MERRILL LYNCH
U.S. GOVERNMENT
MORTGAGE FUND
FUND LOGO
Annual Report
August 31, 2000
This report is not authorized for use as an offer of sale or a
solicitation of an offer to buy shares of the Fund unless
accompanied or preceded by the Fund's current prospectus. Past
performance results shown in this report should not be considered a
representation of future performance. Investment return and
principal value of shares will fluctuate so that shares, when
redeemed, may be worth more or less than their original cost.
Statements and other information herein are as dated and are subject
to change.
Merrill Lynch
U.S. Government Mortgage Fund
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
Merrill Lynch U.S. Government Mortgage Fund
DEAR SHAREHOLDER
On April 17, 2000, Merrill Lynch Federal Securities Trust changed
its name to Merrill Lynch U.S. Government Mortgage Fund. The Fund's
management believes that the new name better portrays the Fund's
main investment strategies. The change in name does not connote a
change in the Fund's investment objective, which remains the same:
to seek high current return through investments in US Government
securities and US Government agency securities, including Government
National Mortgage Association mortgage-backed securites and other
mortgage-backed securities.
Economic Review
The US economy remains on a new course. The new paradigm, featuring
the coexistence of high employment, strong economic growth and low
inflation continues to dominate the current economic landscape.
Indeed, this is in direct contrast to a widely accepted economic
theory, which states that unemployment below 5% is inflationary.
Thus this theory is in danger of being discredited as inflation
remains contained in spite of unemployment measuring near 4% for
most of the past year. Furthermore, the pace of economic expansion
has averaged 6% annually for the past four quarters, more than twice
the amount traditionally believed as inflationary.
The ability of the economy to remain relatively inflation free is
generally attributed to gains in productivity. Technology
improvements during the current business cycle have offset any
increases in raw material costs and limited the impact of wage
increases. Unit costs, as a result of extraordinary productivity
advancements, have remained relatively stable. Therefore, it would
seem that inflation should remain stable going forward, providing
that advances in productivity continue.
Although inflation has remained tame, strong growth and low
unemployment have forced the Federal Reserve Board to increase short-
term interest rates by 125 basis points (1.25%) during the period in
order to slow economic growth. Indeed, there are some signs of
slowing growth. Housing starts have declined and the National
Association of Purchasing Managers' Index fell below 50% for the
first time since January 1999. A reading below 50% is an indication
of a future slowdown. However, until there are further and clearer
indications of a slowdown, the Federal Reserve Board will probably
remain on hold. This is especially likely for the October 3, 2000
Federal Open Market Committee (FOMC) meeting as the Federal Reserve
Board traditionally maintains a perceived position of impartiality
prior to national elections.
During the past year, interest rates have been greatly affected by
Government activity. Tighter monetary policy has caused short-term
interest rates to increase, while Treasury activity (the buyback of
debt) has caused long-term Treasury yields to decline. A positively
sloped Treasury yield curve at the start of the fiscal year turned
negative by year-end. The yield spread between the three-month
Treasury bill and the 30-year Treasury bond went from a positive 111
basis points to a negative 63 basis points.
Fiscal Year in Review
For most of the fiscal year, we touted the attributes of mortgage-
backed securities (MBS). In general, MBS are high quality,
relatively high-yielding securities. Because the majority of MBS
traded at a discount price for most of the past year, the inherent
prepayment risk was never much of an issue. Interest rates, although
changing significantly at the short-end and long-end of the yield
curve, were relatively unchanged in the middle of the curve. The
five-year area served as the fulcrum, as the five-year Treasury note
increased just 9 basis points for the period while three-month
Treasury bills increased 134 basis points and the 30-year Treasury
bond decreased 40 basis points. The yield curve inverted, reflecting
Federal Reserve Board activity at the short-end of the yield curve
and the Treasury buyback program, which drove yields lower at the
long end of the yield curve. Consequently, the Salomon Smith Barney
(SSB) Mortgage Index was the best-performing component of the SSB
Broad Investment-Grade Index. The Mortgage Index outperformed the
SSB Corporate Index by 200 basis points. The Mortgage Index
outperformed the returns of the benchmark-on-the-run Treasury issues
even more, except for the 30-year Treasury bond, which had greater
returns as a result of the Treasury buyback program.
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
For the fiscal year ended August 31, 2000, the Fund's total returns
were slightly below the SSB Mortgage Index, reflecting liquidity
issues and some inter-MBS market performance anomalies. Our strategy
of maintaining an overweight position in the current coupon sector
was successful for the Fund as the pass-throughs priced closest to
par tended to be the superior performer for the period. We were also
exposed to a 25% position in agency-backed multi-family MBS. While
these securities have a high degree of prepayment protection, the
market has yet to achieve the same degree of development as
residential MBS. Thus, they suffered a greater amount of spread
widening during the period. Overall, these two areas of investment
tended to offset each other.
Interestingly, a Fannie Mae 30-year 7.50% MBS started and ended the
period at the exact same price. Very noteworthy is that the same
coupon Government National Mortgage Association (GNMA) had its price
move significantly higher. This reflects the Congressional review of
Fannie Mae and Freddie Mac, the two Government Sponsored Entities
(GSE), and the uncertainty of future regulatory involvement. It is
our view that this underperformance of Fannie Mae and Freddie Mac
relative to GNMA provides excellent investment opportunities going
forward.
While the Fannie Mae 30-year 7.50% MBS was unchanged in price during
the past year, lower coupon MBS in general experienced significant
increases in price (a GNMA 30-year 6% MBS moved from $91.47 to
$93.47), while higher coupon MBS moved lower in price (a GNMA 30-
year 8.50% MBS declined in price from $103.44 to $102.31). This
disparate price movement, coupled with differing prepayment
experiences, caused a significant total return differential within
the MBS market.
