uncashed
distribution or redemption checks. 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 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
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) or CBA(R) Systematic Redemption Program,
subject to certain conditions. With respect to redemptions of Class B or Class C
shares pursuant to a systematic withdrawal plan, the maximum number of Class B
and Class C shares that can be redeemed from an account annually shall not
exceed 10% of the value of shares of such class in that account at the time the
election to join the systematic withdrawal plan was made. Any CDSC that
otherwise might be due on such redemption of Class B or Class C shares will be
waived. Shares redeemed pursuant to a systematic withdrawal plan will be
redeemed in the same order as Class B or Class C shares are otherwise redeemed.
See "Purchase of Shares -- Deferred Sales Charge Alternatives -- Class B and
Class C Shares -- Contingent Deferred Sales Charges -- Class B Shares" and
"-- Contingent Deferred Sales Charges -- Class C Shares." Where the systematic
withdrawal plan is applied to Class B Shares, upon conversion of the last Class
B shares in an account to Class D shares, the systematic withdrawal plan will be
applied thereafter to Class D shares if the shareholder so elects. See "Purchase
of Shares -- Deferred Sales Charge Alternatives -- Class B and Class C
Shares -- Conversion of Class B Shares to Class D Shares."
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. An investor 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 amounts of $100 ($1 for retirement accounts) 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.
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.
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<PAGE> 40
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 the Transfer
Agent 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 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
39
<PAGE> 41
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, and 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, 1998 was 5.56%
for Class A shares, 5.02% for Class B shares, 4.96% for Class C shares and 5.32%
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 Index, the Dow Jones Industrial Average, other market indices, or
performance data published by Lipper Analytical Services, Inc., Morningstar
Publications, Inc., Money Magazine, U.S. News & World Report, Business Week,
Forbes Magazine, Fortune Magazine or other industry publications. When comparing
its performance to a market index, the Fund may refer to various statistical
measures derived from the historic performance of the Fund and the index, such
as standard deviation and beta. 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
40
<PAGE> 42
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.
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"). As long as 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 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). Recent legislation
creates additional categories of capital gains taxable at different rates. 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, as well as the amounts of capital
gain dividends in the different categories of capital gain referred to above.
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. 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"). 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.
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<PAGE> 43
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.
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<PAGE> 44
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 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, the NYSE closes at 4:00 p.m., Eastern 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 that 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
that 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. During the fiscal year ended August 31, 1998, the Fund made payments
of $27,991 to MLSPS for such service.
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<PAGE> 45
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 arrangements, 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:
Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
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 Financial Data Services,
Inc. at 800-637-3863.
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<PAGE> 46
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate
years. These systems may not be able to distinguish the Year 2000 from the Year
1900 (commonly known as the "Year 2000 Problem"). Like other investment
companies and financial and business organizations, the Fund could be adversely
affected if the computer systems used by the Manager or other Fund service
providers do not properly address this problem prior to January 1, 2000. The
Manager has established a dedicated group to analyze these issues and to
implement any systems modifications necessary to prepare for the Year 2000.
Currently, the Manager does not anticipate that the transition to the Year 2000
will have any material impact on its ability to continue to service the Fund at
current levels. In addition, the Manager has sought assurances from the Fund's
other service providers that they are taking all necessary steps to ensure that
their computer systems will accurately reflect the Year 2000, and the Manager
will continue to monitor the situation. At this time, however, no assurance can
be given that the Fund's other service providers have anticipated every step
necessary to avoid any adverse effect on the Fund attributable to the Year 2000
Problem.
------------------------
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.
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[THIS PAGE IS INTENTIONALLY LEFT BLANK]
46
<PAGE> 48
MANAGER
Fund Asset Management, L.P.
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
a division of Princeton 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
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
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> 49
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE FUND, THE 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 Pricing(SM) System... 4
Financial Highlights...................... 8
Investment Objective and Policies......... 12
GNMA Certificates and Other Mortgage-
Backed Government Securities.......... 13
Options and Futures Portfolio
Strategies............................ 14
Other Investment Practices.............. 18
Portfolio Transactions.................. 20
Investment Restrictions................. 20
Portfolio Turnover...................... 21
Management of the Fund.................... 21
Trustees................................ 21
Management and Advisory Arrangements.... 21
Code of Ethics.......................... 22
Transfer Agency Services................ 23
Purchase of Shares........................ 23
Initial Sales Charge
Alternatives -- Class A and Class D
Shares................................ 25
Deferred Sales Charge Alternatives --
Class B and Class C Shares............ 28
Distribution Plans...................... 31
Limitations on the Payment of Deferred
Sales Charges......................... 32
Redemption of Shares...................... 33
Redemption.............................. 33
Repurchase.............................. 34
Reinstatement Privilege -- Class A and
Class D Shares........................ 34
Shareholder Services...................... 35
Investment Account...................... 35
Exchange Privilege...................... 36
Automatic Reinvestment of Dividends and
Capital Gains Distributions........... 37
Systematic Withdrawal Plans............. 38
Automatic Investment Plans.............. 38
Fee-Based Programs...................... 38
Portfolio Transactions.................... 39
Performance Data.......................... 39
Taxes..................................... 41
Additional Information.................... 43
Dividends and Distributions............. 43
Determination of Net Asset Value........ 43
Organization of the Fund................ 44
Shareholder Inquiries................... 44
Shareholder Reports..................... 44
Year 2000 Issues........................ 45
</TABLE>
Code #10259-1198
YZa
MERRILL LYNCH
FEDERAL SECURITIES TRUST
PROSPECTUS
November 25, 1998
Distributor:
Merrill Lynch
Funds Distributor
This prospectus should be
retained for future reference.