Going forward, we believe MBS are posed to perform well. Consider
that a Fannie Mae 30-year 7.50% MBS trades at a discount price. This
is an attractive coupon in the absolute, but especially so when
compared to five-year and ten-year Treasury note yields of 5.96% and
5.72%, respectively. This represents a historically attractive yield
spread. There is good potential for a tightening in yield spreads,
thereby increasing the value of MBS. The indication at the last FOMC
meeting was that the economy was slowing and demand was moderating.
This, coupled with the upcoming November elections, leads us to
believe that the Federal Reserve Board will leave short-term
interest rates unchanged for the next couple of months. In this
environment, we expect MBS to perform well regardless of a yield
spread tightening as coupon flow may be the largest component of
total return.
In Conclusion
We thank you for your continued investment in Merrill Lynch U.S.
Government Mortgage Fund, and we look forward to discussing our
outlook and strategy with you in our next report to shareholders.
Sincerely,
(Terry K. Glenn)
Terry K. Glenn
President and Trustee
(Gregory Mark Maunz)
Gregory Mark Maunz
Senior Vice President and Portfolio Manager
September 29, 2000
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
PERFORMANCE DATA
About Fund Performance
Investors are able to purchase shares of the Trust through the
Merrill Lynch Select Pricing SM System, which offers four pricing
alternatives:
* Class A Shares incur a maximum initial sales charge (front-end
load) of 4% and bear no ongoing distribution or account maintenance
fees. Class A Shares are available only to eligible investors, as
detailed in the Fund's prospectus. If you were a Class A shareholder
prior to October 21, 1994, your Class A Shares were redesignated to
Class D Shares on October 21, 1994. However, in the case of certain
eligible investors, the shares were simultaneously exchanged for
Class A Shares.
* Class B Shares are subject to a maximum contingent deferred sales
charge of 4% if redeemed during the first year, decreasing 1% each
year thereafter to 0% after the fourth year. In addition, Class B
Shares are subject to a distribution fee of 0.50% and an account
maintenance fee of 0.25%. These shares automatically convert to
Class D Shares after approximately 10 years. (There is no initial
sales charge for automatic share conversions.)
* Class C Shares are subject to a distribution fee of 0.55% and an
account maintenance fee of 0.25%. In addition, Class C Shares are
subject to a 1% contingent deferred sales charge if redeemed within
one year of purchase.
* Class D Shares incur a maximum initial sales charge of 4% and an
account maintenance fee of 0.25% (but no distribution fee).
None of the past results shown should be considered a representation
of future performance. Figures shown in the "Recent Performance
Results" and "Average Annual Total Return" tables assume
reinvestment of all dividends and capital gains distributions at net
asset value on the payable date. Investment return and principal
value of shares will fluctuate so that shares, when redeemed, may be
worth more or less than their original cost. Dividends paid to each
class of shares will vary because of the different levels of account
maintenance, distribution and transfer agency fees applicable to
each class, which are deducted from the income available to be paid
to shareholders.
<TABLE>
Recent Performance Results*
<CAPTION>
Ten Years/
6 Month 12 Month Since Inception Standardized
As of August 31, 2000 Total Return Total Return Total Return 30-Day Yield
<S> <C> <C> <C> <C>
ML U.S. Government Mortgage Fund Class A Shares +5.24% +7.23% +50.08% 6.00%
ML U.S. Government Mortgage Fund Class B Shares +4.95 +6.53 +54.84 5.47
ML U.S. Government Mortgage Fund Class C Shares +4.92 +6.47 +43.09 5.42
ML U.S. Government Mortgage Fund Class D Shares +5.22 +7.08 +92.82 5.75
*Investment results shown do not reflect sales charges; results
shown would be lower if a sales charge was included. Total
investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital
gains distributions at net asset value on the payable date. The
Trust's ten-year/inception periods are from 10/21/94 for Class A &
Class C Shares, from 12/23/91 for Class B Shares; and ten years for
Class D Shares.
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
PERFORMANCE DATA (continued)
Total Return Based on a $10,000 Investment
A line graph depicting the growth of ML U.S. Government Mortgage
Fund's Class A and Class C Shares compared to the growth of the
Salomon Brothers Mortgage Index++++. Beginning and ending values
are:
10/21/94** 8/00
ML U.S. Government Mortgage Fund++--
Class A Shares* $ 9,600 $14,409
ML U.S. Government Mortgage Fund++--
Class C Shares* $10,000 $14,308
Salomon Brothers Mortgage Index++++ $10,000 $15,651
A line graph depicting the growth of ML U.S. Government Mortgage
Fund's Class B Shares compared to the growth of the Salomon Brothers
Mortgage Index++++. Beginning and ending values are:
10/23/91** 8/00
ML U.S. Government Mortgage Fund++--
Class B Shares* $10,000 $15,483
Salomon Brothers Mortgage Index++++ $10,000 $17,590
A line graph depicting the growth of ML U.S. Government Mortgage
Fund's Class D Shares compared to the growth of the Salomon Brothers
Mortgage Index++++. Beginning and ending values are:
8/90** 8/00
ML U.S. Government Mortgage Fund++--
Class D Shares* $10,000 $18,512
Salomon Brothers Mortgage Index++++ $10,000 $21,535
*Assuming maximum sales charge, transaction costs and other
operating expenses, including advisory fees.
**Commencement of operations.
++The Trust invests primarily in US Government and Government agency
securities, including GNMA mortgage-backed certificates and other
mortgage-backed Government securities.
++++This unmanaged Index reflects the performance of a capital
market weighting of the outstanding agency-issued mortgage-backed
securities. The starting date for the Index in the Class B Shares'
graph is from 12/31/91.
Past performance is not predictive of future performance.
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
PERFORMANCE DATA (concluded)
Average Annual Total Return
% Return Without % Return With
Sales Charge Sales Charge**
Class A Shares*
One Year Ended 6/30/00 +4.48% +0.30%
Five Years Ended 6/30/00 +5.95 +5.09
Inception (10/21/94)
through 6/30/00 +7.03 +6.26
*Maximum sales charge is 4%.