MLYNCH COMPASS
<PAGE> 50
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 Pricing(SM) 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 Pricing(SM) 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
November 25, 1998 (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 -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is November 25, 1998
<PAGE> 51
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,
1997 and 1998 the Fund's portfolio turnover rates were 349.05% and 301.88%,
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> 52
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. As a matter
of policy, however, the Fund will not purchase shares of any registered
open-end investment company or registered unit investment trust, in
reliance on Section 12(d)(1)(F) or (G) (the "fund of funds" provisions)
of the Investment Company Act, at any time the Fund's shares are owned
by another investment company that is part of the same group of
investment companies as the Fund.
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.
3
<PAGE> 53
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 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.
4
<PAGE> 54
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers and portfolio manager 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
Trustee, executive officer and the portfolio manager is P.O. Box 9011,
Princeton, New Jersey 08543-9011.
ARTHUR ZEIKEL (66) -- President and Trustee(1)(2) -- Chairman of the
Manager and MLAM (which terms as used herein include their corporate
predecessors) since 1997; President of the Manager and MLAM from 1977 to 1997;
Chairman of Princeton Services, Inc. ("Princeton Services") since 1997; and
Director thereof since 1993; President of Princeton Services from 1993 to 1997;
Executive Vice President of Merrill Lynch & Co., Inc. ("ML & Co.") since 1990.
JOE GRILLS (63) -- Trustee(2) -- P.O. Box 98, Rapidan, Virginia 22733.
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 Retirement Funds from 1986 until 1993; 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 since 1992
and elected Vice Chairman in May 1998; Director, LaSalle Street Fund since 1995;
Director, Hotchkis and Wiley Mutual Funds since 1996; Director, Kimco Realty
Corporation since January 1997; Member of the Investment Advisory Committee of
the Virginia Retirement System since 1998.
WALTER MINTZ (69) -- 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. (62) -- Trustee(2) -- 106 Dolphin Cove Quay,
Stamford, Connecticut 06902. Principal of STI Management (investment adviser)
since 1994; Trustee, The Common Fund since 1980; Chairman and CEO of Salomon
Brothers Asset Management from 1992 until 1995; Chairman of Salomon Brothers
equity mutual funds from 1992 until 1995; Monthly columnist with Forbes magazine
since 1992; Director of Stock Research and U.S. Equity Strategist at Salomon
Brothers from 1975 until 1991.
MELVIN R. SEIDEN (68) -- 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 (65) -- Trustee(2) -- 24 Federal Street, Suite 400,
Boston, Massachusetts 02110. Chairman of Fernwood Advisors (investment adviser)
since 1996; Principal, Fernwood Associates (financial consultants) since 1975.
TERRY K. GLENN (58) -- 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 Princeton Funds
Distributor, Inc. (the "Distributor") since 1986 and Director thereof since
1991; President of Princeton Administrators, L.P. since 1988.
JEFFREY B. HEWSON (47) -- Vice President(1)(2) -- Director (Global Fixed
Income) of the Manager since 1998; Vice President of MLAM since 1989 and
Portfolio Manager of the Manager since 1985; Senior Consultant, Price Waterhouse
from 1981 to 1985.
5
<PAGE> 55
GREGORY MARK MAUNZ (46) -- Senior Vice President(1)(2) -- First Vice
President of MLAM since 1997; Vice President of MLAM from 1985 to 1997;
Portfolio Manager since 1984.
DONALD C. BURKE (38) -- Vice President(1)(2) -- First Vice President of
MLAM since 1997; Vice President of MLAM from 1990 to 1997; Director of Taxation
of MLAM since 1990.
GERALD M. RICHARD (49) -- 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; Treasurer of PFD since 1984 and Vice
President thereof since 1981.
IRA P. SHAPIRO (35) -- Secretary(1)(2) -- First Vice President of MLAM
since 1998; Director (Legal Advisory) of the Manager since 1997 and 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.
As of October 31, 1998, 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 non-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 $75,251 for the fiscal year ended August
31, 1998.
The following table sets forth the compensation earned by non-affiliated
Trustees from the Fund for the fiscal year ended August 31, 1998 and the
aggregate compensation paid to the non-affiliated Trustees from all registered
investment companies advised by the Manager and its affiliate, MLAM
("MLAM/FAM-Advised Funds") for the calendar year ended December 31, 1997:
<TABLE>
<CAPTION>
PENSION OR AGGREGATE
RETIREMENT COMPENSATION
BENEFITS FROM FUND AND
ACCRUED MLAM/FAM-
COMPENSATION AS PART OF ADVISED
FROM THE FUND FUNDS PAID TO
TRUSTEE FUND EXPENSE TRUSTEE/DIRECTOR(1)
------- ------------ ----------- -------------------
<S> <C> <C> <C>
Joe Grills........................................ $15,000 None $171,500
Walter Mintz...................................... $15,000 None $159,500
Robert S. Salomon, Jr............................. $15,000 None $159,500
Melvin R. Seiden.................................. $15,000 None $159,500
Stephen B. Swensrud............................... $15,000 None $175,500
</TABLE>
- ---------------
(1) The Trustees serve on the boards of MLAM/FAM-Advised Funds as follows: Joe
Grills (22 registered investment companies consisting of 55 portfolios),
Walter Mintz (20 registered investment companies consisting of 41
portfolios), Robert S. Salomon (20 registered investment companies
consisting of 41 portfolios), Melvin R. Seiden (20 registered investment
companies consisting of 41 portfolios) and Stephen B. Swensrud (23
registered investment companies consisting of 56 portfolios).
6
<PAGE> 56
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 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>
<CAPTION>
MANAGEMENT FEE
--------------
<S> <C>
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, 1998, the fee paid by the Fund to the
Manager was $8,536,593 (based upon average daily net assets of approximately
$1.8 billion). For the fiscal year ended August 31, 1997, the fee paid by the
Fund to the Manager was $9,241,448 (based upon average daily net assets of
approximately $2.0 billion). For the fiscal year ended August 31, 1996, the fee
paid by the Fund to the Manager was $10,650,590 (based upon average daily net
assets of approximately $2.3 billion).
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
7
<PAGE> 57
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 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.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) 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. (except that Class B shareholders
may vote upon any material changes to expenses charged under the Class D
Distribution Plan). Each class has different exchange privileges. See
"Shareholder Services -- Exchange Privilege."
The Merrill Lynch Select Pricing(SM) 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 that use the Merrill Lynch Select
Pricing(SM) System are referred to herein as "Select Pricing 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
8
<PAGE> 58
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 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. For the fiscal year ended August 31, 1998, the
gross sales charges for the sale of Class A shares were $7,978, of which $979
and $6,999 were received by the Distributor and Merrill Lynch, respectively. For
the fiscal year ended August 31, 1997, the gross sales charges for the sale of
Class A shares of the Fund were $3,559, of which $338 and $3,221 were received
by the Distributor and Merrill Lynch, respectively. For the fiscal year ended
August 31, 1996, the gross sales charges for the sale of Class A shares of the
Fund 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, 1998, the
gross sales charges for the sale of Class D shares of the Fund were $124,274, of
which $10,481 and $113,793 were received by the Distributor and Merrill Lynch,
respectively. During the fiscal year ended August 31, 1997, the gross sales
charges for the sale of Class D shares of the Fund were $96,158, of which $8,150
and $88,008 were received by the Distributor and Merrill Lynch, respectively.
During the fiscal year ended August 31, 1996 the gross sales charges for the
sale of Class D shares of the Fund 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 that has not been in existence for at
least six months or that 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.
9
<PAGE> 59
Closed-End Fund Investment Option. Class A shares of the Fund and other
Select Pricing Funds ("Eligible Class A Shares") are offered at net asset value
to shareholders of certain closed-end funds 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 Select
Pricing 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 Select Pricing 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.
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<PAGE> 60
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 Select Pricing 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 Select Pricing 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 the Summit Cash
Reserves 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> 61
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 Blueprint(SM) Program, P.O. Box
30441, New Brunswick, New Jersey 08989-0441.
Employee Access(SM) Accounts. Provided applicable threshold requirements
are met, either Class A or Class D shares are offered at net asset value to
Employee Access(SM) Accounts available through authorized employers. 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 no
less than six months; and second, such purchase of Class D shares must be made
within 60 days after the
12
<PAGE> 62
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 that might result from an acquisition of assets having net
unrealized appreciation that 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 that (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, that 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 Select Pricing Funds. 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
1-800-237-7777.
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 Merrill Lynch Funds
Distributor (the "Distributor"), a division of Princeton Funds Distributor, Inc.
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
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<PAGE> 63
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.
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<PAGE> 64
The following table sets forth comparative information as of August 31,
1998, 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, 1998
-------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
ALLOWABLE AMOUNTS FEE AT
ELIGIBLE INTEREST ON MAXIMUM PREVIOUSLY AGGREGATE CURRENT NET
GROSS AGGREGATE UNPAID AMOUNT PAID TO UNPAID ASSET
SALES(1) SALES CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
---------- ------------- ----------- -------- -------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B
Under NASD Rule As Adopted...... $4,856,443 $303,528 $277,832 $581,360 $149,898 $431,462 $3,139
Under Distributor's Voluntary
Waiver........................ $4,856,443 $303,528 $ 24,282 $327,810 $149,898 $177,912 $3,139
CLASS C
Under NASD Rule As Adopted...... $ 54,928 $ 3,433 $ 711 $ 4,144 $ 515 $ 3,629 $ 237
</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. This figure may include CDSCs that were deferred
when a shareholder redeemed shares prior to the expiration of the applicable
CDSC period and invested the proceeds, without the imposition of a sales
charge, in Class A shares in conjunction with the shareholder's
participation in the Merrill Lynch Mutual Fund Advisor (Merrill Lynch
MFA(SM)) Program (the "MFA Program"). The CDSC is booked as a contingent
obligation that may be payable if the shareholder terminates participation
in the MFA Program.
(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 for more than seven days 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.
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.