**Assuming maximum sales charge.
% Return % Return
Without CDSC With CDSC**
Class B Shares*
One Year Ended 6/30/00 +3.79% -0.14%
Five Years Ended 6/30/00 +5.14 +5.14
Inception (12/23/91)
through 6/30/00 +5.04 +5.04
*Maximum contingent deferred sales charge is 4% and is reduced to 0%
after 4 years.
**Assuming payment of applicable contingent deferred sales charge.
% Return % Return
Without CDSC With CDSC**
Class C Shares*
One Year Ended 6/30/00 +3.74% +2.75%
Five Years Ended 6/30/00 +5.09 +5.09
Inception (10/21/94)
through 6/30/00 +6.16 +6.16
*Maximum contingent deferred sales charge is 1% and is reduced to 0%
after 1 year.
**Assuming payment of applicable contingent deferred sales charge.
% Return Without % Return With
Sales Charge Sales Charge**
Class D Shares*
One Year Ended 6/30/00 +4.33% +0.15%
Five Years Ended 6/30/00 +5.69 +4.83
Ten Years Ended 6/30/00 +6.72 +6.29
*Maximum sales charge is 4%.
**Assuming maximum sales charge.
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
Face Interest Original Maturity
Issue Amount Rate Date(s) Value
US Government Agency Mortgage-Backed Obligations*--98.0%
<S> <C> <C> <C> <C> <C>
Fannie Mae $ 149,867,423 6.00 % 11/01/2023--3/01/2029 $ 139,383,506
302,581,145 6.50 12/01/2008--9/01/2028 292,369,103
16,785,762 7.00 11/01/2013--8/01/2029 16,610,303
263 7.50 1/01/2025 262
567,856 8.00 9/01/2024--9/01/2027 574,083
442,727 8.50 5/01/2010--8/01/2012 453,989
11,062,363 8.50(3) 7/15/2023 11,297,438
7,244,402 9.50 3/01/2020 7,534,179
126 10.50 9/01/2000 126
11,966,971 11.00 2/01/2011--11/01/2020 12,988,921
14,249 11.50 6/01/2015 15,436
819,116 13.00 8/01/2010--4/01/2015 908,772
Fannie Mae #0160465 33,022,454 6.16(8) 8/01/2013 31,307,532
Mortgage-Backed Securities #0380332 9,408,080 6.195(7) 6/01/2005 9,066,358
--Multi-Family++ #0375610 13,606,907 6.465(7) 6/01/2004 13,315,564
#0380021 6,158,196 6.49(2) 1/01/2008 5,977,133
#0073894 962,412 6.525(7) 12/01/2003 943,258
#0073885 867,166 6.545(2) 1/01/2007 845,655
#0073873 747,873 6.625(2) 2/01/2007 732,085
#0073221 1,425,276 6.715(7) 10/01/2005 1,403,581
#0375015 18,750,834 6.79(7) 4/01/2004 18,481,525
#0073915 1,471,820 6.87(2) 1/01/2007 1,456,388
#0073910 11,538,887 6.875(2) 1/01/2007 11,418,229
#0375043 3,489,072 6.895(2) 4/01/2007 3,455,173
#0375007 11,801,063 6.94(2) 3/01/2007 11,711,576
#0375012 3,199,351 6.95(2) 4/01/2007 3,176,608
#0073944 13,526,639 6.96(2) 1/01/2007 13,438,564
#0073952 2,697,219 6.96(2) 1/01/2007 2,679,801
#0073946 5,252,760 6.97(2) 2/01/2007 5,221,035
#0073969 7,745,939 7.05(2) 2/01/2007 7,727,879
#0073962 4,581,241 7.085(2) 2/01/2007 4,578,007
#0073967 4,452,616 7.105(2) 2/01/2007 4,453,710
#0073992 2,530,697 7.115(2) 2/01/2007 2,532,477
#0375069 1,047,769 7.122(2) 4/01/2007 1,048,836
#0073943 1,402,048 7.18(4) 2/01/2019 1,398,823
#0073608 4,733,026 7.49(2) 8/01/2006 4,813,235
#0375052 4,629,895 7.50(2) 3/01/2027 4,771,520
#0109076 2,109,942 7.59(2) 8/01/2006 2,153,924
#0160024 5,005,647 7.625(2) 11/01/2003 5,030,755
#0160095 7,000,716 7.66(2) 3/01/2004 7,049,448
Fannie Mae 98-M1-IO2 93,531,109 0.64031(1) 2/25/2013 4,261,090
Mortgage-Backed Securities 94-M1-IO 72,933,467 0.87(1) 10/25/2003 1,549,836
--REMICs**--Multi-Family++ 98-M3-B 10,960,597 6.45 8/17/2013 10,551,722
97-M8-A2 19,135,000 7.16 1/25/2022 18,925,889
96-M3-A2 40,500,000 7.41 3/25/2021 39,386,250
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
<TABLE>
SCHEDULE OF INVESTMENTS (continued)
<CAPTION>
Face Interest Original Maturity
Issue Amount Rate Date(s) Value
US Government Agency Mortgage-Backed Obligations* (concluded)
<S> <C> <C> <C> <C> <C>
Fannie Mae 94-56-TB $ 5,239,230 6.50(1)% 7/25/2022 $ 1,267,626
REMICs** Trust 273 3,781,420 7.00(1) 7/01/2026 1,087,638
96-W1-AL 8,440,198 7.25 3/25/2026 8,347,947
97-5-SB 2,366,238 9.00 3/17/2019 2,353,837
Freddie Mac 519 10.00 7/01/2019 548
Participation Certificates 5,921,158 10.50 9/01/2000--9/01/2020 6,321,854
1,490,330 11.00 8/01/2010--9/01/2020 1,610,487
1,503,081 11.50 12/01/2011--6/01/2020 1,646,798
662,154 12.00 5/01/2010--6/01/2020 731,994
1,065,242 12.50 9/01/2014--7/01/2019 1,184,509
1,643,940 13.00 11/01/2009--2/01/2016 1,825,926
Freddie Mac 218,082 6.00 4/01/2009 211,606
Participation Certificates 164,951 6.50 9/01/2013 160,903
--Gold Program 49,771,656 6.50 10/01/2028--7/01/2029 47,627,036
9,499,431 7.00 8/01/2011--2/01/2013 9,415,541
49,945,825 7.00 9/01/2028--3/01/2030 48,768,061
11,719,565 7.50 5/01/2009--10/01/2011 11,794,533
382,104 7.50 8/01/2017 382,611
11,345,925 8.00 1/01/2007--7/01/2012 11,526,562
95,469 8.00 10/01/2027 96,599
3,030,270 8.50 1/01/2025--7/01/2025 3,102,831
1,783,056 10.50 10/01/2020--12/01/2020 1,894,341
Freddie Mac REMICs** Trust 134 687,889 9.00(1) 4/01/2022 169,819
Trust 1220 3,181,812 10.00 2/15/2022 3,364,315
Government National Mortgage 77,522,265 6.50 10/15/2023--7/15/2029 74,402,127
Association 174,692,000 7.00 4/15/2023--5/15/2029 171,532,820
115,349,290 7.50 1/15/2007--3/15/2030 115,404,326
39,368,767 8.00 1/15/2024--8/15/2026 40,043,197
17,655,393 10.00 12/15/2015--12/15/2021 18,759,184
68,825 10.50 1/15/2016--4/15/2021 72,970
160 11.00 1/15/2016 174
1,098 11.50 8/15/2013 1,198
Total US Government Agency Mortgage-Backed Obligations (Cost--$1,363,481,069) 1,322,109,502
Face
Amount Issue
Repurchase Agreements***--1.8%
$24,500,000 Donaldson, Lufkin & Jenrette Securities Corp., purchased on 8/31/2000
to yield 6.60% to 9/01/2000 24,500,000
Total Repurchase Agreements (Cost--$24,500,000) 24,500,000
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
<TABLE>
SCHEDULE OF INVESTMENTS (concluded)
<CAPTION>
Nominal Value Strike Notification
Covered by Options Issue Price Date Value
Options Purchased--0.0%
<S> <C> <C> <C> <C> <C>
Call Options 25,826,059 Government National Mortgage Association,
Purchased 30-Year, 6.75% Adjustable Rate Mortgage(5)(6) 100 9/20/2011(5) $ 20,661
Total Options Purchased (Cost--$0) 20,661
Total Investments (Cost--$1,387,981,069)--99.8% 1,346,630,163
Options Written--0.0%
Put Options 25,826,059 Government National Mortgage Association,
Written 30-Year, 6.75% Adjustable Rate Mortgage(5)(6) 100 9/20/2011(5) (25,826)
Total Options Written (Premiums Received--$0) (25,826)
Total Investments, Net of Options Written (Cost--$1,387,981,069)--99.8% 1,346,604,337
Other Assets Less Liabilities--0.2% 2,265,156
--------------
Net Assets--100.0% $1,348,869,493
==============
(1)Represents the interest only portion of a mortgage-backed
obligation.
(2)Represents balloon mortgages that amortize on a 25-year or
30-year schedule and have 10-year original maturities.
(3)Federal Housing Administration/Veterans' Administration Mortgages
packaged by the Federal National Mortgage Association.
(4)Represents a balloon mortgage that amortizes on a 22-year
schedule and has a 22-year original maturity.
(5)Represents European style options which can be exercised only on
the notification date. These options, when combined, represent a
standby purchase commitment whereby the Trust is obligated to
purchase the outstanding principal amount of specific GNMA, 30-year,
6.75% Adjustable Rate Mortgage pools as of September 20, 2011. For
this commitment, the Trust receives a net .12% per annum based on
the nominal value covered by the options.
(6)Adjustable Rate Security. The interest rate resets annually at
the 1-year Constant Maturing Treasury rate plus 1.5%, subject to a
1% annual adjustment cap and an 11% life cap.
(7)Represents balloon mortgages that amortize on a 30-year schedule
and have 7-year original maturities.
(8)Represents a mortgage that amortizes on a 15-year schedule and
has a 15-year original maturity.
++Underlying multi-family loans have prepayment protection by means
of lockout periods and/or yield maintenance premiums.
*Mortgage-Backed Obligations are subject to principal paydowns as a
result of prepayments or refinancings of the underlying mortgage
instruments. As a result, the average life may be substantially less
than the original maturity.
**Real Estate Mortgage Investment Conduits (REMICs).
***Repurchase Agreements are fully collateralized by US Government
Agency Obligations.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of August 31, 2000
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$1,387,981,069) $ 1,346,609,502
Options purchased, at value (cost--$0) 20,661
Cash 166,790
Receivables:
Interest $ 7,949,955
Beneficial interest sold 1,717,067
Principal paydowns 209,672 9,876,694
---------------
Prepaid registration fees and other assets 128,509
---------------
Total assets 1,356,802,156
---------------
Liabilities: Options written, at value (premiums received--$0) 25,826
Payables:
Beneficial interest redeemed 3,612,642
Dividends to shareholders 2,025,029
Investment adviser 441,892
Distributor 434,874 6,514,437
---------------
Accrued expenses and other liabilities 1,392,400
---------------
Total liabilities 7,932,663
---------------
Net Assets: Net assets $ 1,348,869,493
===============
Net Assets Class A Shares of beneficial interest, $.10 par value, unlimited
Consist of: number of shares authorized $ 2,034,973
Class B Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 4,299,984
Class C Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 324,159
Class D Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 7,631,873
Paid-in capital in excess of par 1,581,739,061
Accumulated realized capital losses on investments--net (205,783,825)
Unrealized depreciation on investments--net (41,376,732)
---------------
Net assets $ 1,348,869,493
===============
Net Asset Value: Class A--Based on net assets of $192,118,720 and 20,349,725
shares of beneficial interest outstanding $ 9.44
===============
Class B--Based on net assets of $405,846,708 and 42,999,844
shares of beneficial interest outstanding $ 9.44
===============
Class C--Based on net assets of $30,593,278 and 3,241,592
shares of beneficial interest outstanding $ 9.44
===============
Class D--Based on net assets of $720,310,787 and 76,318,734
shares of beneficial interest outstanding $ 9.44
===============
See Notes to Financial Statements.