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<PAGE> 65
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 certain
instances including 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
in the case of such withdrawals 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, 1996, 1997 and 1998 the
Distributor received CDSCs of $1,283,799, $938,189 and $675,960, respectively,
with respect to redemptions of Class B shares, all of which were paid to Merrill
Lynch. Additional CDSCs payable to the Distributor may have been waived or
converted to a contingent obligation in connection with a shareholder's
participation in certain fee-based programs. For the fiscal years ended August
31, 1996, 1997 and 1998, the Distributor received CDSCs of $37,766, $16,193 and
$13,550, respectively, with respect to redemptions of Class C shares, all of
which were paid to Merrill Lynch.
Merrill Lynch Blueprint(SM) Program. Class B shares are offered to certain
participants in the Blueprint(SM) 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
Blueprint(SM) 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 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
16
<PAGE> 66
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 or with interpretations of
Commission staff.
The Trustees of the Fund have considered the possibility of seeking to
recapture 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, 1996, 1997 and 1998, respectively,
the Fund paid no brokerage commissions.
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
17
<PAGE> 67
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, the NYSE closes at 4:00 p.m., Eastern
time), on each day the NYSE is open for trading. The NYSE is not open on New
Year's Day, Martin Luther King, Jr. 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 that 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.
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.
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<PAGE> 68
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 that 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 Blueprint(SM) 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 retirement account such as an IRA 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.
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<PAGE> 69
AUTOMATIC INVESTMENT PLANS
A U.S. 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. An investor
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 amounts of $100 ($1 for
retirement accounts) or more 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 (provided that, in the event that a
payment on an account maintained at the Transfer Agent would amount to $10.00 or
less, a shareholder will not receive such payment in cash and such payment will
automatically be reinvested in additional shares). The Fund is not responsible
for any failure of delivery to the shareholder's address of record and no
interest will accrue on amounts represented by uncashed distribution or
redemption checks.
Shareholders may, at any time, notify Merrill Lynch in writing if the
shareholder's account is maintained with Merrill Lynch or notify the Transfer
Agent in writing or by telephone (1-800-MER-FUND) if the shareholder's account
is maintained with the Transfer Agent, 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
A shareholder may elect to make systematic withdrawals from an Investment
Account of Class A, Class B, Class C or Class D shares 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 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 shares having a value of $10,000
or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount and
class of shares to be redeemed. Redemptions will be made at net asset value as
determined as of 15 minutes after the close of business of the NYSE (generally,
the NYSE closes at 4:00 p.m., Eastern 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 shares will be redeemed at the
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<PAGE> 70
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 shares in the
Investment Account are reinvested automatically in Fund 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 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 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.
Alternatively, a 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 $50. The
proceeds of systematic redemptions will be posted to the shareholder's account
five business days after the date the shares are redeemed. All redemptions are
made at net asset value. A shareholder may elect to have his or her shares
redeemed on the first, second, third or fourth Monday of each month, in the case
of monthly redemptions, or of every other month, in the case of bimonthly
redemptions. For quarterly, semiannual or annual redemptions, the shareholder
may select the month in which the shares are to be redeemed and may designate
whether the redemption is to be made on the first, second, third or fourth
Monday of the month. If the Monday selected is not a business day, the
redemption will be processed at net asset value on the next business day. The
CMA(R) or 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.
With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares that
can be redeemed from an account annually shall not exceed 10% of the value of
shares of such class in that account at the time the election to join the
systematic withdrawal plan was made. Any CDSC that otherwise might be due on
such redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic withdrawal plan will be redeemed in the same order as
Class B or Class C shares are otherwise redeemed. See "Purchase of
Shares -- Deferred Sales Charge Alternatives -- Class B and Class C
Shares -- Contingent Deferred Sales Charges -- Class B Shares" and
"-- Contingent Deferred Sales Charges -- Class C Shares" in the Prospectus.
Where the systematic withdrawal plan is applied to Class B shares, upon
conversion of the last Class B shares in an account to Class D shares, the
systematic withdrawal plan will be applied thereafter to Class D shares if the
shareholder so elects. See "Purchase of Shares -- Deferred Sales Charge
Alternatives -- Class B and Class C Shares -- Conversion of Class B Shares to
Class D Shares" in the Prospectus; if an investor wishes to change the amount
being withdrawn in a systematic withdrawal plan the investor should contact his
or her Financial Consultant.
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<PAGE> 71
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.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other Select Pricing Funds and Summit Cash Reserves Fund
("Summit"), a series of Financial Institutions Series Trust, which is a Merrill
Lynch-sponsored money market mutual fund specifically designated as available
for exchange by holders of Class A, Class B, Class C and Class D shares of
Select Pricing Funds. 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. Before
effecting an exchange, shareholders should obtain a currently effective
prospectus of the fund into which the exchange is to be made. Exercise of the
exchange privilege is treated as a sale of the exchanged shares and a purchase
of the acquired shares for Federal income tax purposes.
Exchanges of Class A and Class D Shares. Class A shareholders may exchange
Class A shares of the Fund for Class A shares of a second Select Pricing 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 Select
Pricing 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 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 Select Pricing 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 D shares are exchangeable with shares of the same class of
other Select Pricing Funds.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of other Select Pricing Funds or
Class A shares of Summit ("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 charges
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<PAGE> 72
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 or 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 generally may be exchanged into the Class A or Class D
shares, respectively, of the other funds with a reduced sales charge or without
a sales charge.