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
FINANCIAL INFORMATION (continued)
<TABLE>
Statement of Operations for the Year Ended August 31, 2000
<S> <S> <C> <C>
Investment Interest and discount earned $ 102,736,261
Income: Other 217,143
---------------
Total income 102,953,404
---------------
Expenses: Investment advisory fees $ 6,976,712
Account maintenance and distribution fees--Class B 3,631,028
Account maintenance fees--Class D 1,880,067
Transfer agent fees--Class D 1,430,246
Transfer agent fees--Class B 1,011,876
Accounting services 398,927
Transfer agent fees--Class A 370,026
Account maintenance and distribution fees--Class C 304,297
Custodian fees 296,496
Printing and shareholder reports 136,042
Professional fees 131,053
Pricing fees 128,532
Transfer agent fees--Class C 78,674
Trustees' fees and expenses 75,402
Registration fees 71,649
Commitment fees 41,601
Other 42,256
---------------
Total expenses 17,004,884
---------------
Investment income--net 85,948,520
---------------
Realized & Realized loss on investments--net (8,076,919)
Unrealized Gain Change in unrealized appreciation/depreciation on
(Loss) on investments--net 17,073,004
Investments--Net: ---------------
Net Increase in Net Assets Resulting from Operations $ 94,944,605
===============
See Notes to Financial Statements.
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
FINANCIAL INFORMATION (continued)
<TABLE>
Statements of Changes in Net Assets
<CAPTION>
For the Year Ended August 31,
Increase (Decrease) in Net Assets: 2000 1999
<S> <S> <C> <C>
Operations: Investment income--net $ 85,948,520 $ 96,121,800
Realized gain (loss) on investments--net (8,076,919) 212,585
Change in unrealized appreciation/depreciation on
investments--net 17,073,004 (79,217,590)
--------------- ---------------
Net increase in net assets resulting from operations 94,944,605 17,116,795
--------------- ---------------
Dividends to Investment income--net:
Shareholders: Class A (12,162,473) (14,637,036)
Class B (26,575,702) (32,646,717)
Class C (2,070,304) (2,533,956)
Class D (45,140,041) (46,304,091)
--------------- ---------------
Net decrease in net assets resulting from dividends
to shareholders (85,948,520) (96,121,800)
--------------- ---------------
Beneficial Net decrease in net assets derived from beneficial
Interest interest transactions (286,654,061) (108,904,158)
Transactions: --------------- ---------------
Net Assets: Total decrease in net assets (277,657,976) (187,909,163)
Beginning of year 1,626,527,469 1,814,436,632
--------------- ---------------
End of year $ 1,348,869,493 $ 1,626,527,469
=============== ===============
See Notes to Financial Statements.
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
FINANCIAL INFORMATION (continued)
<TABLE>
Financial Highlights
<CAPTION>
Class A
The following per share data and ratios have been derived
from information provided in the financial statements. For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2000 1999 1998 1997 1996++
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 9.37 $ 9.80 $ 9.64 $ 9.40 $ 9.61
Operating ---------- ---------- ---------- ---------- ----------
Performance: Investment income--net .58 .55 .60 .64 .64
Realized and unrealized gain (loss) on
investments--net .07 (.43) .16 .24 (.21)
---------- ---------- ---------- ---------- ----------
Total from investment operations .65 .12 .76 .88 .43
---------- ---------- ---------- ---------- ----------
Less dividends from investment
income--net (.58) (.55) (.60) (.64) (.64)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 9.44 $ 9.37 $ 9.80 $ 9.64 $ 9.40
========== ========== ========== ========== ==========
Total Investment Based on net asset value per share 7.23% 1.24% 8.10% 9.66% 4.55%
Return:* ========== ========== ========== ========== ==========
Ratios to Average Expenses .75% .70% .68% .65% .62%
Net Assets: ========== ========== ========== ========== ==========
Investment income--net 6.23% 5.71% 6.18% 6.73% 6.64%
========== ========== ========== ========== ==========
Supplemental Net assets, end of year (in
Data: thousands) $ 192,119 $ 212,131 $ 277,568 $ 278,103 $ 231,651
========== ========== ========== ========== ==========
Portfolio turnover 37.28% 58.16% 301.88% 349.05% 204.14%
========== ========== ========== ========== ==========
<CAPTION>
Class B
The following per share data and ratios have been derived
from information provided in the financial statements. For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2000 1999 1998 1997 1996++
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 9.36 $ 9.79 $ 9.63 $ 9.40 $ 9.61
Operating ---------- ---------- ---------- ---------- ----------
Performance: Investment income--net .51 .48 .53 .57 .57
Realized and unrealized gain (loss)
on investments--net .08 (.43) .16 .23 (.21)
---------- ---------- ---------- ---------- ----------
Total from investment operations .59 .05 .69 .80 .36
---------- ---------- ---------- ---------- ----------
Less dividends from investment
income--net (.51) (.48) (.53) (.57) (.57)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 9.44 $ 9.36 $ 9.79 $ 9.63 $ 9.40
========== ========== ========== ========== ==========
Total Investment Based on net asset value per share 6.53% .46% 7.28% 8.71% 3.72%
Return:* ========== ========== ========== ========== ==========
Ratios to Average Expenses 1.52% 1.46% 1.45% 1.42% 1.39%
Net Assets: ========== ========== ========== ========== ==========
Investment income--net 5.47% 4.95% 5.42% 5.98% 5.87%
========== ========== ========== ========== ==========
Supplemental Net assets, end of year (in
Data: thousands) $ 405,846 $ 571,969 $ 627,818 $ 672,541 $ 924,885
========== ========== ========== ========== ==========
Portfolio turnover 37.28% 58.16% 301.88% 349.05% 204.14%
========== ========== ========== ========== ==========
++Based on average shares outstanding.