Exchanges of Class B and Class C Shares. Each Select Pricing Fund with
Class B or 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, of another Select Pricing Fund or for Class B shares of Summit
("new Class B or Class C shares") 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 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 CDSC 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 or
Class C shares of the Fund for those of Merrill Lynch Special Value Fund, Inc.
("Special Value Fund") after having held the Fund's 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 Special Value Fund
Class B shares for more than five years.
Exchanges for Shares of a Money Market Fund. Class A and Class D shares
are exchangeable for Class A shares of Summit and Class B and Class C shares are
exchangeable for Class B shares of Summit. Class A shares of Summit have an
exchange privilege back into Class A or Class D shares of Select Pricing Funds;
Class B shares of Summit have an exchange privilege back into Class B or Class C
Shares of Select Pricing Funds and, in the event of such an exchange, the period
of time that Class B shares of Summit are held will count toward satisfaction of
the holding period requirement for purposes of reducing any CDSC and toward
satisfaction of any conversion period with respect to Class B shares. Class B
shares of Summit will be subject to a distribution fee at an annual rate of
0.75% of average daily net assets of such Class B shares. This exchange
privilege does not apply with respect to certain Merrill Lynch fee-based
programs for which alternative exchange arrangements may exist. Please see your
Merrill Lynch Financial Consultant for further information.
Shareholders who exchanged Select Pricing Fund shares for shares of a
Merrill Lynch-sponsored money market fund other than Summit and subsequently
wish to exchange those money market fund shares for shares of the Fund will be
subject to the CDSC schedule applicable to such Fund shares, if any. The holding
period for those money market fund shares will not count toward satisfaction of
the holding period
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<PAGE> 73
requirement for reduction of the CDSC imposed on such shares, if any, and, with
respect to Class B shares, toward satisfaction of the Conversion Period.
However, the holding period for Class B or Class C shares received in exchange
for such money market fund shares will be aggregated with the holding period for
the original Select Pricing Fund shares for purposes of reducing the CDSC or
satisfying the Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her Merrill Lynch Financial Consultant, who
will advise the Fund of the exchange. Shareholders of the Fund, and shareholders
of the other Select Pricing Funds 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. This 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 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. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.
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 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. As long as 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
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<PAGE> 74
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). Certain categories of
capital gains taxable at different rates. Generally, 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, as well as any amounts of capital gain dividends in the
different categories of capital gain referred to above.
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. 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.
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<PAGE> 75
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.
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.
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.
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<PAGE> 76
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.
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.
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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 A SHARES** CLASS B SHARES*
---------------------------- ----------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A VALUE OF A AS A VALUE OF A
PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END $1,000 AT THE END
PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD
------ ------------ ------------- ------------ -------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
One Year Ended
August 31, 1998............ 3.78% $1,037.80 3.28% $1,032.80
Five Years Ended
August 31, 1998............ -- -- 5.12% $1,283.90
Ten Years Ended
August 31, 1998............ -- -- -- --
Class A and Class C Inception
(October 21, 1994) through
August 31, 1998............ 7.61% $1,327.20 -- --
Class B Inception (December
23, 1991) to August 31,
1998....................... -- -- 5.68% $1,446.80
<CAPTION>
CLASS D SHARES (FORMERLY
CLASS C SHARES** CLASS A SHARES)
---------------------------- ----------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A VALUE OF A AS A VALUE OF A
PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END $1,000 AT THE END
PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD
------ ------------ ------------- ------------ -------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
One Year Ended
August 31, 1998............ 6.23% $1,062.30 3.52% $1,035.20
Five Years Ended
August 31, 1998............ -- -- 4.81% $1,264.80
Ten Years Ended
August 31, 1998............ -- -- 7.66% $2,092.00
Class A and Class C Inception
(October 21, 1994) through
August 31, 1998............ 7.84% $1,388.40 -- --
Class B Inception (December
23, 1991) to August 31,
1998....................... -- -- -- --
</TABLE>
<TABLE>
<CAPTION>
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Year Ended August 31,
- -----------------------------
1998......................... 8.10% $1,081.50 7.28% $1,074.30
1997......................... 9.66% $1,096.60 8.71% $1,087.10
1996......................... 4.55% $1,045.50 3.72% $1,037.20
1995......................... 8.91% $1,089.10
1994......................... (2.55)% $ 974.50
1993......................... 7.80% $1,078.00
1992.........................
1991.........................
1990.........................
1989.........................
1988.........................
1987.........................
1986.........................
<CAPTION>
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Year Ended August 31,
- -----------------------------
1998......................... 7.23% $1,073.80 7.84% $1,079.90
1997......................... 8.66% $1,086.60 9.27% $1,092.70
1996......................... 3.67% $1,036.70 4.28% $1,042.80
1995......................... 9.48% $1,094.80
1994......................... (2.06)% $ 979.40
1993......................... 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
</TABLE>
28
<PAGE> 78
<TABLE>
<CAPTION>
CLASS A SHARES** CLASS B SHARES*
---------------------------- ----------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A VALUE OF A AS A VALUE OF A
PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END $1,000 AT THE END
PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD
------ ------------ ------------- ------------ -------------
AGGREGATE TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Class A and Class C Inception
(October 21, 1994) to
August 31, 1998............ 11.56% $1,115.60
Class B Inception (December
23, 1991) to August 31,
1998....................... 4.54% $1,045.40
Class D (formerly Class A)
Inception (September 28,
1984) to August 31, 1998...