*Total investment returns exclude the effects of sales charges.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
FINANCIAL INFORMATION (concluded)
<TABLE>
Financial Highlights (concluded)
<CAPTION>
Class C
The following per share data and ratios have been derived
from information provided in the financial statements. For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2000 1999 1998 1997 1996++
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 9.36 $ 9.79 $ 9.63 $ 9.40 $ 9.61
Operating ---------- ---------- ---------- ---------- ----------
Performance: Investment income--net .51 .48 .52 .56 .56
Realized and unrealized gain (loss)
on investments--net .08 (.43) .16 .23 (.21)
---------- ---------- ---------- ---------- ----------
Total from investment operations .59 .05 .68 .79 .35
---------- ---------- ---------- ---------- ----------
Less dividends from investment
income--net (.51) (.48) (.52) (.56) (.56)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 9.44 $ 9.36 $ 9.79 $ 9.63 $ 9.40
========== ========== ========== ========== ==========
Total Investment Based on net asset value per share 6.47% .41% 7.23% 8.66% 3.67%
Return:* ========== ========== ========== ========== ==========
Ratios to Average Expenses 1.57% 1.51% 1.51% 1.47% 1.43%
Net Assets: ========== ========== ========== ========== ==========
Investment income--net 5.43% 4.90% 5.35% 5.91% 5.82%
========== ========== ========== ========== ==========
Supplemental Net assets, end of year (in
Data: thousands) $ 30,593 $ 46,614 $ 43,038 $ 28,723 $ 22,672
========== ========== ========== ========== ==========
Portfolio turnover 37.28% 58.16% 301.88% 349.05% 204.14%
========== ========== ========== ========== ==========
<CAPTION>
Class D
The following per share data and ratios have been derived
from information provided in the financial statements. For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 2000 1999 1998 1997 1996++
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 9.36 $ 9.79 $ 9.63 $ 9.40 $ 9.61
Operating ---------- ---------- ---------- ---------- ----------
Performance: Investment income--net .56 .53 .58 .62 .62
Realized and unrealized gain
(loss) on investments--net .08 (.43) .16 .23 (.21)
---------- ---------- ---------- ---------- ----------
Total from investment operations .64 .10 .74 .85 .41
---------- ---------- ---------- ---------- ----------
Less dividends from investment
income--net (.56) (.53) (.58) (.62) (.62)
---------- ---------- ---------- ---------- ----------
Net asset value, end of year $ 9.44 $ 9.36 $ 9.79 $ 9.63 $ 9.40
========== ========== ========== ========== ==========
Total Investment Based on net asset value per share 7.08% .98% 7.84% 9.27% 4.28%
Return:* ========== ========== ========== ========== ==========
Ratios to Average Expenses 1.00% .95% .93% .90% .87%
Net Assets: ========== ========== ========== ========== ==========
Investment income--net 5.99% 5.47% 5.94% 6.49% 6.39%
========== ========== ========== ========== ==========
Supplemental Net assets, end of year (in
Data: thousands) $ 720,311 $ 795,813 $ 866,013 $ 927,756 $ 942,388
========== ========== ========== ========== ==========
Portfolio turnover 37.28% 58.16% 301.88% 349.05% 204.14%
========== ========== ========== ========== ==========
++Based on average shares outstanding.
*Total investment returns exclude the effects of sales charges.
See Notes to Financial Statements.
</TABLE>
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch U.S. Government Mortgage Fund (the "Fund") (formerly
Merrill Lynch Federal Securities Trust) is registered under the
Investment Company Act of 1940 as a diversified, open-end management
investment company. The Fund's financial statements are prepared in
conformity with accounting principles generally accepted in the
United States of America, which may require the use of management
accruals and estimates. The Fund offers four classes of shares under
the Merrill Lynch Select Pricing SM System. Shares of Class A and
Class D are sold with a front-end sales charge. Shares of Class B
and Class C may be subject to a contingent deferred sales charge.
All classes of shares have identical voting, dividend, liquidation
and other rights and the same terms and conditions, except that
Class B, Class C and Class D Shares bear certain expenses related to
the account maintenance of such shares, and Class B and Class C
Shares also bear certain expenses related to the distribution of
such shares. Each class has exclusive voting rights with respect to
matters relating to its account maintenance and distribution
expenditures. The following is a summary of significant accounting
policies followed by the Fund.
(a) Valuation of investments--Securities traded in the over-the-
counter market are valued at the last available bid price in the
over-the-counter market or on the basis of yield equivalents as
obtained from one or more dealers that make markets in the
securities. The Fund employs Merrill Lynch Securities Pricing
Service ("MLSPS"), an affiliate of Fund Asset Management, L.P.
("FAM"), to provide mortgage-backed securities prices for the Fund.
Options written or purchased are valued at the last sale price in
the case of exchange-traded options. In the case of options traded
in the over-the-counter market, valuation is the last asked price
(options written) or the last bid price (options purchased).
Financial futures contracts and options thereon, which are traded on
exchanges, are valued at their last sale price as of the close of
such exchanges. Securities with a remaining maturity of sixty days
or less are valued on an amortized cost basis, which approximates
market value. Securities and assets for which market quotations are
not readily available are valued at fair value as determined in good
faith by or under the direction of the Trustees of the Fund.