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Class A and Class C Inception
(October 21, 1994) to August
31, 1998.................... 32.72% $1,327.20 -- --
Class B Inception (December
23, 1991) to August 31,
1998....................... -- -- 44.68% $1,446.80
Class D (formerly Class A)
Inception (September 28,
1984) to August 31, 1998... -- -- -- --
<CAPTION>
CLASS D SHARES (FORMERLY
CLASS C SHARES** CLASS A SHARES)
---------------------------- ----------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A VALUE OF A AS A VALUE OF A
PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END $1,000 AT THE END
PERIOD INVESTMENT OF THE PERIOD INVESTMENT OF THE PERIOD
------ ------------ ------------- ------------ -------------
AGGREGATE TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Class A and Class C Inception
(October 21, 1994) to
August 31, 1998............ 10.80% $1,108.00
Class B Inception (December
23, 1991) to August 31,
1998.......................
Class D (formerly Class A)
Inception (September 28,
1984) to August 31, 1998... 17.34% $1,173.40
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Class A and Class C Inception
(October 21, 1994) to August
31, 1998.................... 33.84% $1,338.40 -- --
Class B Inception (December
23, 1991) to August 31,
1998....................... -- -- -- --
Class D (formerly Class A)
Inception (September 28,
1984) to August 31, 1998... -- -- 218.81% $3,188.10
</TABLE>
- ---------------
* Information as to Class B shares is presented only for the period December
23, 1991 to August 31, 1998. 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, 1998. 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
29
<PAGE> 79
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.
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.
30
<PAGE> 80
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, 1998, is set forth below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Net Assets......................... $277,567,579 $627,817,627 $43,038,463 $866,012,963
============ ============ =========== ============
Number of Shares Outstanding....... 28,333,983 64,105,585 4,394,901 88,430,058
============ ============ =========== ============
Net Asset Value Per Share (net
assets divided by number of
shares outstanding).............. $ 9.80 $ 9.79 $ 9.79 $ 9.79
Sales Charge (Class A and Class D
shares):
4.00% of offering price (4.17% of
net asset value per share)*...... 0.41 ** ** 0.41
------------ ------------ ----------- ------------
Offering Price..................... $ 10.21 $ 9.79 $ 9.79 $ 10.20
============ ============ =========== ============
</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.
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
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.
31
<PAGE> 81
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 November 1, 1998.
------------------------
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.
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated in this Statement
of Additional Information by reference to its 1998 annual report to
shareholders. You may request a copy of the annual report at no charge by
calling 1-800-456-4587 Ext. 789 between 8:00 a.m. and 8:00 p.m. on any business
day.
32
<PAGE> 82
- ------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies...... 2
Investment Restrictions.............. 2
Management of the Fund................. 5
Trustees and Officers................ 5
Management and Advisory
Arrangements...................... 7
Purchase of Shares..................... 8
Initial Sales Charge Alternatives --
Class A and Class D Shares........ 9
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.......... 20
Retirement Plans..................... 22
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............................. 31
Independent Auditors................. 31
Custodian............................ 31
Transfer Agent....................... 31
Legal Counsel........................ 31
Reports to Shareholders.............. 32
Additional Information............... 32
Security Ownership of Certain
Beneficial Owners................. 32
Financial Statements................... 32
</TABLE>
Code #10260-1198
YZa
MERRILL LYNCH
FEDERAL SECURITIES TRUST
STATEMENT OF
ADDITIONAL
INFORMATION
November 25, 1998
Distributor:
Merrill Lynch
Funds Distributor
MLYNCH COMPASS
<PAGE> 83
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, 1998.
Incorporated by reference in Part B:
Schedule of Investments as of August 31, 1998(*).
Statement of Assets and Liabilities as of August 31, 1998(*).
Statement of Operations for the year ended August 31, 1998(*).
Statements of Changes in Net Assets for each of the years in the
two-year
period ended August 31, 1998(*).
Financial Highlights for each of the years in the five-year period ended
August 31, 1998(*).
--------------------
* Included in the Registrant's 1998 Annual Report to shareholders filed with
the Securities and Exchange Commission for the year ended August 31, 1998
pursuant to Rule 30b2-1 under the Investment Company Act of 1940, as
amended ("1940 Act").
(b) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S> <C>
1(a) -- Declaration of Trust of the Registrant, dated July 20,
1984.(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
Management, 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 Merrill 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 Merrill Lynch Funds Distributor, Inc. (including
Selected Dealers Agreement).(d)
(d) -- Form of Class D Distribution Agreement between Registrant
and Merrill 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
Servicing Agency Agreement between the Registrant and
Merrill Lynch Financial Data Services, Inc.(a)
10 -- None.
11 -- Consent of Deloitte & Touche LLP, independent auditors for
Registrant.
12 -- None.
13 -- Certificate of Fund Asset Management, Inc.(a)
14 -- None.
</TABLE>
C-1
<PAGE> 84
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S> <C>
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 Pricing(SM) 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
OCTOBER 31,
TITLE OF CLASS 1998
- -------------- -----------
<S> <C>
Class A shares of beneficial interest, par value $0.10 per
share..................................................... 43,899
Class B shares of beneficial interest, par value $0.10 per
share..................................................... 47,045
Class C shares of beneficial interest, par value $0.10 per
share..................................................... 2,873
Class D shares of beneficial interest, par value $0.10 per
share..................................................... 61,238
</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.
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
C-2
<PAGE> 85
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 interests 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, as
amended (the "Act") against certain types of civil liabilities arising in
connection with the Registration Statement or Prospectus and Statement of
Additional Information.
Insofar as indemnification for liabilities arising under the Act may be
permitted to Trustees, officers and controlling persons of the Registrant and
the principal underwriter 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 registered 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
C-3
<PAGE> 86
Fund, Inc., Merrill Lynch Corporate High Yield 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
registered investment companies: Apex Municipal Fund, Inc., Corporate High Yield
Fund, Inc., Corporate High Yield Fund II, Inc., Corporate High Yield Fund III,
Inc., Debt Strategies Fund, Inc., Debt Strategies Fund II, Inc., Debt Strategies
Fund III, Inc., Income Opportunities Fund 1999, Inc., Income Opportunities Fund
2000, Inc., Merrill Lynch Municipal Strategy Fund, Inc., MuniAssets Fund, Inc.,
MuniEnhanced Fund, Inc., MuniHoldings California Insured Fund, Inc.,
MuniHoldings California Insured Fund II, Inc., MuniHoldings California Insured
Fund III, Inc., MuniHoldings Florida Insured Fund, MuniHoldings Florida Insured
Fund II, MuniHoldings Florida Insured Fund III, MuniHoldings Fund, Inc.,
MuniHoldings Fund II, Inc., MuniHoldings Insured Fund, Inc., MuniHoldings New
Jersey Insured Fund, Inc., MuniHoldings New Jersey Insured Fund II, Inc.,
MuniHoldings New York Fund, Inc., MuniHoldings New York Insured Fund, Inc.,
MuniHoldings New York Insured Fund II, Inc., MuniInsured Fund, Inc., MuniVest
Fund, Inc., MuniVest Fund II, Inc., MuniVest Florida Fund, MuniVest Michigan
Insured Fund, Inc., MuniVest New Jersey 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 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 Pennsylvania Fund, MuniYield Quality Fund,
Inc., MuniYield Quality Fund II, Inc., Senior High Income Portfolio, Inc., and
Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM"), an affiliate of the Manager,
acts as the investment adviser for the following open-end registered 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 Capital Fund, Inc., Merrill Lynch Convertible Fund, Inc., Merrill Lynch
Developing Capital Markets Fund, Inc., Merrill Lynch Dragon Fund, Inc., Merrill
Lynch EuroFund, Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch
Global Allocation Fund, Inc., Merrill Lynch Global Bond Fund for Investment and
Retirement, Merrill Lynch Global Growth Fund, Inc., Merrill Lynch Global
Holdings, Inc., Merrill Lynch Global Resources Trust, Merrill Lynch Global
SmallCap Fund, Inc., Merrill Lynch Global Technology 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 Intermediate
Government Bond 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 Real Estate Fund, Inc., 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., Merrill Lynch Variable Series Funds, Inc., and Hotchkis and Wiley Funds
(advised by Hotchkis and Wiley, a division of MLAM); and for the following
closed-end registered investment companies: Merrill Lynch High Income Municipal
Bond Fund, Inc. and Merrill Lynch Senior Floating Rate Fund, Inc. MLAM also acts
as sub-adviser to Merrill Lynch World Strategy Portfolio and Merrill Lynch Basic
Value Equity Portfolio, two investment portfolios of EQ Advisors Trust.
The address of each of these registered 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 Intermediate Government Bond
Fund is One Financial Center, 23rd Floor, Boston, Massachusetts 02111-2665. The
address of the Manager, MLAM, Princeton Services, Inc. ("Princeton Services"),
and Princeton Administrators, L.P. ("Princeton Administrators") is also P.O. Box
9011, Princeton, New Jersey 08543-9011. The address of Princeton Funds
Distributor, Inc. ("PFD") and of Merrill Lynch Funds Distributor, Inc. ("MLFD")
is P.O. Box 9081, Princeton, New Jersey 08543-9081. The address of Merrill
Lynch, Pierce,
C-4
<PAGE> 87
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 10281-1201. The address of the Fund's transfer agent, 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, 1995 for his or her 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 substantially all of
the investment companies described in the first two paragraphs of this Item 28
and Messrs. 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; Limited Partner of MLAM
Princeton Services, Inc.......... General Partner General Partner of MLAM
Arthur Zeikel.................... Chairman Chairman of MLAM; President of FAM
and MLAM from 1977 to 1997;
Chairman and Director of Princeton
Services; President of Princeton
Services from 1993 to 1997;
Executive Vice President of ML &
Co.
Jeffrey M. Peek.................. President President of MLAM; President and
Director of Princeton Services;
Executive Vice President of ML &
Co.; Managing Director and Co-Head
of the Investment Banking Division
of Merrill Lynch (in 1997); Senior
Vice President and Director of the
Global Securities and Economics
Division of Merrill Lynch (from
1995 to 1997)
Terry K. Glenn................... Executive Vice President Executive Vice President of MLAM;
Executive Vice President and
Director of Princeton Services;
President and Director of the
Distributor; Director of FDS;
President of Princeton
Administrators, Inc.