(b) Repurchase agreements--The Fund invests in US Government
securities pursuant to repurchase agreements. Under such agreements,
the counterparty agrees to repurchase the security at a mutually
agreed upon time and price. The Fund takes possession of the
underlying securities, marks to market such securities and, if
necessary, receives additional securities daily to ensure that the
contract is fully collateralized. If the counterparty defaults and
the fair value of the collateral declines, liquidation of the
collateral by the Fund may be delayed or limited.
(c) Derivative financial instruments--The Fund may engage in various
portfolio investment strategies to increase or decrease the level of
risk to which the Fund is exposed more quickly and efficiently than
transactions in other types of instruments. Losses may arise due to
changes in the value of the contract or if the counterparty does not
perform under the contract.
* Futures contracts--The Fund may purchase or sell financial futures
contracts. Upon entering into a contract, the Fund deposits and
maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the
contract, the Fund agrees to receive from or pay to the broker an
amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time is was closed.
* Options--The Fund is authorized to write and purchase call and put
options. When the Fund writes an option, an amount equal to the
premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option
written. When a security is purchased or sold through an exercise of
an option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premiums paid or received).
Written and purchased options are non-income producing investments.
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
(d) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Dividend income is recorded on the ex-
dividend dates. Interest income (including amortization of discount)
and extended delivery fees are recognized on the accrual basis.
Realized gains and losses on security transactions are determined on
the identified cost basis.
(f) Prepaid registration fees--Prepaid registration fees are charged
to expense as the related shares are issued.
(g) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates.
(h) Dollar rolls--The Fund sells mortgage-backed securities for
delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type, coupon and maturity)
securities on a specific future date. As of August 31, 2000, no
dollar rolls were in effect.
2. Investment Advisory Agreement and
Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM.
The general partner of FAM is Princeton Services, Inc. ("PSI"), an
indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner. The Fund has also entered into
a Distribution Agreement and Distribution Plans with FAM
Distributors, Inc. ("FAMD" or the "Distributor"), which is a wholly-
owned subsidiary of Merrill Lynch Group, Inc.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee based upon the average daily
value of the Fund's net assets at the following rate:
Portion of Average Daily Value of Net Assets: Rate
Not exceeding $500 million .500%
In excess of $500 million but not
exceeding $1 billion .475%
In excess of $1 billion but not
exceeding $1.5 billion .450%
In excess of $1.5 billion but not
exceeding $2 billion .425%
In excess of $2 billion but not
exceeding $2.5 billion .400%
In excess of $2.5 billion but not
exceeding $3.5 billion .375%
In excess of $3.5 billion but not
exceeding $5 billion .350%
In excess of $5 billion but not
exceeding $6.5 billion .325%
Exceeding $6.5 billion .300%
Pursuant to the Distribution Plans adopted by the Fund in accordance
with Rule 12b-1 under the Investment Company Act of 1940, the Fund
pays the Distributor ongoing account maintenance and distribution
fees. The fees are accrued daily and paid monthly at annual rates
based upon the average daily net assets of the shares as follows:
Account Distribution
Maintenance Fee Fee
Class B .25% .50%
Class C .25% .55%
Class D .25% --
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML &
Co., also provides account maintenance and distribution services to
the Fund. The ongoing account maintenance fee compensates the
Distributor and MLPF&S for providing account maintenance services to
Class B, Class C and Class D shareholders. The ongoing distribution
fee compensates the Distributor and MLPF&S for providing shareholder
and distribution-related services to Class B and Class C
shareholders.
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
NOTES TO FINANCIAL STATEMENTS (concluded)
For the year ended August 31, 2000, FAMD earned underwriting
discounts and direct commissions and MLPF&S earned dealer
concessions on sales of the Fund's Class A and Class D Shares as
follows:
FAMD MLPF&S
Class A $ 80 $ 975
Class D $6,634 $50,162
For the year ended August 31, 2000, MLPF&S received contingent
deferred sales charges of $980,687 and $21,747 relating to
transactions in Class B and Class C Shares, respectively.
During the year ended August 31, 2000, the Fund paid MLSPS $12,432
for security price quotations to compute the net asset value of the
Fund.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of
ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, PSI, FAMD, FDS, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended August 31, 2000 were $544,112,578 and
$860,790,173, respectively.
Net realized losses for the year ended August 31, 2000 and net
unrealized gains (losses) as of August 31, 2000 were as follows:
Unrealized
Realized Gains
Losses (Losses)
Long-term investments $ (8,076,706) $(41,371,567)
Short-term investments (213) --
Options purchased -- 20,661
Options written -- (25,826)
------------ ------------
Total $ (8,076,919) $(41,376,732)
============ ============
As of August 31, 2000, net unrealized depreciation for Federal
income tax purposes aggregated $44,305,803, of which $2,995,400
related to appreciated securities and $47,301,203 related to
depreciated securities. The aggregate cost of investments, including
options, at August 31, 2000 for Federal income tax purposes was
$1,390,910,140.
Transactions in put options written for the year ended August 31,
2000 were as follows:
Nominal Value
Covered by Premiums
Put Options Written Options Received
Outstanding put options
written, beginning of year 33,750,521 $ --
Options expired (7,924,462) --
------------ ----------
Outstanding put options
written, end of year 25,826,059 $ --
============ ==========
4. Shares of Beneficial Interest:
Net decrease in net assets derived from beneficial interest
transactions was $286,654,061 and $108,904,158 for the years ended
August 31, 2000 and August 31, 1999, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended August 31, 2000 Shares Amount
Shares sold 8,590,023 $ 80,009,133
Shares issued to share-
holders in reinvestment
of dividends 135,971 1,268,220
------------- -------------
Total issued 8,725,994 81,277,353
Shares redeemed (11,027,002) (102,751,609)
------------- -------------
Net decrease (2,301,008) $ (21,474,256)
============= =============
Class A Shares for the Year Dollar
Ended August 31, 1999 Shares Amount
Shares sold 12,813,289 $ 124,580,867
Shares issued to share-
holders in reinvestment of
dividends 166,732 1,617,633
------------- -------------
Total issued 12,980,021 126,198,500
Shares redeemed (18,663,271) (181,013,495)
------------- -------------
Net decrease (5,683,250) $ (54,814,995)
============= =============
Class B Shares for the Year Dollar
Ended August 31, 2000 Shares Amount
Shares sold 8,212,152 $ 76,667,166
Shares issued to share-
holders in reinvestment of
dividends 1,533,575 14,294,974
------------- -------------
Total issued 9,745,727 90,962,140
Automatic conversion of
shares (2,434,813) (22,718,458)
Shares redeemed (25,398,785) (236,675,449)
------------- -------------
Net decrease (18,087,871) $(168,431,767)
============= =============
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
Class B Shares for the Year Dollar
Ended August 31, 1999 Shares Amount
Shares sold 27,185,080 $ 265,154,843
Shares issued to share-
holders in reinvestment of
dividends 1,975,204 19,124,825
------------- -------------
Total issued 29,160,284 284,279,668
Automatic conversion of
shares (2,637,770) (25,588,976)
Shares redeemed (29,540,384) (285,824,416)
------------- -------------
Net decrease (3,017,870) $ (27,133,724)
============= =============
Class C Shares for the Year Dollar
Ended August 31, 2000 Shares Amount
Shares sold 940,033 $ 8,790,180
Shares issued to share-
holders in reinvestment of
dividends 144,606 1,348,178
------------- -------------
Total issued 1,084,639 10,138,358
Shares redeemed (2,822,028) (26,280,345)
------------- -------------
Net decrease (1,737,389) $ (16,141,987)
============= =============
Class C Shares for the Year Dollar
Ended August 31, 1999 Shares Amount
Shares sold 4,011,973 $ 39,152,041
Shares issued to share-
holders in reinvestment of
dividends 188,808 1,826,208
------------- -------------
Total issued 4,200,781 40,978,249
Shares redeemed (3,616,701) (35,058,808)
------------- -------------
Net increase 584,080 $ 5,919,441
============= =============
Class D Shares for the Year Dollar
Ended August 31, 2000 Shares Amount
Shares sold 12,254,428 $ 114,481,013
Automatic conversion of
shares 2,434,813 22,718,458
Shares issued to share-
holders in reinvestment of
dividends 2,068,822 19,279,824
------------- -------------
Total issued 16,758,063 156,479,295
Shares redeemed (25,435,386) (237,085,346)
------------- -------------
Net decrease (8,677,323) $ (80,606,051)
============= =============
Class D Shares for the Year Dollar
Ended August 31, 1999 Shares Amount
Shares sold 12,696,069 $ 123,050,803
Automatic conversion of
shares 2,637,770 25,588,976
Shares issued to share-
holders in reinvestment of
dividends 2,234,700 21,633,063
------------- -------------
Total issued 17,568,539 170,272,842
Shares redeemed (21,002,540) (203,147,722)
------------- -------------
Net decrease (3,434,001) $ (32,874,880)
============= =============
5. Short-Term Borrowings:
On December 3, 1999, the Fund, along with certain other funds
managed by FAM and its affiliates, entered into a one-year,
unsecured $1,000,000,000 credit agreement with Bank of America and
other lenders. The funds may borrow money for temporary or emergency
purposes to meet shareholder redemptions. Each fund may borrow up to
the maximum amount allowable under the fund's current prospectus and
statement of additional information, subject to various other legal,
regulatory or contractual limits. The funds collectively pay a
commitment fee of .09% per annum on the available portion of the
facility. Amounts borrowed under the facility bear interest at the
Federal Funds rate plus .50%. The Fund did not borrow from the
facility during the year ended August 31, 2000.
6. Capital Loss Carryforward:
At August 31, 2000, the Fund had a net capital loss carryforward of
approximately $197,138,000, of which $175,708,000 expires in 2003,
$16,733,000 expires in 2004 and $4,697,000 expires in 2008. This
amount will be available to offset like amounts of any future
taxable gains.
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Merrill Lynch U.S. Government Mortgage Fund:
We have audited the accompanying statement of assets and
liabilities, including the schedule of investments, of Merrill Lynch
U.S. Government Mortgage Fund as of August 31, 2000, the related
statements of operations for the year then ended, and changes in net
assets for each of the years in the two-year period then ended, and
the financial highlights for each of the years in the five-year
period then ended. These financial statements and the financial
highlights are the responsibility of the Trust's management. Our
responsibility is to express an opinion on these financial
statements and the financial highlights based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included
confirmation of securities owned at August 31, 2000 by
correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights
present fairly, in all material respects, the financial position of
Merrill Lynch U.S. Government Mortgage Fund as of August 31, 2000,
the results of its operations, the changes in its net assets, and
the financial highlights for the respective stated periods in
conformity with accounting principles generally accepted in the
United States of America.
Deloitte & Touche LLP
Princeton, New Jersey
October 10, 2000
Merrill Lynch U.S. Government Mortgage Fund
August 31, 2000
OFFICERS AND TRUSTEES
Terry K. Glenn, President and Trustee
Joe Grills, Trustee
Walter Mintz, Trustee
Robert S. Salomon Jr., Trustee
Melvin R. Seiden, Trustee
Stephen B. Swensrud, Trustee
Arthur Zeikel, Trustee
Gregory Mark Maunz, Senior Vice President
Joseph T. Monagle Jr., Senior Vice President
Jeffrey B. Hewson, Vice President
Donald C. Burke, Vice President and Treasurer
Ira P. Shapiro, Secretary
Custodian
The Bank of New York
90 Washington Street, 12th Floor
New York, NY 10286
Transfer Agent
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