Linda L. Federici................ Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Vincent R. Giordano.............. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Elizabeth A. Griffin............. 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
</TABLE>
C-5
<PAGE> 88
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS,
NAME MANAGER PROFESSION, VOCATION OR EMPLOYMENT
---- ------------------------ ----------------------------------
<S> <C> <C>
Michael J. Hennewinkel........... Senior Vice President, Senior Vice President, Secretary
Secretary and General and General Counsel of MLAM;
Counsel Senior Vice President of Princeton
Services
Philip L. Kirstein............... Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Ronald M. Kloss.................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President and
Controller of Princeton Services
Debra W. Landsman-Yaros.......... Senior Vice President Senior Vice President of MLAM;
Vice President of PFD; Senior Vice
President of Princeton Services
Stephen M. M. Miller............. Senior Vice President Executive Vice President of
Princeton Administrators, L.P.;
Senior Vice President of Princeton
Services
Joseph T. Monagle, Jr............ Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Brian A. Murdock................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services; Director of PFD
Michael L. Quinn................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services; Managing Director and
First Vice President of Merrill
Lynch, Pierce, Fenner & Smith from
1989 to 1995
Gerald M. Richard................ Senior Vice President Senior Vice President and
and Treasurer Treasurer of MLAM; Senior Vice
President and Treasurer of
Princeton Services; Vice President
and Treasurer of PFD
Gregory D. Upah.................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Ronald L. Welburn................ Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
</TABLE>
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) MLFD, a division of PFD, acts as the principal underwriter for the
Registrant and for each of the open-end registered 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, The Corporate Fund Accumulation Program,
Inc. and The Municipal Fund Accumulation Program, Inc.; and MLFD also acts as
the principal underwriter for the following closed-end registered investment
companies: Merrill Lynch High Income Municipal Bond Fund, Inc., Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch Senior Floating Rate Fund, Inc.
A separate division of PFD acts as the principal underwriter of a number of
other investment companies.
(b) Set forth below is information concerning each director and officer of
PFD. The principal business address of each such person is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of
C-6
<PAGE> 89
Messrs. Breen, Crook, Fatseas and Wasel is One Financial Center, 23rd Floor,
Boston, Massachusetts 02111-2665.
<TABLE>
<CAPTION>
POSITIONS AND OFFICES POSITIONS AND OFFICES
NAME WITH DISTRIBUTOR WITH REGISTRANT
---- ---------------------------- ------------------------
<S> <C> <C>
Terry K. Glenn........................... President and Director Executive Vice President
Brian A. Murdock......................... Director None
Thomas J. Verage......................... Director None
Robert W. Crook.......................... Senior Vice President None
Michael J. Brady......................... Vice President None
William M. Breen......................... Vice President None
Michael G. Clark......................... 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.
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 are
maintained at the offices of the Registrant, 800 Scudders Mill Road, Plainsboro,
New Jersey 08536 and its transfer agent, 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) The Registrant undertakes to furnish to each person to whom a
prospectus is delivered a copy of the Registrant's latest annual report to
shareholders, upon request and without charge.
C-7
<PAGE> 90
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 Post-Effective Amendment to its 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 24th day of November,
1998.
MERRILL LYNCH FEDERAL SECURITIES TRUST
(Registrant)
By: /s/ ARTHUR ZEIKEL
------------------------------------
(Arthur Zeikel, President and
Trustee)
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment to its Registration Statement has been signed below by
the following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ ARTHUR ZEIKEL President and Trustee November 24, 1998
- ------------------------------------------- (Principal Executive Officer)
(Arthur Zeikel)
GERALD M. RICHARD* Treasurer (Principal Financial
- ------------------------------------------- and Accounting Officer)
(Gerald M. Richard)
JOE GRILLS* Trustee
- -------------------------------------------
(Joe Grills)
WALTER MINTZ* Trustee
- -------------------------------------------
(Walter Mintz)
ROBERT S. SALOMON, JR.* Trustee
- -------------------------------------------
(Robert S. Salomon, Jr.)
MELVIN R. SEIDEN* Trustee
- -------------------------------------------
(Melvin R. Seiden)
STEPHEN B. SWENSRUD* Trustee
- -------------------------------------------
(Stephen B. Swensrud)
*By: /s/ ARTHUR ZEIKEL November 24, 1998
- -------------------------------------------
(Arthur Zeikel, Attorney-in-Fact)
</TABLE>
C-8
<PAGE> 91
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S> <C>
11 Consent of Deloitte & Touche LLP, independent auditors for
Registrant
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
</TABLE>
C-9
<PAGE> 1
Exhibit 11
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Federal Securities Trust:
We consent to the incorporation by reference in this Post-Effective Amendment
No. 15 to Registration Statement No.2-92366 of our report dated October 14,
1998 appearing in the annual report to shareholders of the Merrill Lynch
Federal Securities Trust for the year ended August 31, 1998, and to the
reference to us under the caption "Financial Highlights" in the Prospectus,
which is a part of such Registration Statement.
Deloitte & Touche LLP
Princeton, New Jersey
November 24, 1998
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